A number of major economies sit dangerously close to recession. Whilst this would cause significant harm, the structure of the contract logistics market means it may have some protection if the worst were to happen.
The ‘inverted yield curve’ has become a popular talking point in recent weeks. The phenomenon is a warning sign that has previously been useful in predicting recessions. It appears now that the US is waking up to the possibility that a recession could be just over the horizon.
The story is similar across numerous developed economies. With its manufacturing sector in a slump as a result of slowing external demand, Germany’s economy is in contractionary territory. Brexit uncertainty has led a slowdown in the UK market, which could only be exacerbated if a no-deal scenario comes to pass. This would also have widespread effects across the rest of Europe, which is showing very limp growth at present too.
Why should those in the transport and logistics sector care about economics so much? Simply, because there is a close link between economic growth and contract logistics growth. The rationale is simple – higher economic output is associated with higher consumption and production, which stimulates greater demand for distribution and warehousing services. It follows then that a recession will severely weaken volumes for contract logistics providers.
But the contract logistics market has structural benefits which don’t exactly immunise it, but do act to soften the blow when the economy is suffering. During downturns, profitability tends to hold up better than in many other logistics sectors. Open-book/cost-plus contracts mean that higher costs incurred can be passed on to clients. This means margins are maintained, although lower activity levels of course mean lower revenues and therefore lower overall profits. Revenues tend to be more cyclical than profitability, but some degree of protection may be afforded by agreed minimum volume levels.
In addition, the length of contracts immunises the sector to a certain extent from short-term shocks. Average contracts tend to be three to five years in length. This provides a continuous revenue stream for contract logistics providers.
Asset-light business models have an advantage over asset-heavy models during recessions. These offer a degree of flexibility over operational assets that asset-heavy providers struggle to match. As shippers put LSPs under pressure to reduce rates, they do not have the weight of a high fixed cost base to contend with.
In addition, the advantages of outsourcing play a role in manufacturers’ and retailers’ decision making. Outsourcing provides companies with the benefit of moving logistics assets off their books and allows them to focus on core competencies. It means they can contract logistics providers that offer sophisticated IT solutions to provide efficiencies in their network. The ability of providers to foster a good relationship with shippers and to provide efficient solutions stands them in good stead at any time in an economic cycle, where deeper relationships and integration over time raise a shipper’s barriers to exit.
A recession would certainly damage the contract logistics market as a whole. Total revenues and profits are likely to fall. However, the blows to the market are generally softened by the very characteristics that define parts of the market. Those with asset-light operations running mostly open-book contracts are more protected.
Source: Transport Intelligence, August 22, 2019
Author: Andy Ralls
