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December 16, 2017
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U.S. logistics costs: Are we measuring the right things?

Comment
Inventory carrying costs represent a big chunk of the U.S. logistics costs measured by the annual "State of Logistics Report." Some would argue that carrying costs should be excluded.

When the first "State of Logistics Report" was released back in 1989, its author, the late Robert V. Delaney, established logistics expenditures as a percentage of the overall U.S. economy as the measure of logistics efficiency. He also set 10 percent as the benchmark for logistics success. A ratio below 10 percent of the U.S. gross domestic product (GDP), he said, indicated that logistics managers were doing an effective job of controlling costs and efficiently moving and storing goods. (Today the annual "State of Logistics Report" is authored by economist Rosalyn Wilson. It is sponsored by the Council of Supply Chain Management Professionals and presented by Penske Logistics.)

Delaney put forward that benchmark just a few years after the U.S. government deregulated transportation. His argument was that if deregulation unleashed market forces in the transportation sector, then transportation practices would become more efficient, transportation costs would be reduced, and the ratio of logistics costs to GDP would therefore decline. His prediction was correct: In 1981, before the industry felt the impact of trucking deregulation, logistics as a percentage of GDP stood at 16.2 percent. By 1995, that ratio had dropped to 10.4 percent.

For the next 10 years, the logistics-to-GDP ratio mostly stayed well under 10 percent. In 2005 it saw a substantial jump upward, and by the time the Great Recession hit in late 2007, it had reached 9.9 percent. But in 2009, during the nadir of the Great Recession, the ratio plummeted to 7.9 percent—the lowest level in the history of the report. That drop, by the way, was largely due to a decline in production rather than from any improvements in efficiency. Since then, it's hovered above 8 percent, and for the past two years (2011 and 2012) it's held steady at 8.5 percent.

At this writing, there are signs that the ratio could climb back up, but that uptick will be unrelated to transportation. Instead, it will be due to inventory carrying costs, calculated as the value of inventory multiplied by the commercial paper rate (the rate banks charge their top business customers). This year's report notes that inventory carrying costs would have been higher if not for a drop in the annualized commercial paper rate, from .13 percent in 2011 to .11 percent in 2012.

The paper rate is tied to the actions of the Federal Reserve, which has been holding down interest rates as a way to stimulate—or, as some would argue, sustain—the American economy. Back in June, Federal Reserve Chairman Ben Bernanke indicated that the central bank would stop its bond-purchasing program when the economy picks up. Taking that action will push up the commercial paper rates along with those for home mortgages and credit cards.

If the commercial paper rate rises, so will inventory carrying costs. And if overall inventory levels stay the same or increase as expected, then higher interest rates will surely bring about higher carrying costs.

And that, in my personal opinion, raises a concern. Carrying costs for business inventories constitutes one of three main components of logistics costs in the "State of Logistics Report." (The other two are transportation costs and shippers' administrative costs.) That means carrying costs are a determining factor in the judgment of logistics efficiency. Yet logistics managers have no say or control over interest rates; the Federal Reserve and credit markets influence those charges.

As the old saying goes, you can't manage what you don't control. Since logistics managers can't really manage carrying costs, then perhaps it's time to change the calculation for U.S. logistics costs to include only those elements that are under the sway of practitioners.

Editor's note: When this commentary appeared online, it elicited a number of responses from readers. To read their letters, see "Chain Reactions". If you'd like to share your own thoughts, please send an e-mail to jcooke@supplychainquarterly.com.

James A. Cooke is a supply chain software analyst. He was previously the editor of CSCMP's Supply Chain Quarterly and a staff writer for DC Velocity.

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