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December 18, 2017
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"State of Logistics Report" says end of cheap inventory financing will create supply chain challenges

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Inventory carrying costs in 2015 rose 5.1 percent over the year-earlier period, according to the report.

The tailwind of low inventory carrying costs that U.S. businesses have enjoyed in recent years came to an end in 2015, and carrying costs are likely to prove a tougher challenge should the cost of money become dearer, according to the 27th annual "State of Logistics Report." The report was written by the consulting firm A.T. Kearney for the Council of Supply Chain Management Professionals (CSCMP) and is presented by Penske Logistics.

According to the report, released today in Washington, D.C., inventory carrying costs in 2015 rose 5.1 percent over the year-earlier period, paced by a 7.4-percent increase in the inventory's "financial cost." The financial cost was derived by multiplying the value of a company's business inventory by the average cost of capital it has borrowed to finance the inventory.

Storage costs, which were included in the total inventory calculation, rose 2.5 percent year-over-year, according to the report. The cost of what the report classifies as "other" factors, including inventory obsolescence, insurance, and handling, rose 5.1 percent year-over-year.

Following the U.S. Federal Reserve's moves to cut its benchmark federal funds rate (an overnight interbank lending rate) amid the 2007-08 financial crisis and subsequent recession, inventory carrying costs have sat at historic lows. From 2010 to 2014, capital costs grew by just 0.9 percent, compounded annually, the report concluded. By contrast, storage costs rose 4.7 percent a year, compounded annually.

In December, the Fed raised the benchmark rate from between near zero and 0.25 percent to between 0.25 and 0.50 percent, its first increase in nearly 10 years. The central bank said at the time it was considering several rate increases during 2016, but subpar economic growth in the United States and abroad since then has led policymakers to rethink that position.

From 2010 to 2014, a period generally associated with U.S. economic growth, inventories rose 5 percent a year as businesses restocked in the hope of increased demand, and mega-fulfillment centers were erected to accommodate what would become a multiyear surge in e-commerce traffic. Though inventory levels flattened in 2015—rising just 0.25 percent—the cost of capital did not, the report concluded.

Businesses today have costlier inventory loads to finance than at any time in years. In 2009, inventory value stood at $1.93 trillion. At the end of 2015, it stood at $2.51 trillion, according to the report's data.

The nation's inventory-to-sales ratio, which in the retail trade measures the value of inventories relative to final sales, has been climbing steadily for years, resulting in a protracted inventory bloat. Despite concerns over rising inventory levels and higher borrowing costs, the report's authors do not forecast a general recession. Rather, they say the current trends—notably, the dramatic slowdown in inventory growth last year—represent an "inventory correction." They also expect a rebound in freight volumes and revenues as 2016 progresses.

All told, it cost $1.4 trillion to maintain the U.S. business logistics system in 2015. That equated to 7.85 percent of last year's gross domestic product (GDP) of more than $17 trillion. Logistics costs rose 2.6 percent year-over-year, a decline from the 4.6 percent compounded annual growth rate (CAGR) from 2010 to 2014. The gains during that period were mostly fueled by 5.5 percent annualized growth in transport costs, the report said. However, transport costs in 2015 rose just 1.3 percent year-over-year, as declining fuel surcharges triggered by the rapid drop in oil prices depressed carrier revenue.

Logistics costs as a percentage of GDP, historically one of the report's most often-quoted data points, was just six basis points below last year's number, indicating that the system was operating in only a marginally more efficient manner than the year before, according to the report. In the early 1980s, long before the impact of transport deregulation was fully felt, logistics costs accounted for about 15 percent of GDP. The dramatic increase in transportation and logistics efficiency during the last 35 years has been an overlooked factor in the success of the U.S. economy during much of that period.

Transport revenue by mode diverged considerably in 2015, according to the report. Less-than-truckload (LTL) and parcel revenues rose 7 and 8 percent respectively, as both modes benefited from increased demand for e-commerce-related transactions. However, truckload revenue rose just 3 percent, intermodal revenue rose 2 percent, and airfreight and water revenues—which include import, export, and domestic waterborne traffic—increased 2.1 percent. Rail carload revenues, hurt by a sharp decline in coal demand, fell 12 percent, while pipeline revenues, hampered by lower crude oil prices, fell 11.8 percent, according to the report.

The divergence in modal revenue is a harbinger of long-term change, according to the report's authors. A profound change in buying habits has now put American consumers "at the wheel" when it comes to influencing U.S. transport costs, rather than traditional industrial standbys like energy. This change may be permanent, the authors said.

The "State of Logistics Report" was prepared by A.T. Kearney in partnership with CSCMP and other stakeholders. This is Kearney's first attempt at the report, which was launched by the consultant Robert V. Delaney and was continued by his associate, Rosalyn Wilson, after Delaney's death in 2004.

Editor's note: Go here to watch a video of the June 21 "State of Logistics Report" presentation at the National Press Club in Washington, D.C. A video of the panel discussion that followed the report's release is available here.

Mark Solomon is executive editor—news at DC Velocity, a sister publication of CSCMP's Supply Chain Quarterly.

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