Freight transportation is often viewed as the tactical element—the physical, practical side—of supply chain management. It may not get much attention from top executives, yet the movement of goods is critical to the efficiency of global supply chains. Moreover, the transportation function is as sophisticated as any other area of operations management in terms of the technology and level of expertise required to manage it. In addition, because transportation touches all aspects of a company's operations, the data contained within that realm can be exceptionally valuable.
For these reasons, companies should track trends and innovations in the movement of goods and analyze their potential effects on their business. This is especially important right now. In the next few years, several transportation developments will have a profound impact on supply chains and how companies bring their products to market. Some of those changes involve fuel sources and physical infrastructure. But the biggest impact on how companies operate their supply chains is likely to come from advances in software.
The vital link
Transportation is the vital link in the physical flow of virtually all supply chains. It is the only function that truly touches all aspects of the company, from the point of sourcing to the point of consumption. It spans the entire organization, and as part of the supply chain management function serves as the bridge connecting an enterprise to both its vendors and its customers.
A well-designed and well-managed transportation network cannot just connect trading partners, however. It must also serve as a "shock absorber" for the enterprise—adjusting and adapting to any changes in market demand, input prices, regulations, and so forth.
Indeed, one of the primary objectives of a transportation network is to enable a company to operate its core business smoothly. This can be achieved through a combination of flexibility and robustness. Having dual contracts across modes for the same lanes, for example, is becoming more commonplace, as it allows a shipper to seamlessly shift modes as fuel prices rise or fall. Similarly, having multiple routing options in place allows for rapid adjustments in response to unexpected natural disasters, changes in regulations, and similar events. This is especially important in global transportation networks, where the probability that external factors will change is higher than in purely domestic networks.
Transportation networks, then, are most commonly designed to minimize the need for changes in the larger supply chain design.
However, this logic also applies in reverse. Changes in transportation (be it in the conveyance technology, the infrastructure, the guidance system, or elsewhere) can greatly influence where firms source, manufacture, and distribute. There are many examples from history of this phenomenon; in fact, it can be argued that the history of transportation innovations parallels the history of mankind.
For example, when the Erie Canal opened in New York state in 1825, it was only 325 miles long. Yet, by connecting the cities of Albany and Buffalo, the waterway effectively linked the "breadbasket" of the Midwest to the U.S. East Coast and Europe. The cost of shipping a ton of flour from Buffalo to New York City dropped from US $120 to $6, and transit time was reduced from three weeks to just six days! This is why shipment volume on the canal jumped ten-fold within a decade and New York City became the major urban center that it is today.
Technological innovations in transportation aren't the only changes that can shape supply chains and the markets they serve; changes in government regulation also can deeply influence them. For example, the Motor Carrier Act of 1980, which essentially deregulated the trucking market, dramatically changed the underlying economics of truck transportation in the United States. The resulting increase in competition among motor carriers not only reduced the price of transportation by more than 40 percent within a decade, but it also (and more importantly) transformed the structure of the U.S. trucking market. Prior to 1980, most trucking companies were hauling both less-than-truckload (LTL) and full truckload (TL) shipments. The law's removal of the artificial regulatory constraints bifurcated the trucking market into clearly defined LTL and TL industries. This, in turn, changed how shippers use the different modes, and thus how they design their supply chains.
Developments to watch
Many transportation innovations are now emerging or are being introduced. Which are likely to have a long-term impact on supply chains? It is not easy to predict, as unforeseen and unintended change can arise from a simple and seemingly unrelated innovation. For example, very few people anticipated the long-term effects on international trade, offshore sourcing, and the global economy that eventually resulted from Malcolm McLean's shipment of 58 aluminum containers from Newark, New Jersey, to Houston, Texas, in April 1956.
At the moment, when so much is changing so quickly, it is hard to differentiate between transportation developments that will have a lasting impact and those that are unlikely to be meaningful over the long term. But at the risk of being wrong, I will highlight just a few transportation trends or innovations I believe are worth thinking about, along with some of their potential impacts.
Low-cost and abundant natural gas. Over the last 20 years or so, diesel and natural gas prices in the United States generally have risen and fallen in rough correlation. That changed in the summer of 2009. Since then, diesel prices have continually climbed while natural gas prices have plummeted to points not seen since 1994. In the spring of 2012, for example, while the price of Number 2 diesel was almost four times higher than it was in 1994, the price of natural gas was actually below its 1994 levels. The reason: Technological improvements in horizontal hydraulic fracturing have enabled the economical capture of large quantities of domestic natural gas, which greatly increased supply.
This dramatic drop in the cost of a primary input is rippling through the transportation industry. The Texas Department of Transportation recently announced that it is switching its truck fleet to compressed natural gas (CNG). The waste hauler Waste Management reported that 80 percent of its new truck purchases would run on natural gas. The telecommunications giant AT&T has switched 1,200 vehicles in its fleet of cargo vans to run on CNG. This is likely to be just the beginning of the trend, and I expect that many more truck fleets will convert from diesel and gasoline to natural gas. Initially, fleets that travel locally will convert, and as the delivery and distribution infrastructure network for natural gas expands and becomes more accessible, longer-haul fleets will adopt CNG.
There has been a lot of interest in and discussion of natural gas as a fuel for commercial vehicles. But although the use of lower-cost natural gas to fuel truck fleets will have a tremendous impact on vehicle manufacturers and fleet operators, I do not believe it will lead to fundamental or transformational changes to supply chains in the United States. The net effect will be lower variable input costs for trucking companies—albeit with a higher capital investment (at least initially, until economies of scale in manufacturing these expensive engines are achieved). This could lead to some shifting away from intermodal movements as the price differential between road and rail diminishes, but it will not, in my opinion, cause dramatic changes overall in supply chains.
Panama Canal expansion. Approved in a national referendum in October 2006, the expansion of the Panama Canal was designed to double the canal's cargo throughput by 2014. The expansion actually is an integrated series of exceptionally large and complex construction projects that include the construction of new locks as well as the widening, deepening, and (in some cases) excavating of numerous access and navigation channels. Recently, however, construction complications have delayed the project, and the completion date has been pushed into the spring of 2015.
The extent to which the Panama Canal expansion will influence shipping patterns and logistics remains the subject of continual debate. Allowing larger ships through the canal potentially could lead shippers to dramatically increase the amount of goods they route through U.S. East and Gulf Coast ports. One reason is that East Coast ports are close to the largest U.S. population centers, so inland transportation from those ports to many end markets would be faster and cheaper than delivery by rail via West Coast ports. Additionally, all-water shipment means there would be less handling of the freight, which could reduce product damage. However, the real deciding factor in how shippers will choose to route their freight may be the prices set by the canal authority and the corresponding rate changes implemented by the primary railroads that handle the eastbound intermodal moves in the United States.
I believe the overall effect of the Panama Canal expansion will be muted. The main exceptions to this will be in bulk shipping of commodities. The wider canal will be able to accommodate larger bulk vessels than it could in the past, providing a faster and cheaper route between certain countries. This, in turn, could open up new markets for some bulk commodities. For example, the expanded canal will open Chinese markets to coal from Colombia and iron ore from Brazil, as well as open European markets to Chilean copper.
The "break-even" line separating cost and time efficiencies for shipping via East Coast versus West Coast ports might shift westward a little, but not all the way to the coast. Competition between the East Coast ports for any new shipment volume that shifts to the region will continue—but it is unclear which port (if any) will capture the lion's share of that new business. Ever since the 2002 West Coast port lockouts, importers and exporters have favored using a portfolio of ports rather than threading all of their business through a single gateway. This suggests that there may be no single "winner" on the Gulf and East coasts. Instead, a set of ports that can handle the larger ships likely will attract the additional cargo volumes.
China-to-Europe railways. China now accounts for one-fifth of all manufacturing in the world, but it is facing severe labor- and congestion-related cost challenges. One of the primary reasons for rising costs is that most of the manufacturing facilities in China are located in the economically developed coastal provinces. While this makes it easier to link to ocean shipping services, it has led to much higher labor costs. The Chinese government is well aware of this problem, and since 2000 it has been advocating a "Go West" policy that is designed to shift more manufacturing to China's vast western hinterlands. This program has been exceptionally successful: The western provinces have seen average economic growth in excess of 10 percent per year over the last decade. However, the cost for inland transportation from these more remote areas to the traditional ports along China's eastern coast is very high, and the transit times are very long.
One possible solution to this problem is the re-introduction of the old Silk Road connecting Europe to China. Two rail routes, a northern one through Russia and Belarus and a southern one through Kazakhstan and Ukraine, now connect western China to Europe in about half the time it takes to ship by water. While the average transit time (about 20 days) is about half that for shipping by ocean, the cost is about double that for a standard container—but it is still much lower than the cost of shipping by air.
Manufacturers such as Hewlett-Packard, Foxconn, and Acer are all using this new rail route to ship finished product to Europe. More interesting, however, is that some companies in Europe are using the same route to ship parts and components to China for manufacturing and assembly. For example, BMW, Audi, and Volkswagen all are shipping auto parts manufactured in Europe via rail to China.
There still are drawbacks to the new rail route, including having two different rail-gauge systems that require time-consuming and costly switching at various borders. However, these disruptions are being minimized through better switching technology as well as more standardized regulations. As these conditions improve, freight volumes will increase, the frequency and level of service will improve, and shipping costs should continue to drop. This is as critical to western China as the Erie Canal was to the Midwestern United States in the 1800s.
Software improvements. The three trends or innovations previously discussed are typical of those seen in transportation over the years: input cost reductions and infrastructure improvements. But the last one I want to mention is quite different, and perhaps unexpected: software improvements that are specific to transportation management systems (TMS). I believe that this is the most important innovation to occur within transportation in the last several decades, and that it has the greatest potential long-term impact on how companies use and view transportation.
There have been four major advances in TMS over the last few years that are starting to bear fruit in practice:
The whole burgeoning field of "robust optimization" is changing this, however. The idea is to develop a robust, "living" plan using stochastic optimization (which considers randomness in the input variables), and then tie this to a real-time operational system that can dynamically replan as the state of the environment changes. For example, if a natural disaster occurs that closes a port in a particular region, a good replanning system would suggest an alternative routing that would minimize any disruption or increased cost. The airline industry is leading the way in this area, as the delays and disruptions that occur in most passenger air networks require carriers to constantly revise their plans as they try to catch up to the pre-established plan. But other modes and industries are starting to develop robust planning techniques that are less fragile than traditional plans and have room for the operations side to adjust to unforeseen changes.
The road ahead
Transportation will continue to play its primary role as a "bridge" and "shock absorber" for businesses and supply chains. But, as we have seen, the transportation function can have a much broader impact on how companies manage their businesses. Technological innovations that reduce variable costs (natural gas pricing), as well as infrastructure changes (Panama Canal expansion and railroads connecting China and Europe) could change how some companies organize and manage their supply chains. In addition, improvements in software within transportation management systems are expected to lead not only to greater efficiencies in the physical flow of goods, but also to the uncovering of additional insights from transportation data.
Taken together, these four developments demonstrate how transportation continues to be a hotbed of innovation. That innovation encompasses not only the more traditional infrastructure-network improvements and advances in locomotion technology, but also (and more importantly) the transformation of transportation from simply a physical activity to a source of new data. The software improvements discussed above are enabling companies not only to mine more insights and value from their transportation data but also to better control their global freight operations. One could make the argument that the information contained within the traditional transportation-transaction data is almost as valuable as the product being moved—if it is adequately mined and analyzed. But that could be the subject of another (longer) article.