Pricing Power

by Jason Rhyno

TORONTO, Ont. — Noel Perry of FTR Associates is holding up four fingers and one thumb. He had asked a room full of Ontario trucking executives, rhetorically, “how many dry van carriers or reefer carriers have the capability to bid – in a big way – on a Walmart tender?”

He was talking about pricing in trucking during the Ontario Trucking Association’s (OTA) Annual General Meeting at their yearly, and very well-attended, economic outlook session. Perry, along with John Larkin, managing director, Stifel Associates; Doug Payne, president and COO, Nulogx Inc.; and Emanuella Enenajor, economist, CIBC World Markets, talked about the economy and what to expect next year. The brunt of the conversation, however, was about the need for not only carriers and shippers to work together, but also for carriers to work with other carriers. They also spoke about, as Perry phrased it, how trucking “is in radical need of a pricing renaissance, in understanding where you have market power.”

The session kicked off with Enenajor giving CIBC’s outlook: think around 1.5% GDP growth, much of that tied to the US. Slow, flat growth, but growth, nonetheless. There’s been a pick-up in US manufacturing, she said, nodding towards re-shoring. But here in Canada? Not so much. In fact, that very same day Heinz announced it was closing it’s 104-year-old Leamington, Ont. plant.

“In terms of what is the outlook, given that Canada is leveraged quite heavily to the US, our leverage to the US has actually been a very good thing recently, from the perspective of exports.”

Canada’s exports to the US have increased throughout the recovery, she noted. “We do see improvements,” she said. “Canada’s going to be piggybacking a little bit on the US in terms of our ability to export to the US. We really need external growth to boost domestic growth and we’re likely going to see that in 2014 as we see US growth accelerate in the coming year.”

Still, don’t expect much from Canada’s manufacturing sector, she said. “It’s likely that manufacturing will be less and less an important part of the Canadian economy and resource extraction will increasingly be an important part – and when I say resource extraction, I mean primarily oil and gas.”

There’s lumber, of course, and other goods tied to housing. But while the US housing market has had a bit of a comeback recently, it’s hit or miss.

“You are seeing some recovery in housing, but it’s not universal,” Larkin said. “There’s a house across the street from us in Baltimore that’s on the market for what we paid for our house…over 20 years ago. It’s a little depressing to think about that, but it goes to show that the entire housing industry hasn’t turned around.”

As for how the trucking industry survives in a slow growth environment, with Federal Motor Carrier Safety Administration (FMCSA) regulations set to shave a few points off productivity and data, according to FTR Intel, showing that capacity is at an all-time high, well, that’s where pricing comes in.

“The pricing culture in our industry, whether it be north or south of the 48th latitude, is based on 50 years of falling costs,” Perry said. “And therefore we didn’t have to learn the art of price increase in this industry. Well, them days is over.”

We need an environment where people know how to bring prices up when necessary, he said.

“The proof is if you look at Heartland and Knight, the publicly traded guys, who have answered this, their operating ratios are what? Ten points lower than the good carriers? And it ain’t because they hire cheaper drivers or buy fuel cheaper than you guys do, it’s because they know how to price with respect to the productivity of the move. I believe that in the US – and there is bound to be a big spillover in Canada – if indeed the FMCSA does what they say they are going to do, there is going to be a major capacity crisis. That capacity crisis may provide the market opportunity where truckers will re-frame the way they price. Right now they are shy, and I think you guys are shy, too. If the market tightens, we’ll get a change in that.

“Price has been near zero for the last year and a half,” he continued. “Most of the publicly traded guys either lost margin in the last quarter or came in below expectations. It’s because they have not been able to take advantage of this market opportunity, despite the fact that this market opportunity has been making their costs higher. So there’s a big issue here. We had it for a short time in ’04, but then the shock of the Great Recession caused everyone to go into the hole again. There is a major need for a complete re-framing for the way that we price in aggregate, and the reason is that instead of costs going down and not having to worry about price, costs are going up. That’s the simple conclusion.”

The trucking industry isn’t really an infinitely open market, he said. “It’s a collection of individual markets, each of which has two to five individual competitors. So it’s a collection of many oligopolies. For instance, take a look at Walmart’s bids. Walmart sends out these spreadsheets that have thousands of lanes in them – I’m sure some of you have competed on that – and they expect their large suppliers to bid on most of those lanes. Well, how many dry van carriers or reefer carriers have the capability to bid in a big way on a Walmart tender?” Five. “And at some point, as the railroads have learned after years of chaos, those five guys are going to figure out how to price in a way where they don’t ruin their margins by market share competition.”

Payne backed Perry. Looking at his company’s Canadian General Freight Index (CGFI) from 2008 to August 2013, pricing has only increased marginally, he said. “And if I look at year ago, we are still three points behind where pricing was a year ago. We are getting the same trends and I do think those opportunities are there for the tide to change.”

The last time the trucking industry saw large-scale success in pricing was after the hours-of-service (HOS) changes in 2004, noted Perry.

“That particular change was distinguished by a large amount of public commentary by the carriers about the cost increase from hours-of-service; it legitimized the price increases. One of the things that’s happening right now is that the carriers…are doing the same thing with respect to the change this time. It’s a month or two late, but if you look at the trade press you’ll see panels with five truckers and each one says the same thing: ‘Hours-of-service is decreasing my productivity by 3-5%, I’m taking prices up’.”

It’s those looming regulations that may be setting the stage for a capacity crisis. “There are 27 agendas now that the US regulatory agencies have and when these shocks hit the system, we get behind in the driver hiring and capacity shortages result,” Perry said.

If the FMCSA does what it says it’s going to do, there will be a major capacity crisis, Perry said plainly.

Land of opportunity

While being aware of the possible fallout from government regulations is important, it’s clearly not where you want to put all your chips. The best game in the house right now is working with shippers to cut costs.

“This is really where the big land of opportunity lies,” Larkin said. “We can’t really rely on longer trailers – rely on wider or taller trailers or longer combination vehicles – we’re not going to have more hours-of-service to work with, everything is pushing in the direction of less productivity. The real field of opportunity is shipper and carrier working together, and in some cases carrier and carrier working together, to turn equipment quickly.”

The industry can’t afford to have equipment tied up at loading docks for four or five hours, he said. “We have to figure out how to do that more efficiently. If it takes opening the loading dock off-hours, maybe we’ll have to try and figure out how to do that and split the benefits of doing so.”

The last couple of years have seen a focus on TMS systems he said, “better costing systems, better network optimization, no wasted available hours-of-service, minimized empty miles. There’s been a tremendous amount of progress in this arena,” he said, progress that has delayed “the mother of all capacity shortages that may not arrive here until more and more regulations are put in place.”

“This really is the land of opportunity and it’s time for shippers to stop beating the carriers over the head on price and start working with their highest quality carriers to find a way to do things more efficiently and to split the benefits between the shipper and the carrier. That’s really, it seems to me, the enlightened way to do things in this environment.”

Perry seconded Larkin. “The smart guys are ahead of the curve and they are enlightened. The dumb guys, those of us that make up 90% of the business,” he said to laughter from the audience, “will get the point when the carriers finally master the business of pricing productivity.”

Here again he pointed to Heartland and Knight. “They are twice as profitable as the rest of us. So as the industry gets better at pricing, the incentives to the customers to do exactly what John said will become far more powerful and it won’t be just the smart guys, people like Cargill who are doing it already – it will be everybody.”

Fuel costs, diversifying and mergers

Here are a few other key areas the OTA’s Economic and Industry Outlook panel touched on:

Driver shortage. Friend or foe?

The difference between the average wage of an American worker and that of your average American trucker is $6,000. Still, said Larkin, he’s guessing that if trucker wages were in line with the national average, that still wouldn’t be enough. “We are aware of some companies — take Heartland Express as an example — that are at the very top of the pay scale. If you do everything that you are supposed to do as a driver, earn a little better pay in the northeast, you can make $60,000 to $65,000 relatively easily.”

Thing is, Heartland struggles to find drivers “and their pay scale is well above the limits. It occurs to me that there is something else going on here; it’s a very difficult job and we’re not making it a whole lot easier. But anything you do to relay freight and get your drivers home and allow them to see their daughter’s ballet recital really does help.”

Larkin said that it remains a big challenge, one that the big carriers are better suited to solve. “Ultimately, they will have what drivers are available working for them and that will put them in a strong position as regulations kick in here to upsize price increases.”

Mergers and acquisitions

It’s picked-up this year, especially in recent months. Heartland bought Gordon Trucking, Celadon purchased Yanke, and Vitran sold off its US LTL so it could focus on its much better performing Canadian LTL operation.

“It is tough to grow organically in this sluggish economy, so companies are relying on acquisitions to grow,” Larkin said. “Often times there is a generational issue where the next generation in line is not capable or willing to do so.”

And, added Perry, “if you were an aggressive trucking entrepreneur in 1980, you are now 70. So the people that built the industry are now retiring.”

Expect more activity on this front.


Are LTL and TL carriers diversifying their operations?

Yes, said Larkin. “The thought is customers are looking for a one-stop solution and the question then becomes, do you integrate those services or run them separately? Is your management team capable of handling all those different operations? Can your systems knit together all these operations?”

It may sound great on paper, but be careful of spreading yourself too thin. “We think it’s rather difficult to be all things to all people and do a good job. It has been our experience that those that are diversify really struggle to optimize all those operations and to get the marketing synergies.”

Fuel surcharges

According to FTR’s Perry, fuel surcharges are not as important as they used to be, but that doesn’t mean you should ditch them.

“First off, no one is talking about the price of fuel going back down to where it used to be, so therefore if your fuel surcharges are pegged at let’s say $2 a gallon, you still need that fuel surcharge to cover the cost unless you want to revolutionize your pricing and do away with it. The second thing, which is obvious, is that fuel prices aren’t changing anymore, at least not very much. So in the short-term, fuel surcharges are not that important. The danger here is we still have the opportunity for shocks, which either raise the price up or surpluses which lower the price and so my advice to is keep the ones you have because there is a chance we can get some variation on this.”

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