Economic Comeback? Fits & Starts
Sluggish economic recovery and rising costs mean another challenging year for truckers.
PATRICIA SMITH
SENIOR EDITOR
Labor Day brought some devastating news for trucking: Consolidated Freightways was out of business. The 73-year-old carrier -- long one of the country's "Big Three" less-than-truckload operations -- was filing petitions for Chapter 11 bankruptcy and would liquidate all but its CF AirFreight and Canadian Freightways subsidiaries. It wasn't a total surprise. CF has been running in the red for almost two years and was more than $300 million in debt. But it was a jolt to anyone looking for some light at the end of a fog-filled economic tunnel.
After a heartening upturn in July, productivity and manufacturing growth had again turned sluggish. Businesses had never really warmed to the upturn and consumer confidence appeared to be lagging. The stock market took another big dive.
The media hinted at a slide back into recession, but most economists calmly advised against panic. "The economy doesn't generally move in a straight line in either direction," noted Ken Kremar, DRI-WEFA. "It moves in starts and fits."
"It takes more than a few months to set a trend," explained HDT economist Jim Haughey. "If you look at the fundamentals, interest rates have never been lower, the dollar is falling, which means more exports, economies overseas are expanding. With only a few exceptions, we're going in the right direction."
According to the U.S. Department of Labor, productivity rose 1.5% in the second quarter, slightly more than most analysts expected but well below the 8.6% growth rate in first quarter. Data released in early September by the Institute for Supply Management (formerly the National Association of Purchasing Management) showed manufacturing growth every month since January. However, backlogs declined in July and August, and supplier deliveries slowed. ISM said comments from purchasing and supply executives reflected soft demand and very competitive markets. The major culprit: lack of confidence among businesses and, possibly, consumers.
Consumer spending has been the economy's lifeblood since we began to sink into recession and July figures showed a healthy 1% rise -- the largest in nine months. Summer surveys indicating that consumer confidence was waning were worrisome, but not cause for alarm, said Haughey. "Consumer opinions are always a couple of months out of date with reality," he explained. The downtrend probably reflected consumer reaction to slackness in the economy reported a couple of months earlier and lingering fallout from corporate accounting scandals. Moreover, he noted, much of the election year rhetoric has focused on economic woes, which may affect consumer attitudes.
The economy's weak point is business investment, said DRI-WEFA's Kremar. Business failures over the last couple of years have made banks a little more cautious about lending money for expansion and made companies a little more cautious about extending credit to each other. And, as the ISM September report noted, even executives who acknowledged that their business is improving weren't confident enough to forecast continued improvements in the months ahead.
It's no surprise then that the general mood among economists is guarded, but optimistic. "I'm not a double dipper," said the American Trucking Assn.'s Chief Economist Bob Costello. "I don't think there's going to be another recession, but I do think that growth is sluggish."
"I see 2002 as the transitional year when we're sort of building the groundwork for better days ahead," said Kremar. "Certain things are carrying others, but by next year we should be hitting on all cylinders."
FREIGHT: INCHING UPWARD
Freight volume growth was well behind economic growth in the early part of the year, mainly because manufacturers had to work off excess supplies before they could start moving production lines and freight.
"During the second half of 2001 businesses were bloated with inventories," noted Costello. "That's when trucking was really getting hit hard." Since then business have sold off most of the overstock and, starting last spring, there was word that warehouses were running out of product. That meant a pick-up in manufacturing and, with it, trucking. Nevertheless, he warned, "I think you're looking at very sluggish growth. Once the inventory corrections are made, freight volumes will slow down."
Eight of 20 industries in the ISM's August Index reported manufacturing growth: printing and publishing, leather, transportation and equipment, apparel, chemicals, food, industrial/commercial equipment and computers and paper. Orders declined slightly after eight consecutive months of growth. The rate of inventory liquidation by manufacturers slowed. All but the food industry said customer inventories were either just right or too low.
Orders for exports have been growing some since the first part of 2002. Haughey expects exports to be strong next year due to a weaker dollar plus economic recovery of U.S. trading partners -- including our two biggest, Canada and Mexico. That should help boost manufacturing and, ultimately, demand for freight in and out of factories.
Auto sales continue to be a bright spot, thanks mainly to rebates and zero-interest loans. "The automakers know how to sell," Haughey said. Incentives will come and go as needed but should keep production lines moving, and that weak dollar could mean more exports from U.S. assembly plants.
Truckers hauling agricultural products are probably facing a flat market. The U.S. Department of Agriculture expects some increase in farm cash receipts this year, but most of the gain will come from higher prices, not increased production.
The construction industry should continue to enjoy a robust residential segment. Kremar said the market for new houses has probably peaked, but will remain strong. Low interest rates on mortgages and home equity loans have also spurred home remodeling, which boosts the demand for appliances and furnishings as well as building materials.
Non-residential construction is still very weak and not expected to recover until businesses start expanding and investing. The truck intensive heavy construction market is volatile, but seems to be doing OK, Haughey said. Lower tax revenues will reduce spending on roads and other government funded projects but the full impact won't be felt until next summer or possibly 2004. "They could be struggling while everyone else is going strong," he noted.
Freight Rates: Less Pressure
Rates will always be competitive but carriers continue to insist that the days of selling on price alone really are over. As Schneider National's new president and CEO Chris Lofgren recently told HDT, shippers "are starting to realize that this is not a rate game."
High profile closures like Consolidated Freightways are grim reminders of trucking's tight margins. As Lofgren noted, most shippers recognize that trucking's major costs -- namely fuel, insurance and drivers -- aren't going to go down anytime soon. Consequently, they can't squeeze rates if they want to maintain trucking capacity. Instead, said Lofgren, customers are looking to carriers for help with distribution networks and freight flows, seeking the best overall cost structure instead of the lowest rates.
"We're trying to find mutual ways to be successful," said Dennie Carey, senior vice president of marketing for FedEx Freight. Over the last few years they've seen significant growth in next-day and second-day regional LTL coverage, driven by the quest for lower inventories and faster cycle times.
FedEx Freight, he said, can provide next-day service up to 900 miles. "Imagine the impact that could have for customers in terms of improving their competitive position. They're able to get the product to their customers sooner than anyone else."
Rates for both truckload and LTL freight did go up some this spring, which Haughey attributed to less discounting, a slightly stronger freight market, and some small boosts from fuel price adjustments. He expects the upward trend to continue through through 2003, although carriers may still have to struggle some to stay ahead of higher costs.
Nevertheless, rate changes aren't uniform, he cautioned. "Stronger carriers that have invested in quicker, more reliable service are holding rates better than marginal carriers that are discounting to survive."
Insurance: Still Going Up
Earlier this year Smithway Motor Xpress took a couple of bold steps. Despite slow freight demand in two of its key markets -- construction materials and Midwest steel -- the Ft. Dodge, Iowa-based carrier started turning away business. And despite trucks that were parked for lack of drivers, the company tightened its hiring requirements and stopped taking on trainees.
"We're trying to put safety first, even if we have trucks sitting," said Donald Orr, executive vice president and COO.
There's no overnight miracle in this story. In fact, Smithway posted a $1.2 million loss in second quarter versus a $384,000 profit a year ago. But weekly revenue per seated tractor was up 1.3%. They still had trucks waiting for drivers, but their service and turnover have improved. And after a huge hike in 2001, their insurance premiums actually went down with this year's renewal. That may put Smithway among an elite few.
Despite statistics that indicate continued safety improvements, trucking companies over the last couple of years have seen rate increases ranging from 15% to 50% or, in many cases, much more. Some of the biggest hikes came with liability and umbrella coverage after Sept. 11. The terrorists attacks hurt, but most insurance experts still point to a long run of price competition, followed by high losses and an insurance exodus from trucking.
"From the late 1980s to 1998 there was an abundance of commercial auto providers in the marketplace and rates steadily declined for 10-12 years in a row," explained David Love, executive vice president and national director of transportation for San Antonio-based Vista Insurance Partners. "In late 1998 we began to see a gradual firming of the market. Commercial auto providers began exiting the marketplace or increasing rates. Since early 1999 the number of commercial auto providers has continued to decrease and rates have continued to climb. Obviously, fewer companies writing truck insurance means fewer choices and higher rates."
The rise and fall of financial markets also played a part. In the mid-to-late 1990s, when things were cooking, insurance companies could subsidize low premiums with investment earnings. "Now the only way to make money is from premium dollars and, hopefully, by controlling claims," said Shawn Sullivan, president of Truck Writers Inc., Minneapolis.
A third culprit in rising insurance costs is escalating liability claims. An ATA survey of 1,000 trucking companies puts the average increase for 2001 renewals at 32% for general liability (37% after Sept. 11) and 74% for umbrella insurance (120% after Sept. 11). Costello admitted that most people went into the study ready to blame greedy insurance companies. Once they dug deeper, they stopped thinking that way.
"Rates are going up because insurance costs are going up," he said. "Even though the trucking industry continues to get safer and safer, the cost per claim continues to rise. You would expect some increases in terms of general inflation, but this goes well beyond that. It involves some factors that don't have much to do with economics, and more to do with the legal system."
Trucking is a favorite target in the U.S. tort liability system, which seems to be badly in need of repair (see accompanying story). More lawsuits and higher awards add up to higher insurance costs. Since insurance is really protection against possible claims, everybody's rates must go up. Said Sullivan: "Even if you have a pretty good loss record, the insurance company has to set aside money to pay for that possible big judgment."
Most insurance brokers and agents are expecting premiums to level off next year, with most increases in the mid teens to low 20s. Those who took the biggest hits in 2001 and 2002 may see only minimal rate hikes -- if their safety record is good.
"I believe you will see underwriting discipline continue for the foreseeable future," Love said. "(Insurance) companies are allocating capacity to the programs that they are convinced will produce profitable underwriting returns."
That means closer scrutiny of safety programs, including everything from driver screening to maintenance. Fleet managers need to pay special attention to safety performance data made available through the U.S. Department of Transportation's Safer and SafeStat systems. These very public report cards, showing accident and out-of-service histories, have become key tools for insurance companies.
"A high vehicle or driver out-of-service ratio is a red flag for underwriters," he said. "The SafeStat system allows underwriters to drill down and identify the variables driving the ratios. There are some acceptable circumstances for a ratio that is higher than average. However, some of the results on SafeStat cannot be explained away. There are times when the results indicate the company is hiring drivers who are unsafe and/or they are not maintaining their equipment. Underwriters are not interested in writing a trucking risk that is not complying with DOT regulations. It's hard to debate that logic."
New CDL rules that expand the list of disqualifying offenses and close some loopholes at the state level are welcomed by an insurance industry that has become meticulous about driving records. The new regulations mean that the government "will do a lot of the due diligence for the insurance companies," noted Sullivan.
Beyond painstaking safety programs, the best way for carriers to hold down insurance premiums is to assume more of the risk. "Before, people would look for minimal deductibles," he said. "Now you're looking at a $1,000 deductible for a small company or owner-operator where they once wanted $250 or $500." For medium to larger fleets, deductibles can be anywhere from $10,000 to $100,000.
The choice depends on what the company can afford and what management is willing to risk, noted Sullivan. In order to determine the "right" dollar amount, he recommends that companies and their insurance agents pull loss history for the past five years, then compare premium discounts they would have received at various deductibles with out-of-pocket costs for claims not covered by insurance.
Another way to save may be through self-insured or captive programs. Truck Writers is a third-party administrator for such groups and Sullivan said they do see cost savings and even better claims handling -- but only for the safest companies. "You want companies that are sound financially, but you also want management with a safety mentality," he said, "because the loss of one affects the whole group."
Driver Pay: Better Benefits
Few economists expect near-term improvement in overall unemployment because job growth won't be rapid enough to absorb new workers. "It takes about 120,000 new jobs a month to keep the unemployment rate steady," Haughey explained. "We haven't seen that for a long time and it could be well into next year before we see it again."
That should mean more people looking for trucking jobs, but don't expect the good ones to come cheap.
The National Master Freight Agreement expires next March, which means the Teamsters and the major LTL carriers will square off over pay and benefits for some 160,000 drivers.
Tim Lynch, president and CEO of Motor Freight Carriers Assn., a trade association that represents most union carriers, told HDT in late August that preliminary talks with the union were already underway but neither side was ready to discuss details.
"I don't think there's any question that we are in a very competitive marketplace and we want to do things that will allow the companies to grow their businesses. I think that, by and large, the union understands that," he said. "The theme of the negotiations for us is security of jobs, security of the companies, and opportunities to be flexible going into the future in a very competitive marketplace."
Judging from chat on the Internet, the top priorities for union members are "decent" wage increases and protection of health care benefits.
The latter may bring some interesting discussions since recent studies show that most employers are facing another year of double-digit increases for health insurance premiums. Small companies are likely to get hit even harder since they have little bargaining power. To save money, companies are asking employees to pick up more of the costs, either by paying part of the premium or through higher deductibles and co-pays.
The National Survey of Driver Wages, a quarterly study of truckload carrier pay packages, is recording two significant trends: pay is going up and insurance co-payments are going down.
When freight began to slow and the driver shortage began to ease, truckload carriers began making cuts in mileage pay for newly hired drivers, said Gordon Klemp, president and CEO. But the latest survey showed some increases in second quarter of this year, for both new and experienced drivers.
Insurance co-pays began rising in 2001, but that trend is also reversing. "It's reflective of the recruiting climate," he noted. "It's easier to recruit drivers if you have lower co-pays."
Driver pay for freight handling is going up, even among carriers that aren't adjusting per-mile pay. And while complex bonus programs have all but disappeared, Klemp said they're starting to see more cash incentives for safety and productivity.
Sign-up bonuses in the $1,000 to $2,000 range tend to be effective for recruiting owner-operators "if the rest of your package is right," he said. Carriers are also picking up more permit, licensing, and other costs for owner-operators.
Tight credit, especially for first-time buyers, may be part of the reason so many carriers now offer lease/purchase plans for their owner-operators, but Klemp said the programs also say something about owner-operator supply and demand.
"Right now lease/purchase programs are pretty attractive, which indicates to us that owner-operators are undersupplied," he said. "There are a lot of drivers out there who would love to own their own trucks and companies are making it very affordable. But they'll be reluctant to buy until other drivers start reporting that they're making money."
One fear is that the industry isn't bringing along enough new drivers to satisfy future demands. Klemp said the number of carriers that will take on a student driver, or one right out of driving school, has fallen dramatically in the last five years -- mainly because of insurance. With little hope that insurance premiums will decrease in the foreseeable future, the bidding for experienced drivers may continue to go up.
Fuel: It's Up To Bush
Fair or not, many oil industry analysts are blaming the fate of fuel prices on the politics of President Bush. The wild card: U.S. war with Iraq. As Haughey said, "Iraq is not a big supplier, but they have a lot of friends who are big suppliers. Even if they didn't do something overt, they could put pressure on prices." Judging from increases this summer, just "beating the war drums" can have an effect.
The administration has also been criticized for continuing to buy oil for the Strategic Petroleum Reserve, and for rejecting suggestions to release some of the reserve in order to help stabilize prices. In early September the Oil Price Information Service warned of a possibly supply crunch in the Midwest as farmers went into the plowing season. Nationally, however, supplies are reportedly at safe enough levels to get us through all but the most frigid winter.
That brings us back the Middle East and OPEC which, said Haughey, has been "on its best behavior" since Sept. 11 because of widespread suspicion that its members support terrorists. But upward price pressure is building with worldwide economic recovery so OPEC could decide to tighten supplies. "Not enough to make us mad, but enough to make them some money," he said. His diesel price forecast: up an average half-cent a month through 2003.
Equipment: '02 Questions
Fuel prices are one concern. Fuel economy is another -- and one reason many truck buyers stepped up equipment orders to make sure they got trucks built before the Oct. 1 cut-in for stricter emissions standards.
An ATA study of some 800 carriers concluded that the changeover would pull some 8,000 new trucks from late 2002/early 2003 production to pre-October deliveries. That works out to an average 100 "pull forward" orders per fleet but, as Costello pointed out, it doesn't really work that way. The larger carriers stocked up but the small companies didn't have the capital or financing, he explained. "Small carriers are always going to be hit harder by these things."
Those who didn't, or couldn't, beat the deadline may be looking at an extra $3,000 to $4,000 or more per truck, plus lower fuel economy, higher maintenance costs and more breakdowns. On the other hand, they may be looking at some sweet deals.
Manufacturers say fears regarding the new engines are unfounded, and are backing their claims with special warranty programs. Truck manufacturers have cut post-October production but will also try to smooth the anticipated post-October sales slump with aggressive pricing and other incentives like reduced fee maintenance plans and special deals on certain components.
One bit of good news: the used truck "glut" that plagued the industry last year seems to have disappeared. Fleets say they'll keep current equipment or buy used if the new engines prove to be as troublesome as some fear, which should boost resale values on late model equipment -- for those willing to trade.
Finance
"The aggressive lending practices we've seen over the last few years really have disappeared," said Daryl Cornell, executive vice president and CFO of Team Vehicle Sales, a nationwide used truck chain.
The rash of carrier and owner-operator business failures, the shaky economy and worries about residual values on post-October heavy diesels have scared many lenders away. Those that stayed are limiting their best deals to equipment buyers with "A" credit. Generally, that means no bankruptcies, no history of late payments, a chunk of cash to put down, a nice cushion of cash in the bank, and a proven track record in trucking.
Finance leases are especially tough. "Unless you're going to use captive finance you'd better be investment-grade quality or else go full-service," said Cornell. "Small businesses that want to do some unbundled leasing really have been shut out of the marketplace." Team Vehicle Sales is putting together a finance lease package for small fleets, but only local or regional operations. "We prefer the trucks we can put our hands on, that come home every night," he explained.
Start-ups are going to have the toughest time finding affordable financing, especially if they have little cash to invest. Finance companies are especially wary of new owner-operators. Many now say they'll serve that market through lease/purchase programs backed and administered by established carriers.
One long-time dealer speculated that manufacturer-owned finance companies will offer some very attractive interest rates to help move trucks, but they won't likely let up on credit requirements. "They listened to the sales guys a couple of years ago and got burned," he confided. "I don't think they're going to do that again for a long, long time."
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Outlook 2003
A System Out of Control
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