Reduction in force: Shippers rationalize their universe of 3PL providers

In an effort to avoid high spot market prices, some shippers are bypassing their 3PLs and negotiating directly with truck owners for capacity. Will that come back to haunt them?

By Mark B. Solomon

Like everyone else, truck shippers are sweltering through the dog days of summer. Yet as they formulate their 2016 transportation budgets, their strategies may be influenced by what occurred 20 months ago and in the dead of winter.

During a four-month stretch between December 2013 and early March 2014, heavy snow and ice storms paralyzed highways and kept large volumes of truck capacity off the roads. Desperate shippers turned in droves to freight brokers and third-party logistics service providers (3PLs) to find space pretty much at any cost. That meant a disproportionate reliance on the non-contract or "spot" market, where rates are substantially higher than contracted pricing. Several estimates suggested that 40 percent of all truck activity in the quarter went through the spot market; normally, about 15 to 20 percent of truck movements are handled there.

Intermediaries able to fully flex their carrier networks helped shippers get their goods to market. But it came at a high price: Spot rates for dry van trailer services, the most common type of trailer used, hit an all-time high of $2.08 a mile in March 2014, according to DAT Solutions, a research consultancy. Spot van rates stayed in that elevated range into the summer.

For many logistics and procurement executives, 2014 turned into a year of budget busting, with some shippers spending about twice as much on brokerage services as they would normally do. In most cases, top brass tolerated the cost overruns due to the extraordinary wintertime circumstances. Yet CEOs would not be happy with any repeat performances, and they have put their logistics staffs on notice that steps need to be taken to secure appropriate shipping capacity at reasonable rates.

One step has been for shippers to negotiate for capacity directly with the asset owners, thus bypassing the 3PLs and by definition, reducing their sphere of influence. Thomas S. Albrecht, managing director, transportation equity research at investment firm BB&T Capital Markets, said in a recent interview that of about 100 large shippers he spoke with in the past several months, between one-half and three-fourths have scaled back their broker networks or are looking to do so, and are directly engaging motor carriers to handle more of their freight. Shippers are taking that route because they want to reduce their exposure to volatile spot markets and increase service consistency, which they believe comes with having direct access to asset-based truckers who can provide assured capacity, Albrecht said.

Whether it is due to changes in shippers' strategy or better weather in the first quarter of 2015 that allowed contract capacity to keep rolling, spot market demand has been under pressure virtually all year. Spot loads in June were down 21 percent from June 2014 levels, though they were up 5.7 percent sequentially, according to DAT. June's load-to-truck ratios, which measure the number of loads posted on DAT's load boards for every truck posting, were down year over year by 44 percent for van, 51 percent for refrigerated, and 49 percent for flatbed transport, the consultancy said. Spot rates were down 10 percent for van, and in the high single-digits for the other two equipment types, DAT added.

DRACONIAN CUTS

At some shipper companies, the broker cutbacks are resulting in reductions of just a few providers. Other cuts, however, are more draconian. For example, on March 1, a large beverage shipper completed a revamp of its 3PL/broker network that reduced its provider universe to 25 from 130, according to Albrecht, who declined to identify the company. In addition, a big food shipper that had used as many as 90 brokers has a mandate to shrink the count to 36, according to an executive at the company, who spoke on condition of anonymity and asked that the organization not be identified.

Because their products have seasonal spikes, food and beverage shippers typically use more brokers than shippers in other industries so they can accommodate the potential freight overflows during the busy cycles. The food shipper has so far narrowed its 3PL/broker count to 40, according to the executive. It allocates about 20 percent of its volume and spending to brokers, down from around 29 percent for the past five to 10 years, the executive said. Meanwhile, the shipper is spending more time working directly with carriers, the executive said.

The decision to narrow its broker universe has been in the works for some time, according to the executive. The company has long sought to reduce, if not eliminate, the practice of supporting carrier and broker markups on the same transaction ("margin on a margin," the executive called it). It had also become dissatisfied with geographic overlaps, inconsistent service, and incidents of price gouging that came with having so many brokers. These shortcomings became especially evident during the 2013-14 winter cycle, the executive said.

The executive emphasized that the rationalization of brokers is a long-term strategy that would unlikely be altered even if truck capacity tightens further due to a shortage of equipment and drivers. The company mostly uses regional carriers and therefore, largely relies on brokers with regional capabilities bookended by three or four core nationwide brokers.

Several brokers that were asked to comment for this story either declined to do so or did not respond to requests.

Not everyone is seeing broker rationalization taking place, possibly because many shippers don't work with many providers to start with. "I haven't come across a situation where I've seen a shipper with, say, eight brokers," said Michael P. Regan, founder and chief of relationship development at TranzAct Technologies Inc., a consultancy involved in the 3PL sector. "What I've seen are shippers with one, two, or three brokers." Richard Armstrong, founder and chairman of Armstrong & Associates Inc., a consultancy that closely follows the 3PL segment, said nearly half of large shippers use two to five brokers, while 38 percent use six or more.

Armstrong said shippers aren't consolidating their universe of brokers as much as they are becoming shrewder about whom they use. Big shippers will continue to migrate to a core group of brokers, commonly known today as "domestic transportation managers," that can reliably handle—and optimize—significant volumes, he said. Most of these transactions are handled under contract; spot market transactions are a small part of the total, Armstrong said. These sophisticated providers, which account for a fraction of the 15,500 licensed brokers in the U.S., should see net revenue—gross revenue minus the cost of purchased transportation—increase by 10 percent a year for the foreseeable future, the consultancy said in an industry report published in June.

In addition, not every carrier is experiencing an influx of shipper business that had formerly been handled by brokers. A spokeswoman for Schneider National Inc., a leading truckload carrier and logistics service provider, said Schneider is seeing no evidence of diverted volumes being sent its way.

Albrecht of BB&T said that a shift away from brokers to asset-based carriers might serve shippers well for the balance of 2015 and through next year. However, he expects the pendulum to swing back to the brokers by 2017 as the driver shortage worsens and new government regulations, such as those mandating the use of electronic logging devices in each vehicle, drive up fleet costs, push smaller carriers—which still account for most of the nation's truck operators—out of business, and tighten capacity to unprecedented levels.

At that point, brokers' capacity-procurement capabilities will become more valuable than ever, Albrecht said. Unless carriers can resolve the driver shortage issue, "freight brokers are likely to have another day in the sun" perhaps as early as next year, he said in a mid-June research note.