Freight costs increase the price of Cheerios, but the future may provide other options

 (Photo: By Seanutbutter at the English language Wikipedia, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=1880625

(Photo: By Seanutbutter at the English language Wikipedia, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=1880625

Historically, freight costs have been an after-thought by most CEOs of non-transportation companies. They treated shipping as a utility function and not something core to the business operations. Industry executive Jett McCandless reminded us at a JP Morgan investment conference that Homer Simpson was relegated to the shipping department after he blew up the nuclear plant. If pop culture can poke fun at shipping and transportation, you can expect that CEOs of Fortune 500 companies wouldn’t pay much attention to their shipping and transportation departments or costs.

But that is changing. In recent quarters, CEOs have been forced to address margin compression in their earnings calls and forecasts due to transportation inflation. In a supply-driven retail environment, what was on the shelves was driven by top-down decision-making and planning. In the world brought to us by Jeff Bezos, the script has been flipped and we live in a demand-driven world. Not having inventory available for consumer purchases at the time of request is inexcusable and down-right reckless.

The most recent example of this development was General Mills CEO Jeff Harmening. On Wednesday morning, he came out and delivered disappointing news to the street that General Mills was facing margin compression due to higher transportation costs and exposure to spot rates. Readers of FreightWaves would not be surprised by this, as we have been talking about a day of wrecking for North American shippers that have not been managing their spot-market exposure for months.

”Our full year outlook has been impacted by an increase in supply chain costs in a dynamic cost environment," Harmening said. "We called out increased freight costs at our update at CAGNY, but the cost pressure we're seeing is even higher than we'd thought at the time.“

He mentioned rising spot market exposure as one of the reasons for missing internal forecasts. In recent years, shippers have been attacking costs in their transportation budgets by moving demand into the spot market and playing route guide whack-a-mole with carriers. For shippers that didn’t develop contingency plans in their route guide and were forced to pay the going spot rate market, recent inflation in the freight market has cost them dearly.

No company is immune to an unpredictable market. There are periods of stability and managed growth that give a false sense of confidence. The freight market has proven to be no different. According to DAT, the average national rate per mile has increased from $1.79 in August 2017 to $2.24 in January 2018. That is a 25% increase in five months when rates are typically declining.  

Even more telling is that food staples companies have historically enjoyed more stable routing guides than the cyclical consumer and industrial goods business. This should enable General Mills to have more consistent access to capacity. Apparently, even they faced rapid inflation and market disruptions. Had General Mills enjoyed access to a futures market to hedge their transportation costs, much like they hedge corn and wheat futures, the spot market impact to margins would have been mitigated. Unfortunately, trucking freight futures will not be available until late 2018 when DAT index-linked futures start trading on the Nodal Exchange.

General Mills has the highest concentration of plants in the Midwest. As a result, it would have had a great deal of freight moving out of the Chicago market. In September the spot market rate from Chicago to Dallas saw a dramatic increase, going to $2.34 per mile from $1.93, a roughly 20% increase in one month. Those costs could have been hedged, which would have made their investors happier down the road. 

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