Trade Forcast 2009
Time to buy Strategic growth in truckload
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The truckload sector is a mature, fragmented and intensely competitive business in which dozens of carriers fail every year. Yet even in the current harsh environment, certain competitors have demonstrated a superior ability to create shareholder value. What are the secrets to their success?
Clearly, one way to create shareholder value is to expand profit margins. Previously, we wrote about how certain TL competitors achieve above-average profitability through effective customer and market selection that enables them to optimize system-wide pricing, operating costs and fleet requirements (November 2008 American Shipper, pages 56-75).
In this article, we focus on another path to creating shareholder value: accelerating revenue growth. We will look at how successful TL competitors manage to consistently grow faster than the overall industry, and make the case that while TL carriers historically expand organically rather than through acquisition, a window is opening in which acquisitions will become an unusually attractive and increasingly potent strategic tool. Our smartest clients are asking how to prepare to take advantage of this window of opportunity.
Competitors can grow by increasing share of existing market segments and/or expanding into new market segments. For this discussion, the TL market can be meaningfully segmented by service (over-the-road, dedicated, intermodal and brokerage), equipment type (dry van, reefer, flatbed and bulk) and geography (using an elastic definition of 'cities', given that many warehouses and factories lie outside urban areas).
Each segment's relative growth varies over time due to macroeconomic and competitive factors. Secular trends drive sustained, above-average growth in certain segments. For example, TL brokerage has benefited from small carriers' need to outsource marketing to large and specialized brokers with the resources to invest in people, IT and business intelligence to find loads.
Key issues for carriers seeking to grow are related less to broad concepts of strategic scope than to a concrete framework emphasizing market attractiveness, customer behavior and shared cost structure.
Most TL carriers have done best when expanding services offered in existing geographic markets. Ideally, such expansion is based on existing customers, or new customers who offer routes complementary to the existing network structure. Given that cost position and profitability are largely driven by route structure and the ability to utilize trucks at optimal pricing, there is usually little direct benefit to expanding equipment types, even if there are opportunities for cost sharing in areas like maintenance and procurement.
Competitors can also expand into new geographic markets, using the same equipment and service type employed in other markets. This has been the cornerstone of Knight Transportation's value creation strategy, leveraging its operating expertise, systems and customer base to set up new locations. Knight's formula has worked well, with a compounded annual growth rate of 14 percent in earnings per share and 20 percent in share price over the last decade.
Another growth strategy is to expand into new service types, such as freight brokerage, dedicated or intermodal, that complement OTR businesses. Many customers seek dedicated and OTR services from the same carrier. In fact, there's often a fine line between dedicated and OTR when price-elastic dedicated customers negotiate more flexible contract terms that results in a 'quasi-dedicated' operation blended into one-way OTR networks. This enables carriers to more efficiently utilize common equipment.
Freight brokerage has been effectively pursued as an add-on service to OTR and intermodal. In addition to J.B. Hunt, Knight and Con-way Truckload have successfully grown customer revenues in this segment without adding assets. Typically, a TL carrier can use its brokerage capability to source third-party capacity for unattractive routes that it serves to satisfy customers (the 'overflow model'). With excess owner-operator capacity in the market, carriers can reduce their own capital requirements while maintaining customer service and a small margin. For this strategy to be successful, carriers need to move beyond the overflow model and offer a broader array of services including intermodal, less-than-truckload and Web-based transportation management systems in order to penetrate medium-sized shippers preferring an integrated solution.
Among large carriers, J.B. Hunt and Schneider have adopted strategies emphasizing service breadth. Both have sizeable positions in OTR, dedicated and intermodal. Schneider also has a large brokerage business and has acquired port services. By pursuing a full-service strategy instead of an overflow model like other asset-based carriers, J.B. Hunt accelerated its brokerage efforts, increasing that unit's revenue by 37 percent and nearly doubling operating profit in the first six months of 2009. Other TL carriers have emphasized growth initiatives in the relatively fast growing intermodal segment and brokerage (e.g., Swift and Werner). Traditional long-haul carriers such as USXpress have sought to increase their exposure to shorter haul dedicated markets.
We see little evidence that either acquisition or organic driven growth is superior. However, TL acquisitions, though offering relatively few opportunities to rationalize overhead costs (because TL overhead costs are relatively low) have fared better than aquistions in other freight sectors for three reasons:
' Small improvements can go a long way in creating value. Including capital costs, a one percentage point decrease in operating ratio can create a 10 percent increase in value.
' Acquisitions can be made with low premiums. Many TL acquisitions have occurred at close to the market value of the assets acquired. Currently, there are numerous distressed TL carriers, with record bankruptcies and low-priced assets available.
' Making acquisitions now gives the buyer time to integrate and be ready for the significant upturn in TL volumes expected in mid-2010.