Peter Dixon, Equities Economist
- The logistics process represents a microcosm of the forces acting on the 21st century economy.
- It encompasses increasingly complex and global supply chains with all the attendant problems of managing in a multipolar world.
- It is also undergoing a process of rapid change, triggered by the impact of technical progress on the demand and supply sides of the economy.
- But as we have learned over the past 30 years, managing the supply chain is one of the keys to ensuring profitability, and the technical revolution will ensure that this remains the case over the coming years.
From one era of globalisation ….
As economies become more complex so the management of supply chains becomes more difficult. Globalisation has magnified these complexities, although the logistics industry has long experience of coping with the challenges it poses. As long ago as 1919, the economist John Maynard Keynes described the pre-1914 era of globalisation thus: ‘The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he may see fit, and reasonably expect their early delivery upon his doorstep.’ Whilst it was possible to ship quantities of tea and other goods halfway around the world a century ago the problems have since become much more complex, largely because there has been a huge increase in the volume of cross-border transactions. However, there have also been significant technological advances which have allowed suppliers to keep pace with rising demand.
Mass consumption proved to be the catalyst for a supply chain revolution, and one of its originators was Henry Ford, who started out as an assembler of parts produced elsewhere in much the same spirit as the global supply chain operates today. But quality control a century ago was not what it is today, and as demand for cars increased so Ford was forced to take much greater control over his supply chain in order to ensure product standardisation. By 1928 Ford had built the River Rouge Complex in Detroit, which included its own steel mill and power station, and was the world’s largest integrated factory complex.
The process of vertical integration, pioneered by Ford and adopted across a range of industries, was also costly as companies were forced to invest in activities which were outside their core business. By the 1980s the challenge to the dominance of the US auto industry from Japan forced many manufacturers to adopt the just-in-time (JIT) management processes pioneered by Toyota. This system aims to reduce flow times in the production process and had numerous side effects: perhaps the most important is that many links in the production chain were outsourced to third-party suppliers. For example, in the auto industry components are now sourced from many different suppliers which required them to pay more attention to optimal inventory holdings given expected levels of demand. Consequently, inventory-to-sales ratios have fallen sharply since the early-1980s (Chart 1) which has reduced the amount of working capital tied up in stocks of finished goods and raw materials.
…. to another
But the real supply side revolution of the last 20 years has arisen due to a series of unique events, including the deregulation of trade and the liberalisation of foreign investment, which have opened up new production centres around the world. Today, businesses operate on the basis of global supply chains which allow them to source components and assemble products in lower income economies whilst selling in high-income markets. Managing all the moving parts in such a system has increased the challenges for businesses which now have to deal with aspects ranging from production, order processing, inventory management, warehousing and transportation (Chart 2). This is all done in such a way that consumers are unaware of, and indifferent to, these stages of the production process. All they care about is that the goods they require are ready for purchase or delivery when promised.
The theory of global supply chains was best summed up in the work of author Thomas Friedman who argued very strongly that ‘the world is flat’ and that those companies able to take advantage of lower production costs elsewhere would be best placed to benefit from the new wave of globalisation. But this model has not quite matched up to the claims made for it by its proponents. Longer, more complex supply chains are more susceptible to disruption, as the 2010 eruption of the Icelandic volcano Eyjafjallajökull and the Thailand floods of 2011 demonstrated. In the former case, there were significant flight disruptions within Europe, which hampered product deliveries, whilst in the latter case production facilities suffered serious damage.
Another common problem is that many companies simply look at the lower costs offered by foreign locations but fail to account for different levels of risk. For example, inexperience in dealing with local regulatory issues can significantly raise overall business costs. In any case, the advantages of many low-cost locations have been steadily eroded by rising labour costs and, as the events of recent years have shown, political risk has by no means been eliminated. What is particularly striking is that there is a strong positive correlation between income per capita and the World Bank’s Ease of Doing Business indicator (Chart 3). Ideally, we would want the two to be negatively correlated implying that it is easier to operate in low-income locations: the fact they are not indicates that there is a clear trade-off between cost reduction and the efficient management of foreign operations. At issue is when the benefit of lower costs is outweighed by rising operational difficulties. Clearly, many organisations believe they have crossed the threshold, which explains why we have seen moves towards onshoring some of the production and assembly tasks which had previously moved offshore.
Delivery is the key
A key aspect of the logistics process is the apparently simple task of moving goods from one location to another. In many ways this is not particularly cutting edge. Suppliers transport their produce in bulk to distribution depots whereupon it is broken down into smaller loads and delivered to the customer, often via a courier using some conventional form of road transport. What has changed over the last 20 years is the speed with which goods can be delivered and the greater ability to track individual items in the system. Thus, whilst the delivery vans, which roll up at your front door, have not changed hugely in 50 years (the ubiquitous Ford Transit which carries so much of this produce first hit the road in 1965), the process of getting the stuff from the warehouse to your door has changed out of all recognition.
Home shopping is of course not a new phenomenon. The London described by Keynes in 1919 was full of tradespeople able to deliver items from their shop to the front doors of the well-to-do. By the 1970s, catalogue shopping made it possible to order a huge range of goods from the comfort of your own home. This system relied on a network of agents who would take the orders and deliver them to a central provider. Up to a week later the deliveryman (for it was invariably a man) would roll up in his van and deliver the required item to your door. But this was a slow and cumbersome process, with delays depending on the extent to which the order was in stock and the efficiency with which goods navigated the delivery system. Moreover, agents would often wait a few days before submitting orders so that they could deliver a batch rather than process each one individually. This method of shopping gradually began to fall out of favour as retailers such as Walmart built ever larger stores in which it was possible to pick up most, if not all, of the desired items immediately.
But the Internet has generated a swing back towards home shopping, only this time it offers much more immediacy. Amazon began life as an online US bookseller in 1994 and by the end of the 1990s was branching out into other items. By 2015, it had surpassed Walmart as the biggest retailer in the US by market capitalisation (Chart 4). Its success is due to the fact that the Internet has enabled people to see what goods are available, from which retailer and at what price. But the real innovation in online retailing is the sheer range of products on offer and the speed with which they can be delivered. If Amazon itself does not stock a product, the likelihood is that it will be able to find a supplier for you and commonly available items can be offered with same-day delivery. The speed of delivery has been facilitated by computer systems which allow the supplier to track what is in stock, where it is stored and to calculate how quickly it can be delivered to the purchaser.
In effect, this system offers the convenience of 1970s home shopping with the immediacy of visiting a local hypermarket. Yet, despite the dominant position which Amazon has now achieved, technological advances mean that it cannot afford to stand still. New technology means that many of the standard methods of produce management and delivery used today could soon become obsolete.
Future trends in logistics
There are numerous areas where these improvements are likely to impact upon the logistics sector (Chart 5). The rise of robotics and computerised automation has significant implications for the warehousing and distribution branches of the industry. In addition, changes in the channels which consumers use to evaluate, pay for, order and collect their purchases will require retailers and sellers to adjust their distribution channels in order to keep up (omnichannel logistics).
As noted above, the transport arm of the process is still recognisable as the same industry from 40, 50 years ago. But that might be about to change. Although there are major concerns regarding the use of unmanned vehicles for the transportation of people, one of the most obvious potential uses is in the logistics of managing freight delivery. Autonomous vehicles are already used in warehouses although they are designed to stop when they hit an obstacle and will not restart until it is cleared or a driver takes manual control. But the new generation of vehicles is able to steer around obstacles, which will obviously increase their efficiency, and many of them are able to incorporate other processes such as automatic loading and unloading. Proponents of this technology claim that it will make the workplace safer by reducing the interaction between man and machine. What it will certainly do is to displace labour – much of it unskilled – which currently does much of this work.
A more intriguing prospect is the use of autonomous vehicles to deliver from the warehouse to the end consumer. Goods are generally transported from the central warehouse to the distribution centre by heavy truck. It is already feasible to apply highway trucking systems which keep trucks in the right lane, obey speed limits and maintain a safe distance to vehicles in front. At present, these have not been licensed for use on public roads, and when they are they will require the continued presence of a driver. But it may be possible to apply the technology to vehicle convoys in which only the lead vehicle requires a driver whilst those behind are fully automated.
Last-mile delivery is the most challenging part of the process, as it involves complex and changing conditions which are harder to automate given current technology. But even here there are a number of alternative technological possibilities. Increasingly, customers are making use of drop-off points rather than waiting at home for produce to be delivered. Rather than customers travelling to the collection locker at a fixed point in the middle of a town, it is possible to imagine a system of mobile repositories which drive closer to where people live (like old-fashioned mobile shops or libraries). DHL has speculated that we could move to a future of self-driving parcels in which packages are distributed from a vehicle which then autonomously make their way to their final destination. And before we dismiss this as fantasy, a partnership of German firms has already developed a system of self-driving vehicles potentially capable of doing the job. In a similar fashion, we may not be too far away from a time when drone technology can be used to deliver small- and medium-sized parcels from a distribution centre to their final destination.
As the Amazon story has shown, the way in which consumers buy their products has an impact upon the shape of the business itself. Consumers increasingly interface with sellers across a wide variety of different media, all of which differ slightly in terms of price, product information and service levels. Customers increasingly expect many of the same services online that they previously were only able to obtain in-store, such as the ability to return items. But to offer all of these services across all platforms is costly, and with retail growth likely to be driven increasingly by online sales over the coming years (Chart 6), businesses will have to radically restructure their supply chains to ensure that they are able to meet demand across all platforms, and not maintain a single supply chain for each platform.
Like a duck paddling over the water, there is clearly a lot more happening under the surface of the distribution process than many people realise. Whilst it has long been recognised that supply chain efficiency is a key driver of profitability, technical change has revolutionised and accelerated the process. Those firms which are not able to adapt to the new challenges of the 21st century risk falling further behind, and even the new giants of the scene are not immune to these forces. But as Jeff Bezos, founder of Amazon, once said, ‘If we can keep our competitors focused on us while we stay focused on the customer, ultimately we’ll turn out all right.’