Third-Party Sector Faces Profit Margin Pressure

By Rip Watson, Senior Reporter

This story appears in the April 5 print edition of Transport Topics.

Brokers are facing a number of critical new challenges as the economy recovers and government intervention threatens the business environment, industry experts said.

On the economic front, brokers are reporting profit margin pressure as freight capacity tightens in an improving economy. Meanwhile, the industry’s structure is changing as some third parties leverage their size and technology to compete with brokerages run by asset-owning carriers.

At the same time, brokers of all sizes are coping with tougher federal safety standards and cost pressures such as health-care expenses. Those issues fill the agenda as leaders gather in Tucson, Ariz., this week for the Transportation Intermediaries Association’s annual meeting.

“The third-party logistics industry faces the same ongoing economic and government-related challenges that all other industries do,” Robert Voltmann, president of TIA, told Transport Topics. “The industry also faces its own emerging issues.”

Those issues are what he called “the development of a significant number of very large providers in what is otherwise a fractured industry of family-owned businesses” and growing tension between asset-based companies’ brokerages and non-asset-based providers.

“Hopefully, where we go from here is that the economy will tick up, and the increase will be steady rather than meteoric,” Voltmann said. “Economic growth will help in the long run, and higher freight volumes will offset margin compression.”

That margin compression has hit C.H. Robinson Worldwide Inc., Eden Prairie, Minn., the largest transportation broker, with more than $7.6 billion in annual revenue. The company acknowledged the margin squeeze, without giving details.

Other sources suggested that industrywide profit margins have slipped two to three percentage points.

“Like Robinson and others, we have seen a little bit of margin compression,” said Andy Cole, CEO of Total Transportation Services LLC, Frisco, Texas. He noted that factors such as fuel price swings also will affect cash pressure, especially on smaller carriers.

“For brokers, it is all about cash,” BB&T Capital Markets analyst Thom Albrecht told Transport Topics. “Cash flow from shippers has been stretched out, carriers want to be paid faster with quick pay programs and there are bad debt claims brokers have to deal with.”

“One of our biggest concerns has been cash flow,” said Tim Barton, president of Freightquote.com, Lenexa, Kan., an Internet freight site. “It’s like there is a gentleman’s agreement in the trucking industry to pay late. For a lot of the smaller shippers, we charge their credit cards so we have positive cash flow.”

Albrecht said a popular choice during the recession has been “quick pay” programs, which boost broker margins by reducing payments to carriers by 2% or 3% and help truckers with immediate payment.

Use of “quick pay” more than tripled in the past four years, Albrecht said. Speakers at a February investor conference said up to 60% of carriers wanted it.

But not all carriers like quick pay.

“It’s like getting a payday loan,” Thomas Kretsinger Jr., president of American Central Transport Inc., Liberty, Mo., told TT. “Carriers don’t have enough margin to give back 2 or 3% of their revenue. You only do that if you are strapped for cash, and that approach degrades your profits even further.”

Broker cash flow also is under pressure as shippers seek to preserve rate reductions gained during the recession.

Instead of paying more, shippers will try to offer other enticements, such as paying bills faster, Cole said.

Smart customers are careful not to squeeze too hard, executives said.

“Good customers want to keep brokers in business,” said Jeff Silver, CEO of Coyote Logistics LLC, Lake Forest, Ill. “They want you to be profitable. There is an eye toward keeping us healthy because they need us.”

“The larger and more astute customers are trying to take advantage of the supply-and-demand situation,” said Leo Suggs, chief executive officer of Greatwide Logistics Services, Dallas. “They don’t expect you to lose money over the long term.”

“For a while, brokers will absorb carrier price increases, but over time, shippers will have to raise prices in order to get trucks,” said Richard Mikes, managing director of Transport Capital Partners.

Pressure on smaller brokers will mount because carriers want to deal with just a few brokers, Mikes added.

“Brokerage is becoming more of a case of the haves and have nots,” Cole said. “A real divide has been created. The haves are the ones with gross revenue of $100 million and beyond. They have the wherewithal to get bigger in terms of technology.”

“It’s hard for a small guy starting out to get carriers to work with,” said Silver, although entry into brokerage is easy because a $10,000 bond is the biggest cost.

Brokers should participate in large and small markets alike, Vip Sandhir, senior vice president of Echo Global Logistics, told TT.

“In the spot market, it is really driven by relationships,” he said. “What we are seeking is a truck for a load that day.”

Echo uses proprietary optimization programs to match loads with its 22,000-carrier base. The company pursues larger accounts by recruiting carriers to handle that business on a regular basis and putting operational experts at the customer’s site.

Barton said brokers of any size need to differentiate themselves from rivals.

“Our niche has been small- and medium-sized shippers who wouldn’t get the same technological choices and buying power somewhere else,” he said. “If you just call around and say ‘I am a broker, give me some loads,’ that probably won’t work. You have to have a purpose.”

For Coyote, produce shipments are a key market that requires specific skills, Silver said, such as hour-to-hour adjustments of demand driven by crop size, temperature and tight delivery schedules.

Smaller brokers who tend to wait for the phone to ring with new business opportunities will find themselves more limited to smaller carriers, Voltmann said.

Some smaller brokers aren’t waiting for calls.

“We’ve got very hungry sales reps,” said Greg Harris, founder of Backhaul Direct, which intends to raise its revenue 50% to $30 million this year.

“We didn’t lay anyone off,” he said. “Other smaller companies have let people go. We’ve kept calling and knocking on doors.”

As the freight business improves, Harris said, “customers are opening the door and we are starting to see the fruits of our labors.”

In addition to the size gap, the industry is being divided between asset-based fleets that do brokerage and non-asset operators.

Albrecht said most asset-based carriers are “overflow” brokers that use other fleets for their freight that doesn’t fit operational or profitability needs.

“There are big differences between the two models,” Albrecht said, because asset-based companies’ “overflow” units typically don’t have a large sales force or the specialized technology that larger third parties use.

Albrecht predicted that “overflow” brokers will have difficulty growing much larger because of those gaps.

J.B. Hunt Transport Services Inc., one of the 10 largest U.S. freight companies, evolved from the “overflow” model to a stand-alone approach that focuses on what’s best for the customer.

“There is more than one lane to profitability,” said Shelley Simpson, president of Hunt’s brokerage unit, called Integrated Capacity Services.

“In brokerage, it is much simpler to understand pricing to make a return on that one load to get it moving,” she said, compared with a complex truckload network.

Voltmann said the asset-based carriers that reduce their margins on brokered overflow business are making a mistake.

“Everyone has to understand their own business to make their own money,” he said, hastening to add that both types of brokerage can be “great” when run as separate profit centers.

While brokers grapple with market and competitive issues, the regulatory environment is changing.

“The biggest government issue that growing and small businesses alike have to deal with is regulatory and financial uncertainty,” Voltmann said.

He highlighted the Federal Motor Carrier Safety Administration’s Comprehensive Safety Analysis 2010 program.

That program, which begins this summer, will assign safety scores to drivers and carriers, using a wider range of violations.

Brokers are concerned about fleets whose marginal safety performance could raise risks for brokers and disqualify them from being used by shippers.

Another key issue, Voltmann said, was the health-care reform process that could increase costs.

Still another unresolved issue is the question of how inheritance taxes and capital gains will change.

“There is a big penalty to sell a business to children” if current federal rules that run out at the end of the year are not extended, Voltmann said.

Independent contractors’ status also is in play, he said since the Obama administration announced a crackdown on companies that fail to classify workers as employees.

On the plus side, Voltmann said interest in cap-and-trade emission programs seems to have subsided for now.