Transportation companies must adapt to higher capital costs

Amid elevated interest rates and a prolonged slump characterized by declining freight rates and overcapacity, the transportation industry is showing signs of a gradual recovery. However, significant structural changes are reshaping the operational landscape and the financial strategies of transportation companies.

In 2021, as the economic and supply chain shocks of the COVID-19 pandemic eased, a boom in the freight market brought many new entrants attracted by high freight rates and rising demand. Aided further by the financial support from the federal government’s Paycheck Protection Program, the freight market reached overcapacity in early 2022, when freight volumes declined, the ripple effects of the pandemic wore off and monetary policy shifted.

Through excess capacity leaving the market, coupled with expected easing in financial conditions, the sector is likely to experience a more favorable environment over the next 12 to 18 months as supply and demand come into a better balance. However, companies will also navigate a challenge they haven’t seen in two decades: higher capital costs. 

In the capital-intensive transportation space, companies have long relied on rock-bottom interest rates to maintain profitability. Over the past two years, falling freight rates and rising costs have further squeezed margins and required companies to adjust financial and operational targets. 

While the Federal Reserve’s recent projections indicate a reduction in the federal funds rate to around 3.4% by the end of 2025 and to a long-term neutral rate of 2.9% by the middle of 2026, elevated capital costs are here to stay, representing a structural shift after two decades of a zero interest rate policy. According to public company filings, the weighted average cost of capital has increased approximately 32% over the past four years for transportation companies included in the Russell 3000 Index with annual revenues up to $10 billion.

With recent clarity on the path of monetary policy, now is the time for transportation companies to reassess their capital allocation and operational strategies to seize profitable opportunities and maintain an edge in the highly competitive sector.

Transportation companies may want to revisit and adjust three key areas of business strategy in a higher cost-of-capital environment:

1. Asset purchase strategy

Having a well-defined asset purchase strategy is crucial for optimizing investments and maximizing cost and operational efficiency. With higher capital costs, companies must reassess the ideal fleet mix of new, used and leased trucks to meet business objectives and profitability targets.

Recent public company filings indicate that gains on equipment sales fell to a 15-year low in the first quarter of 2024, highlighting weakness in the truck aftermarket. While purchasing aftermarket fleet assets often results in significant upfront cost savings, companies need to evaluate whether these savings outweigh the benefits that come with newer assets such as improved fuel efficiency, safety features and overall performance. Leasing is another option; although it typically comes at a premium, leasing offers flexibility and can free up capital for higher-return investments such as technology.

2. Pricing strategy

Understanding total cost per mile has become increasingly crucial for developing effective pricing strategies. Not all miles are profitable miles, especially in a higher cost-of-capital environment, and companies need to ensure customer contracts are appropriately priced for profit. This involves a thorough analysis of all costs associated with each mile, including fuel, maintenance, labor and capital expenses.

Companies should leverage real-time data to make informed decisions about accepting or declining loads in the spot market. By using advanced analytics for real-time visibility into operational costs, companies can quickly assess whether a particular load will be profitable. This data-driven approach allows for more strategic decision making, ensuring that every mile driven contributes positively to a company’s bottom line.

3. Technology strategy

Investing in technology can significantly enhance companies’ asset purchase and pricing strategies and boost return on investment. For instance, fleet management systems are becoming increasingly common and offer numerous benefits, including cost reduction, enhanced safety, route optimization, reduced downtime and improved customer service. By optimizing routes and improving load matching to minimize empty miles—which industry standards estimate to be around 30% of total miles driven—companies can substantially lower their total costs per mile.

Additionally, preventive maintenance software that leverages machine learning and data analytics can predict maintenance needs based on historical data and real-time monitoring, potentially extending the lifespan of fleet assets. Sensors can monitor various metrics such as tire pressure, brake condition and engine health, providing continuous feedback that allows for timely maintenance and ultimately reducing costs.

Labor considerations

Alongside those three strategies, labor costs remain an important consideration. Truck drivers earned 10% more during 2023 than in the previous two years, even in a weak freight market, according to the American Trucking Associations’ latest Driver Compensation Study results. Rising wages are likely related to the truck driver shortage, which the ATA estimates was about 60,000 drivers last year.

Rising driver wages are likely to continue due to an aging workforce, difficulties in attracting new drivers and the growth of e-commerce. With driver turnover rates typically exceeding 90%, companies will need to determine how their asset purchase strategy aligns with driver recruitment and retention goals. While sign-on bonuses typically improve recruitment, newer fleet assets can improve retention.

Additionally, investments in technology can offer opportunities for saving on labor costs. Reducing empty miles and out-of-service time for fleet assets can lower the overall number of drivers and routes needed.

The takeaway

With structural shifts in interest rates, transportation companies must reassess their operational and financial strategies to ensure profitable growth. Reviewing asset purchase, pricing, and technology strategies and how they interact is crucial to creating a comprehensive business plan tailored to today’s transportation landscape. Developing data-driven models to assist in capital allocation will enable companies to make informed decisions with confidence.