Freight Forwarding is perfectly suited for E-Business

These four steps transform YOUR COMPANY into an E-Forwarder:

1. Establish a highly appealing digital customer interface
2. Automate your business processes
3. Apply Advanced Business Analytics
4. Establish a Central Operations Hub (COH)

As outlined in previous articles, freight forwarding is one of the most profitable businesses in the world (see for example: How to succeed in the most profitable industry in the world, By Oliver Gritz, Jeff Ward and Arsenio Martinez, Supply Chain Management Review, April 13, 2019). Long time industry profit leaders like the US based Expeditors and Swiss based Kuehne + Nagel generate returns on capital employed (ROCE) of more than 40%. Due to the shortage of transport capacity in recent years, industry returns have increased to even higher levels.

Still, in terms of business valuation even the profit leading conventional forwarders like Expeditors and Kuehne can not keep up with a group of new market entrants – the so-called Digital Forwarders or E-Forwarders. Prominent examples of this group are the Silicon Valley company Flexport and the German company Forto. While Kuehne and Expeditors trade at values of about 1 to 1.5 times revenue (19 to 22 times net income), their digital competitors are valued at 4 to 5 times their revenue. What are the reasons for this dramatic difference in valuation? After all, both the conventional and the E-Forwarders do the same business, i.e., serve the same customers with similar services. These consist predominantly of arranging international transportation using multiple modes of transport.

The real valuation difference between the profit leading conventional forwarders and the E-Forwarders is even more extreme than the comparison of revenue multiples suggests. As mentioned, Kuehne and Expeditors are profit leaders in their industry generating world class returns on capital. The E-Forwarders on the other hand are currently still loss making. Their entire valuation is based on future expectations. In the future investors expect E-Forwarders to have a significant competitive edge over conventional forwarders. E-Forwarders are expected to dominate the international freight forwarding market. Why? Because investors expect that they will be in the position to offer freight forwarding services of better quality at significantly lower cost.

What are the main reasons for this expectation? Answering this question is the purpose of this article. In addition, this article will provide suggestions for conventional forwarders to compete against the E-Forwarders. We will make the case that it is entirely possible for every forwarding company today to obtain the qualities of E-Forwarders and to achieve similar valuations.

What are the common characteristics of e-businesses in general and why are successful e-businesses so valuable? E-businesses are all types of business models that include sharing information across the internet to facilitate commercial transactions. To the champion’s league of e-businesses belong companies with well known brands that sell, produce, and deliver products or services online at very low or even zero marginal cost and that act in huge and fast-growing markets. Prominent examples in this context are Google, Facebook, and Airbnb. These are all so called platform businesses, i.e., businesses that don’t own any means of production but that create value exclusively through facilitating information exchange between buyers and sellers. They can do this in large volumes because they possess access to large groups of buyers and sellers often in combination with superior technology. This combination of competitive advantages leads to global market domination because information-based products have no natural business expansion barriers. Everyone can access the internet. Selling additional products or services requires neither physical presence nor additional capital. Therefore, successful platform businesses are often called “winner-takes-all businesses”, i.e., businesses that over time will achieve a natural monopoly. These types of businesses are obviously the dream of every investor. Consequently, it is not surprising that the successful platform businesses enjoy valuations of up to 50 times revenue during their start-up phase and up to 30 times revenue once they have achieved a more mature state. They can achieve these valuations even if they are loss making. Investors expect these businesses to become profitable latest once they achieve a dominant market position.

Is freight forwarding an industry that is well suited for e-business? The answer is clearly ‘yes’. Freight forwarders broker freight services between shippers and carriers, do generally not own any means of production and are, therefore, purely an information exchange business by design. But does freight forwarding also have champion’s league e-business potential? These are the three most relevant questions in this context:    

1. Do freight forwarders have access to a large and fast-growing market?
2. Is it possible for freight forwarders to lock in a unique competitive advantage for example through superior technology?
3. Is it possible to achieve very fast business growth at low or even zero marginal costs?

International freight forwarding has a global market size of almost US$ 200 billion. The market is expected to grow in line with world trade by about 5% annually until 2025. What makes this market interesting for new entrants is its high fragmentation. DSV, the largest global freight forwarder, has a global market share of only about 8%. The largest five freight forwarding companies together have a market share of only about 30%. The remaining 70% are divided between thousands of companies. As barriers to entry into this business are low, it is not particularly challenging to capture a piece of this market within a relatively short period of time. Both Flexport and Forto have succeeded to do so. Their revenues have almost doubled every year for the last five years.

What is the key to their success? Do they possess any unique technology that significantly sets them apart from their conventional competition? Answering this question is interesting and complicated at the same time. Without doubt freight forwarding has been a low-tech industry with low levels of innovation and in parts an even grubby reputation. E-Forwarders like Flexport and Forto have recognized this and taken advantage of the situation. Both developed their own transport management systems that have well-designed digital customer interfaces. Providing online quotations, online shipment booking, accurate shipment tracking, proactive exception management as well as customized customer reporting and performance analysis is the norm for these companies. Especially the publicly recognized success of Flexport has accelerated the effort of the entire freight forwarding industry to increase their digitalization efforts significantly. Every serious freight forwarding company today is heavily working on improving its digital customer interface. But have the E-Forwarders already locked in a unique and non-replicable competitive advantage?

In our view the answer is a clear ‘no’. While E-Forwarders like Flexport and Forto undeniably provided a noticeable technological face-lift to the freight forwarding industry, they still struggle with the industry fundamentals like everyone else. The hallmark of freight forwarding is its service diversity with its ensuing business process complexity. Freight forwarding companies must deal with shipments of all weights, sizes and commodities including complicated ones like dangerous goods or perishables. They must deal with all modes of transport. They cannot rely on fixed transportation networks but instead must design many different customer and product specific multi-modal transport chains. They must deal with specific regulations of a many different countries. And finally, they must deal with varying international commercial terms (Incoterms) that require them to implement relatively complex intercompany invoicing systems. This complexity is the reason why conventional freight forwarding has prevailed. It is also the reason why the freight forwarding market is still so fragmented and why industry consolidation has been rather slow.

There is no doubt in our view that it will eventually be possible to master this complexity with the help of computer algorithms and to fully automate the freight forwarding business processes. Flexport is already heavily moving in this direction. Press articles suggest that Flexport is not only focusing on constantly improving its digital customer interface but also on automating its business processes. The stated goal is to reduce transactional costs per shipment as low as possible. Currently, the industry average for these costs is about 20% of total shipment costs. They include all white-collar costs for shipment processing, administration, and sales. Centralization, standardization, and automation will lead to substantial cost reductions and eventually to cost elimination. The remaining about 80% of shipment costs are direct costs for shipment transportation and handling (cost of sales). These cannot be fully eliminated and managing them requires a fair amount of sophistication. Doing so can be called the “mastery of freight forwarding”. In our assessment neither E-Forwarders nor conventional forwarders apply digital solutions to managing these costs to any noteworthy degree.  We will touch on this subject in a later part of this article.

E-Forwarders potentially have an edge over conventional forwarders in terms of digital customer interface and business process automation. This edge, however, is currently not significant enough to provide the E-Forwarders with an unbeatable competitive advantage. Conventional freight forwarding companies can still win the technology race and grow their businesses successfully. Doing so, however, requires fast and decisive action. What must be done? Here is our list of needed actions:  

1. Establish a highly appealing digital customer interface. This should enable online quotation, booking, customized reporting and analysis, real time shipment tracking, shipment delivery prediction, exception management and online invoice and payment management. All this functionality is supported with a module that we call “Customer Portal”. This portal automates the information exchange with the customer and, therefore, is also an essential element of business process automation.

2. Automate your business processes. This includes the automated capturing and generation of information (e.g., automated shipment creation or invoice processing), automated error detection (i.e., detection of wrong or missing information), automated error correction and automated report generation (e.g., operational reports, financial statements). A significant part of information comes from customers and vendors. Customer information is mainly captured through above-mentioned Customer Portal. Information from vendors like rates, shipment milestones and invoice information is captured through a digital vendor interface that we call “Vendor Portal”. Additional automated data capture happens through other external interfaces and portals (e.g., with banks), and IOT devices like scanners and scales. Automated generation of information (like customer invoices or cost estimates), automated error detection and correction (like missing or erroneous invoice items) and automated report generation are facilitated through an organized wholistic company data model. In this context all company data should be stored in short intervals (or real time) in one single company database (called “Data Hub”) that contains at least three years of data history. This database will be enriched with many algorithms. These enable for example 24/7 electronic control of all business transactions. This way all relevant operations and accounting tasks can be efficiently monitored and managed from anywhere in the world. Tools that we call “Operations and Accounting Control Dashboards” facilitate this process. Moreover, these algorithms enable new and improved ways to analyze business performance and improve business steering, a process that we call “Advanced Business Analytics”.

3. Apply Advanced Business Analytics. This is a process whereby computer algorithms analyze all revenue and cost of sales transactions by product, customer, lane, unit load device (ULD) and carrier. It enables the forwarder to optimize shipment routing, maximize ULD (truck, container, pallet) capacity utilization, avoid unexpected carrier cost, and avoid revenue leakage and duplicate costs. Moreover, Advanced Business Analytics enables forwarders to improve customer pricing and finally adopt advanced pricing practices like yield management and dynamic pricing that have long been used in other industries.

In summary: The freight forwarding industry has great e-business potential. However, industry digitalization and automation are still on a relatively low level. E-Forwarders have a slight edge in this domain over conventional freight forwarders. But they have not achieved an unassailable lead yet. Conventional forwarding companies of all sizes can catch up or even overtake the E-Forwarders if they act fast. For companies that intend to embark on this journey, we have one final tip:

Centralize your operations and accounting processes in one location. We call such a location Central Operations Hub (COH). This will help you to organize, standardize, automate, and scale your business processes faster to reduce transaction costs and improve quality at the same time. Moreover, a COH often enables you to run a 24/7 operation.

In former times centralizing operations and accounting often led to a loss of customer proximity, reduced service quality, and sometime even to complete loss of control. Today these concerns are no longer relevant. You can maintain customer proximity through a network of lean and well-organized customer service and sales locations. Through above-mentioned Operations and Accounting Control Dashboards the customer service representatives can monitor service quality constantly and coordinate any corrective action with the support of the COH.

Finally, such a COH enables you to grow your business faster. Geographic expansion will be a lot quicker and cheaper if it can be limited to opening lean customer service and sales locations instead of full-fledged branch offices. Moreover, a well established COH allows you to integrate the business of acquired companies quite easily. As shown above, fast revenue growth is one of, if not the most significant reason for the significantly higher valuation of E-Forwarders compared to conventional forwarders. You should emulate this approach if you are interested in maximizing the value of your business.

Want to know more: Get the book "Data Mastery in Freight Forwarding" now.

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