Overcapacity seems to be the big concern for the trucking industry the rest of 2007 and well into 2008. According to all three of this year's "outlook" experts, the rush to buy new trucks ahead of 2007 emissions technology pumped too many vehicles into the system at a time when the economy was slowing.

Unless economic and freight growth revives faster than expected, the general consensus is that it will take at least a year to regain equilibrium – just in time for truck buyers to start thinking about the next-tier emissions regs due in 2010.

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KENNETH WM. VIETH III, PARTNER, A.C.T. RESEARCH CO., COLUMBUS, IND.

After receiving his B.S. from Southern Illinois University, Kenny Vieth spent six years in city government and education before joining A.C.T. Research in 1991. He became a partner in 2000. Since its inception in 1986, A.C.T has become the leading source of commercial vehicle market data and analysis in North America. Vieth oversees commercial vehicle analysis and is the company's principal heavy truck and trailer market analyst. In that capacity he has become an adviser to truck and trailer manufacturers, suppliers, Wall Street and the Federal Reserve. Vieth is a frequent contributor to the Federal Reserve's Beige Book report, and has presented at major industry and Wall Street conferences. He is quoted by the commercial vehicle trade press as well as major financial news sources, including the Wall Street Journal and Financial Times.

The economy "may not set the world on fire over the next 12 to 18 months, but we should see economic growth in the 1.5 percent to 3 percent range," Vieth says. The biggest concern for the U.S. economy has been and remains the depressed housing market, but even there the pessimism isn't broad-based.

"Keep in mind that the housing market is only 5 percent of the economy," he explains. "Consumer spending accounts for 70 percent and that seems to be on fairly firm footing."

Real estate and equities have appreciated substantially over the past several years, giving many people a still-solid asset base. Despite recent signs of weakness, the job market is considered to be relatively strong. And while discretionary spending has slipped, people are still buying non-discretionary items. "Even if your house is in foreclosure, you still need to feed your family and buy clothes for your kids," he notes.

Vieth regards the mortgage market meltdown and rapid deterioration in global credit availability to be more smoke than fire. "Investors are more cautious, but that's not all bad. The worst excesses of the past several years' easy credit markets are being reigned in while the world's central bankers make sure markets remain liquid." Since borrowing has become more difficult, there could be some short-term economic impact, but ultimately, "investors can't make money unless they invest." If there is a silver lining in the current situation, it is that "not all of the bad mortgage debt that was securitized is held by U.S. investors."

Corporate America, which represents the remaining 25 percent of the economy, didn't have a great second quarter, but most businesses are still making money – and still investing, "The baby boomers are just five years away from potential retirement, which puts continued stress on American business to continue investing in productivity enhancements," he says.

Manufacturing is also benefiting from a weak dollar, which makes U.S.-made goods attractive in overseas markets where growth remains strong. Noting the dollar's current weakness against the euro, "wherever we're competing against the Europeans, U.S. manufacturers are very well positioned," Vieth notes. At the rate they're growing and expanding their capabilities, "we're probably an economic cycle away from strong competition from the Chinese in global export markets."

Unfortunately, several economic factors and market conditions will likely give trucking a bumpy ride through the rest of this year and well into 2008. One concern: fuel prices. After the hard lessons of 2000 and 2001, any truckers still in business have built fuel surcharges into their hauling contracts, he says. Surcharges generally recoup 80 to 90 percent of fuel price increases, so the direct impact on trucking operations is relatively small, but high fuel prices hurt the economy which, in turn, hurts trucking.

The U.S. consumes about 160 billion to 170 billion gallons of gas and diesel per year, Vieth explains. Every penny increase in the price of fuel takes about $1.6 billion from discretionary spending. Whenever you take discretionary dollars out of consumer or business pockets, it hurts freight. To illustrate, let's say a certain soft drink costs $1 per can and 50,000 cans can be hauled in the average trailer. If fuel prices go up a penny, consumers have $1.6 billion less to spend on this discretionary item. That's 1.6 billion cans that don't get sold and 32,000 truckloads that don't need to be shipped.

A freight slowdown may provide a brief respite from driver recruiting and retention problems, but the industry will eventually have to face a long-term demographics change. There are more baby boomers than baby busters, so as older drivers retire there will be fewer young people to take their place. "People used to say that truck drivers were the second sons of Southern farmers, but there are a lot fewer Southern farmers than there used to be, and many of those who are left are only having one kid. The historic labor pools just aren't there anymore."

But there is a solution. "Our take has always been that it's not so much a driver shortage as a driver pay shortage," he says. "The problem will be solved when people can't get their products shipped. Driver wages will go up and it will be a decent-paying job again."

Freight is generated by the economy, and as long as the economy is reasonably healthy, trucking should be reasonably healthy too. The problem now is overcapacity. Last year's pre-buy, driven by 2007 emissions rules, meant that the nation's trucking fleet grew at a much faster pace than the economy itself. "We were adding trucks at a prodigious rate while the economy was dropping down a couple of gears," he notes. "It wasn't just the economy, it was the economy combined with the pre-buy that created the situation we now find ourselves in."

Data from publicly held carriers indicates that revenue per mile – the common proxy for rates – has decreased each of the last three quarters. In the second quarter of this year, the aggregate revenue per mile for all public trucking companies was down 1 percent from a year ago. In the first and second quarters, miles-per-tractor were down 5 percent from the previous year.

Most of the price deterioration is reportedly being felt in the spot market. Contract freight rates are supposedly holding fairly steady. Vieth says his firm has no firm data to prove that's what's happening, but it makes sense. "Shippers haven't forgotten the huge fallout in 2001 and 2002 when they couldn't find enough truckers to move their freight. Most of the big carriers also remember that fallout. This time, if they can't make any money they won't take the freight."

A.C.T. data indicates that by the end of 2006 there were approximately 120,000 too many Class 8 trucks purchased relative to available freight. Much of that overcapacity should be worked off by the latter part of 2008 – just in time for another pre-buy.

There are several reasons why fleets stock up on trucks prior to an emissions technology changeover, Vieth says. One is price. New technology in 2007 added $8,000 to $10,000 to the price of a new Class 8 truck. Some manufacturers have reportedly dropped the increase to the $4,000 to $7,000 range – better, but still significant. Nobody yet knows what the 2010 technology surcharge will be.

"If you're the first guy who buys a new truck that costs that much more, you don't have any initial recourse in the marketplace," he notes. "You can't go to your shippers and say'I just bought new trucks and I need an extra 2 or 3 cents a mile.' They'll remind you that there are plenty of others out there who haven't bought new trucks and are willing to haul the freight for less."

Potentially higher operation costs – especially in fuel consumption – were another big driver of the 2007 pre-buy. The leading technology contender for 2010 is selective catalytic reduction (SCR), which promises better fuel economy but will require the purchase of a urea solution. Cost estimates for 2010 will be a long time coming, but "when profits are measured in nickels and dimes, 2 or 3 cents a mile is a big deal," he says.

Pre-buy reason No. 3 is reliability. There were horror stories about 2002 trucks parked waiting for parts. Two manufacturers have already had recalls on their 2007 engines. "Our parents always told us'the early bird gets the worm,' but the problem here is that the early buyers get the bugs," Vieth notes.

Cost and reliability worries are heightened by the absence of good test data. As Vieth points out, the first government certifications for 2002 engines didn't come until five months before the mandated changeover. The first certifications for the 2007 engines came only seven weeks before the deadline. "If five months was bad, seven weeks was horrible," he says. SCR engines are now running in Europe, so manufacturers that adopt that technology for 2010 may be able to draw from that data. Still, buyers are likely to be wary.

It's therefore no surprise that A.C.T. is forecasting a significant pre-buy for 2009. In 2006, North American Class 8 production was approximately 378,500 units. Production is expected to be 223,000 units this year, 275,000 in 2008, 388,000 in 2009 and 235,000 in 2010. Says Vieth: "There may be some debate on the numbers, but that will definitely be the shape of the curve."

Trailer demand is also weak. Reasons include the softer economy, lower truck profits and reduced equipment budgets among fleets that pre-bought tractors last year. Over the past few years fleets have increased their tractor-to-trailer ratio, which has decreased the number of annual miles per trailer. Also, today's trailers last much longer than they used to.

A.C.T. doesn't expect trailer demand to bounce back significantly until the economy accelerates and tractor overcapacity is worked off. Last year North American shipments totaled about 280,100 units including all types of trailers but excluding intermodal equipment. The forecast for this year is 238,000, then 249,000 in 2008, 274,000 in 2009, and 272,000 in 2010.

Somewhere in the future, trailer sales may get a boost from higher weight limits as Congress addresses interstate congestion. "Americans don't like to be taxed. As a result of the'no tax is good tax' mentality fostered over the last couple of decades, the condition of the Interstate Highway System isn't good and bridges are falling into rivers," Vieth says. "Congestion is a growing concern. The existing system simply won't be able to handle projected traffic growth."

Toll roads are one proposed solution, but "I can't think of a worse way to kill productivity than putting in a bunch of toll roads," he says. Another idea is to let trucks carry more – possibly increasing the interstate highway limit to 95,000 pounds. That wouldn't affect truck demand, since Class 8 buyers "already tend to over spec that equipment," but fleets would have to switch from two-axle to three-axle trailers to accommodate the heavier loads.

There is talk of easing highway congestion by shifting more freight to railroads, but Vieth doesn't see rail intermodal as a threat to trucking. "Intermodal is only competitive when you get above 700 miles, so it only impacts trucking in the longest haul markets," he explains. "If you're a trucker trying to compete in high-volume dedicated lanes, like Los Angeles to Chicago, you don't have a chance. But outside a few high-density corridors, the railroads are not competitive."

Much of that traffic on high-density lanes is containers filled with imported goods, and imports do hurt trucking. Domestic manufacturing is a trucking-intensive business typically involving multiple truck movements from raw materials through finished goods. By contrast, an import involves only a couple of domestic moves – from the port to a warehouse, then on to a retailer. Much of that port-to-warehouse freight travels on trains.

At the same time, today's global economy presents some "massive opportunities" for U.S. manufacturers, including makers of truck parts and components. The big market is China, Vieth says. "Ten years ago, just over 200,000 commercial vehicles were produced annually in China. Next year that number will be over 500,000. That's a lot of trucks that need brakes, transmissions, engines and other components."

For now, U.S. manufacturers with operations in China are selling everything they can make to the domestic market. "They're so busy trying to satisfy demand in the Chinese market that they're not even close to thinking about exporting goods back to the U.S.," he says. But the move to vertical integration by U.S. truck manufacturers makes some people wonder if component suppliers that get shut out of this market will someday come back via China.

"The Chinese have a way to go before they rival U.S. or European heavy truck manufacturers in terms of quality," Vieth says. But U.S. and European component makers that are setting up shop in China are insisting on the same quality standards they meet in other countries. That should help make Chinese trucks competitive worldwide.

"As good as they are, the Japanese have never been able to crack the U.S. heavy truck market," he says. "But you have to wonder what would happen if a truck from China, using U.S. component technology, was offered in this country for $10,000 or $20,000 less than domestic brands. I don't have any answers, but in light of truckers' reactions to emissions mandates this decade, it's a question certainly worth asking."

STEPHEN LATIN-KASPER, MARKET DATA AND RESEARCH DIRECTOR, NATIONAL TRUCK EQUIPMENT ASSOCIATION, FARMINGTON HILLS, MICH.

Latin-Kasper started his career as an economic statistician for the U.S. Department of Commerce, Bureau of Census. In 1981 he joined the Peace Corps and worked as an economic development adviser for the Republic of Marshall Islands. Prior to joining NTEA he was economist and statistical services manager for the National Fluid Power Association. Since 1999 he has been responsible for NTEA research and analysis on markets and economic indicators as they relate to the work truck and trailer industry. He teaches economics at the Milwaukee Area Technical College and has served as chairman of the National Association for Business Economics' Corporate Planning Roundtable.

Latin-Kasper doesn't expect a recession in 2007 or 2008, but economic growth could slow to a crawl – possibly as low as 1 percent. The big concern: consumer spending. Cars, clothing, food, household goods – all add up to about 70 percent of U.S. expenditures. Consumer spending had recently slowed to a modest growth rate compared to previous economic expansions, he says. Now tight credit, the housing slump and turmoil in the financial markets will likely make consumers more hesitant – and less able – to spend.

The summer sub-prime mortgage meltdown will have a deadening effect on residential construction at least until the latter part of 2008. "There are a lot of houses for sale right now, but not many people buying," he notes. "That has to turn around before we start building again."

Non-residential construction remains fairly strong, especially government projects. State and local budgets are driven by revenues received, thus are not yet affected by this year's softening economy, he explains.

Federal construction spending should be robust, with a large portion going to matching funds for state and local projects. Latin-Kasper reminds us that 2008 is an election year, so politicians will be looking to woo voters with construction money. We may even see a push for tax incentives to encourage capital investment.

That makes non-residential construction a potentially good market for the work truck and trailer industry in 2007 and 2008. Another market worth watching is utilities. "Demand for electricity is going to remain very strong in coming years," he says. "Utility companies will be adding capacity. They'll need equipment for construction and additional equipment for maintenance."

He also sees significant sales opportunities in the growing global market. "The roads in Europe are narrow and don't easily accommodate the kind of big trucks we build in the U.S., but emerging markets like China, India and Russia have transportation models that are similar to ours," he points out.

While economic growth in other parts of the world presents opportunities for U.S. exports, it also keeps pressure on the price of energy and raw materials. "China and India make up almost half the world's population," he notes. "There are a growing number of workers in those countries who can afford cars and the gas to run those cars. We may see some fluctuation, but demand from those growing economies is likely to continue to drive prices up for at least the next 10 years."

In August, the Federal Reserve took some short-term steps to rein in interest rates and ease stock market jitters, but Latin-Kasper expects them to remain cautious. Massaging the U.S. economy with money supply and/or interest rate adjustments has never been as simple as it seems to most people, and today's global economy adds further complications. In the end, though, it comes down to a key consideration: inflation. "Lower interest rates risk inflation," he says, "and right now the Fed is most concerned about keeping inflation from creeping up"

Tight credit will curb consumer spending. Some businesses may also feel the pinch – especially small businesses. Most are sole proprietorships so "their businesses finances are wrapped up in their personal finances," he explains.

Higher interest rates, tighter credit and a general wariness regarding the economy will certainly have some effect on the demand for new trucks, but the big factor driving medium and heavy truck sales now through 2010 is the cost of stricter emissions regulations. Latin-Kasper estimates that the average price increase for an EPA 2002/2004-compliant Class 8 truck was $5,000. For 2007 models the increase averaged $10,000. For 2010 models the added cost is expected to be $10,000 to $15,000. "That means that from 2004 through 2010 the price of a new Class 8 truck will have gone up roughly $30,000," he points out.

Roller-coaster sales the last few years have been blamed mainly on pre-buying by big fleets, but Latin-Kasper says he talked to many fleet managers who bought only what they needed – not more. "I don't think they were as afraid of the new technology as some of the smaller fleet operators," he says. "They were better prepared to manage the additional costs."

He also believes that truck sales were skewed by operators of small work truck fleets – the electrical or plumbing contractor, for instance – who weren't aware of the new technology and its impact on truck pricing and demand. "In December 2006 they went to their dealers to buy new trucks, and instead of the usual end-of-year discounts they found that prices had gone up," he says. "A lot of them decided to wait."

Considering the potential price hike, pre-buying is likely to be even more pronounced in 2009, making forecasts relatively easy for the next few years, he says. U.S. Class 8 retail is projected at 187,000 units this year, down from 253,000 in 2005 and 283,000 in 2006. The forecast is 205,000 units in 2008, 280,000 in 2009, and 195,000 in 2010. "It should get back to a normal cycle in 2011 and beyond," he adds.

Pre-buys for medium-duty trucks weren't as dramatic as Class 8 because the price increases weren't as large. He estimates the average at $1,500 for 2002/2004-technology engines and $4,000-$5,000 for 2007. But the anticipated price hike for 2010 medium-duty trucks is again almost double, in the $8,000-$9,000 range.

Class 4-7 retail sales were 244,000 in 2005, 260,000 in 2006 and are expected to be around 230,000 in 2007. For now the forecast is 245,000 for 2008, 278,000 for 2009 and 257,000 for 2010, but he says 2009 and 2010 numbers are likely to change as 2010 price increases become more apparent. "If prices go up as much as we think they will, I think we're going to see a much bigger medium-duty pre-buy in 2009."

FRANK HAMPSHIRE, SENIOR DIRECTOR OF MARKET RESEARCH, MOTOR & EQUIPMENT MANUFACTURERS ASSOCIATION.

As head of MEMA's research department, Hampshire oversees a variety of programs. including product-line reporting and benchmarking services that allow members to measure their products and services against the marketplace while maintaining confidentiality. MEMA and its market segment associations, including the Heavy Duty Manufacturers Association, publish several market research reports, such as Heavy Truck Maintenance in the USA, Replacement Rates of Automotive Parts, Automotive Aftermarket Status Report, and the quarterly newsletter, Market Analysis. Prior to joining MEMA in 1992, Hampshire was manager of forecasting and strategic planning for AlliedSignal Automotive and served as a consultant on a variety of automotive projects ranging from new product introduction to the marketing of remanufactured motor vehicle parts. He has a BA in psychology from the University of New Hampshire and an MBA from Duke University's Fuqua School of Business. He also has a Master of Arts degree in experimental psychology and biomedical engineering. While a graduate student, he was employed by the U.S. Environmental Protection Agency, conducting research in behavioral toxicology, and he completed an internship in strategic marketing with Xerox Corp. Besides his education and business experience, Hampshire was an active-duty helicopter pilot and aircraft commander in the U.S. Army and in the Army National Guard. His military awards include the Bronze Star and 16 Air Medals.

We're going to have to work hard to achieve 2.5 percent to 3 percent economic growth the rest of this year and early in 2008, but Hampshire doesn't expect to see a sharp downturn. One reason he didn't buy into this summer's economic jitters was that corporate profits were relatively good – at least among companies not in the sub-prime mortgage business. Some nervous investors were getting out of the market, but "the stock still has value," he says. "Some may sell but others will step in because the prices are good, and that will drive the market back up."

Globalization is another reason not to join the pessimists. The U.S. economy may have slowed, but other countries are doing well. Technology (namely, the Internet) has broken down many of the information and communications barriers to international trade. "For companies like Ford, GM, Federal Mogul and Disney, it's a global economy," he says, "and because it's more global, the ups and downs and bumps and jitters in the domestic market don't have the same effect on corporate performance as they might have had 20 years ago."

There are lots of opportunities for U.S. motor vehicle parts manufacturers to sell products in other countries, but good markets aren't necessarily the widely touted "hot" markets, he notes. "If I were a parts manufacturer, I'd look at the countries with a lot of vehicles and vehicle sales," he says. "I'd let that influence my decision more than the number of people in a country or the amount of times a country has been mentioned in the economic news." 

For instance, Brazil has more than 20 million vehicles on the road, which makes it an excellent prospect for vehicle parts and components. "They build, sell and maintain vehicles," he points out. "The number of vehicles they have in use says a lot about their economy and their infrastructure." China will soon pass Brazil in terms of vehicle population. Russia also has growth potential. On the other hand, the newly independent Eastern European countries have a long ways to go. "There are probably more vehicles in Rhode Island than there are in some of the countries," he says.

U.S. truck and component manufacturers are finding they need those overseas markets to help weather the current slump in domestic sales, which could last through most of 2008.

"A lot of people were hoping we'd see sales come back next year, but we're starting to realize that probably won't happen," Hampshire says. The steep decline in truck sales this year was due, in large part, to pre-buying in 2005 and 2006 to stay ahead of stricter EPA emissions standards in 2007. Optimistic 2008 forecasts were based on speculation that the 2010 emissions changeover would prompt truck buyers to step up equipment purchases starting in 2008. But it now appears that the pre-buy will be delayed until fleets work off some excess capacity.

"We pumped a lot of new vehicles into the system in the last couple of years – more vehicles than the freight market needed," he explains. "Tonnage is declining because the economy is slowing. Even if the overall economy manages 2.5 percent growth this year, not all of that will be truckable GDP."

He does foresee a "decent bump" in Class 8 sales for 2009. One reason is the EPA 2010 pre-buy. Another is that pull-ahead buying in recent years has shifted the replacement cycle. "It's like ripples in a pond," he says. "If you jumped on the bandwagon in 2005 and bought trucks to avoid the production crunch in 2006, those trucks are due to be replaced in 2009. They are trucks you might otherwise have purchased in 2006 or 2007 and replaced in 2010 or 2011, so the cycle has been disrupted."

Hampshire, like most everyone in the industry, is looking forward to trade cycles based on more predictable factors like operating costs. "The inability to forecast is very expensive for truck manufacturers and their suppliers," he notes. "It would be great if we could get rid of some of the uncertainty, and even greater if the government had a better idea of how the timing of regulations can cause disruptions."

Unfortunately, budget cuts are making it increasingly hard to find good government data on truck, trailer and transportation trends. "If the EPA wants to study the economic impact of a regulation it's considering, the accuracy of that study is a function of the data used," he explains. "If they do an analysis based on great data, it's more likely that the impact will be accurately represented and the recommendation will be great; but if they have less than great information, their estimate will be less than great. At the same time, people who act on that recommendation – like legislators – can't accurately judge the quality of the EPA's impact statement if they don't have good data."

To a large extent, the quality of government data depends on how well the industry is represented in Washington. "If you're from a state that manufactures pencils and you have a representative on the committee that makes budget recommendations, the pencil report won't get cut," he says. "Our industry (motor vehicle parts and components) is gigantic, but it's spread all over the United States, so we don't have any local guys looking out for us. Legislators and rulemakers think the automotive industry is Ford, GM and Chrysler, so what's good for them is good for the USA."

Despite crushing deadlines, engine manufacturers have so far been able to meet emissions standards "without financial support from the government," Hampshire points out. The push continues as truck, engine and component makers develop technology that reduces fuel consumption and ultimately reduces emissions. "Pollution from trucks is a function of how much power it takes to drive the truck and how efficient it is," he notes. "If you increase efficiency you reduce pollution."

Another big challenge for the trucking industry is highway congestion. According to the U.S. Department of Transportation, the amount of drive time spent in traffic jams has increased 18.5 percent in the last 20 years. In 2006 almost a third of all drive time was spent in congestion.

"The Federal Highway Administration is focused on strategies aimed at reducing demand by putting high priority on congestion pricing or variable toll roads," he notes. "Congestion on our highways impacts truckers more than anyone else, and the solution is not toll roads."

A more logical idea: dedicated truck lanes. "Everybody eats and most food is delivered by trucks," he says. "Yes, there are fewer voters who are truck drivers than there are motorists who vote, but we can't cater to motorists. It doesn't make sense for trucks to be put in a position where they waste fuel and time using side roads or sitting in traffic while motorists use the express lanes. We need to design the highway system so that trucks delivering milk and bread to Los Angeles can actually get to Los Angeles."

Delivering the goods isn't the only concern. "We need to reduce congestion and allow more flexibility," he adds. "If there's a national disaster somewhere, the ability to respond depends on the ability to get trucks to that area."

Another possibility for easing congestion: Allow trucks to carry more. "It's not inconceivable that in 25 years we'll have a very different kind of Class 8 truck," he says, "perhaps one that uses hybrid turbine electric power and is very streamlined – very long and very fast. If we had designated truck lanes where they could do that, it would increase highway capacity a lot."

 

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