It appears as though brokers and middlemen are becoming less relevant as more companies in different industries move toward in-sourcing. However, that isn't true across all businesses and markets. From 2009 to 2013, the outsourced transportation industry in the U.S. has been growing at an annualized rate of 8.5%, compared to the 6.8% CAGR for the overall transportation industry. This suggests room for third party logistics, or 3PL, brokers.
In particular, Echo Global Logistics (NASDAQ:ECHO) , a non-asset based third-party logistics provider, mostly focused on domestic truck brokerage, has been among the strongest beneficiaries, increasing its revenues and EPS by a five-year CAGR of 35.9% and 42.2% over the same period. What is the magic behind Echo's success?
Scale and technology
Echo Global was named among the five top freight brokerage firms in Transport Topics' 2013 survey of the largest logistics companies, covering freight management and forwarding, brokerage services and warehousing and distribution. Industry giant C.H. Robinson Worldwide (NASDAQ:CHRW) was the top company on that list, which ranked firms by revenues.
The 3PL industry is one where scale plays a critical role in creating network effects for profitability. Shippers seek freight brokerage firms with the largest number of clients and the greatest purchasing power because that helps to reduce their overall shipping costs. Similarly, carriers want to optimize their capacity utilization by making sure that they have the most number of shippers on board.
This is the classic network effect in action, where shippers go to the broker with most number of carriers on its network and the broker with largest availability of freight opportunities (or shippers) is favored by carriers. As a result, leading freight brokers like C.H. Robinson and Echo Global tend to gain market share at the expense of smaller competitors.
Besides scale, Echo Global also has a technological edge over its peers, even larger ones like C.H. Robinson. In July last year, both Echo Global and C.H. Robinson were voted as among the 10 top 3PL companies by readers of Inbound Logistics Magazine.
While C.H. Robinson was highlighted for its accessibility via its office network, Echo Global was lauded for its ability to "delivers insights and uses data to develop successful solutions." Echo Global has leveraged on technology such as data science to increase process efficiency (from order to settlement); improve transaction speed and decision making; and drive pricing advantages.
For example, Echo Global helped its customer, strapping and packaging manufacturer Samuel Strapping, optimize and consolidate the number of purchase orders and shipments through the analysis of transportation data. One of the tools Echo Global uses to simplify clients' transportation management needs among many others is RateIQ 2.0, a web-based technology which generates real-time pricing and transit time information for shippers almost instantaneously.
Consolidation opportunities for the right-sized companies
Size matters, but only the right size matters. It's important for a 3PL firm to be sufficiently large to benefit from scale and network effects, but not too big that it can't benefit from consolidation opportunities. The market for commercial freight transportation and third-party logistics services is fragmented, leaving opportunities for mid-sized companies like Echo Global to snap up smaller outfits.
Another example is Universal Truckload Services (UNKNOWN:UACL.DL), an asset-light provider of transportation and logistics solutions throughout the U.S., Mexico, and Canada. Universal Truckload is targeting margin accretive acquisitions of companies generating more than $20 million in revenues. As a signal of its seriousness in expanding inorganic growth, Universal Truckload even has a dedicated professional entrusted with the responsibility of identifying and evaluating potential acquisition opportunities.
Registering a billion dollars in 2013 revenues, acquisitions of this size make sense for Universal Truckload. This wouldn't be possible for giants like C.H. Robinson delivering close to $13 billion of 2013 sales, where small acquisitions will be like a drop in the ocean in its effect on revenues and earnings.
Of Echo Global's 2013 revenues of $884 million, about 43%, or $381 million, were either contributed by inorganic growth newly acquired businesses in 2013 or organic growth from past acquisitions. Looking ahead, Echo Global has targeted the pursuit of additional acquisitions as of its key 2014 objectives.
Echo Global Universal is well-positioned to leverage opportunities in industry consolidation, precisely because its size is in the sweet spot, at market capitalization and revenues of $400 million and $900 million, respectively. Future acquisitions of small freight brokers are expected to drive Echo Global's growth.
Foolish final thoughts
Echo Global benefits from the best of both worlds. On one hand, it is sufficiently large to capitalize on network economics; on the other hand, bite-sized acquisitions are still meaningful for companies of its size, unlike industry giant C.H. Robinson. This makes Echo Global one of the best proxies for the growth in outsourced transportation.