Surviving Creative Destruction

With Strong Balance Sheets and Asset Conversion

Joseph Schumpeter says that when entrepreneurs innovate, they do more than figure out how to use new inventions. Schumpeter believes that entrepreneurs innovate by introducing new ways to produce new products and by creating new markets. Perhaps the highest form of innovation by the entrepreneur is the creation of new forms of organization.

This innovation by the entrepreneur leads to gales of Schumpeter’s Creative Destruction as old inventories, ideas, technologies, skills, equipment, and organizations become obsolete. Capitalism destroys existing structures, creating new structures, new markets, and new businesses, causing continuous progress and improvement for everyone. We are seeing this in the long-haul truckload industry as the industry recovers from the hard winter of ’08 and ’09.

The Horrible Trucking Winter

The year 2008 proved to be destructive for the trucking industry as the double whammy of tightening credit and dramatic fuel-cost increases hammered hundreds of undercapitalized small trucking companies into oblivion. The economic winter hit hard as tonnage dropped, and rates dropped with it.

Carriers with decent balance sheets turned their noses into the wind in the early months of 2008, unloading older model tractors as quickly as they could. Ro-Ro ships bound for Europe enjoyed full payloads of used, heavy-duty diesel tractors destined for the highways of Eastern and Central Europe. Driver turnover in the larger fleets became a nonissue, as many fleets stopped their training programs, unloading trainee drivers as quickly as they could.

The over-the-road, long-haul trucking industry convulsed. Hundreds of small trucking companies shut their doors. Capacity couldn't shrink as quickly as the available freight. In 2009 the bloodletting continued; income statements hemorrhaged red ink, and money on the bottom side of the balance sheet disappeared as bank loans and lines of credit evaporated.

The size of the company didn't matter. Even the proudest fell to their knees. Poorly managed companies fell quickly. Some, such as flatbed carrier, Arrow Truck Lines, attempted to survive through bank fraud. Arrow shut its doors just before Christmas 2009, stranding over two thirds of its drivers at truck stops when their fuel cards were denied. YRC Corporation, parent to Yellow Freight, Roadway and truckload carrier, Glenn Moore, pulled just about every financial trick it could to renegotiate debt, eventually turning to the Teamsters union for assistance.

The Fortress of a Strong Balance Sheet

The trucking industry lost money in the downturn of '08 and '09. No one was spared the red ink on their income statements. But a number of major trucking companies survived by taking quick action to strengthen their balance sheets, building fortress walls with cash and assets that could carry those companies through the winter.

Hibernating animals eat hard in the late summer and fall, building up fat on their bodies for the long sleep. Foraging animals build up storehouses of food, seeds, and nuts to sustain them as they winter. Just as these animals store up for the winter, the trucking survivors lived through the downturn.

Some trucking companies survived the downturn, emerging from the winter anemic and anorexic. They didn't replace tractors, and as the economy came back, these companies felt the sting of higher maintenance costs incurred by their older, high-mileage equipment. The new engine emissions mandates for 2010 raised the cost of heavy-duty tractors by tens of thousands of dollars, pumping the price tag to over $125,000 per unit. When the major trucking companies sent their unwanted fleets overseas, low-mileage, used trucks in the domestic market disappeared. Some smaller carriers built up their capacity with the few available tractors in the used market. Still, many carriers just did not have the cash or the credit on their balance sheets to recover from their weak financial condition.

You might think that it would be feeding time for the carriers with cash on their balance sheets. But carriers that have cash on their balance sheet—or in reality, better lines of credit—are investing in new tractors and preparing for the IT investment to support electronic onboard record-keeping. So, there's not a lot of M&A activity going on.

Creation of New Forms of Organization

Except for Celadon. CEO Stephen Russell is proving to be an entrepreneur of a class that would make Joseph Schumpeter proud. Russell follows a different kind of game plan, picking up smaller regional players in their weakened condition and tucking them into his company. Celadon buys the equipment, sells it off to convert the cash into new equipment, hires the best drivers, and takes on the customer base. As Russell says, the transactions are very successful for the company.

In late 2011, Celadon snapped up the dry van fleet of Frozen Food Express, picking up 125 new drivers in a market characterized by a driver shortage. In December, Russell struck again, creating a deal with YRC to buy the money-losing Glen Moore. This move allowed YRC to shed a business unit that no longer fit its new strategy, with a focus on LTL.

Celadon gets access to a large pool of drivers. The company is still interviewing about 450 former Glen Moore drivers and expects to hire most of them. This gives the company a chance to filter out drivers whose records and safety scores don't meet Celadon’s standards. Celadon also gets a pool of tractors that are ready for trading, generating some additional cash assets that can be converted into new tractors.

The recovering economy will still deliver headwinds to trucking companies that lack the fortress of a strong balance sheet. This means that creative entrepreneurs like Stephen Russell will continue to build their companies from the wreckage left by this destructive economic winter.

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