Transports cut headcount to cyclical trough

It’s not just carriers: Third-party logistics providers and freight tech startups are cutting headcount in response to industry cycles and shifting investor priorities.

In 2019, so many trucking carriers shut their doors and parked their tractors that the “trucker bankruptcy” story took on a life of its own, picked up by the mainstream press and reported on by media from The New York Times to local news outlets.

A combination of low rates, too many trucks, rising wages and insurance costs, and higher diesel costs pushed carriers out of the industry; even established carriers let their fleets contract by attrition as they optimized capacity for their most profitable lanes. More than 800 carriers failed in 2019, about triple the number of the previous year.

While trucking carriers in the spot market are the most exposed to the freight cycle due to their high fixed costs and pressure to maintain high asset utilization, now other parts of the transportation and logistics industry are being affected, too, and adjusting their workforces accordingly.

Third-party logistics providers are traditionally considered to have more resilient business models than trucking carriers because they tend to have many more customers, use many more carriers, and are able to exploit structural information asymmetries and pricing spreads. Low capital expenditures and incentive-based compensation help 3PLs flex cost up and down as necessary. But eventually, after multiple quarters of margin compression, contract price de-rating and anemic volume growth, even freight brokers and forwarders let people go, too.

On Wednesday, multiple sources told FreightWaves that C.H. Robinson (NASDAQ: CHRW) had imposed systemwide cuts on its sales force after reporting that profits were down by 45% in the fourth quarter of 2019. Echo Global Logistics (NASDAQ: ECHO) ended 2019 with 2.7% fewer brokers than it had at the end of 2018. We hear cuts are coming at Coyote Logistics, too.

In our view, the intensified competition over price and technology that BoAML transports analyst Ken Hoexter termed the “broker wars” is a major contributor to these organizational changes.

If the 3PL business model — which lets brokers and forwarders expand margins in the first half of a down cycle — makes logistics providers more resilient, it’s the funding models of venture capital-backed tech companies that tend to let them grow relatively independently of cyclical volumes and pricing.

In 2018 and 2019, venture capitalists were decidedly “risk on,” tolerating high cash burn rates in experimental marketplace businesses with questionable unit economics. The idea was to grow fast, then pivot and use network effects to capture value. Gross margins and customer acquisition costs were de-emphasized in an economy with falling interest rates, healthy economic growth, and a public equities market that would return just over 30% in 2019.

A series of events eventually shifted VC risk tolerances. Uber’s (NYSE: UBER) and Lyft’s (NASDAQ: LYFT) share prices plummeted after their initial public offerings. Both companies laid off staff in 2019 in an attempt to stem losses, establish a clear path to profitability, and adjust to a world of valuations based on earnings rather than revenue.

But WeWork’s failed IPO and disastrous revaluation exposed frothiness in the venture capital space, especially in late-stage companies, that needed to come to an end. In retrospect, of course, the weaknesses in the business were easy to see.

“Rather than describing itself as an unprofitable office landlord that depends on unusually short leases from its tenants, WeWork thickly laid on the hyperbole in its SEC filings, declaring that it was ‘a community company committed to maximum global impact … [with a mission] to elevate the world’s consciousness,’” wrote value investor Seth Klarman in Baupost Group’s Q4 client letter.

At the time, we predicted that venture capitalists would flee to the quality of software-as-a-service’s high-margin recurring revenue. Strong businesses are of course continuing to do well. Convoy raised $400 million at a valuation of $2.75 billion.

But across the freight tech space, companies are adjusting headcount, lowering burn rates, and refocusing on the revenue streams most highly valued by their investors. “Sustainable growth” is the watchword of the day, and venture capitalists’ appetite for exotic projects not accretive to valuation in the short term has waned. In a sense, rapid and unsustainable growth-at-all-costs is now viewed as a sugar rush fueled by empty calories.

For that reason, we were not surprised to see cuts at NEXT Trucking, the digital freight matching platform focusing on drayage, and Flexport, the digital freight forwarder. But in our view, the risk-off mood prevailing among venture capitalists — and we emphasize that “risk-off” is relative here — is incredibly positive for founders of VC-backed companies.

Permission and encouragement to pursue sustainable growth, expand margins and extend runways lets founders time subsequent rounds of fundraising to favorable points in the market when the supply of capital is loose, rather than being forced into more dilution by a high burn rate.

It is easy to paint a picture that layoffs at venture-backed companies are a sign of distress in these franchises, but that is often not the case. High-growth startups are encouraged to innovate and grow at all costs, pursuing projects that may or may not work out. This experimental appetite is part of what creates the most successful winners to begin with, but at times can feel chaotic or make pivots appear abrupt. When a fast grower lays off, it is usually a sign of a change in direction or a reinvestment in other parts of their business. Layoffs that make headlines may only impact one division of a company and simply represent a pivot away from a new project that isn’t working, or a return to a headcount of a few months prior.

Flexport’s layoff of 50 employees, or 3% of its headcount, is not equivalent to a legacy 3PL’s cuts in response to collapsing earnings. Startup founders would maintain that the ability to “move fast and break things” — the dynamism required to try something new and quickly double-down or retreat — is an important advantage that venture-backed companies have over mature businesses.

In the mature, sclerotic companies that startups are tasked with disrupting, unprofitable projects limp along in perpetuity, vice presidents with nebulous job descriptions proliferate endlessly, and innovation grinds to a halt. Startups’ ability to adapt quickly and iterate and improve faster is one of their main sources of strength.

That said, no company in transportation or logistics, whether a 3PL or a VC-backed freight tech startup, is wholly immune to cyclical industry dynamics. That includes FreightWaves.

FreightWaves, which had expanded staff and projects rapidly in 2019, received investor feedback that projects without a near-term path to building recurring revenue were value-dilutive and would distract management from scaling the core business: freight market data analytics and forecasting in North America. In recent weeks, FreightWaves has shut down overseas offices and shuffled teams into projects that are highly valued by investors due to recurring revenue or high margins.

“Our recurring revenues grew by more than 1,800% in 2019, but we also saw expenses accelerate during the same period,” said Craig Fuller, FreightWaves CEO. “Some of the investments were experimental and not accretive to the company’s value. At worst, they were distracting to our team.”

In discussing the broader venture sentiment in 2020, Fuller highlighted that investors were highly focused on sustainable and recurring revenue growth.

“Venture capital investors have made it clear they will pay up for recurring revenues but will largely discount any revenues that are not repeatable or predictable,” Fuller explained. “Investors expect founders to focus on projects with recurring and predictable revenue streams. Projects with revenues that are not predictable will be a drag on valuation. Founders who wish to pursue products with a one-time revenue component are encouraged to focus on products that generate high margins and contribute to the core recurring revenue business.”

Another reason that venture-backed companies are cutting back on speculative projects has to do with the maturation of the market and the companies in it.

In the early phase of the market, no one really knows how the market will evolve or what model will win out. Over time, the winning model becomes obvious and is rewarded. The companies that have the winning strategy are encouraged to double down on what works, prioritizing projects that build onto that model and diverting investment away from those that don’t. 

When startups are early stage, investors give an enormous amount of room to experiment and expand. But as business models scale, a winning strategy starts to emerge. Much like a healthy diet, sugar-packed foods give a lot of short-term pleasure but turn out to be empty calories. At mature growth companies, investors want balance, allowing for the occasional indulgence.