Will Digital Freight Apps Kill Truck Brokers?

Digital freight-matching companies, or DFMs, such as Uber Freight have entered asset-light truck brokerage over the past few years. It’s early in their evolution, but most DFMs hope to reinvent the truckload shipping process via highly automated marketplaces that can match shippers and truckers on demand. At times, this has caused investor trepidation over the potential threat to traditional providers, and that is likely to recur, creating buying opportunities for the informed.

We don’t believe the proliferation of DFMs spells disaster for moatworthy brokers. The network effect can mount a powerful defense, pure app-based companies’ service capabilities appear limited, and the large providers aren’t standing still. DFMs are starting out with digitized platforms, but we think they’re essentially low-cost truck brokers, and it remains to be seen to what degree their head-count-light model will gain traction.

That said, while buying opportunities are likely to arise in the future, we’d stay on the investing sidelines for most asset-light freight brokerage stocks for now, not because of risk from DFMs, but because valuations appear lofty.

The large pure-play highway brokers we cover, especially industry leader

Adding to the list of threats recently is the so-called Uberization of freight, or the proliferation of digital freight-matching companies, which are also referred to as mobile app-based marketplaces. These new entrants are essentially looking to connect shippers and truckload capacity (and less-than-truckload capacity, to a lesser degree) via mobile-based platforms. Ride-sharing pioneer Uber entered the market early in 2017 with the launch of a freight-matching app from its Uber Freight division, and although details are limited, Amazon AMZN may eventually be jumping into the fray. Convoy, Transfix, and Trucker Path are other examples of new DFMs looking to make their mark.

There are at least two dozen startups endeavoring to use mobile app platforms to create highly automated, less people-intensive, and lower-priced marketplaces linking shippers and asset-based carriers. According to logistics industry consultant Armstrong & Associates, DFMs raised in the ballpark of $200 million in venture capital funding between 2011 and 2016. However, investor interest accelerated in 2016. Around $67 million of the $200 million of investment came in 2016 alone, and that number increased materially in 2017. One of the more vocal and visible DFMs, Convoy (which started in 2015), has raised $80 million, with $62 million of that secured this past June in a Series B funding round, while New York-based Transfix raised $42 million in a Series C funding round in July.

The evolution of DFMs’ operating structure and impact on the asset-light highway brokerage marketplace are in their infancy, and providers keep their progress and operating statistics close to the vest. Thus, information is limited, and our take on these new entrants is highly preliminary. Nonetheless, in terms of strategy, we think most mobile app-based marketplaces intend to capitalize on what they see as an opportunity to reinvent the truckload shipping process, along the lines of what Uber accomplished for the ride-hailing/taxi industry. DFMs are attempting to apply software platforms (using machine learning, algorithms, and mobile apps) to create faster, more on-demand marketplaces linking shippers and asset-based truckers than most traditional highway brokers have forged. It is true that trucking isn’t highly digitized, especially in terms of connectivity with the vastly fragmented carrier base, which comprises hundreds of thousands of owner-operators and small fleets with fewer than six trucks--these usually aren’t sophisticated operations. Additionally, outside the top 20-30 traditional brokers, which are relatively sophisticated on the IT front and becoming more so, most brokers lack the resources to automate much of their operational processes and thus have a higher-cost model.

Communication between parties in trucking remains quite manual; sometimes it takes brokers and asset-based truckers hours to complete a transaction, given the need for multiple phone calls and emails including scheduling, rate negotiation, status updates, and so on. Exception management (equipment breakdowns, for example) is labor-intensive as well. Small and midsize shippers must endure a similar manual process to secure capacity directly with small carriers. Mobile-based freight apps are new to the scene, process only a small amount of freight, and are unproved. However, by making the truckload transaction faster and more efficient for carriers and shippers, they hope to attract capacity and take processing share from traditional brokers and even asset-based carriers.

Convoy's platform provides a good example of most DFMs' shipment process. On the shipper side of the transaction, customers enter their cargo specs into the company's website or app, which provides up-front pricing and fees and, subsequently, GPS tracking. On the supply side, certain carriers in Convoy's network receive an alert with the shipment details (including a fixed offer price) via the company's mobile app and can accept it at the touch of a button. Convoy employs algorithms to match a host of load specifications (size, distance, destination, price, and so on) to the preference of carriers. Over time, its software learns what an individual owner-operator or small fleet may prefer and pushes loads most likely to suit their preferences. Overall, Convoy believes its network can book transactions faster than many traditional brokers because of its more digitized platform. Uber Freight, which we believe has a similar platform, claims it booked shipments in 34 minutes on average (from the time posting on its app until a carrier claimed the load) for a shipper looking to send full truckloads of large quantities of bottled water into Houston following the late summer hurricane, according to The Journal of Commerce. Overall, Convoy and many of its DFM peers hope this faster process will increase carrier adoption and thus their access to capacity.

What About Amazon? Asset-light highway brokerage is yet another addition to the seemingly endless list of industries facing the threat of Amazon as a new entrant. While little is known about its intentions, Amazon appears to be building the infrastructure for a mobile app-based marketplace. It recently launched Relay, an app that will help truck drivers automate and streamline the pickup and delivery process at Amazon warehouses. Relay isn't a freight-matching app, but it could be the first step in that direction, where perhaps the company is building and testing an automated communications infrastructure capable of reaching thousands of asset-based carriers.

It’s unclear if Amazon’s suspected entry into the brokerage landscape will take the form of in-sourcing third-party brokerage services used to move freight for existing vendors and sellers, or if it intends to launch a broader marketplace open to non-Amazon shippers as well. For reference, the company has relationships with numerous third-party brokers and carriers that move suppliers’ palletized freight from the U.S. ports and warehouses to Amazon’s fulfillment centers. On the basis of our discussions with brokerage industry participants, we speculate (and we reiterate speculate) that the company may be looking to add warm bodies for front-end sales and carrier-sourcing efforts; recall that most DFMs are using head-count-light models to eliminate costs. This suggests that Amazon may want to build more than just a digital freight-matching app platform and adopt the characteristics of a traditional full-service broker.

In terms of risk to the large traditional highway brokers, Amazon differs slightly from other DFMs in that it could quickly scale up a base of retail end-market shippers (consider its vast vendor base) while leveraging that freight to attract truckload capacity. Thus, it might gain network density faster than any other DFM could. That said, Amazon doesn’t spell disaster for the moatworthy brokers. The $62 billion domestic truck brokerage space remains highly fragmented, comprising more than 9,000 small operations with limited resources. We believe the smallest brokers will bear the brunt of the impact if several DFMs and/or Amazon gain traction. The brokerage marketplace is still big enough for Amazon to consolidate share from small brokers without an all-out pricing war with the major players, albeit it’s a risk because Amazon often doesn’t care about posting profits in the short run. Additionally, the broader for-hire trucking market approaches $370 billion, with brokers processing only about 16% of that freight spending. Thus, plentiful runway exists for both Amazon and moatworthy brokers like C.H. Robinson and Echo to take processing share from asset-based carriers (for example, entering shippers’ routing guides). If Amazon enters the market as more of a pure freight-matching app, then its addressable market will be bounded. The company may find it even harder to gain traction if retail/e-commerce shippers (Target or Walmart, for example) that are also Amazon’s competitors balk at using its brokerage network for fear Amazon could gain competitive insight into their operations.

The increasingly competitive environment has long been a consideration for the large brokers we cover. It’s also why we don’t assume the traditional providers will take share at the same rate they have in the past, and in our models, we bake in gradual declines in gross margins (net revenue/gross revenue). That said, the wide-moat providers have successfully navigated ubiquitous threats over the past decade, and we expect that to persist. XPO Logistics, for example, pushed into the truck brokerage market in 2012 via an aggressive rollup strategy, posing an apparent threat to the large incumbents, but over time the market proved large and fragmented enough to absorb another large player without sending industry gross margins into a chronic downward spiral.

Are DFMs Really That Different Than Traditional Brokers? In our view, DFMs' strategy of bringing greater efficiency to the trucking industry sounds a lot like what moatworthy highway brokers like C.H. Robinson and Echo have been doing for more than a decade. These traditional brokers add value to shippers by providing access to the massive fragmented supply base of small truckers and attract carriers by aggregating freight demand and providing abundant cargo opportunities (substantial lane density). This is also where the network effect comes into play--as a broker's network of shippers and carriers expands, it becomes more valuable to all parties. While there's certainly room for productivity gains from digitizing more of the transaction, and the large providers are increasingly on that path, evidence of traditional brokers' strong value proposition shows up in the fact that brokers (as a whole) have materially increased their processing share of the $370 billion for-hire trucking market over the past decade.

We think the key differences between DFMs and traditional brokers like C.H. Robinson, Echo, and Landstar have more to do with freight apps coming out of the gate with a more digitized, head-count-light infrastructure; you don’t have to pay sales commissions to computers. The large brokers we cover have built their model around a combination of technology and highly proactive salespeople, and people cost more. The way we see it, DFMs are essentially trying to enter as tech-savvy, low-cost brokers--Convoy’s management team considers its operations to be “automated freight brokerage.” Most DFMs intend to amass a broad network of small carriers by leveraging mobile tech-enabled connectivity while winning freight via a lower-cost model that (theoretically) allows them to offer lower sell rates to shippers than most traditional brokers, yet still post a profit. But we don’t think it’s that simple.

This is where investor concerns arise in terms of the competitive positioning of C.H. Robinson, Landstar, and Echo, as well as the brokerage divisions of high-quality multimodal transports like J.B. Hunt, Schneider, and XPO Logistics. Throughout much of 2017, C.H. Robinson and Echo saw negative sentiment mount. We think this was due to misconceptions surrounding persistent gross margin compression, along with rising concerns about the impact of DFMs, which have become more visible in the headlines. Echo also struggled with a few idiosyncratic issues. On the other hand, both companies’ market valuations recently rebounded sharply as it became evident that cyclical (loose capacity and falling contract pricing) rather than competitive factors have been behind the industry’s gross margin woes. Improving operating conditions for brokers--namely a swing to tightening truckload capacity and a likely uptick in sell rates and gross margins--have probably masked some fears about app-based marketplaces. However, we think confusion over the implications of DFMs for moatworthy brokers will recur when operating conditions once again turn challenging and it becomes hard to differentiate cyclical from competitive factors; that will probably create additional buying opportunities for informed investors.

We don’t believe the proliferation of DFMs will derail the growth prospects of the moatworthy brokers we cover for three chief reasons: (1) The network effect mounts a powerful defense in asset-light truck brokerage (customer and carrier density are paramount), (2) digital freight apps’ limited sales and service capabilities will probably curb their addressable market, and (3) the large brokers aren’t standing still. DFMs are driving the top-tier traditional companies to automate more processes (especially carrier connectivity) and adopt a less people-intensive model, though head count will remain a key input for success. Additionally, the brokerage industry is fragmented enough to handle new entrants; we believe the masses of small unsophisticated brokerage companies face the greatest threat from losing market share to successful DFMs and traditional moatworthy brokers.

Network Effect Can Mount a Powerful Defense The network effect, which supports the economic moats of several truck brokers we cover, provides context for framing the threat of digital freight-matching companies. At its heart, the network effect implies that the more parties (suppliers and customers) that use a logistics provider's network, the more powerful the network becomes and the harder it is to replicate. Large traditional brokers like C.H. Robinson, Echo, and Landstar have each amassed an immense customer base of shippers that aggregates sufficient demand to attract substantial truckload capacity while bestowing robust buying power relative to small and midsize brokers and shippers. Along these lines, vast capacity relationships and deep lane experience have allowed C.H. Robinson and Echo to win highly service-intensive price-committed business among large shippers over the years. Also, these companies are no slouches on the IT front--heavy investment has allowed them to monetize their deep reservoirs of market-transaction data, and we expect that to persist. These factors, when coupled with significant lane density, enable moatworthy brokers to top the charts on gross margins, despite an increasingly competitive marketplace. Benefits of the network effect also translate into economic profit.

On the other hand, we believe most DFMs, like any new entrant, will grapple with losses until their networks scale up and greater density is achieved, even with a head-count-light infrastructure that tries to avoid the productivity pressures of a salesforce. We consider the brokerage industry to have low barriers to entry but high barriers to success, given the need for network scale. A handful of DFMs will probably gain traction over time (likely those with deep pockets, significant contacts, and the ability to attract experienced leadership talent), partly because the brokerage industry is still heavily fragmented. We think there’s sufficient runway for certain freight apps, as well as the moatworthy brokers, to consolidate market share from the masses of small brokers that lack network scale and have limited resources with which to digitize their infrastructure. That said, success won’t happen overnight. To succeed, a digital freight app will need to build enough density to offer shippers lower transportation costs while offering high levels of service and generating a profit.

Pure App-Based Marketplaces Appear Limited in Sales and Service Scope DFMs add more value than traditional online load boards (such as those run by Truckstop.com), which have been around for decades, because of their cutting edge back-end (algorithms) and user-facing (mobile tech) IT capabilities. Most will also offer some degree of operational support such as real-time load matching, carrier prescreening, and fast payment processing. However, it looks to us as if most DFMs' sales and service capabilities are limited relative to traditional providers because of their desire to operate a low-cost, head-count-light model capable of charging lower sell rates. The large traditional players will automate more processes over time, but there's a reason they still employ lots of commission-based sales reps and operational personnel: The 12%-15% spread (gross profit margin) they earn covers more than just linking shippers and carriers.

Freight apps are service-light, but trucking is service-heavy. Unlike the ride-sharing business, where companies like Uber brought greater automation and visibility at a lower cost to sentient riders able to manage the process and problem-solve, hauling freight is service-intensive because cargo can’t make its own decisions. Truck brokerage demands more than IT. It requires human support, especially for manual oversight of location tracking, appointment scheduling, and exceptions like billing errors, cargo damage, and late arrivals. These issues can’t be resolved solely via digital means, and that won’t change overnight. Despite widespread smartphone use, connectivity with small truckers is still largely done via phone and email; it will take time for truckers to adopt habits that allow the freight transaction process to become more automated and less people-intensive. Phone calls will remain important for brokers to ensure that a carrier meets quality expectations, including its ability to deliver loads with the correct equipment and in a timely manner and comply with regulation such as hours of service.

Large traditional brokers handle the entire process using both tech and people, enabling shippers to outsource, or at least supplement, the aforementioned activities. However, most DFMs are fixated on a digital-only connection, minimizing many service aspects of the transaction. Thus, in many cases, shippers must be willing to bring parts of the shipment process back in house when using service-light DFMs. This will probably limit many DFMs’ addressable market, especially contractual business among large shippers.

Building a carrier network requires sourcing personnel. On the supply side of the transaction, pure app-based marketplaces are hoping to swoop in with a head-count-light model that attracts small carriers to their networks via cutting-edge algorithms and mobile tech-enabled platforms aimed at making connectivity more efficient (eliminating phone calls and rate negotiations to offer on-demand load matching). However, finding enough trucks to process freight levels remotely close to that of moatworthy providers like C.H. Robinson, Landstar, or Echo could prove challenging, especially during periods of tight supply (2018 is likely to be one of those phases). Sourcing capacity in the incredibly fragmented truckload market first requires freight density (significant volume opportunities), which DFMs don’t quite have yet, but it also calls for numerous carrier-facing sales personnel to be in constant contact with small fleets, which make up most of the carrier base. The more that capacity tightens, the more a broker must work the phones to secure trucks to get freight moved.

Client-facing sales head count is still a key growth driver. Front-end sales functions remain a vital input for market share gains and volume growth in asset-light truck brokerage. The large traditional providers employ hundreds of transactional and enterprise sales reps for a reason: Relationships and account management matter. This is especially true for brokers that handle committed/routing guide business or outsourced transportation management services among large shippers, which usually have complex supply chain needs.

Uber’s technology successfully lured more drivers to the ride-sharing industry by sidestepping the regulated taxi industry, thus boosting the market’s capacity. But that won’t occur in truckload shipping, which is deregulated to begin with and is grappling with persistently limited driver availability that an app won’t rectify. Additionally, some have argued that some DFMs’ focus on attracting small truckers to their network (via an innovative mobile app) will give large shippers better access to a part of the carrier base that’s hard for them to work with. We think this premise overlooks the fact that large traditional brokers like C.H. Robinson already have those relationships. C.H. Robinson’s massive customer base drives substantial lane density that enables the company to fill small carriers’ empty miles, which keeps those carriers in the network. Aggregating the fragmented supply base of owner-operators and efficiently connecting them with shippers of all sizes has been a key part of the company’s value proposition for years.

Traditional Moatworthy Highway Brokers Aren't Standing Still It's certainly possible that a few DFMs will manage to maintain a low-cost infrastructure (less people-intensive operations and minimal commission-based sales reps) while raising the scope of their service capabilities, thus increasing the range of freight they can handle. However, the pure-play moatworthy brokers aren't standing still. C.H. Robinson, Echo, and Landstar--and even the brokerage divisions of multimodal transports like Knight-Swift, XPO Logistics, and J.B. Hunt--have long been investing heavily in IT infrastructure. Furthermore, we believe increased publicity surrounding high-profile DFMs like Uber Freight (and speculation about Amazon) in recent years has pushed these brokers to take an even more aggressive stance in terms of driving greater transaction automation, back-office efficiency, and salesforce productivity in their operating models.

It’s a stretch to characterize companies like C.H. Robinson or Echo as having an archaic operating model. These companies invest vast sums in IT infrastructure annually and have been doing so for years. For C.H. Robinson, much of its $91 million in capital expenditures in 2016 alone related to capitalized IT-related costs, including a new data center, and it spent nearly $1 billion on IT infrastructure in general over the past decade. Echo’s capital expenditures will approach $20 million in 2017, and much of that is also IT-related, a common theme among the large providers. These companies process millions of transactions per year (C.H Robinson’s truck brokerage division recorded 11 million shipments in 2016), which create vast data repositories. They then apply these IT capabilities in terms of data analytics and machine learning to become more predicative and optimize pricing to carriers and shippers, which improves gross margins. Most DFMs won’t be able to leverage such transaction data density in the near term.

IT is usually not a competitive advantage. The large traditional brokers can easily replicate digital freight-matching companies’ automated app-based functionality for both shippers and carriers. While they don’t disclose much for competitive reasons, we believe most of the large brokers we cover already have or are developing mobile app technology for both sides of the transaction, including true auto-tender capabilities for asset-based carriers.

Mobile apps or not, transactions are already becoming more automated. For one, C.H. Robinson’s less-than-truckload brokerage unit offers customers a fully automated solution where a shipper can go online, place an order, and track its shipment through delivery without any human interaction. The company also estimates that roughly 6,000 carriers use its Navisphere system’s carrier mobile app daily for load searches, status updates, and so on.

It's Early, but DFMs' Most Addressable Market Could Be $15 Billion-$20 Billion We acknowledge that a handful of DFMs will gain traction over time. DFMs are in the infant stages of their evolution, but our initial take is that $15 billion-$20 billion of brokered freight (truckload and, to a lesser degree, less than truckload) could prove most addressable for DFMs. Based on our discussions with industry participants, we speculate 20%-30% of large brokers' business is most ripe to be processed via a lower-cost/lower-priced self-service platform, particularly among shippers seeking a more automated relationship, and where carrier sourcing would be auto-tendered with minimal human interaction. Applying that mix to the $62 billion of freight spending that flowed through asset-light brokers in 2016 implies $15 billion-$20 billion. We think this would mostly reflect certain kinds of transactional and last-minute spot freight because such shipments often require less in the way of front-end sales relationships and can be price-sensitive. In terms of price, DFMs could theoretically leverage a service-light, low-cost platform to offer lower sell rates to shippers than traditional providers historically have charged on such freight. In our view, not all spot shipments fit pure app-based platforms cleanly because a lot of them are scheduled in advance, giving brokers like C.H. Robinson an edge in relationship management.

Indeed, to the degree digital freight apps choose to be more like the large moatworthy brokers, with more front-end sales, carrier sourcing, and operations personnel, they have the potential to address a larger portion of the brokerage market. Yet in that case they are no different than any other brokerage startup entering a crowded market. We also note that DFMs’ head-count-light model is unproved in terms of being able to underprice traditional brokers “profitably.” Any new entrant can undercut the competition to grab freight, but this isn’t sustainable if the margins aren’t there. Companies that come in charging unsustainably low rates only to raise them later will see freight rapidly leave their network. Furthermore, the ability of any one DFM to ramp business will be constrained by the degree to which it has a national footprint of small truckers in their network, and limited lane density and minimal sourcing personnel will make that tough to achieve in the near term.

In terms of their addressable market, we don’t believe DFMs will be stealing all those shipments from moatworthy brokers. We think it will be primarily felt by the masses of traditional small and midsize companies. There more than 9,000 highway brokers in the United States, the vast majority of which are small (size falls off quickly outside the top 20). We can envision how such providers already operating on thin margins will get squeezed out over time as they are caught in the middle--on the one hand, having less automation and thus higher costs than pure IT-driven freight apps (especially for lower-margin spot freight), and on the other, lacking the network-driven value proposition of large traditional players that are likely to remain the dominant providers for service-intensive freight and contractual business.

The moatworthy brokers aren’t exempt from the intrusion of DFMs, but they can mount a solid defense. For one, the network effect is powerful, and providers like C.H. Robinson, Echo, and Landstar enjoy a robust value proposition to shippers for spot freight because of their unmatched capacity access that DFMs probably won’t be able to replicate near term. Second, the large traditional brokers aren’t standing still and are automating more of their processes to drive down costs, which should allow them to gradually lower sell rates on certain low-touch spot shipments while remaining profitable. They are also quite capable of launching app-based functionality as needed. Furthermore, DFMs’ potential growth won’t necessarily all be coming from within the $62 billion brokerage industry. It will also reflect greater processing share from direct carrier-shipper relationships, and that’s a large market--the total for-hire trucking industry approaches $370 billion. That means the asset-light brokerage industry itself can continue to expand. It grew 5% in 2016 and 8.5% on average over the past five years (through 2016).