Traditionally, the Baltic states have positioned themselves as the bridge between East and West: the region offers access to non-freezing port on the Baltic Sea and a developed railway and road transportation system. However, the region still lags behind the EU in providing quality, value-added logistics services. Third-party logistics providers are almost nonexistent. In an environment of retail-market consolidation and major chains' increasing bargaining power, in the near future only select distributors will be capable of meeting the stringent requirements.
Currently, a majority of transportation and logistics services in Latvia, Lithuania and Estonia boil down to simple distribution. The big retailers have tended to develop their logistics in-house and are not inclined to outsource it to specialized companies. Local giants like RIMI and Vilniaus Prekyba (Maxima stores) set up their own distribution centers and do the logistics themselves. Producers take care of distributing their products as well; only a few large producers separate transportation from their core business to optimize their dispatch functions.
In Latvia, for example, only two or three companies provide integrated logistics services for clients on a day-to-day basis. The usual range of services includes custom-made logistics solutions, warehousing, statistics and analysis and transportation and delivery services. Some of the third-party logistics providers offer advanced customer-relations management services. Currently the primary target market for third-party logistics services is multinational companies distributing their products in the Baltics.
The potential demand for logistics services is also high among state enterprises, public catering enterprises and some retailers. External pressures will force these companies to spin-off or outsource logistics operations, which is not their core business, in order to remain competitive and preserve their margins.
A majority of companies still think it unusual to outsource logistics in order to optimize cash flow. But from a business point-of-view, it is important to consider not only direct costs but indirect ones as well. For example, high direct transportation costs in a company may be the result of poor asset management and low productivity. However, such indirect expenses as poor delivery, high inventories and shortages are usually neglected as "immaterial" by managers. But professional logistics companies may add the missing value to any business and to diminish those "immaterials."
The market is putting extreme pressures on transportation and logistics companies in both Europe and the Baltics. The transportation industry is plagued with low margins: the annual returns are below the cost of capital. The average logistics EBITDA (earnings before interest and tax) margins are just about 5 percent at the cost of capital about 10 percent. In the Baltics, there is still lack of effective information management systems and adequately trained work force. Investment in IT is strongly undervalued by management, and one would be hard pressed to find a logistics degree program in a higher educational institute.
On the demand side, customers become more demanding on costs and quality of services. Thus the number of transportation companies in the Baltics has decreased approximately eight-fold in 10 years. The logistics market is being forced to consolidate to ward off competitive threats.
Consolidation will become not just the mere cost cutting cure but a matter of survival. The transportation market is still very fragmented. Pan-Baltic consolidation may bring scale and scope advantages to transportation companies and result in better bargaining power over the contracts with clients, especially with key retailing chains. The significant driver of consolidation will remain the cost savings and profitability improvement necessity.
Logistics companies will need to focus on their core competencies 's the ones that will be difficult for their rivals to imitate. It may require investing further into efficient information systems or warehousing services. The overall future of the industry will depend on the ability to add the real value to the clients' business by offering high value customized logistic solutions, multimodal transportation possibilities based on the evolvement of core competencies.
Kristine Kolosovska is an analyst
with Bridge Capital.