New money chasing an old industry

With the venture capital discovering logistics industry in 2013 there has been a steady flow of funds to one of the oldest industries in the world that has traditionally been seen as a story of inefficiencies and gradual improvements. The story is changing and the sector has seen marked improvement in the recent years.

The transport and logistics sector has seen marked improvements in recent decades, despite its history of coping with inefficiencies. As new technologies have entered the market, efficiency has increased and prices have decreased. Yet the industry continues to face significant challenges, including a high number of breakpoints, complex pricing rules, and a lack of data standardization.

While low profitability has made it difficult for the industry to address these issues, a new generation of logistics start-ups aims to solve them. A new report by McKinsey & Company analysed more than 120 of the biggest logistics start-ups — representing an estimated 93 percent, or $26 billion, of total start-up funding in logistics to date—and explored recent funding trends and their implications for incumbents, start-ups, and investors.

Despite all this progress, inefficiencies are still far from being eradicated. In fact, they are prevalent everywhere you look in the industry. A high number of breakpoints (e.g., a normal cross-country trade has to go through more than ten parties, each of which has multiple touch points; dwell time in container yards can exceed five days), complex pricing rules, intuition-based decision making, and little data standardisation present significant challenges in the industry. Shippers and consignees need to interact with up to 25 different entities. A typical door-to-door spot freight quote contains more than 20 line items. 50 percent of the US’ largest importers still use spreadsheets to manage their complex international supply chain. These are only a few examples of the many inefficiencies that the industry continues to face. The complexity of the industry’s landscape and its operations has prevented the development of quick-fix solutions to these inefficiencies.

In fact, logistics costs as a share of GDP have decreased by 1 to 7 percentage points over recent decades. Developed countries, such as Germany, Switzerland, or the US, could reduce logistics costs as a share of GDP by about 1 percentage point, while some emerging markets, such as Malaysia, Taiwan, or the UAE have reached a reduction as high as 7 percentage points from their previously higher base.

Most funding, around $11.1 billion, was raised by start-ups offering last-mile delivery services to retailers and individuals.

Low profitability has made it difficult for the industry to experiment with fundamentally new solutions – it’s hard to reinvent yourself when you’re struggling to maintain profits quarter after quarter. The comparatively low and continuously decreasing prices have also kept the industry’s customers relatively quiet – increasing customer expectations and direct pressure from the consumer that have led to changes in many other industries have been largely absent until recently in a traditional, B2B-shaped industry. Today’s incumbent logistics companies have only gradually adapted to new technologies. Requirements for flawless execution, operational efficiencies amid complexity, and low margins have prevented them from testing radical solutions on existing issues and shielded them from the first wave of disruptive start-up activity seen in other sectors with the advent of the internet. Vessels have become bigger and equipped with more and more technology, but the basic operating model has stayed the same.

Seeing an enormous market that is growing and is poised for disruption given the vast inefficiencies, the venture capital industry has increasingly cast an eye on start-ups in the logistics industry. Around $28 billion has been invested, almost all of which was raised in 2015 or later. 2019 began with strong tailwind in Q1. Highlights include the $1 billion round from Flexport, a US-based digital freight forwarder. However, the rest of the year saw a significant slowdown compared to the boom in 2018. Nonetheless, funding is much higher compared to the years before 2018.

Even when excluding private equity and corporate rounds, logistics funding in 2019 grew 17-fold compared to 2014 and has therefore clearly outgrown overall venture funding across all industries, which has “only” doubled since 2014. While only around $375 million was raised in 2014, $6.3 billion was invested in logistics start-ups in 2019. Similar to other industries, funding is highly concentrated, and several start-ups with enormous funding receive just as much funding as the remaining start-ups combined. Consequently, the ten best-funded companies have received about 46 percent of total funding, and the top 20 have accounted for around 66 percent of total funding.

This last-mile segment benefits from the growth in their addressable market, eCommerce logistics (8 to 9 percent CAGR from 2017 to 2023). Most of the analysed last-mile start-ups rely on unconventional delivery modes, e.g., using crowd-sourced delivery, drones, and parcel lockers. As they make up $ 9.9 billion of the 11.1 billion, these are more successful in raising funds when compared to their peers relying on a more traditional fleet.

Another segment that has captured a lot of attention and funding is freight platforms. This holds especially true for platforms that focus primarily on road transportation, which have received about $6 billion in funding. While the vast majority of this sum comes from investment funds, this segment has also seen the most corporate funding.

Some incumbent players have already reacted: DHL Freight launched the online marketplace Saloodo in 2016, and Kühne + Nagel launched FreightNet, a road freight booking platform, in 2014. Transport Intelligence revealed that around 10 percent of volumes are shipped or booked through online freight booking platforms, marketplaces, or online forwarders, which include incumbents’ platforms like FreightNet.

Although logistics incumbents are not going anywhere, the question remains: how disruptive will these start-ups turn out to be? Will they gradually eliminate traditional value pools and monopolise future ones? Or will they converge with innovating incumbents competing for the same customers and profits in the same services?

The number of corporate investments in start-ups will grow further: growth in China is booming, and incumbents are enjoying low interest rates. This will not only include corporate investments; M&A activity will also dominate the headlines in the coming years. Incumbents are already eyeing targets to in-source growth verticals. Not only will the regional revenue split become more balanced, but also the capabilities: while increasing complexity of managing a large logistics business will push start-ups to own assets, incumbents are increasingly improving user experience and their IT front end.

Innovation will continue and by 2030, e-forwarding or crowd-sourced delivery will become the new normal, and start-ups will build complementing services to these new segments of logistics.

In 2030, retailers might leverage a control tower solution developed by a start-ups (that might not even exist yet) to manage Instacart and other delivery options.

The logistics industry in 2030 will have moved even closer to customers. eCommerce and B2C will become the new normal, and incumbents will have improved their processes to become more customer friendly. Logistics companies that did not exist ten years ago will join DHL, Maersk, and other global heavyweights on the list of the largest logistics companies.

This cover story is based on a recent report by McKinsey & Company exploring geographic investment trends and niches in which logistics start-ups are gaining momentum. The report analysed more than 120 of the biggest logistics start-ups — representing an estimated 93 percent, or $26 billion, of total start-up funding in logistics to date — and explored recent funding trends and their implications for incumbents, start-ups, and investors.