Beating the cycle

Sustainability is a hot topic these days, ranging from environmental policies to business and economic practices. But considering the difficulty of today’s business environment, you might be wondering if your business model is sustainable.

Record fuel prices, suppressed rates, debt-soaked balance sheets and a new round of engine technology coming in 2010 are a few of the major challenges that require careful consideration.

For one of the best examples of a sustainable business model, look back to 1990 when Kevin Knight, his brother and two cousins launched Knight Transportation. The company began with a handful of trucks and $10 million in debt. In 1994, the owners took the company public with 234 trucks, $34 million in revenues and a debt-free balance sheet.

To date, the company continues to be, after proceeds of public offering, debt-free while growing to 3,750 tractors and 8,000 trailers. Its operating ratio (OR) has been the envy of the industry by staying in the high 70s and low 80s.

One of the fundamental principles for Kevin Knight, the company’s chief executive officer and chairman, is to grow the business only when return on invested capital (ROIC) is at least 15 percent. Another fundamental business principal for Knight is to maintain a debt-free balance sheet.

“If you are debt-free, you don’t work for anybody,” Knight says, joking that “our shareholders would probably tell you differently.”

If you can show a banker an OR in the low 80s, he will lend you all the money you want, Knight says. But if you are debt-free, you won’t need the money. Instead, you can grow with internally generated funds without paying interest. Growing without debt requires extreme discipline, Knight says. But it doesn’t slow your growth – it empowers it. “It’s a great feeling to know that every truck and every facility is paid for.”

Along with other carriers, Knight Transportation has felt the effects of the current trucking environment. In the first quarter of 2008, year-over-year operating income decreased for the first time in the company’s history.

“We went backwards this year a little bit,” Knight said during a speech in late March at a meeting of the National Accounting and Finance Council (NAFC) of the American Trucking Associations in Scottsdale, Ariz. “We are not getting the financial returns we expect.”

For the first quarter in 2008, Knight Transportation’s OR was 86.7 percent – slightly higher than the 85 OR Knight requires to justify growth, but still one of the lowest ratios in the truckload industry.

Knight believes the trucking industry would have fared much better in 2008 if carriers had not purchased excess vehicles to beat the 2007 emissions standards from the Environmental Protection Agency. In effect, fleets chose to save a few thousand dollars on trucks that produce more pollution.

“Don’t just worry about timing the system to save a few thousand dollars,” says Knight, who did not join the pre-buy bandwagon in 2006 or 2002. Today, the company operates more than 1,000 vehicles that meet the 2007 emissions standards.

“In the end, do what is right for the environment and to maintain a healthy balance in terms of supply and demand,” Knight says. “We need to remain consistent in our purchasing patterns so we don’t overdramatize those cycles.”

The 2006 pre-buy added extra capacity into the market and caused equipment utilization to drop by 5 to 6 percent for carriers, and will negatively impact used truck prices in 2009 – the next time another pre-buy situation comes in advance of the 2010 engine emissions standards, he says.

“We have to be better stewards in our industry when we think of these issues,” Knight says. “It’s tough out there right now. The fact of the matter is that it shouldn’t be as difficult as it is.”