Ocean Freight Carriers Weather Rough Seas
Capacity gains in ocean container shipping continue to outpace demand. Here's how shippers, carriers, and intermediaries ride out market volatility and uncertainty.
Marketplace volatility caught ocean carriers, non-vessel-operating common carriers (NVOCCs), and other intermediaries in its torrent, and could rain down fundamental changes in how shippers perform global freight movements. What the future looks like is still an open question.
Like many other transportation sectors, ocean shipping has seen its share of consolidation. The barriers to entry have never been small, but the current economy's ebbs and flows have raised the ante.
Bill Woodaur, senior vice president for container shipping company Maersk Line, acknowledges the heightened role ocean shipping plays in the global economy. "Ocean shipping has become the standard for connecting trading partners from different geographies," he notes.
From the 1950s through the 1990s, the marine industry experienced rapid growth. That has changed. "Carriers are no longer able to buy a $100-million ship on a speculative basis, which they could do when growth was 10 percent per year," says Woodaur. "Today, with annual growth between two and four percent, ocean carriers have to come up with the money first, then be very sure they can utilize that asset."
Despite its heavy commitment to long-term assets such as vessels, the ocean freight industry is also driven by short-term market changes. "Events in the short-term markets have a great impact on the bottom line relative to those long-term assets," Woodaur says.
Growth patterns are changing, not only because of the economic downturn but because the market is starting to mature in the East-West trades. "The average carrier's asset deployment is 55 percent in the Asia-Europe and Trans-Pacific lanes; some are as high as 70 percent," says Woodaur. "Service offerings are becoming blurred and commoditized."
Rick Wenn, vice president of business development for Hong Kong-based container shipping carrier OOCL, agrees. "2009 was the worst year on record for container shipping; the industry lost $20 billion," he says. "During 2010, demand picked up as retailers restocked. But vessel capacity did not keep up with customer demand, resulting in equipment and space shortages, prolonged delays, and pricing volatility."
Even with some marginal improvements, "container volumes today are still less than they were in 2006," Wenn adds. "Capacity gains in 2012 vs. 2011 outweigh capacity withdrawals."
It sounds like the capacity pendulum is swinging back in the shipper's favor, but the key will be in how ocean carriers deploy their assets. "As mega ships leverage economies of scale in the uncertain Asia-Europe trade, smaller vessels will cascade into the Trans-Pacific, North Atlantic, and north-south routes," says Wenn. "The potential conflict between capacity and demand brings volatility and uncertainty."
Container revenues have dropped, while carrier costs rose dramatically, explains Wenn. The average revenue per twenty-foot-equivalent unit (TEU) declined seven percent, while transportation and fuel costs spiked.
"The U.S. import market averaged $1,600 per TEU, and that number hasn't noticeably changed in the past 12 years," says Greg Tuthill, senior vice president, sales and marketing, for shipping company NYK Line. "Recently, however, we've seen rate vacillation. Ocean carriers need to look at that and identify ways to structurally change the way we enter contracts and conduct business."
"In 2011, carrier costs increased about $250 per TEU," adds Wenn. "Fuel and transportation expenses rose, and we dealt with the currency factor. While slow-steaming (reducing the speed at which ships move in order to cut fuel consumption) cut fuel costs, those savings were largely offset by adding more strings to maintain weekly schedules."
As an industry, ocean carriers cite significant efficiency improvements. "Carriers have done an excellent job of managing costs," says Tuthill. "We have reduced slot costs and become more efficient. We also offer broader service coverage and frequency."
Alliances among carriers are also part of the improvement. "Over the past 10 years, we have achieved efficiency gains through alliances," Tuthill adds. "These partnerships bring down costs, improve efficiencies, and broaden port coverage, while eliminating the investment constraints of trying to operate independently."
The larger containerships offer some efficiencies for operators, but they also introduce more volatility to the market. "Because 13,000-TEU ships have a 30-percent lower cost per TEU than 8,000-TEU ships, smaller ship operators are leveraged out of the market by competitive ships with larger scales of economy," explains Wenn. "Smaller ship owners are unable to make margin at lower costs."
So, if ship technology has improved and new processes have enhanced operations, why can't ocean carriers earn a decent profit?
"Ocean carriers haven't focused enough on value," Tuthill suggests. "We should be improving speed to market, adding IT services, and delivering products to shippers more efficiently.
"The 'create value' proposition is an opportunity for carriers," he adds. "We have a lot to gain by focusing on value."
"Poor customer forecasting is another issue," says Wenn. "Shipper forecasts help carriers achieve better asset utilization. We need to communicate better with shippers and openly share information so we can meet their demands."
Aligning vessel capacity to meet demand outlook, with quicker decision-making to synchronize carrier activities, makes Wenn's improvement wish list. Accomplishing this requires the ability to share information with shippers and trading partners "openly, transparently, and responsibly," he says.
Stuart Ratray, senior vice president, Southeast, for container shipping line Hapag-Lloyd, would also like to see carriers forge better and closer relations with shippers. "We should work together to determine how to weather market instability—for example, negotiating long-term contracts to reduce volatility and increase stability based on transparency and reciprocity, good faith, and a proven record of relationships and partnerships."
in it for the long term
How will the industry reach a convergence of long-term contracts and fair pricing? "We need to add stability to the contract arrangement between the shipper and carrier," suggests NYK's Tuthill. These contracts will require provisions for consequences and adjustments along the way.
"Four things drive our business—supply and demand externally, and economy of scale and asset utilization internally," notes OOCL's Wenn. "Carriers with big, full ships can make money.
"As far as forecasting is concerned, every time we don't profile a vessel in a buoyant market, we miss an opportunity," Wenn adds. "Customers might hoard capacity that they won't use, while four other customers waiting in line would love to have that space.
"One initiative is to penalize customers who do not provide forecasting or who don't perform when they book shipments," he says. "But we'd like to be more proactive than that, and strive for closer cooperation and communication."
The forecast for forecasting
Forecasting is also a hot button for Matthew Sarfity, director of procurement Americas, for global third-party logistics provider (3PL) Geodis Wilson. "Shippers are challenged in their ability to acquire accurate forecast data and communicate it to carriers," he says. "On the carrier side, demand for space helps keep rates up. But when, for example, shippers have multiple facilities booking volumes based on what they think they need, then making changes, it affects carrier capacity and pricing. After it happens a few times, the carrier will release that space."
Sarfity offers the example of a company with five facilities. Each facility negotiates 20 containerloads with five different carriers. When the time comes to ship those goods, the volumes aren't there and the shipments get consolidated onto one carrier, leaving four carriers without expected volumes.
"That's tough to manage, whether it is in a single organization or through five different companies," says Sarfity. An intermediary such as an NVOCC or freight forwarder can play a role in helping to monitor and adjust those bookings, he suggests.
Carriers have continued to cooperate with each other to reduce cost. "But, this has led to service commoditization," Sarfity says. "Services that used to be differentiated now look very much alike. Carriers are going back to their roots and concentrating on ocean services. Many services have stopped or deteriorated, and one role of intermediaries is to close that gap for shippers."
Intermediaries will continue to focus on rates. "Pricing is the main value intermediaries bring to their small and medium-sized shipper customers," says Sarfity. "Pricing is less a factor for larger shippers who have the volumes to negotiate."
The same pricing clout accrues to intermediaries. Fragmentation of the intermediary segment led to some large players with dominant roles commanding freight volumes that get the attention of carrier pricing departments.
One global 3PL that fits this model is CEVA Logistics. When it acquired Eagle Global Logistics (EGL) in 2007, CEVA handled very little ocean freight, admits John Pattullo, CEO.
EGL had lower profitability than the best forwarders because those forwarders had well-defined processes in place. But, CEVA intends to become a top-five freight forwarder, Pattulo says, and has made investments in people and systems to accomplish that goal.
With the ambition of becoming a major force in the forwarding arena, CEVA already serves a stable of 50,000 customers. But, the 3PL plans to concentrate on bigger customers and increase CEVA's share of their logistics spend. CEVA's top 100 customers represent 55 percent of the company's business, but CEVA represents only five percent of their logistics spend, Pattullo explains. Enhancing forwarder operations is one way to boost that business.
"Our relationships with ocean lines used to be tactical and transactional," says Pattullo. "But we have started to build proper partnerships, and they're now talking seriously about our target lanes. We introduced a trade lane structure where we focus on building business on particular lanes. We can't claim to be a forwarding company and not have a strong ocean business."
Coping With Volatility
"From my perspective, ocean capacity seems to be controlled in concert," notes one mid-sized forwarder. "At one point, most carriers were reducing capacity in an effort to raise rates. This happened to such an extent that it appeared to be an overt exercise in collusion. Then, in the fourth quarter of 2011, again in concert, the bottom fell out of export rates, particularly to the Pacific Rim.
"Effective March 1, 2012, numerous carriers implemented general rate increases," he says. "Carrier rates and capacity will be determined by a 'pull' scenario, thus eliminating rate stability."
With the entire ocean freight industry calling for more discipline and stability, some segments won't settle down any time soon. But intermediaries are also undergoing transformation.
"Global logistics suppliers are melding," says Andrew Spector, a transportation attorney with Arnall Golden Gregory LLP, a law firm in Atlanta, Miami, and Washington, DC. "They promise they can do it all: 3PL, 4PL, domestic transportation, import/export compliance—whatever shippers want them to do."
That type of intermediary never existed before, says Spector. "When companies offered just domestic trucking, for example, shippers could understand what they did," he says. "The maritime sector was always that way; service providers and shippers knew that world." Today, however, the modern players are "a new animal," blending all services into one entity, he adds.
In a recent presentation to a maritime group, Spector asked, "How many of you have an NVOCC operation in your company?" Every hand shot up. Then he asked, "Do you have a company employee who goes to work for the NVO?" They all laughed, because, he says, "of course, none of them did." Now, it's the NVO that is offering these services.
"Pure NVO services mirror ocean carrier offerings," explains Spector. "But when an NVO combines operations with other services, their role gets murky." And murky is what keeps Spector in business.
When a service provider wants to "do it all," there are gaps in knowledge, says Spector, because it didn't handle those services in the past. Like people, a business repeats its habits—for example, a domestic company starts offering international services, but tries to conduct business the domestic way. "They return to their comfort zone," explains Spector.
It's important for shippers to know what service they are engaging, and that the lines may blur when using a multi-service intermediary.
The stakes can be high. Spector argued a case where the distinction between NVOCC and freight forwarder came into play. In Prima US Inc. v. Panalpina, Panalpina was contracted as a freight forwarder to handle an international project move of an oversized load. The cargo was improperly secured and caused damages to other property on the vessel during the ocean voyage.
Panalpina's customary arrangement with the cargo's beneficial owner was to act as a freight forwarder. But, Panalpina had made a statement that the shipment "will receive, door-to-door, our close care and supervision."
A lower court interpreted this statement to mean that Panalpina was acting as a carrier or NVOCC, and ruled the company liable for the damages. On appeal, the U.S. Court of Appeals for the Second Circuit ruled that Panalpina acted as a forwarder and had no liability for damages.
Panalpina had not issued a house bill of lading or performed other steps that would have been consistent with acting as an NVOCC. And the reassuring language about close care and supervision did not change that fact, Spector argued.
Yet, it shouldn't come as a surprise when an intermediary becomes a carrier, he points out. Companies grow by transitioning from facilitator to service provider. It's logical that on transportation moves, an intermediary could be performing a carrier function, whether it thinks it is or not.
Lawyers would advise intermediaries to maintain those distinctions, and list arranging fees and document fees as separate line items, says Spector. "But the bill for a $500 freight move just went up by $300. And that's where it becomes a contradiction," says Spector.
Is he exaggerating? Maersk's Woodaur equates it to the dilemma of slow steaming. If a carrier is delayed en-route and won't hit its schedule, should it speed up and burn more fuel to make the schedule or continue at the prescribed speed and arrive late?
"Fuel comprises the majority of a vessel's operating costs and variable expenses," Woodaur says. "Slow steaming could end tomorrow, but then rates would have to rise significantly. Bunker fuel costs about $750 per ton. Back when schedules were faster, prices fell between $175 and $225 a ton. When customers ask about not slow steaming, we tell them what it would cost. That's part of the transparency needed between shippers and carriers."
The ocean freight landscape is changing, but slowly. The demands of volatile markets and the structural changes taking place in the industry suggest a much clearer dialog between shippers and carriers is needed, as Woodaur and others insist.
Both carriers and intermediaries face a challenge. "There is an opportunity to take what could be a cluster of sameness and break it down into differentiated service," Woodaur explains. "All partners play a critical role in capitalizing on this oppportunity. We need to make sure that we create value."