CSCMP's Supply Chain Quarterly
November 13, 2019

Bargains abound—for now

Overcapacity and low oil prices are keeping airfreight rates low, but shippers should not expect that to last forever.

Tepid growth continues to weigh on the air cargo industry while passenger demand fuels overcapacity in the market. In May, the International Air Transport Association (IATA) reported that global freight ton-kilometers (FTK) for the year to date had declined by 0.5 percent, and that load factors were down by 2.9 percent. Cargo revenues have correspondingly fallen as well; Air France-KLM, for example, saw revenues decline by 16.1 percent in the second quarter of 2016. And according to the U.S. Department of Transportation, the airfreight market is down in all segments in the United States this year. U.S. domestic cargo volumes (cargo revenue ton-miles) are down 0.6 percent for the year as of this writing, while volumes into Latin American are down by almost 12 percent.

Any discussion of overcapacity must begin with the passenger market. According to The Boeing Company, the trend away from "hub and spoke" routing to direct-flight models in international air travel has been enabled by the introduction of more-efficient widebody aircraft. Robust growth in the passenger segment has driven the increased deployment of widebodies, bringing additional cargo capacity in the form of belly space to the global market. Overall, IATA reports that revenue passenger-kilometers are up 6 percent for the year; load factors are near historical highs but are down slightly compared with 2015. The fastest-growing passenger markets have included international lanes into and out of the Middle East, Africa, and Asia.

Article Figures
[Figure 1] Selected global air forwarders' profit and volume
[Figure 1] Selected global air forwarders' profit and volume Enlarge this image

Carriers are responding to the glut of capacity by managing cargo-specific aircraft. Air France-KLM, for instance, has removed over 3 percent of its cargo capacity so far in 2016, much of it in full-freighter aircraft. Cargolux, a freight specialist, appears to have shifted some of its existing capacity to new routes, adding services linking Central America to Europe and Europe to Asia, with a focus on the perishable markets. The potential for market forces to drive a reduction in freighter capacity on traditional routes may be a concern for some shippers, particularly those that are reliant on specialized freighter services, such as the chemical industry and others with hazardous shipments that are too dangerous to carry in the belly space of passenger aircraft.

The continued winding-down of inventories suggests that there is no immediate turnaround ahead when it comes to demand growth. The U.S Federal Reserve in Atlanta reported that investment in inventory was down 0.79 percent in Q2 of this year; reduced inventory investment means there is less physical product flowing through supply chains. This trend will eventually shift, but for the short term, at least, continuing overcapacity means that shippers can expect to enjoy low airfreight rates.

Additionally, there will be continued downward pressure on demand as shippers continue the trend of "mode switching" from air to ocean. This trend experienced a brief reversal in 2015, when ocean volumes briefly plummeted due to port labor issues while air volumes remained steady, but the strategy will likely gain more traction in the increasingly uncertain economy. Currently, three factors drive the air-ocean mix:

  • The types of commodities shipped worldwide. Certain commodities, such as raw materials, are less amenable to air transport. Moreover, production trends like nearshoring would reduce the amount of finished goods in transcontinental air cargo flows.
  • Inventory policy. Many companies' focus on minimizing the amount of capital tied up in inventory while goods are in transit tends to favor air transport.
  • The value of the product being shipped. When the total cost of ownership (TCO) is considered, high-value or short-shelf-life goods like pharmaceuticals, fashion retail, and high tech generally favor air, while other industries favor ocean.
  • Service-level requirements. Increasingly, modal decisions are being viewed in the context of the actual service requirement. Some shippers are breaking shipments into separate air and ocean components, with the air portion being the minimum amount required to maintain satisfactory service levels.

As for pricing, air shipping is a fuel-intensive mode, so low oil prices have had an outsized influence on the total cost of transport. With oil inventories at elevated levels, prices—around US$40 a barrel at this writing—continue to be depressed. This, together with overcapacity, is keeping airfreight rates low.

Shippers have become accustomed to using the spot market to get the best pricing for their shipments. Large consumer packaged-goods companies that traditionally would have shipped 80 percent of their cargoes under contract have flipped and are shipping a similar amount of cargo on the spot market. This has made the most sense given market conditions, but if those conditions change, shippers with short positions may struggle to get capacity if their relationships and knowledge of the marketplace have atrophied while the market is soft.

Air forwarder outlook
The picture for air forwarders has been mixed as they continue to adjust (and readjust) to the weak market. In their most recent quarterly reports, the global airfreight forwarders Kuehne + Nagel (K+N) and Panalpina showed growth in gross profit and airfreight volumes. Meanwhile, DHL Global Forwarding and Expeditors saw decreases in both figures. (See Figure 1.) Some of the big airfreight forwarders have viewed the market as ripe for expansion. Others have been "high-grading" cargo—strategically turning away business that would not provide sufficient financial returns.

While forwarders work on their airfreight strategies, vertical integration by retailers will be a key theme for the short term. The most notable example is Amazon, which has announced that it will lease 20 Boeing 767s for use in domestic service. Large retailers such as Wal-Mart Stores might increasingly find benefits in owning their own freight network—particularly if they are faced with soaring logistics costs. Separately, Amazon China has also registered to operate as a freight forwarder in the United States.

While the market continues to struggle with supply and demand, there is hope on the horizon for airfreight operators. In the first quarter of 2016, cancellations of aircraft orders outpaced new orders at Airbus, and the forecasts for growth have been subdued.**superscript{1} While there is still significant overcapacity in the market, this is the first glimmer of hope for rate stabilization in a long time. Until that happens, though, shippers can expect to enjoy continued low rates.

1. Robert Wall, "Airbus Trails Boeing for New Orders and Deliveries in the First Quarter," The Wall Street Journal (April 11, 2016)

Joshua Brogan is a vice president in the Transportation practice of A.T. Kearney, a global strategy and management consulting firm.

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