CSCMP's Supply Chain Quarterly
December 16, 2018

Balancing act

Carriers are trying to prop up rates by reducing capacity, but they could counterbalance that by sharing the cost benefits of operating efficiencies with their customers.

The past year has brought a great deal of change to the ocean shipping industry. Realignment among carriers has transformed their economic underpinnings in ways that are still playing out and are not yet fully understood. Nevertheless, structural oversupply is still the dominant force affecting how the market for ocean carriage will shape up over the next few years.

Some carriers thought that a possible solution to structural oversupply was to create a step-change in operating costs by pooling resources. The motivation behind the "P3 Alliance" proposed by Maersk, MSC, and CMA CGM was to realize efficiencies by combining the assets of three of the largest container carriers into a single, optimized fleet deployment. The Chinese government's surprise ruling denying the formation of the alliance caught a lot of people by surprise—especially the three carriers, which had to that point been offering rate reductions to key customers based in part on those efficiencies.

Article Figures
[Figure 1] Port of Los Angeles loaded containers
[Figure 1] Port of Los Angeles loaded containers Enlarge this image

Smaller carriers see this ruling as something of a victory. What is still unclear, though, is how committed the P3 carriers remain to driving value through scale. Aggressive growth through merger or acquisition could drive the economies the larger carriers initially sought through alliance and create competitive cost and service advantages.

This interesting set of developments is coming at a time of slow but steady growth in ocean freight volumes. For example, as shown in Figure 1, in April the Port of Los Angeles reported year-on-year increases in imports and exports of 11 percent and 8 percent, respectively, with overall year-to-date totals up 8 percent over the same period in 2013. While this is the first traffic increase seen at those ports in some time, these healthy volume increases need to be considered in the context of the oversupply that exists in the market.

Carriers still have orders with shipbuilders for larger-sized vessels, so more capacity is on the way. Meanwhile, they've had to become much cleverer about managing their current capacity. Using such practices as slow steaming and layups, ocean carriers have created capacity constraints on certain lanes. Additionally, the research firm Alphaliner reports that ocean carriers are continuing the record-level scrapping of smaller vessels seen in 2013. Even with these aggressive capacity-control levers in place, vessel space is still increasing at 8.4 percent, or slightly faster than current demand, according to Alphaliner's Cellular Fleet Forecast.

While demand certainly has not been growing at the same clip as capacity, volume growth and capacity management have allowed carriers to influence pricing to their advantage, even if only for short periods of time. The ebbs and flows of ocean freight rates have enabled a handful of carriers to scrape together meager profits, and the industry as a whole is financially well ahead of the darkest years of the recession.

Efficiencies could keep rates down
Rate volatility is having a negative impact on shippers and their ability to accurately forecast costs. While rates generally were down for most of 2013, spasms of variability continue to show up in spot pricing, even on relatively stable trade lanes. This has caused many shippers to consider their options when it comes to contracting with ocean carriers.

One such option for shippers is "index-based pricing," which has been around for many years but hasn't taken off in a big way. Index-based pricing locks in pricing at the beginning of a contract term and fluctuates according to the performance of a predetermined index at set intervals. One of the biggest obstacles to implementation is identifying a mutually agreeable baseline index. Carriers favor solutions from within the industry, such as Container Trade Statistics' World Liner Data Limited database.

But shippers would be wise to consider all options if this concept is attractive to them. Linking pricing to an index supplied by an industry with antitrust immunity might be cynically viewed as a conduit for reintroducing general rate increase (GRI) clauses to shippers' ocean contracts. (GRI clauses commonly are struck from large shippers' contracts, but many small and medium-size shippers have such clauses in their contracts.) Shippers should be wary of GRI clauses because they transfer risk from the carrier to the shipper, they remove an incentive for carriers to invest in increased efficiency, and they generally are based on pricing data provided by carriers or carrier organizations.

Taking the longer view, when supply and demand do eventually stabilize, container carriers will have more market power than ever. At the same time, they will be more efficient than ever, having been forced to run leaner and leaner throughout the recession and slow global recovery. The high-fixed-cost nature of the industry, along with the pursuit of contribution margin, will ensure that these efficiencies continue to develop and that the cost benefits are shared with shippers, even with a bit less competition in the marketplace.

Lars R. Eismark is a partner at the global strategy and management consulting firm A.T. Kearney. 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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