The Curious Case of Carrier Profitability

The pandemic has rattled global supply chains due to demand shocks caused by the lockdown. Its impact accelerated the impetus for companies who were in the midst of change to relocate their manufacturing sites and to switch modes from a just-in-time model (lean inventory) to a just-in-case model (higher inventory). For companies who were not already embarking on a transition, the crisis has caught many flat-footed because the rate of change in the external environment is moving faster than the rate of change occurring in their boardrooms.

According to a recent Gartner poll, 33 percent of supply chain leaders have already moved their sourcing and manufacturing activities out of China or plan to do so by 2023. ASEAN has already overtaken China to become the EU’s biggest trading partner and Vietnam (ranking as the third biggest apparel exporter after China and Bangladesh) has become the biggest winner of the economic grouping after ratifying the EVFTA (European Union-Vietnam Free Trade Agreement). 

The biggest pull factors from countries hoping to attract these companies include concessions on land, power, water, capital flows and tax breaks. The biggest push factors include cost, quality and supply chain resilience, responsiveness and flexibility. Though they are not always at the forefront of global trade issues, shipping lines and the transportation services they provide have a lot to do with the push factors of supply chain resilience and supply chain volatility due to port to port transit times, which often are the longest component of the entire logistics journey of a good or product.

Eight international carriers split into three different alliances control 80 percent of the market today. Up until the end of 2019, more than half of the carriers were unprofitable. Due to the previous surge of China as the world’s factory over the last two decades, much of the global carriers’ business has revolved around transporting cargo between the U.S. and Asia and Europe and Asia, and carriers have had to plan for, allocate and optimize their networks to support the growth of global shipping along these trade lanes.

Consider the trunk line carrier services from Shanghai to Los Angeles, which benefit from the deployment of ULCVs (Ultra Large Carrier Vessels). The benefits of ULCVs include reduced slot costs, reduced bunker fuel costs and reduced break-even cost on a per-TEU basis. However, in Intra-Asia routes where shipping ports are not deep enough to accommodate large vessels, feeder vessels are used instead to ply the smaller ports and ‘feed’ the collected cargo into the larger vessels at the larger transhipment hubs (Busan, Hong Kong and Singapore). The model works much in the same way as a feeder bus service in a local neighborhood feeds passengers into interchanges, where trunk services take over for the inter-city routes.

There are two main competing strategies in the market for this network logic - a point to point model versus a hub-and-spoke model. For this, we can take a page out of the competing models between Airbus and Boeing for the airline industry. Airbus believed in building bigger aircraft such as the A380 as they envisioned a future where the hub-and-spoke model would be preferred by their passengers. Bigger aircraft would benefit from a hub-and-spoke model because such aircraft would fly between large airport hubs and passengers would then switch to smaller planes to get to their final destinations in smaller cities.

Boeing, on the other hand, envisioned a future of point-to-point flying where passengers would prefer to fly directly to the smaller cities, completely bypassing the mega-hubs. They kept their planes to a moderate size to cater for this. At the start of 2020, Boeing seemed to have been winning the battle and their bet seemed to have been proven right due to surging orders, but after the pandemic struck throwing the entire industry into disarray, both manufacturers have been hit hard. It remains to be seen how travel patterns may change because of the pandemic and which air transport model will eventually dominate. 

Returning to the shipping industry, carriers that have invested heavily in the hub-and-spoke model - like Maersk and CMA CGM - comprehend the physical constraints of the landside port infrastructure. The economies of ship size at sea are severely restricted by the diseconomies of ship size at port. These include port-side restrictions on total cargo throughput due to labor productivity (labor relations and unions), port operational efficiency (crane loading speeds, berth capacity and storage capacity) and infrastructure productivity, which includes hinterland connectivity like intermodal networks, highways and on-dock rail facilities. All these are factors that prove that the hub-and-spoke model cannot be established solely through the carriers' efforts. 

Port infrastructure investment encompasses a hybrid of various blended investment schemes involving sovereign governments, commercial manufacturers and shipping lines themselves. ULCVs require deepwater harbors and dredging is a costly enterprise. This makes only a handful of ports naturally viable as hubs. 

Enter one of Asia’s most vibrant hubs, Singapore. Its investment in the Tuas mega port is a bold statement in its positioning as an anchor hub for South-East Asia. However, as it takes time for construction to occur - Singapore’s mega port will only be completed by 2030 - the introduction of too many large capacity vessels ahead of demand will hamper each carrier's quest for profitability, even if generous incentives are provided by port operators.

The effect of cascading large vessels into smaller routes has been done to make space for the ULCVs on the trunk routes, but this has done little to mitigate the oversupply and overbuilding of ships over the last decade. Market supply in container capacity has outstripped average annual demand growth of four percent by an additional six to eight percent. In what has been a relative period of economic boom after the global financial crises in 2009, the oversupply of ships has primarily been due to the low build price of ships. 

The use of size to push down freight prices and capture more market share in this case has its limits in the international shipping network. Indeed, for a long time, this was the running methodology guiding shipping line executives - scaling up drives down per-unit costs, which equates to longer-term profitability.

However, some researchers (such as Gkonis and Psaraftis) have found that increased ship sizes by themselves do not equate with lower unit costs. They have identified several other key factors like route characteristics, accounting practices, prevailing level of freight rates, prevailing level of charter rates, load factors and the construction price of ships. Further, analysts believe that most carriers have already maxed out the number of container slots they can build on a vessel and the corresponding size of the vessel itself. 

An industry that has been focused on cost leadership for a very long time and neglected service loop and transit time reliability has led to recurring financial losses for most shipping lines over the last few years. In the next part, we’ll look at the new tactics shipping lines have adopted and the consequent impact on supply chain volatility for shippers. 

Luke Robert consults for SME and MNC clients in navigating trade tariff agreements, industrywide regulation and the impact of political and economic trends on their supply chains. He is currently with one of the largest global forwarders in the world. The views expressed here are entirely his own.