Battered, but still aloft
Soaring fuel costs and security restrictions have pushed the air-cargo industry into retrenchment mode. Still, predictions of catastrophe seem premature.
The air-cargo industry is a resilient beast. It has survived trade wars, the temporary shutdown of operations in the United States after the 9/11 terrorist attacks and the permanent restrictions that followed, countless self-inflicted wounds, and the dysfunctional business model of the airline industry to which it is inextricably linked. Through it all, air cargo has continued to grow, at times representing the only profitable segment of global aviation.
Those are extraordinary challenges indeed, yet today's business environment may present an even greater test of air cargo's mettle. The record run-up in oil and jet fuel prices, combined with stricter security measures and an uneven global economy, has triggered a dramatic reconfiguration of global air-cargo services. Freighter aircraft are being grounded and routes eliminated or consolidated. Markets that once enjoyed all-cargo service are being dropped because the volume or mix of traffic doesn't justify the amount of fuel burned to serve them. And a recently passed U.S. law could lead to crippling delays for domestic and international shipments (see sidebar). All of that means tougher times ahead, not only for cargo carriers and freight forwarders but also for their shipper customers, who may soon find themselves scrambling for the service they need—and paying more when they get it.
Grounded for good?
MergeGlobal Inc., a transportation consulting firm, estimates that 15 percent of all intercontinental freighter capacity—excluding space flown by integrated carriers like FedEx Corp., UPS Inc., and DHL Express, has been grounded in the past 12 months. The situation is likely to get worse. As one executive of a major freight forwarder remarked, "This is just the start."
Other air-cargo executives share that pessimistic outlook. "Worldwide, capacity is being reduced on advanced schedules and on an ad hoc basis," says Chuck Cocci, vice president, global airfreight services for UPS. Should fuel prices stay at current levels or continue to rise, he predicts, it's unlikely that much of the grounded lift will return. UPS relies on a network of carriers to handle freight that doesn't move on its own livery.
Neel Shah, who recently left the top cargo job at United Airlines to become vice president of cargo at Delta Air Lines, says the downshifting of cargo capacity is likely to accelerate after the peak summer travel season. Delta and United do not operate all-cargo planes, relying instead on the lower decks, or "bellies," of their passenger aircraft.
The signs of change are impossible to ignore. In the trans-Atlantic market, Air Canada has stopped flying freighters between Toronto and Frankfurt. To pick up the slack, Lufthansa Cargo has returned to the Canadian market after an eight-year hiatus with two weekly MD-11 freighter flights linking the two cities, with the return leg to Frankfurt routed through Atlanta. Polar Air Cargo has withdrawn its Boeing 747-200 freighters from the New York to London lane, according to a forwarding industry internal document issued this summer. At this time, no direct freighter service links New York's JFK International Airport—one of the world's key air-cargo centers— and the United Kingdom.
Trans-Pacific routes aren't faring much better. As of Aug. 27, Japanese carrier Nippon Cargo Airlines eliminated four weekly flights between Tokyo and New York, while adding two weekly flights to Chicago in an effort to rationalize its U.S. operations. Northwest Airlines, the only major U.S. carrier that operates both passenger and all-cargo flights, has canceled freighter service at Guangzhou, China, and Taipei, Taiwan. Earlier this year, it dropped freighter service over Tokyo to Singapore and Bangkok. Air China has withdrawn one weekly freighter from New York, while Hong Kong-based Cathay Pacific Airways has suspended all flights from Chicago at least through the end of September, the document says.
Miami, the main U.S. cargo hub feeding Latin America, is experiencing capacity shortages on routes into Chile, Brazil, Argentina, and Peru, creating serious backlogs for exports into the region.
One byproduct of all this turmoil is significant rate increases. Polar has raised rates by 40 to 50 percent on cargo flights from Miami to Sao Paulo, Brazil. Chilean carrier LAN Cargo has hiked rates 25 percent from Los Angeles to Sao Paulo. Air New Zealand has slapped a 10-percent general rate increase on U.S.-South Pacific traffic, while China Airlines plans a 10-percent rate increase across its network.
As capacity shrinks, the freight forwarders that manage a sizable share of the world's airfreight shipments are feeling the pinch. According to the industry document, the space situation in the domestic U.S. market and on U.S. export lanes "is becoming critical." Carriers are raising rates or accepting only premium-priced express bookings, and those serving the United States are canceling flights on "very short notice" if inbound volumes are inadequate, says the document. One forwarding executive expects to see rate increases worldwide as more planes are grounded, flights are eliminated, and carriers look to recoup their escalating costs.
In what may have been intended as a heads-up to forwarders, FedEx Chairman and CEO Frederick W. Smith told analysts in a mid-June conference call that international air shipments will travel in "smaller lots, and in door-to-door express movements rather than in the larger consolidations" that have been the industry's bread and butter for years.
Growth despite the pain
At the core of the airlines' capacity problems is the astonishing rise in oil and jet fuel costs.According to the International Air Transport Association (IATA), jet fuel prices averaged the equivalent of $160 a barrel in May, 87 percent—and $75 billion— higher than at the same time last year. This represents a 20- to 30-percent rise in the per-unit cost of flying passengers and cargo, IATA says.
Fuel surcharges have risen in lockstep. At this writing, the average fuel surcharge on flights from the United States to Europe, Asia, and the Middle East is $1.20 per kilogram (2.2 pounds). On the typical flight from the United States to Asia, the fuel surcharge is three and a half times the base rate charged by the airlines to carry the cargo.
Fuel surcharges on flights in and out of Central America and the Caribbean average a steeper $1.50 per kilo, and they have reached $1.80 per kilo to and from South America. The higher charges in the Americas reflect weak northbound demand for cargo services. Because the airlines still have to pay hefty operating expenses for the round trip regardless of freight volumes, they're forced to charge more for fuel to compensate for the dearth of revenue-producing freight on the northbound leg.
Yet despite the pain of higher fuel costs, on a global scale, the industry is not contracting. According to data from Boeing Co., worldwide air-cargo traffic has grown an average of 4 percent since 2004, when the spike in oil prices began. By contrast, from 1990 through 1992, the period of the last major oil price surge, annualized air-cargo growth averaged a paltry one-half of 1 percent.
The difference today, say Boeing analysts, is that stagnation in established economies like the United States and the Euro Zone is being somewhat offset by strength in Russia (where firstquarter air-cargo volumes were up 40 percent from 2007), the Middle East, China, and emerging markets. Intra-Asia and Asia-Europe demand remains robust, the company says.
Lest anyone thinks soaring oil and weak economies have dulled the industry's appetite for cargo aircraft, Boeing notes that the world's fleet of B-747 freighters has increased to 335 in April 2008, up from 317 in the same period of 2007. Twenty-eight fuel-efficient 747-400 freighters—both new equipment and aircraft converted from passenger configuration— have entered the fleet during that time, while 22 of the older, fuel-guzzling 747-100 and -200 models have been taken out of service.
Skeptics might say Boeing paints an overly rosy picture because it's in the business of selling airplanes. For its part, the company acknowledges that it has significantly cut its growth forecasts from the early part of the decade. Still, it stands by its forecast of a tripling of air-cargo traffic by 2025 and a doubling of the world's freighter fleet in that time.
"The growth of the industry has been affected by oil prices, and that's an understatement," says Thomas Crabtree, regional director of business strategy and marketing. "But still, there's growth."
Multimodal middle ground
While the carriers and forwarders struggle to stay aloft, higher fuel prices are also affecting those who pay the industry's bills. Rising fuel costs and improved ocean shipping services are pushing air-cargo users to migrate to lower-cost ocean freight, some experts claim.
Products like "OceanGuaranteed," a day-definite service launched in 2006 by trucker Con-way and third-party service provider APL Logistics, are designed to exploit that trend. APL Logistics moves cargo via ship from Asia to the U.S. West Coast, where the goods are pushed into Con-way's ground transportation channel for delivery to the consignee's door in the United States and Canada. The product offers faster delivery than traditional ocean shipping service and is significantly cheaper than all-air movement.
APL and Con-way do not disclose what portion of their business comes from traditional air shippers. However, executives from both companies have said from the start that air-cargo users would be a fertile market for the service.
"We do hear a lot of comments from shippers about the rising cost of fuel and security, and we have heard anecdotally that some international shippers are re-examining how they use international air freight and are emphasizing ocean where possible," says Con-way spokesman Gary N. Frantz. Demand for the service has grown in each quarter since its launch, he adds.
OceanGuaranteed and other multimodal services may be enjoying increasing success, but as long as the cost of inventory obsolescence remains a concern for supply chain managers, air cargo will be the preferred mode for moving highvalue goods to market. However, because cargo generates such a large percentage of an airline's international revenue— as much as 45 percent, depending on the carrier— any threat of modal conversion is worrisome. And if the U.S. experience is any guide, airlines should be concerned.
The U.S. airfreight industry prospered in the mid to late 1990s as demand surged for high-value technologies to build out the Internet, develop telecommunications systems, and prepare for Y2K. But the dot-com implosion and the subsequent recession caused shippers to rethink their inventory management strategies. Regional warehousing and distribution networks became the rule, and many businesses shifted to lower-cost expedited trucking services, which promised time-definite deliveries instead of the fastest transit times.
Since then, the map of U.S. commerce has been redrawn. Today, the typical domestic shipment moves less than 500 miles, an easy one- to two-day reach by ground transportation. As a result, regional trucking models have thrived while the domestic airfreight business has stagnated.
The shift to cheaper modes is still evident today, as UPS and FedEx, the leaders in domestic air services, struggle with volume weakness. During the FedEx conference call, Smith said the company's air express unit would be used more as the domestic link for inbound international movements than for all-domestic transportation services.
Ironically, ocean freight will likely be part of the solution to the dual problems of higher airfreight costs and shrinking global capacity. There has been renewed interest in "seaair" service, where goods move much of the way by ship and then are transferred to air for the final leg of the journey. Cocci of UPS says sea-air transit times are normally seven to eight days, versus three to five days for air. The idea is to find the middle ground between a cheaper but slower all-water voyage and a faster but costlier all-air move.
Ripe for improvement
For now at least, the air-cargo industry's best defense against volatile oil prices may be to identify other areas where it can wring out costs and improve efficiencies. A prime target is the physical handling of documents and freight.
It is estimated that 70 percent of an air shipment's total journey is actually spent on the ground, often in bottlenecks that undermine air carriers' efforts to capitalize on their signal advantage: speed. The industry has been criticized for having too many people "touch" the cargo as it moves through the supply chain, and for relying too heavily on paper-based, manual processes.
Many see increased automation as the best solution for those problems. Airlines and forwarders have been slow to embrace automation, but one area where it is gaining traction is in shipment booking. Christopher Shawdon, vice president, logistics solutions for Unisys Corp., estimates that only about one-third of all international bookings are transacted online. Unisys offers Cargo Portal Services, an e-booking service that is free to forwarders; airlines pay a $1 fee for each transaction.
Shawdon believes the industry's long-standing reluctance to fully embrace automation will crumble as soaring fuel costs force companies to opt for Web-based solutions rather than maintain staffs to develop, implement, and service proprietary software and systems. Many other aspects of air-cargo operations are also ripe for improvement, and none are likely to escape scrutiny as costs increase. Higher oil and security costs, Shawdon adds, "will affect everybody's thinking."
For airlines and forwarders, an even stiffer test than gyrations in the oil markets may lie ahead. A law enacted late last year requires that by October 2010, each piece of cargo moving in the belly of passenger aircraft be screened before the goods are put aboard. The law, which covers all passenger flights operating in domestic and international service from the United States, is estimated to cost $3.75 billion over 10 years. Because no taxpayer money will be involved, airlines, freight forwarders, and shippers will have to bear the expense of developing and administering the program.
For an industry already coping with onerous fuel surcharges and a shaky U.S. economy, the idea of screening each piece of cargo conjures up visions of massive service delays that could cripple a business built around speed of delivery.
The Transportation Security Administration (TSA), which oversees the program, says if enough inspections are performed upstream in the supply chain and the burden is shared equally among shippers, forwarders, and airlines, the mandate can be met without forcing airlines to check all of the cargo at airports prior to boarding. To that end, the TSA has developed the Certified Cargo Screening Program, or CCSP, an initiative designed to create a "chain of custody" and make the shipper, the forwarder, or the airline voluntarily responsible for verifying that a shipment has been screened. TSA was expected to issue an interim directive for CCSP last month.
Many forwarders contend that voluntary compliance with a legal mandate is a recipe for chaos, and that TSA's notion that the screening responsibility will be divided equally among shippers, forwarders, and airlines is, at the very least, dubious. They also argue that post9/ 11 security laws, which rely on knowledge and verification of shipper profiles, are already a cost-effective deterrent to terrorists.
Small to mid-size forwarders contend they lack the capital to buy expensive equipment needed to screen the cargo, thus disqualifying them from the CCSP. The result, they warn, could be extensive shipping delays and many smaller forwarders being forced out of business.
A recent survey conducted by the Air Forwarders Association and the National Customs Brokers & Forwarders Association of America found that, unless federal funds were made available, all AFA members with less than 10 offices would opt out of the TSA program. If that happens, airlines will have to pick up more of the screening slack, as they will be responsible for inspecting unscreened freight tendered by those forwarders, says Brandon Fried, executive director of the AFA.
The new rules are so draconian, some forwarding executives say, that they threaten to destroy an entire industry. "The attitude of the TSA reminds me of the … statement by a U.S. army captain who, during the Vietnam War, says "we have to wipe out the village to save it,'" wrote Julian Keeling, the CEO of Los Angeles-based forwarder Consolidators International Inc., in a recent company newsletter.
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