April 7, 2014
transportation report | Air Freight

Into thin air?

Into thin air?

The beleaguered airfreight industry may see some cyclical sunshine, but secular trends are likely to bar a return to the glory days of growth.

By Mark B. Solomon

You couldn't fault airfreight executives for smiling a bit. It's been a rough 14 years, what with a financial meltdown, two recessions, a terrorist attack and the security measures that followed, rising oil prices, and profound changes in supply chain strategy turning the industry into a shell of its former self. So when the International Air Transport Association (IATA) reported that January volumes rose at their fastest year-over-year pace since 2010 and supplemented the data with an upbeat forecast for 2014 from global airline cargo chiefs, the sighs of relief were almost audible.

Yet it didn't take long for reality to set in, reminding folks how little has changed to disturb the secular trends that took root years ago. In a March 31 report, U.K. consultancy Drewry said volumes dropped back in February, a sign the prior month's activity was due largely to the timing of an early Chinese New Year that led to a surge in volumes before factories shut down for the two-week holiday. What's more, Drewry said that its index of rates across 21 East-West trades declined in February for the third straight month. The drop in January, even in the face of better volumes, "underscores the weakness of a market hampered by oversupply and lackluster demand," the consultancy wrote.

At an IATA cargo conference March 11 in Los Angeles, U.K. advisory and investment banking firm Seabury Group issued a sobering report on the global outlook, saying the "conventional belief that the cargo industry will grow at 5-6% per year does not hold any more." The following day, Hong Kong's national carrier Cathay Pacific, considered a bellwether of global cargo activity because of its huge presence in the space, warned that the business remains "problematic" despite early signs that this year will be better than last. "There is still no sign of any sustained improvement in the market, and some changes in the business appear now to be structural rather than cyclical," says Chairman Christopher Pratt.

But for a mix of symbolism and substance, nothing could match what happened on March 4 at a maritime industry conference in Long Beach. There, the founder and chairman of FedEx Corp.—a man more closely linked to air cargo than anyone in its history—took to the podium to extol the virtues not of his core business, but of sea freight.

Frederick W. Smith delivered a message air types won't find too comforting: that ocean services were becoming increasingly relevant in addressing the needs of the modern-day supply chain and will gain market share in coming years, and that air freight in its traditional form had become less relevant and would continue to lose market share.

For some time, Smith has argued the trends that transformed U.S. logistics and transportation have begun to spread across the globe. Domestically, the market for high-speed and pricey air transportation had long ago been eclipsed by less-expensive ground services that promised precise delivery times to cost-conscious shippers. The same pattern, Smith reckons, is playing out abroad. Shippers and beneficial cargo owners (BCOs) coping with the uneven post-Great Recession recovery and a quadrupling of jet fuel prices over the last decade have stepped up efforts to cut international transportation costs by shifting some of their air shipments to cheaper sea freight. Liner companies are obliging with ever-larger vessels that offer shippers and BCOs unprecedented economies of scale and cost savings.

The modal conversion has been encouraged by historically low global interest rates that have minimized the cost of carrying inventory that spends weeks on the water, Smith said in his remarks.

Meanwhile, shipping lines have followed the lead of truckers in the U.S. and Europe, and have come to market with faster, more efficient, and more reliable delivery services. This is tailor made for practitioners that want to incorporate more time-definite schedules using ocean services. Smith said the push by liners to slow their steaming speeds, a step taken to conserve bunker fuel and reduce carbon emissions, has been a boon to customers because improved ship- and goods-monitoring technologies enable them to deliver goods at "precisely the right time."

Liner companies are also looking to pick off perishable commodities that have traditionally moved via air transport because of their short shelf lives. In late January, Danish giant Maersk Line, the world's largest container line, said that by the second half of 2014, it plans to equip refrigerated containers with an air cleaning system that eliminates mold, bacteria, fungus, and chemicals from the atmosphere and extends the life of cut flowers and fresh produce. By preserving the quality of these products over ocean voyages, Maersk says it hopes to underprice air and grab market share in both segments.

According to Smith, today's global shipping game has three players but only two chairs. One goes to the express services such as FedEx, UPS, and DHL Express, which support fast-cycle shipments of high-value goods through integrated air-truck networks along with in-house information systems and customs brokerage operations. The other goes to the ship lines aiming at the price-sensitive, heavier-weighted portion of the market.

Left standing is the legacy airport-to-airport model populated by airlines and their freight forwarder or agent partners. Unlike the so-called integrated carriers, these companies operate disparate air and ground networks as well as separate information technology (IT) systems and operational processes. These siloed operations have come to be perceived as too slow and inefficient for the fast-cycle crowd. At the same time, they are priced too high for the folks that can tolerate the slower pace of sea freight.

In his remarks, Smith trotted out data showing that air express and ocean services compounded their revenue by 6 percent a year from 2004 to 2012. The traditional airfreight sector, by contrast, showed only 1 percent compounded annual growth during that period.

IATA, for its part, is mindful of the trends. At the Los Angeles event, Des Vertannes, the group's global head of cargo, called on providers to slash 48 hours from their end-to-end transit times by 2020 through an increased use of digital platforms and through more streamlined processes. According to IATA, it takes six to seven days for an airfreighted product to reach its destination, even though it takes less than a day to fly it there. Cutting the delivery window by 30 to 40 percent will increase the industry's relevance to its customers, which is currently on shaky ground, Vertannes said.

Ted Braun, an industry veteran and today a technology consultant to aircargo companies, says those objectives, while laudable, do little to improve transit times and only divert attention away from the crisis of weak demand perpetually plaguing the business. "The real burning problem [is] that there isn't enough economic activity globally to resuscitate air cargo," Braun says. Vertannes' directives "distract folks from focusing on what IATA can't address, much less solve," he adds.

Besides soft demand, the profitability of the traditional model will be impacted by the growing supply of capacity in the lower decks, or bellies, of wide-bodied passenger planes. Belly capacity worldwide will increase by 4.4 percent over the next six months, according to the Seabury report. What's more, belly space will account for about 70 percent of the cargo capacity to enter the global market over the next five years, Seabury says. Freighter capacity will constitute the balance.

Overall cargo capacity has outpaced demand for seven of the past eight years, according to Seabury. The trend is likely to continue, pressuring carrier revenue and margins, according to the firm. In response, carriers have begun parking the older and bigger workhorse freighters like the Boeing 747-400—a wonder plane in its heyday—that are no longer suited for the world air freight lives in. Freighters' high operating costs, persistent overcapacity, and the abundance of cheaply priced below-deck lift could make freighters extinct save for use by the express carriers, some believe.

Observers differ as to when the seeds of change were sown. Brian P. Clancy, a partner at consultancy Logistics Capital & Strategy, says the industry's dynamics mirror those of the high-tech business, which at air freight's peak in the 1990s accounted for about half of the weight carried aboard an aircraft. Since the late 1990s, the relentless shrinking of electronic goods has reduced both product weight and cubic dimensions, thus cutting the tonnage and revenue that air carriers generate, Clancy argues. Yesterday's desktop and laptop are today's smaller and lighter mobile devices, and a growing number of functions once requiring hardware that had to be shipped are now being executed with cloud-based software that doesn't, he says.

At the same time, stiff competition and rapid product obsolescence have caused producers' selling prices to plummet. To bolster profit margins amid these headwinds, they have turned to cheaper modes of transport to drive down costs, Clancy says. The conversion to sea freight is a symptom of a bigger issue rather than an issue in and of itself, he argues.

Today, air freight is mostly relegated to so-called unplanned use, such as shipping emergency consignments like spare parts to maintain production lines, Clancy says. Back in the 1990s, airfreight use was split between what Clancy called "planned and unplanned" users. "The planned users have changed their plans," he says.

Gene Ochi, executive vice president and chief marketing officer for forwarding and logistics giant UTi Worldwide Inc., says the shift took hold during the Great Recession when airfreight volumes collapsed. As air shippers worked through the aftermath, they began using their optimization tools to, in Ochi's words, "reset the predictability" of their deliveries. They discovered that some portion of their air freight could be potentially converted to sea without compromising their delivery schedules.

Just as important, according to Ochi, was the dramatic drop in interest rates that reduced businesses' cost of capital and, by extension, their tab for carrying inventory. No longer was it critical to move goods by air to compress inventory cycle times because the cost of carrying the product had become so low, Ochi says.

At present, there is a tug-of-war of sorts between businesses that have shifted to sea freight and have grown comfortable with it, and those who are riding the wave of cheap borrowing and will jump back to air freight should interest rates normalize, Ochi says. "I do know that if the cost of capital rises, airfreight use will rise with it," he says.

Air usage should also revive once businesses gain more confidence in the global economic climate and their ability to trade, Ochi says. "However, that confidence is not there right now," he says.

As mentioned previously on these pages, for all its challenges, air freight remains a critical part of global commerce. About 35 percent of the value of worldwide cargo, an immense $6.4 trillion, moves each year by air. In addition, few companies will convert all of their air freight to the sea. And there will always be bullish cycles. Seasonal demand for high-end summer apparel and more high-tech consumer goods should boost activity and rates for part of the spring, Drewry reckons.

Shawn Boyd, executive vice president-marketing and sales for freight forwarding behemoth DHL Global Forwarding, a unit of DHL, says customers just don't pick up the phone and tell his staff to shift 20 percent of their product mix from air to ocean. "It's more complex than that," Boyd says, noting it requires a detailed analysis of a customer's shipping characteristics to determine where conversion makes the most sense.

Boyd says air freight is thriving in fast-growing regions like Latin America, which has a broad enough geography to justify the use of the mode. As more global economies rebound and companies are in stronger positions, demand for air will accelerate, he predicts.

For now, however, airfreight growth remains a slog for Boyd's company. In its most recent fiscal reporting year, air tonnage declined 4.8 percent from the year-earlier period. Ocean freight tonnage fell 1.2 percent over the same period.

About the Author

Mark B. Solomon
Executive Editor - News
Mark Solomon joined DC VELOCITY as senior editor in August 2008, and was promoted to his current position on January 1, 2015. He has spent more than 30 years in the transportation, logistics and supply chain management fields as a journalist and public relations professional. From 1989 to 1994, he worked in Washington as a reporter for the Journal of Commerce, covering the aviation and trucking industries, the Department of Transportation, Congress and the U.S. Supreme Court. Prior to that, he worked for Traffic World for seven years in a similar role. From 1994 to 2008, Mr. Solomon ran Media-Based Solutions, a public relations firm based in Atlanta. He graduated in 1978 with a B.A. in journalism from The American University in Washington, D.C.

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