Transpacific ocean cargo lanes require long-term carrier investment

Editor’s Note: Brian Conrad, Executive Administrator, Transpacific Stabilization Agreement, will be presenting his views at an industry event staged in Southern California this week focusing on Asia Pacific maritime issues.

In an exclusive interview with our sister publication – Supply Chain Management Review – he addressed some key questions posed by ocean cargo shippers.

Supply Chain Management Review: Can you briefly go over the most urgent challenges facing the carrier community today?

Brian Conrad: Current market uncertainty worldwide has made it difficult to plan for long-term reinvestment in and configuration of carriers’ global services. Markets are increasingly news-driven and prone to wild swings. To the extent that trade and finance are linked, a combination of political, regulatory and financial uncertainty have constrained investment and economic activity. At the same time, when we look behind the numbers we see signs of gradual recovery and slow growth, so we are generally optimistic for the Asia-US trade going forward over the next 18 months. It should be stressed, however, that there is still little expectation that trade growth will return anytime soon to the robust levels seen in 2008. Furthermore, a range of non-economic factors also drive liner shipping, among them the overall supply of ships and the price of fuel.

Carriers’ global financial losses over 2009-11 present a major challenge. With the exception of at most two quarters of surging demand in 2010, container lines have been caught in a downward rate trajectory. Many carriers have priced their services at levels below profitability, choosing instead to focus on ensuring some contribution to cover their variable fleet operating costs. This approach has driven some lines to attempt to ‘’save their way’’ out of unprofitability by employing larger ships with lower unit slot costs – a strategy that is not sustainable in the long term. Lines will ultimately need to achieve returns above their cost of capital in order to adequately maintain service levels and reinvest for the future.
 
The two most difficult challenges in the transpacific, however, involve two prevailing shipper perceptions – that winter season promotional spot rates should be carried over into 12-month contracts, and that carriers should price their services not according to any measurable supply chain value proposition, but solely according to whether the supply-demand balance at contract signing is seen to be in the carriers’ or the shippers’ favor.

Supply Chain Management Review: How does TSA prepare for contract negotiations?

Brian Conrad: Keep in mind that TSA does not negotiate service contracts on behalf of its members. They negotiate individually and confidentially, and we have no specific knowledge of their internal processes for doing that. However, as you know, TSA does typically establish voluntary guidelines that carriers can use as guideposts in their individual negotiations. The process for that can generally be described as follows:
TSA lines each bring to the table their best assessments of current market conditions and forecasts developed internally and by independent outside industry sources, including their customers. They consider both macroeconomic trends and market conditions in major moving commodity segments.
They assess cost increases during the past year and likely increases over the coming contract term, in areas such as inland transportation, cargo handling, equipment management, vessel feeder and charter costs, IT spending and regulatory compliance.

Finally they look at rate trends relative to cost recovery and profitability targets. The objective is to begin contract negotiations each year from a compensatory baseline coming out of the winter season, and then adjust rates and charges in light of forecast conditions.

Supply Chain Management Review: Can you provide a brief description of the contracting procedures?

Brian Conrad: Again, the contract process varies by line and by customer account.

Generally speaking, 90 percent of Asia-U.S. container cargo moves under some 10,000 contracts each year. TSA announces its recommended revenue program guidelines around the beginning of each year to provide the market with an initial sense of carriers’ concerns and priorities around rates, charges and service.

Carriers initiate contact with existing accounts to discuss renewal and reach out to shippers in particular market niches they want to pursue. Carriers also receive bid requests from shippers and from 3PLs acting on their behalf.

Carriers and customers discuss their needs for the coming year – volume, equipment, route segments, transit times, price – and more detailed negotiations continue from there, in a series of back and forth discussions that typically run from February through April of each year. Both shippers and carriers generally have to compromise on various issues during contract negotiations; it’s a two-way process.

In that context, it is important for all contracting parties to recognize that financially healthy, competitive carriers are in the best interests of the trade as a whole. For that reason, both shippers and carriers need to take a long-term view of their relationship and negotiate accordingly.

Supply Chain Management Review: Where do you expect shippers to compromise this year? And why?

Brian Conrad: It is not useful to view negotiations in adversarial or zero-sum terms. It is the carriers’ job going into negotiations to know their costs and to resist competitive pressures to discount where it threatens their overall viability. Carriers should also not pass up opportunities to explore service options that can offset potentially higher rates with supply chain efficiencies or cost savings – or perhaps lower rates in exchange for benefits that help them reposition equipment or spread out cargo volumes year-round.

Shippers, meanwhile, might rethink the long-held view that transportation/logistics is simply a cost on the P/L statement to be bargained down to meet overall internal landed cost targets. Instead, many customers have found the contract framework useful in achieving service benefits, in the form of cost savings and competitive advantages across the supply chain, by sharing information and building in mutual service commitments, shipment visibility and performance measures.

Supply Chain Management Review: Have carriers adequately addressed over-capacity issues?

Brian Conrad: TSA as a group does not involve itself with issues related to capacity management; those decisions are made entirely by the individual lines based on their service goals, competitive objectives and assessments of market conditions.

It is worth pointing out in a general sense, however, that the increase in global capacity seen in recent months as new, larger ships are delivered, does not have the same effect in the transpacific as in other cargo markets. Infrastructure constraints, mainly channel drafts at most U.S. ports and in the Panama Canal as well as terminal productivity levels, will continue to limit average vessel size and loadability through 2013. So the largest ships, and many of the cascaded ships they replace, will remain in other trades.

Supply Chain Management Review: In the best-case scenario, where do you see future opportunity and growth?

Brian Conrad: We see the U.S. market steadily recovering, with demand already picking up in the automotive sector and green shoots in many areas of retailing, including apparel, footwear, home/garden supplies, appliances and toys. We expect other segments to pick up as the job market and housing crisis improve.

A rising entrepreneurial middle class in Asia is likely to translate into new business formation with an eye to exports as well as domestic consumption. A large share of two-way transpacific trade is related to two-way manufacturing and retail investment – Japanese auto parts feeding U.S. plants, hard drives made in Thailand, frozen potatoes and poultry for U.S. fast food chains throughout Asia. That trend is likely to continue and expand. 

Trade is remarkably simplified with the ability to market worldwide over the internet, with business-to-business portals, social media and online payment. New bilateral and multilateral trade agreements will offer even small and mid-sized businesses in emerging Asian markets expanded opportunities to conduct global business across the Pacific. All of this new trade growth will in turn translate into cargo growth as 90 percent of physical goods moves by ocean, much of it in containers.