Quarterly Transportation Market Update: Will consolidation change air cargo?

The air cargo industry has recognized 2013 as the 100th year of commercial aviation; but so far, the sector’s expected profit margin of 1.3 percent is very weak—and shippers concerned about securing enough air capacity are taking notice. Furthermore, says the International Air Transport Association (IATA), current returns on investment are less than half the industry’s cost of capital, which continues to erode shareholder value and add to shipper anxiety.

However, according to Tony Tyler, IATA’s director general and CEO, during the course of this year governments should resolve to bring down the barriers to connectivity and growth and help airlines get back on a path to prosperity. “This can be done by addressing excessive taxation, high infrastructure costs, onerous regulation, and improving the capacity and efficiency of airports and air navigation services,” says Tyler. “A strong air transport sector is in the self-interest of governments eager to support economic growth and development, and trade is the key to that growth. For that,” he adds, “connectivity is critical, and it’s aviation that makes that happen.”

The big story for U.S. air shippers, however, was the latest episode of airline consolidation, with American finally signing a deal to merge with U.S. Airways last month. While it’s far from clear what the implications will be for U.S. shippers, consolidation has been good for carriers.

Currently, more than 70 percent of the U.S. market is in control of just four airlines: the new American, United, Delta, and Southwest, (which acquired AirTran three years ago). However, industry analysts say that change will not be dramatic in the short term.

The new American Airlines brings both carriers to the same level as Delta and United—not only in terms of cargo payload, but also in global reach. Shippers will be left with just four U.S. mega-airlines to pick from, and the merger will likely bring to a close more than 30 years of U.S. airline consolidation.

US Airways CEO Doug Parker will run the new airline—now the world’s biggest—with American CEO Tom Horton serving as chairman. Parker notes that the combined airline will have the scale, breadth, and capabilities to compete more effectively and profitably in the global marketplace.

“Our combined network will provide a significantly more attractive offering to shippers, ensuring that we are always able to take their cargo to its destination,” says Parker. Yet to be measured is what impact—if any—the merger of American and US Airways will have on existing code share agreements with other airlines.

Industry analysts dismiss this as a minor concern, however.

“Unlike the passenger market, where code sharing provides added convenience for the passenger and potential additional traffic for the airline through the use of computerized reservation systems, air cargo does not make much use of code sharing,” says Russell Tom, regional director of airline market analysis for Boeing Corp.

For example, bookings by shippers and forwarders are made directly with the individual airlines, often contracting for capacity over a period of time rather than for a specific trip and through a neutral site, which is often the case for passenger bookings.

“Because of this difference in the nature of the businesses, the benefits of code sharing to air cargo are minimal, and that is not expected to change with consolidation in the industry,” adds Tom.

Duopoly dominates
According to Boeing, the integrated carriers comprising the freight duopoly of UPS and FedEx continues to dominate the domestic U.S. air cargo market with about 65 percent of the traffic measured in revenue.

In 2012, American and US Airways combined accounted for about 3 percent of U.S. domestic air cargo. Currently, scheduled air cargo carriers—which includes combination carriers such as American and US Airways—carry about 14 percent of the U.S domestic air cargo. Boeing analysts say it’s a safe bet that, domestically, the dominance of UPS and FedEx would continue, especially since they offer more popular express-type services.

Internationally, UPS and FedEx account for about 9 percent of the revenue carried, and American and US Airways account for about 2 percent. “So we don’t really expect to see a negative impact for the two giant integrators overseas,” says Tom.
It is not expected that a merger of American and US Airways would have a noticeable effect on UPS and FedEx in the international market, add analysts.

Jerry Hempstead, president of parcel consultancy Hempstead Consulting, agrees, noting that the commercial passenger airlines are simply creating four mega-hub-and-spoke competitors that will have very similar coverage. “The hubs may differ, but we could see greater competition for passengers and cargo since there will be multiple options between city pairs,” says Hempstead. “Empty below deck capacity will mean competition for freight especially on longer flights.”

According to analysts like Hempstead, it appears that UPS and FedEx, along with niche cargo operators like Atlas Air World Holdings and Air Transport Services Group, are going to be doing the “heavy lifting,” thereby creating the greatest fight for air cargo.

Both Tom and Hempstead observe that while consolidation reduces the number of airlines, it does not appreciably change the choices that air shippers have. Recent merger activity has been among the U.S. legacy carriers, and these airlines have had relatively small air cargo operations compared to other airlines from other regions.

Rate picture blurry
Brandon Fried, executive director of the Airforwarders Association (AfA), says that the recent merger announcement of US Airways and American creates worry that there will be higher rates. However, knowing that two weak carriers could combine as one for a more certain future may offset this. At its darkest hour of need, it looked like American might actually disappear, thereby depriving shippers of scores of jumbo freighters.

“The grounding of freighter aircraft is always a concern because commercial passenger planes cannot handle everything, and forwarders need access to these all-cargo operators for outsized pieces and large special project shipments,” says Fried.

At the same, though, Fried acknowledges that freight forwarders have adjusted their business models in response to adverse economic demands over the past several years. Few rarely focus on one single transport mode and most offer ancillary services formerly reserved for third party logistics providers.

“For example, forwarders once specializing only in next-day air cargo may now offer various air service levels and ocean shipping to fit tight customer budgets,” says Fried. “Storage, pick-and-pack, and kitting services are common ways to increase revenue while addressing increasing customer needs.”

And other industry analysts insist that the current air cargo rate structure will not be dramatically altered in any case. “If your volume is down, you can expect carriers to raise your rates,” says Charles “Chuck” Clowdis, managing director of transportation advisory services at IHS Global Insight.

“And if your volumes are up, expect to be asked to lunch and continue to pay at the existing level.”

Base, rates, Clowdis adds, will be raised on slight scale in any case. But there’s always a margin for error, he adds. “Capacity is still abundant, and fuel costs are stable,” he says. “High tech shipments are always subject to volatility, and a dramatic global economic recovery is still possible. But the freight forwarder who tells you that he expects increased earnings from increased air cargo is looking into the wrong crystal ball. It just ain’t gonna happen.”