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In most industries, a conglomeration of larger, more powerful companies would have customers worried about higher prices, fewer choices and declining service. Not so in the ocean shipping business, whose dynamics often seem drawn from "Alice in Wonderland" rather than a textbook on classic economics.
The trends of the last two decades are clear:
"All lines know that they've got to perform as advertised or their reputation is going to be shot." -Mick Barr of Procter & Gamble
bigger containerships, bigger and fewer shipping lines, bigger marine terminals. Yet the growing dominance of a handful of players hasn't driven up prices to any meaningful degree. On the contrary, says London-based Drewry Shipping Consultants Ltd., carrier volumes in 1998 were 14.7 percent higher than two years earlier, while revenues were 1.2 percent lower. And despite a trans-Pacific rate increase of around $900 per 40-foot container, 1999 saw a continuation of that trend globally.
The industry's obsession with size is driven by a desire to cut costs in a time of flat revenues. In theory, larger ships translate into lower costs per container slot, and mergers reduce administrative expense in areas such as billing, maintenance, sales and marketing. But with competition fierce, "carriers haven't been able to attack the revenue side," says consultant Jim Dolphin, a principal in the commercial freight practice of Booz-Allen & Hamilton Inc. in McLean, Va.
It's not for lack of trying. Ship lines in the major trades have tried for years to pump up prices, first through rate-setting conferences, then through looser affiliations of rate agreements. (In the latter case, carriers may announce increases as a group, but their members are under no obligation to adopt them.) These joint actions have even spawned pacts to limit the number of slots carriers can offer to shippers, although regulators frown on that practice. In addition, most carriers have entered into space-swapping agreements that are supposed to make better use of existing capacity.
Last year, carriers and shippers were dealt a wild card when the Ocean Shipping Reform Act of 1998 went into effect in the U.S.. OSRA severely weakened the power of traditional rate-making conferences to command the obedience of their memberships, ended public tariff filing by carriers, and allowed confidential service contracts. For the most part, the shipping industry welcomed the legislation, which was supposed to reduce the pressure on carriers to offer similar discounts to multiple shippers. And while it did away with the dreaded "me-too" clause in shippers' contracts, the new law did little to raise rates overall.
The culprit, from the carriers' point of view, was and continues to be overcapacity. For years, carriers have insisted on building ever-larger ships, to the point where Denmark's Maersk Sealand commands vessels that can haul the equivalent of more than 6,000 twenty-foot containers (TEUs). The result has been a glut of available space, with the exception of select lanes such as Asia to North America during the summer and fall Christmas rush.
"It's a bit of a vicious cycle," says Dolphin, describing how bigger ships lead to overcapacity, poor financial results and additional cost-cutting measures - usually in the form of bigger ships. And, despite recent mergers, including P&O Containers' marriage with Nedlloyd Lines and Maersk's acquisition of Sea-Land Service, no carrier has yet achieved the kind of market dominance that would allow it to dictate terms to customers; especially when those customers are behemoths like Sears, Kmart, Nabisco, Procter & Gamble and 3M Co.
Ocean shipping is subject to a curious paradox: It is highly capital-intensive, yet carriers can enter new markets with relative ease. Unlike other modes of transportation, ship lines can quickly redeploy equipment, to take advantage of sudden strong demand. And spare ships are always available for lease or charter. That keeps any single carrier or group of carriers from asserting a permanent chokehold over a given trade.
Beyond the issue of price, merged carriers offer a number of side benefits to shippers, including a consolidation of highly skilled management and a "one-stop shopping" environment for global transportation services, says Theodore Prince, a shipping-industry veteran who now serves as senior vice president of sales and marketing with Kleinschmidt Inc., an electronic services provider.
Prince says carriers are putting too much faith in the belief that bigger ships will reap huge economies of scale. Citing a Drewry study, he says the move from a 4,000-TEU ship to one of 6,000 TEUs saves a carrier just $27 per TEU in a fully loaded vessel.
If shippers have any major objections to carriers' obsession with size, they're keeping quiet about it. The National Industrial Transportation League, the nation's largest lobbying organization for shippers, has never been shy about voicing its members' concerns. Indeed, NITL was one of the chief drafters of OSRA.
But President Edward M. Emmett hasn't heard any complaints about industry consolidation. With conferences dissolving, and confidentiality the rule of the day, shippers "probably feel they're getting a better deal," he says.
Mick Barr, associate director of global services with Procter & Gamble, says ship size hasn't had a major impact on cost and service - at least up to now. He sees a need for larger vessels and fewer carriers as a means of holding down overhead.
Longer term, carriers could begin to assert a newfound power if economies in Asia and elsewhere begin to strengthen, says Barr. That would help to fill up the megaships and give carriers more clout at the bargaining table.
In any case, Barr doesn't expect lines to compromise on service reliability, despite the prospect of congestion at massive new marine terminals. On the contrary, shippers are demanding even better service from vendors, as they struggle to hold down inventories while meeting the needs of their own finicky accounts.
Customers the size of P&G won't tolerate any falloff in quality by carriers. "All lines know that they've got to perform as advertised or their reputation is going to be shot," Barr says.
Shipping-line mergers are simply mirroring a trend toward bigger and fewer in all industries, he says. Companies are slashing the number of vendors and suppliers with whom they work. P&G, for example, now relies on just 10 ocean carriers on a global basis. As a beneficial side effect, Procter & Gamble's growing size and scope has made possible the negotiation of global contracts, in which a multinational shipper puts all of its business on the table in exchange for even better rates.
Still, P&G doesn't want its decisions to be limited by a smaller universe of carriers. "Our preference would be that we make those choices, and have as many choices as possible," Barr says.
One reason carriers might not be enjoying the benefits of larger ships is that competitive pressures have forced them to pass on most of their savings to shippers, says Scott McCauley, manager of export distribution with U.S. Borax in Valencia, Calif.
The trend toward flat or falling rates can be seen everywhere. McCauley says the new megaships have pushed older vessels into less traveled lanes, especially north-south routes. But those displaced ships, with a decade or more of life in them, are only small by comparison. A 4,000-TEU ship can overwhelm smaller trades, sending freight rates even lower.
He doesn't expect the situation to change anytime soon. Citing a container market outlook report published by Drewry Shipping Consultants last October, he notes that ship capacity in the U.S.-to-Asia trade was projected to increase by more than 17 percent in 1999. Yet demand was expected to be up by just 5.5 percent.
Drewry adds that container port handling capacity should grow at the rate of 7.4 percent through 2005, while port-to-port traffic will rise by only 6.8 percent. That gap, says the consulting firm, "represents a further cost imposition to the carrier industry, which must be clawed back through other economies if profitability is not to be further eroded."
Leveling the Field
Smaller shippers, who otherwise lack the clout to score bargains in today's freewheeling competitive environment, are banding together into shippers' associations. Those groups negotiate collectively with carriers for the same kind of discounts available to big multinationals.
Since OSRA took effect on May 1 of last year, the number of new shippers' associations has exceeded those formed in the previous 20 years, says Joseph Saggese, executive managing director of the North Atlantic Alliance Association.
Los Angeles-based Streamline Shippers Association, bringing together the volumes of multiple industries into one contract, has experienced a 26 percent increase in membership over the past year, says Gordon Lee, director of international operations. SSA now boasts 9,000 shippers, a third of whom are currently doing business with the association. Its success is a direct result of OSRA and the simultaneous growth of shipping lines, Lee says.
Saggese's group includes many freight forwarders and non-vessel operating common carriers, the latter of whom act as intermediaries between shipping lines and small shippers. OSRA, which denied NVOs the right to sign confidential contracts yet required them to keep filing tariffs, sent these hybrid entities scrambling for the protection of shippers' associations.
A number of associations are confined to specific industries. Among them is the Wine and Spirits Shippers Association (WSSA), a dominant player in the Europe-U.S. trade. Managing Director Geoffrey Giovanetti echoes the views of individual shippers in finding little negative impact arising from bigger ships and fewer lines.
He is worried, however, about the tendency of carriers to call fewer ports, while serving others through transshipment or overland connections. In the past, he says, carriers have initially opted not to charge extra for the additional service. Gradually, they have begun shifting the cost onto shippers. Boston, Philadelphia and Portland, Ore. are among the ports to have lost direct calls by mainline carriers over the last decade.
Today, carriers are more upfront about the need to recover the cost of serving a region beyond their regular rotation. One big vessel-sharing alliance that terminated calls at Boston imposed a surcharge on local shippers at the outset, Giovanetti says. The additional cost to shippers who want their product in Northern California can run as high as $400 per container for rail service from Long Beach, the nearest loadport.
For now, WSSA has enough choices among carriers or carrier groups to ensure low rates.
But Giovanetti is keeping a watchful eye on the industry. The full impact of the Maersk-Sealand merger has yet to be felt, as the world's largest container line figures out how to combine terminal operations at ports around the world. The NOL-APL union, the second in this round of mega-mergers, is just hitting its stride. And more activity is on the way. Canada's CP Ships will likely continue its aggressive acquisition strategy. And P&O Nedlloyd is said to have amassed a war chest to buy up more lines, in response to the Maersk deal.
"If carried to the extreme, you could get three to five big guys," says Giovanetti. "It's a cause for concern for the future."
Even smaller shippers with a go-it-alone philosophy seem to be getting along. Herbalife International, a Century City, Calif.- based seller of health products, has too many specialized details in its contracts to hook up with a shippers' association, says Kimberly Olsen, manager of transportation planning. It has nevertheless managed to capitalize on deregulation, by using confidential contracts to get satisfactory rates from carriers.
Herbalife had some problem getting space on ships from Asia last year, even to the extent of having to curtail a product launch. But its contract minimizes the number of times that freight can be bumped from a ship, and dedicated chassis pools at marine terminals help to speed incoming product to destination, Olsen says.
The Carriers' View
Carriers are downplaying their revenue woes, insisting that the adoption of larger ships is a long-term strategy that will eventually yield big benefits. And, despite a series of mergers, the number of lines in major markets hasn't shrunk. In the trans-Pacific, eight new services have entered the trade since last May.
"My membership is pretty stable, even with the Maersk-Sealand merger," says Albert O. Pierce, executive director of two trans-Pacific "stabilization agreements." The groups set rate and service guidelines for their members, yet have no power to enforce them.
Pierce calls mergers "a natural outgrowth of world markets." They lead to improved service because carriers can more easily control costs. At the same time, he says, confidentiality has given carriers a degree of contracting flexibility that can benefit shippers large and small.
For Maersk Sealand, the giant new ships provide the ability to address market surges better than their predecessors. With so much space in reserve, Maersk can more easily handle peak periods such as the Christmas rush, says director of marketing communications Tom Boyd.
Year-round, Maersk's strategy is to draw on secondary markets to help fill up its ships at a handful of hub ports. Boyd acknowledges that those big marine terminals are relatively few in number. A port must have 45 to 48 feet of water, depending on how fully the ship is loaded, in its channel. It must offer large amounts of backland for container storage and movement, along with a string of giant cranes that can work ships classified as post- Panamax - too wide to fit through the Panama Canal.
The first of Maersk's "S" class vessels was launched in 1996. The line was able to control costs - as well as shield the ships from prying eyes - because they were built in a private shipyard in Denmark. That gave Maersk a headstart over competing carriers, several of whom are designing and building even bigger ships.
Boyd says the Maersk-Sealand merger was a natural fit between two strong partners who had been sharing vessel space for years. He doesn't believe it will lead to a lessening of choices for shippers. Big as it is, he says, Maersk Sealand today commands only a 12 percent to 15 percent share of the worldwide ocean shipping market. "That's nowhere near what goes on in the rail business."
The Question of Ports
Shippers worry about another potential bottleneck in the ocean-shipping supply chain: ports. As carriers group together into vessel-sharing alliances, or grow through acquisition, they require bigger and more sophisticated marine terminals. Already major ports such as Los Angeles have experienced periodic congestion, made worse by the fact that most carriers tend to call a given port on the same day of the week.
Ten years ago, most container carriers were content with a 100-acre terminal. Today, they need facilities four times that size. Maersk Sealand's new terminal at Los Angeles, the first phase of which should come on line in late 2001, will sprawl over 484 acres, equal to 366 football fields. Even larger terminals are sure to be built.
Port designer Jon Fisher, a senior planner with Oakland, Calif.-based VZM TransSystems, says the trend toward larger terminals won't result in gridlock. Ports and carriers will utilize state-of-the-art computer systems to process containers, plan ship stowage, and link up with inland transport. The result, he says, will be an even higher level of service.
Ports will have to play a kind of real-estate chess game in order to create large enough parcels to handle the expected surge in business. Los Angeles is working to free up parcels of 200 to 300 acres for its tenants, says Marketing Manager Al Fierstine. At the same time, terminal operators must find ways of boosting productivity at existing facilities, whether by stacking containers in the yard, installing new computer systems or increasing hours of operation.
Ocean shippers remain nervous about the future, even as they reap the benefits of excess vessel capacity. In his many public appearances, Pierce has long voiced concerns over the prospect of a handful of mega-carriers dominating the trades. But he doesn't see that happening in the near term.
"Shipping rate levels," says Pierce, "are the bargain of the new millennium."
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