U.S. air exports posted an all-time record last year, but air cargo carriers continue to grapple with a number of issues that could affect long-term growth.
According to a new report from the Atlanta-based Colography Group, there were nearly 92.4 million air export shipments from the U.S. in 2005, an increase of almost 8 percent over the prior year. It was the first time the industry had topped 90 million shipments. Carriers also set air export records in terms of revenue, which totaled $9.5bn, and tonnage, at 6.2 billion pounds.
Ted Scherck, president of The Colography Group, attributes the stellar performance to the impact of a weaker dollar and strong markets around the world. "Beyond the macro factors, however, the results demonstrate that airfreight is an increasingly vital force in enabling global trade and supporting world-class international inventory models," he says.
Yet the industry's future is clouded by several negative trends. Chief among them is the soaring price of oil, which has driven up operating costs to a level that can't be recouped through rate increases. As a result, major airlines have continued to lose huge amounts of money, despite cost-cutting efforts.
Fuel isn't the only worrisome factor. Labor continues to pose a big challenge for airlines, says Scherck. Both FedEx and UPS are engaged in prolonged negotiations with their pilots, who have been without new contracts for several years. Scherck doesn't believe a pilot strike looms in the near future, "but there is always that risk."
Rising interest rates are jacking up the cost of capital for airlines. Over much of the past decade, stubbornly low rates have helped to spur growth in the U.S. economy, but that trend is finally coming to an end. "There's no end in sight" to the Federal Reserve Board's newfound determination to raise rates, Scherck says. And the higher cost of money won't just affect airlines directly; it will likely put the brakes on economic expansion, with a corresponding drop in demand for premium airfreight services.
Air carriers are facing a stronger competitive threat from surface transportation. According to The Colography Group, ground parcel shipments reached 4.1 billion in 2005, with tonnage topping 42 billion pounds and revenue surging above $26bn. All were industry records, with an increase of nearly 5 percent for tonnage and more than 8 percent for revenue.
Regional less-than-truckload (LTL) transportation continued to boost its share of the U.S. market in 2005, to 80.6 percent from 80 percent in 2004. National LTL operators saw a drop in market share, to 19.4 percent from 20 percent. The numbers reflect a greater dependence on short-haul, regional carriers to distribute goods less than 600 miles. Two-thirds of U.S. goods already move less than 700 miles to end users, Scherck says.
Overall, U.S. LTL shipments in 2005 rose to 131 million from 128.3 million, while revenues of $22.8bn topped the prior year by nearly $2bn, and tonnage climbed to 139 billion pounds from 136.2 billion pounds.
Back to Earth
With their supply chains under growing pressure to cut costs, shippers are increasingly turning to surface transport options, Scherck says. Integrated carriers such as FedEx and UPS can oblige them with their own extensive ground networks, but the trend nevertheless drives down rates overall.
Air cargo carriers on international and long-haul routes are more protected from surface options - meaning mostly ocean transport in this case - but there still is cause for concern. In 2004, global surface tonnage grew faster than air tonnage for the first time in two decades, Scherck says. Even with longer supply lines due to offshore manufacturing, shippers are finding opportunities to save money through greater use of ocean freight. They are driven by a combination of factors, including the rising cost of jet fuel and service improvements by steamship and trucking operations.
"For many companies capable of migrating to surface from air, modal conversion is becoming an increasingly viable option," Scherck said in notes accompanying a recent Colography report on industry prospects for 2006. "Indeed, if fuel prices remain at their current levels, modal conversion may become a competitive imperative for shippers and goods at the margin of the cost/value proposition."
Traditional industry cycles could also serve to dampen the fortunes of airfreight carriers. Scherck worries that carriers, bolstered by strong demand for their product in recent years, aren't preparing for the inevitable dip to follow. On the contrary, they are planning new capacity that doesn't account for a downturn. They risk being saddled with too much space when a hot market cools off.
That happened in the trans-Atlantic trades, in which carriers invested heavily when demand surged, only to be stuck with idle capacity. The current magnet for air cargo business is Asia, especially China, where economic growth has approached 10 percent a year. Such a rate of expansion can't be sustained indefinitely, yet Scherck believes the air cargo industry as a whole "risks repeating the sins of the past. Will they end up with too much capacity, chasing too few shipments? My suspicion is yes."
The ability of traditional airlines to compete with integrated, all-cargo carriers such as FedEx and UPS is limited by their need to put passengers first. As passenger planes get smaller, and are required to turn around at the gate faster, it becomes ever more difficult to find the room and time for freight other than mail, Scherck says.
Internationally, it's a different story, where the introduction of larger widebodies offers ample room for containerized freight on passenger aircraft. As a result, Scherck says, integrators have a smaller share of that market.
A Surge for United
United Airlines, which exited Chapter 11 bankruptcy protection early this year, is still struggling with the economics of running a global operation based on the hub-and-spoke model. Yet despite continuing difficulties on the passenger side, the carrier has seen stronger than anticipated demand for its cargo services, says Neel Shah, vice president of sales and marketing with United Cargo. Approaching mid-year, it was 6 percent ahead of plan on the cargo side.
Both the inbound and outbound freight sectors have been solid, Shah says. He attributes the results to a strong U.S. economy, which has fueled imports from Asia and other regions. The dollar's relative strength against the yen and euro, at least until this year, was another factor. And the now-weakening dollar should help U.S. export volumes this summer, especially for high-value products such as agricultural perishables. "A couple of pennies makes the difference whether you buy lettuce from California or Spain," Shah says.
The industry's biggest vulnerability remains its fuel surcharges, a necessary response to high oil prices. "A lot of shippers are hitting that crossover point between air and ocean," Shah says. "There's a decent amount of discretionary freight out there."
United Cargo's business plan assumes that oil will hover around $67 per barrel through the rest of the year, although it was closer to $70 as of the beginning of June. Still, Shah believes United will keep on exceeding the cargo industry's performance as a whole, due to better service, more effective selling techniques and efforts to form "deeper relationships with our customer base." While it relies almost entirely on independent freight forwarders to generate cargo business, United joins them in making proposals to certain shippers.
Shah admits that the integrated carriers are posing a greater challenge to passenger airlines with cargo operations. "They're getting a lot more aggressive on the heavy freight side," he says. At the same time, the two sides aren't always adversaries. UPS's supply chain unit is a "huge customer" of United.
Integrators have the advantage of a variable costing model for heavy freight, depending on how much space is left on their planes after parcels and small packages are accounted for. As a result, Shah says, "they are formidable competition."
He argues, however, that the involvement of integrators in heavy freight waxes or wanes according to the strength of their package business. During peak seasons, they are less likely to pursue the heavier types of shipments. That gives combination airlines like United a more consistent image in the eyes of the shipper, Shah says.
Still, United's cargo operations are driven largely by the needs of passengers, who account for 95 percent of overall revenues. Shah agrees that the greater demands on aircraft efficiency, with the need for tighter turns at the gate, make it difficult to move large volumes of freight on narrow-body passenger planes. "We're working within the new realities of what we have to do as an airline," he says.
That said, United president and chief executive officer Glenn Tilton remains "incredibly supportive" of the cargo industry, and the airline's cargo division is encouraged to pursue all possible opportunities, Shah says. For the most part, United's major passenger markets are also the strongest opportunities for soliciting freight.
On the operational side, United outsourced its ground-handling functions two and a half years ago. Most of the business went to two entities, Swissport Cargo Services and Worldwide Flight Services. Following a difficult transition in 2003, the arrangements are now operating smoothly, Shah says.
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