Friday, January 23, 2015

STEAMSHIP LINES AND RATE STABILITY — CHASING IT THE WRONG WAY?

Container lines struggle with rates in many ways. Part of their efforts includes hedging freight rate volatility in an industry that struggles with pricing stability.

Many levels of carrier management wish to use hedging tools to stabilize and secure revenues, but they cannot always get this up their hierarchies, often with no justification. This is despite the obvious benefits that it can provide in terms of stabilizing future revenue. Moreover many carriers already use hedging tools to protect themselves against foreign currency exchange and fuel risk, so the idea is not completely alien.

Lines are considering the idea of achieving stability through “insurance” or hedging. To achieve this, they would continue to offer prices as per usual, i.e., moving up and down with the market. But they would then buy an insurance contract that offsets the changes in price. For example, if today they buy an insurance contract at $1,100/TEU for next month, they are in effect securing their future income streams regardless of market developments. If next month, the volatility in the market means prices move lower to $950 per TEU the carrier still sells his physical space at $950 as usual. However the insurance contract pays the carrier $150/TEU. The net result is volatility for the carrier is removed and his net income is secured at $1,150/TEU ($950 from shipper + $150 from the hedge or insurance contract). Of course, the reverse of this situation is true, however the end result is the carrier achieves a stable income, but outside of the shipper-carrier relationship.

The problem is that the insurance or hedge is a crutch, not a solution. Hedging is a confirmation that carriers are failing at an important need and speaks volumes. Enough of proving Einstein and insanity. Stop looking at ways to continue to do business as they always do. Nothing changes. So what is the point? It is time for out with old and in with the new for pricing and service.

If you exclude 2009 when the lines laid up many ships to improve rates, what can carriers do? Volatility, almost by definition, shows a lack of control over pricing. And given that ship supply exceeds demand, what are they going to do except the standard practice of cutting rates to fill the ships? What is next—hedging the hedges?

First, it does not look like carriers can offer and protect non-volatile pricing. To a great extent they have lost control over their pricing. And to make it worse, there are other factors. Many shippers are being measured by the rates they pay, so they have interest with rates generally being soft. And carriers have abdicated a lot of market pricing to ocean transport intermediaries/freight forwarders. If we are talking beneficial cargo owners, carriers, with their limited sales forces, pursue a select few, basically the large accounts. The small-medium markets are for the forwarders.

There are two parts to carrier profits. One is cost management. Mega ships offer that with lower expenses. But only a few lines have serious experience with a fleet of ultra large vessels. So how do carriers with one or few megas manage cost enough? What about carriers with no ultra large ships?
That brings the second part for profits. Revenue management. And that may be the biggest weakness with the lines. The challenge of securing containers for mega ships is not giving away the cost benefits in low rates. A few lines have walked away from large shippers and the low rates or closed depots in certain locations where pricing was not attractive. What then happened? Other lines jumped in to get the business that the few deliberately left. What does that say? The question is whether carriers, with their track record, lack the discipline to manage revenue to provide rate stability. If carriers lack credibility to control price volatility--and the market knows it, then they need a new approach.

Part of the problem--aside from a lack of discipline by management--is the use of the monolithic model for pricing. There is a narrow way to deal with business.

All is not lost. Ignore the organization silos. Go the opposite direction. Segment and aggregate the markets in different ways. This is not the standard trade lane, commodities, volumes, etc. approach. Segmentation is a start. From that develop approaches--both pricing and service-- for each segment. This presents targeted alternatives. Create different price and service programs for each segment.
For example, look at the big picture from the supply chain management perspective. What are carriers selling? What are shippers buying? Are carriers providing what shippers really want? Think of carrier service and how it has caused supply chain performance erosion. These ideas are hypothetical without the proper analysis and analytics.

Then, change the whole contract construct. Stop it from being a rate contract with some service points. Make it a supply chain operation and performance contract or whatever works for each segment. Understand what is required for managing a supply chain or whatever—position it for each sector.

There are no quick fixes and easy answers to the problem. Change is needed for all parties. Container line chaos helps no one. Stop thinking of pricing as an absolute. Stop thinking about volatility and hedging it. Start thinking about what is really needed in market as defined by its segments.
With the proper approaches, pricing can stop being the #1 topic. Moving away from the monolithic model may be the only way to achieve market stability---not pricing stability per se.