Navigating Risk And Change In Surface Transport Markets

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As shippers look to move their goods across the country and across oceans, demand for freight transportation has been rising faster than capacity in some markets. During the past decade, surface transport modes have increased their total share of the nation’s shipments, while airfreight’s share has declined. As surface transportation markets have grown in importance to a range of businesses, they have begun to change in dramatic ways that are making carriers’ capacity, availability and adherence to shipping schedules more uncertain. The demand and supply shifts that are occurring in these markets are expected to increase shippers’ risks during the next several years.

Thus, shippers should use the fourth quarter to take stock of their shipping needs and carrier options. During the fourth quarter, freight volumes and rates fall toward the low point that always occurs early in the new year, when demand is slack in the aftermath of the holidays. With the best season for contract negotiations on the horizon, IBISWorld has put together an overview of the issues complicating national trucking services, deep-sea cargo transportation and rail cargo transportation. Shippers that address these issues in negotiations are more likely to find carriers or forwarders that consistently deliver their goods on time and with minimal added costs.

National Trucking Services

Recent price gains in the national trucking services market belie its fragmented and highly competitive nature, as well as the recent drop in diesel prices. During the past three years, annualized price growth of 3.0 percent has resulted from carriers’ inability to expand capacity at the rate of demand growth. This inability stems from a driver shortage, an issue that has plagued the market for several years and was exacerbated in July 2013 when new hours of service restrictions from the Department of Transportation went into effect. The lasting effects of these recent regulations are forecast to help drive price upward at an annualized rate of 3.2 percent during the next three years, as demand growth continues to outpace carriers’ ability to boost capacity.

However, savvy shippers can take several steps to secure capacity and combat price growth. Being a good customer goes a long way in this market, and discount availability remains high despite the upward price trend. Shippers that reduce a carrier’s costs through consistent shipments of similar volumes that are well packaged, and loaded and received smoothly, are well positioned to negotiate for customer-specific discounts and freight class exceptions. Freight class exceptions are applied before discounts, multiplying their effect, and they also reduce a shipper’s risk of incurring penalties associated with misclassifying goods.

An additional consideration for shippers is that the recent drop in diesel prices will hit its limit soon. Saudi Arabia has recently refused to cut production, in part to test the cost effectiveness of fracking in the United States, and has helped send the world price of oil to less than $70 per barrel in December. However, this price is near the limit at which Saudi Arabia’s budget will balance, according to an International Monetary Fund Gulf Cooperation Council report. The inevitable return to growth for oil prices combined with the relatively low operational costs of natural gas vehicles will increase the latter’s attractiveness as a fuel source. Natural gas’s rising popularity is also driven by stricter emissions standards, a growing natural gas infrastructure and bolstered environmental awareness among consumers and shippers. As a result, high-volume shippers such as Owens Corning are working collaboratively with carriers to transition to natural gas. Major carriers that are leading the charge toward natural gas fleets, such as freight integrators UPS and FedEx, are in a better position to pass fuel cost savings on to shippers.

Deep Sea Cargo Transportation Services

Since the recession, shippers have increasingly turned to ocean carriers to save on transportation costs. Due to carriers’ economies of scale, which result from their use of massive container ships, waterborne transport is vastly cheaper than shipping by air, which is the main form of external competition for deep-sea carriers. Still, substantial growth in trade volumes since the recession have not resulted in healthy profit margins for deep-sea carriers. In 2013, only six of the largest 19 carriers operated in the black, and IBISWorld estimates that carriers’ average profit margin is just 1.4 percent in 2014. Additionally, carriers have substantial debt burdens due to their massive capital investments in container ships. Carriers are financially distressed and have a high risk of bankruptcy, which boosts the likelihood of service disruption and limits the attractiveness of contract shipping.

On the surface, these market characteristics do not appear favorable for shippers. However, ocean carriers’ low profit margins and resulting high bankruptcy risk stem from persistent overcapacity, which has kept freight rate growth miniscule during the past three years. During this period, carriers undermined their profitability through heavy discounting, which had been the primary strategy in their battle for market share. Over the three years to 2014, the price of deep-sea cargo transportation has risen at an annualized rate of 1.2 percent. Because this growth is below inflation, it represents a general increase in shippers’ purchasing power.

Freight rate growth is expected to pick up slightly during the next three years as a result of the large-scale capacity coordination that expanded alliances will allow. The newly signed 2M pact (between market leaders Maersk Line and Mediterranean Shipping Co.) and improved cooperation among G6 members (six other major carriers) will help carriers cut costs, but their cost savings will not be fully passed on to shippers; in helping major carriers coordinate capacity and boost market share, stronger alliances heighten carriers’ pricing power. For shippers, their benefit will be the increased shipping lane (i.e. route) options that vessel sharing allows, more frequent departures and, in theory, faster transport times.

Achieving the latter benefit is proving difficult in practice. Carrier alliances have come partly in response to a new generation of container ships, which are capable of holding more 20-foot equivalent units (TEUs) than the commercial offices of a single carrier can fill. Unfortunately for shippers and the carriers using the ships, the world’s ports are not yet equipped to handle the massive ships. The shift to larger vessels has occurred much more quickly than anticipated by the twin ports of Los Angeles and Long Beach, which handle roughly 40.0 percent of the nation’s imports. As a result, current delays at these ports last up to two weeks. Other major global ports, including Oakland, Rotterdam, Hong Kong and Singapore, are also struggling to adapt to the new ships. To limit their losses, some ocean carriers and the trucking companies awaiting their cargo have introduced congestion surcharges, adding to the already high costs shippers incur from a major delay.

When composing an RFP and negotiating with ocean carriers (or the freight forwarders that subcontract them), shippers should inquire about the key sources of risk in this market: shipping rates, punctuality, and surcharges. When inquiring about shipping rates, shippers should uncover the frequency and magnitude of recent general rate increases (GRIs) over their shipping lanes, and how future GRIs will affect their contract shipping rate. Punctuality questions should address any recent or expected problems with megaships interfacing with the ports that will load or unload the shipper’s cargo. Surcharge questions should focus on fuel surcharge rates, but should also delve into the more than 350 different surcharges used in this market (by the estimate of trade magazineInbound Logistics).

Rail Cargo Transportation Services

Rail cargo transportation is the epitome of a seller’s market. Only seven Class 1 (i.e. long-haul) railroads carry freight in the United States, and a few large railroad holding companies dominate among regional and shortline railroads (Class 2 and 3 railroads, respectively). Shippers’ choice is constrained by location, and generally, no more than two rail carriers serve a given route, creating a duopoly. Many routes are served by only one carrier. The “captive” rail shippers along such routes account for about 20.0 percent of rail traffic, according to Curt Grimm, Professor of Supply Chain and Strategy at the University of Maryland. Because carriers use differential (i.e. customer-specific) pricing, a shipper’s ability to leverage alternative rail carriers and transport modes plays a large role in determining their price. Captive shippers pay higher prices as a result, as do shippers whose goods cannot be cost effectively moved by truck or pipeline (air shipping is generally not cost effective for the many heavy, low-value goods that are transported by rail).

Rail carriers’ market power is reflected in their high profit margins, which average about 29.7 percent. Although their profitability makes them stable business partners, the substantial market power and low competition it reflects have negative consequences for shippers. In 2014, railroads fielded a barrage of customer service complaints from shippers whose goods were delayed. The shippers claimed the delays were meant to enable the railroads to increase crude-by-rail traffic. Railroads deny favoring crude oil over other commodities, but the fact that crude-by-rail traffic has grown at an annualized rate of about 140.0 percent over the past three years, according to the Association of American Railroads, has undoubtedly stressed railroad capacity over certain routes and contributed to delays.

During the three years to 2014, rail transportation prices have risen at an annualized rate of 3.2 percent, which reflects a constriction in shippers’ purchasing power. Still, due to the market’s differential pricing, shippers can take several steps to improve their contract terms. First, shippers should learn as much as they can about the costs the carrier incurs from moving their goods. Shippers can use this knowledge to derive the railroad’s pivot point, which is the maximum discount that allows the carrier to profit from the additional volume the discount brings them. Shippers should also use the availability of any potential substitute carriers (e.g. other railroads or alternative transport modes) as leverage in negotiations. Shippers can contract multiple carriers and incentivize strong performance by rewarding the one with better rates or service with an increasing share of their business. Additionally, railroads are often responsive to the business needs of their shippers. Shippers that can show how a discount will make their business more competitive, and hence boost their volumes, are more likely to convince the railroad to grant it. Finally, shippers can stay informed of trends and concerns in the market and take part in advocacy efforts by joining industry trade groups, such as The National Industrial Transportation League or Consumers United for Rail Equity.

The Route to Lower Risks and Costs

Freight markets naturally carry a significant level of risk due to the possibility of capacity and demand mismatches on any given route, the potential for bottlenecks at major hubs and carriers’ general reliance on petroleum-based fuels, which have volatile prices. In addition, regulatory agencies have a major hand in shaping the dynamics of these markets; regulatory interventions have altered the landscapes of the national trucking market and the deep-sea cargo market during the past three years. Conversely, the deregulation of railroads in 1980 and the ensuing low level of regulatory change from the Surface Transportation Board, which has economic oversight over railroads, has been influential in shaping that market. By understanding the issues currently troubling these transportation markets, helping their carriers lower costs and leveraging all viable transportation options in negotiations, shippers will be better equipped to minimize the risks and costs associated with moving their goods.

For a printable PDF of Navigating Risk and Change in Surface Transport Markets, click here.


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