Core Category Detail

by Rachel Rutkoski

Executive Observations
Transportation project activity increased by 45 percent in the third quarter compared to the second quarter of 2008, with average spend increasing significantly due to several large global ocean freight and small parcel projects. Project activity was mixed between truckload, less than truckload, ocean freight, air freight, small parcel/courier services, and warehouse logistics services. We saw several large corporations start their ocean freight sourcing exercises in September, ahead of the traditional sourcing time period of October – March. We also observed companies examining non-traditional project spend areas such as warehousing and storage services, and becoming more conscientious of all aspects of their logistics/transportation spend. Overall, savings rates were favorable, which continued to validate that freight volumes are down across all transportation modes and that the industry remains a shipper’s market.

Many small parcel shippers have been able to achieve deep discounts off of list price along with aggressive incentive revenue bands. Carriers have seen a significant downturn in freight demand and are becoming extremely aggressive with pricing to secure freight from the competition.

Oil prices have settled below $100 per barrel after seeing record levels in the previous quarter. Fuel continues to be a main focus for the transportation industry, but not to the same extreme as in prior quarters. Prices for diesel, jet fuel, and bunker fuel all decreased in the third quarter.

Third Quarter Trends
The American Trucking Association announced that the trucking industry saw a 3.6 percent reduction in seasonally adjusted truckload volume in July. July is typically a slow month due to summer shutdowns at manufacturing and assembly plants, but July’s loads this year were even softer than expected. Unlike truckload, the less-than-truckload market experienced a slight increase of 0.2 percent in seasonally adjusted shipments.

Driver turnover for large truckload carriers ended the second quarter at 83 percent, the lowest driver turnover rate since the first quarter of 1998.

International air cargo freight experienced three consecutive months of decreasing freight volumes, with a 2.7 percent drop in August on the heels of declines of 1.9 percent in July and 0.8 percent in June. Carriers within the Asia-Pacific region posted the biggest loss, with a 6.5 percent decline in July and a 6.8 percent decrease in August. Since Asia-Pacific carriers represent 45 percent of the global air freight market share, their recent decreases have had a significant impact.

Other regions such as Europe and the United States showed weak results in air cargo volumes in August. European carriers reflected a 0.9 percent decrease in freight, while U.S. carriers reported a slow 0.8 percent growth.

As ocean freight carriers are seeing a decline in demand, new vessel orders that were ordered several years ago (when demand was at record highs) are finally being delivered. Carriers are being forced to decide if they should try to sell the new vessels, keep them in hopes of an upturn in demand, or convert the ships to more profitable usages, such as tanker vessels or cruise ships.

Ocean freight trade lanes, such as Asia to Europe, that have historically been relatively well-balanced are now seeing a true imbalance as regional economies change. On routes moving between Europe and China, 60 percent of the containers are now returning empty, when in the past most containers moved full.

An agreement between the International Longshore and Warehouse Union (ILWU) and the Pacific Maritime Association (PMA) was reached at the end of July, avoiding any disruptions in service at West Coast ports. The two sides were negotiating terms for a new six-year contract for more than 25,000 dockworkers at 29 West Coast ports.

Bulk ocean rates on the Baltic Dry Index continued their decline from May’s historic high, dropping by approximately 40 percent in the third quarter to reach a two-year low. Analysts are attributing the decline in rates to China’s decrease in demand for bulk materials due to a combination of factors: ongoing rumors involving agreements between Chinese steel mills and Brazilian iron ore miners, the Olympics, several weather-related disasters, and the global financial credit crisis.

Both UPS and FedEx announced service-level enhancements in the last quarter. UPS has announced changes to their On-Call Pickup services that went into effect in July. They increased the number of zip codes in which the service is available and extended pick-up times for numerous zip codes. On-Call Pickup allows for customers to have a shipment picked up from a home or office by scheduling the pickup either online or over the phone. FedEx has enhanced service for customers shipping from Europe to major U.S. East Coast cities. Those that previously had to use two-business-day services can now utilize overnight services. Those that use next-business-day shipping now have pick-up times that are up to six hours later. The improved service levels will be available to cities such as Washington DC, New York, Newark, Boston, Baltimore, and Philadelphia.

CH Robinson has acquired Transera, a Canadian project freight forwarder, expanding its overall freight-forwarding capabilities. By acquiring Transera, CH Robinson has extended its offerings to include over-dimensional and heavy lift shipments.

The U.S. Department of Transportation (DOT) announced its intent to extend the Mexican cross-border trucking pilot program for an additional two years. The program allows Mexican and American drivers to deliver goods across the U.S./Mexican border. Administration reports in favor of the program have stated that the program is cutting transportation costs and reducing truck emissions by eliminating short-haul drayage trucks at the border. Quickly after the DOT announced the program extension, the House of Representatives voted overwhelmingly in favor of stopping the program. The program’s future will now be determined by the Senate.

Fourth Quarter Trends
While the air freight industry has seen recent relief in jet fuel prices, it is still considered to be in “crisis” mode. The industry is predicting an annual loss of $5.2 billion due to earlier high oil prices and lower demand. Experts are calling for the industry to reduce overall costs and improve on operational efficiencies in order to combat the losses that have already occurred this year.

In the ocean freight industry, analysts are predicting that the fourth quarter will bring record-low container rates on routes that have historically been high volume due to the widespread downturn in demand. Some are predicting that rates may decline as much as 75 percent versus last year’s rates. With the global economy in a state of flux, some ocean freight companies may choose to either cut shipping schedules and/or reduce capacity. Companies should make sure they examine or determine alternative routes if a lane they currently utilize is removed.

The Clean Truck Program is slated to be implemented October 1 at the Port of Los Angeles, banning all trucks made prior to 1989 from entering the port and levying a fee to those trucks that do not meet the 2007 EPA emission standards. The objective of the Clean Truck Program is to reduce air pollution caused by harbor trucks at the Long Beach and Los Angeles ports by at least 80 percent over the course of five years.

FedEx will begin domestic next-business-day service in Mexico in early October with FedEx Express Nacional. This service level will be available for delivery to any address in Mexico and feature online tracking of FedEx’s money-back guarantee.
In the midst of a challenging Less-than-truckload (LTL) environment, YRC Worldwide has announced that the company will speed up the overall integration between Yellow and Roadway. Since the merger in 2003, the company has reduced duplicate efforts/activities and will now offer one comprehensive portfolio of services to try to increase density within their network and reduce fixed costs.

While the fourth quarter typically represents a peak shipping season for the trucking industry, analysts are warning trucking companies against banking on seeing any relief this peak season. Freight is predicted to remain weakened through the end of the year and into 2009.

Industry Grapevine
TNT has been the center of rumors that both UPS and FedEx may be interested in acquiring the company. While all companies involved deny these rumors, similar rumors surfaced between Exel and UPS right before Deutsche Post World Net bought Exel to form DHL Exel Supply Chain.

Ariba’s take: If the rumors prove to be true and TNT is acquired by either UPS or FedEx, the acquiring company will significantly strengthen their global footprint and competency. While the industry is still waiting to see the full extent of DHL’s announced reorganization, what is clear is that DHL will increase focus on their core competency, coverage and service within Europe. If UPS or FedEx were to acquire TNT, they would be able to compete directly with DHL in Europe and stand alone as a true global provider with significant strength in the United States and Europe.

Saia, Inc. has announced it will reduce its workforce by five percent due to lower-than-expected freight demand, with most of the job cuts coming from field operations and the corporate office. Saia is ranked No. 25 on the Transport Topics 100 listing of U.S. and Canadian for-hire carriers.

Ariba’s take: Saia is just another example of a trucking company taking measures to reduce costs. Carriers such as JB Hunt, Werner Enterprises, and Knight Transportation have removed long haul over the road capacity, and will focus more on regional moves or intermodal moves. Statistics for the first six months of this year concerning the number of trucking companies filing for bankruptcy estimate that 88,000 trucks, or 4.5 percent of the trucking industry’s capacity, has been directly affected. Most of the bankruptcies have come due to the downturn in the economy, lower freight demand, and, in particular, high fuel costs. As we move into the last quarter of the year, carriers are going to examine any and all ways in which they can improve operational efficiencies and cut costs in order to survive the downturn in demand, and avoid the same fate that has closed the doors of many trucking companies this year.

Category Perspective:
Air Freight

by Rachel Rutkoski

Industry Overview
The global air freight market is estimated at over $50 billion. The industry accounts for only five percent of the world trade volume by weight. However, air freight cargo value accounts for over 36 percent of total cargo value shipped. The value of goods shipped annually via air freight is valued at over $3.25 Trillion USD. The industry can be categorized into a small parcel sector (shipments up to 150 pounds) and heavy air freight (shipments above 150 pounds). Typical types of commodities shipped via air freight are apparel, high-value consumer electronics, and high-tech computer components. The shorter transit times associated with air freight is appealing to these commodities due to the difficulty in long-term demand forecasting.

Market growth is driven by the state of the global economy. However, specific events, such as natural disasters or political unrest, can have short-term effects on available capacity. The market, in terms of kilograms shipped, is expected to grow by 4.8 percent annually over the next five years, according to the International Air Transport Association (IATA).

The air freight market is serviced by international providers who primarily grow through acquisitions. These suppliers are classified as either asset-based or non-asset-based. The top suppliers in this industry include DHL, FedEx, UPS, BAX Schenker, Kuehne & Nagel, Panalpina, Eagle Global Logistics, and Expeditors. These global suppliers account for less than 30 percent of the entire market and, as a result, competition remains fierce in this sector in order to secure business. Suppliers must distinguish themselves through a combination of price and service. The most competitive pricing tends to be realized by buyers with large spend amounts in excess of $2 million annually.

Market Trends
In early 2008, airlines throughout the world were reporting a growth of just below five percent in tonnage carried when compared with their respective 2007 tonnages. However, by the end of summer 2008, the industry reported the first year-over-year freight declines (1.9 percent) since 2005. Freight has historically been strong within Asia-Pacific, between Asia-Pacific and North America, and between Asia-Pacific and Europe, but recently Asia-Pacific carriers have been hit the hardest with freight demand reductions. North America is historically the largest region for freight in terms of number of shipments, but it is expected to be surpassed by Asia within 20 years. Global air freight market shares by region in terms of tonnage are Asia-Pacific (45 percent), Europe (27.3 percent), North America (16.9 percent), Middle East (seven percent), Latin America (two percent), and Africa (one percent).

While world trade grew 7.5 percent in 2007, air freight growth in 2008 was forecasted to be four percent, showing that competition for freight volume is strong from other modes of transportation. However, as of August 2008, the industry is showing a slight decrease in volumes. Within North America, there has been a significant modal shift towards ground transportation, as more trucking companies expand next-day service areas. Globally, ocean freight is providing fierce competition, as ocean carriers have increased their sailing schedules and offer lower prices. Three main trends are occurring in the air freight industry right now that are affecting the broader market: 1) global economic turbulence, 2) high fluctuations in oil prices; 3) loss of business to other modes of transportation, specifically ocean freight.

Cost Drivers
The demand for freight capacity, and the space or total weight of cargo that an aircraft can carry on a route, is what drives pricing. At a macro level, global trade levels influence freight capacity demand. At a micro level, capacity demand is driven by passenger levels (baggage takes priority), and seasonal cargo flows (for example, the pre-Christmas retail flows from Asia into North America and Europe). Rates are usually quoted by weight in kilos.

Surcharges to capture variable costs are often levied. All airlines impose a fuel surcharge, which is passed on at cost by forwarders. Security surcharges are also a common levy charged by suppliers.

Suppliers maximize profits in two ways. First, they buy cargo capacity in bulk (usually in Unit Load Devices (ULDs) or aircraft containers). Second, suppliers optimize the cargo mix by combining light and heavy cargos together. Heavy or dense freight often attracts a discounted rate because this allows the forwarder to optimize revenues by mixing it with light cargo. Light cargo, also known as volumetric cargo, is the predominant type of cargo shipped.

Supply Management Best Practices
Ariba has identified the following best practices:

• Identify companies aggressively looking for market share since competition is intense, especially among the top 20 worldwide air freight forwarders
  
• Aggregate global spend since the supply base is capable of managing global projects
  
• Incorporate good quality data, a clear service-level definition, and common pricing methods for multi-site operations to encourage cost reductions from suppliers

Category Assessment
Leverage: High business impact with a low supply risk (minimal obstacles to switching suppliers and a competitive supply base)

Successful Strategies: Standardization, LTA, and resourcing.

The business impact is high since products transported via air freight are time-sensitive. In addition, since there is a large supply base, switching suppliers is relatively easy.

Air freight companies are constantly looking to improve their negotiating positions with the airlines. The bigger their cargo spend with key airlines, the greater their buying power and ability to pass on these benefits to their customers.

The majority of air freight business is conducted by way of rate agreements. One- or two-year contracts are attractive to most air freight forwarders, since they can then buy capacity and give a firm commitment on contracted tonnage or spend. Buyers can also benefit with reduced pricing if they are willing to commit.

Case Study
Current Situation: A multinational pharmaceutical manufacturer was looking to drive cost savings in their air freight spend by rationalizing their supply base. They had a diverse and fragmented supply base with up to six suppliers in each of their countries of operation. At the same time, key service levels, driven by both the nature of the product and their clients, had to be strictly maintained.

Solution: Only air freight forwarders that could provide 100 percent coverage of all requirements in the countries of origin of the cargo were considered. The cargo routes were grouped at the country level, which allowed optimal aggregation of spend. A qualifying round was crucial to ensure supplier quality, and only suppliers that could fully conform to all requirements were invited to the final negotiation.

Impact: The results included a price compression in excess of 20 percent, and a rationalization of the supply base to one preferred air freight forwarder per country of manufacture.

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