Inside Logistics

Grounded

The pros and cons of the air cargo crisis


October 16, 2009
by Deborah Aarts

Air cargo rates are down and carriers are hungry for business. It should be a feast for shippers. But with airlines barely surviving, it might be worth taking a more cautious approach. Deborah Aarts surveys the view from the top.

Last December, Jeff Cullen found himself in what would normally be a very uncomfortable position.

Just days before Christmas, the CEO of the North American operations of freight forwarder Bellville Rodair International and his team got an order to move a rush shipment from China to the US. The cargo was substantial enough to warrant two full 747s. Such a massive request at a time of year when air carriers are typically at peak demand would usually be impossible.

Yet the company had no problem. It was able to easily secure two charter planes and ferry them in from another site. And when the shipment ultimately had to be pushed back a day, the company was not hit with any penalties for keeping the aircraft grounded.

Cullen was shocked. “In the past, trying to find space around Christmas for 100kg of cargo, much less two 747s full of it, is like trying to find fairy dust,” he tells MM&D. “There was just no peak season last year.”

A brutal year

Around the world, shippers and intermediaries are reporting variations on the same story.

The air cargo sector has been ravaged by the recession, arguably more significantly than any other mode. As the most expensive means of transportation, it’s the first thing shippers cut back on when times are lean.

According to the International Air Transport Association (IATA), year-over-year traffic volumes have been down by double digits since January. From December through April, demand was off by more than 20 percent. While traffic has been increasing slowly since May, the sharp drop in business has had a brutal effect on the industry.

“The changes have been incredible, nothing anyone ever would have expected,” Cullen says.

Jamie Porteous, executive vice-president of sales and service at Mississauga, Ontario-based Cargojet, says he has never seen the airfreight industry in such a state. “In past downturns, the air cargo market was somewhat sheltered,” he says. “This is the first time I’ve seen it so dramatically affected.”

His company’s business is down about 10 percent—better than the IATA average, but still painful. He attributes the drop in part to the general listlessness of the economy and in part to modal shift: many customers have decided they can get by using expedited ground options instead.

The relative affordability of holding inventory compared to transporting it is another reason for the drop. In the past, when the economy tanked, many shippers rushed to reduce inventory, and they often turned to air cargo to do it in a hurry. This time around, it’s cheaper for companies to hang on to stock than it is to get rid of it.

These pressures are magnified by the high fixed costs of air transport. For most carriers, the drop in shipment volumes is not quite enough to warrant flight cancellations. That forces them to pay 100 percent of the cost of a flight that may only be 80 percent full. The alternative—grounding part of a fleet—is even more unattractive, as it means paying mortgage and storage fees without any revenue at all.

So things are very turbulent in the air cargo sector. Eighteen months ago, airlines were fretting about fuel surcharges. Now, some are questioning their very survival.

Coping strategies

Carriers are coping with the downturn in several different ways.

Cargojet, for example, has reduced its operating costs by cutting capacity, laying off staff and pressing its own suppliers for lower rates. Air Canada Cargo is taking a different approach, targeting shippers of recession-proof commodities like food, pharmaceuticals and mail.

But the most common strategy has been to lower prices. Excess capacity has pushed freight rates down across the board. Cheaper fuel has also contributed, and surcharges are now far less than they were two or three years ago; on some routes, the rates are one-fifth of what they used to be.

“There’s been a downward trend in airfreight rates,” confirms Jim Ramsay, vice-president of air and ocean freight for UPS Supply Chain Solutions. “It’s been driven a lot by [the lower price of] fuel, but also a downturn in demand.”

Cullen calls the rate drop unprecedented.

“[Carriers] may have the same volume of traffic, but where they were charging a dollar, now they’re charging 50 cents,” he says. “For certain pieces of business, the selling price today is what the margin used to be.”

In some extreme cases, airlines have eliminated the freight charges entirely, asking customers to simply pay variable costs like the fuel and security surcharges in efforts to keep planes moving.

Unsurprisingly, this strategy is not popular among other airlines.

“Clearly the situation is not sustainable. Just charging variable costs is not going to bring in any money,” reports Michael Morey, director of marketing, business development and network operations for Air Canada Cargo.

The shipper advantage

For shippers, this may not appear to be a problem at all. Those that already use air cargo are getting cheaper rates, and many are welcoming the situation as a reprieve after years of sky-high prices.

Some have stepped away from long-term contracts and are tendering out each major shipment, which is driving prices down further as carriers clamber for the business.

Since air shippers are in such short supply, they currently hold an unusually large balance of power. This heightens the appeal, particularly for companies that have not traditionally been able to afford air shipments. So is it worth it for such firms to take advantage of the low rates?

Unless they intend to make airfreight part of their standard transportation use, experts agree it’s a perilous proposition.

“If you move to a premium mode like airfreight because in the short term it makes sense for you, you could potentially get into a difficult situation down the road,” Ramsay says.

“The good thing about downturns is that they eventually become upturns, and at that point you’re going to see some changes in the dynamics of the industry. You’ll want to make sure you’re managing your business in such a way that you don’t suddenly have costs growing faster than you would have otherwise.”

Cullen has a similar view. When the current logjam releases, he says, the global economy is going to have to deal with the shock of going from waived freight rates to full price in a hurry. And the change may be coming sooner than people think.

“Whether anyone wants to admit it or not, [airlines] are choking off supply in certain areas to try and get to a place where prices can be driven up again.”

The post-recession prognosis

There’s a sense among the experts that the air cargo landscape is going to be very different on the other side of the recession. Some carriers will likely come out leaner and stronger than before. Many will regroup and emerge looking quite unlike their former selves. Some, unfortunately, won’t make it through at all.

Morey advises shippers to take caution before chasing down the lowest-price option, because the carriers that survive won’t soon forget w
hat happened during the downturn.

“Once things stabilize, we’ll go back to the traditional markets where it’s more profitable for airlines,” he says. “The shippers that play the game smartly—and there are some out there—might be paying us five or ten cents more per kilogram than they might be able to get on the market, but they’re also taking a long-term perspective. When the other carriers leave and the market shrinks, they’ll have a guaranteed channel. And the price will be much higher for everyone else.”