The Year Ahead: Cargo service in jeopardy as economically fragile airlines continue to cut service

The past year can hardly be described as a banner year for the air cargo industry.

It has been a rather turbulent period marked by economic uncertainty, ongoing heavy losses for the airlines, and questions about security and the impact of measures on that front on the flow of goods. The end result is not good news for shippers.

Cargo executives would like to see a brighter 2003, some noting that things could hardly get worse than they have been, but much of the uncertainty remains. If anything, it has been increased by the specter of war in the Middle East.

“It’s totally unpredictable,” says Claude Morin, Vice President for Cargo of Air Canada, citing economic uncertainty and concern about military action in Iraq. “If I’m optimistic, I’d say the first quarter of 2003 can’t be as bad as 2002. This year the first quarter was abysmal, then things picked up.”

Another major factor will be security. More than one year after the terrorist attacks of September 11, it is still not clear how exactly new security regulations will pan out. The industry is looking to the US, which has yet to finalize its rules on that front. Bill Gottlieb, President of David Kirsch Forwarders and Chairman of the Airfreight Institute of FIATA, the international freight forwarders association, says that the industry is still in the formative stage of the process, but warned that a viable security regime will have to be established soon. “If we don’t come up with solutions, there are still people who want to ban cargo from bellies (of passenger aircraft),” he remarks, adding that passenger airlines have warned that a loss of cargo revenue could push them over the brink.

“This is about risk management,” agrees Morin. “The US carriers are very fragile financially. Is the government going to put more restrictions on them? Already FedEx has got much of the mail,” he comments, referring to the ban on mail weighing more than 16 ounces on US passenger planes that the US authorities imposed in late 2001 and still haven’t withdrawn, which has meant significant amounts of lost revenue for the airlines.

Given their financial predicament, the airlines are not likely to make huge investments in cargo projects. Morin says that Air Canada Cargo was thinking of acquiring a new revenue management system but decided to save the money for the time being.

What should concern shippers are signs of airlines cutting back. American Airlines announced in September that it was suspending cargo service to several North American markets, including Vancouver and Calgary. Clive Shepherd, President of TNT International Express Canada, reckons that this trend will continue, predicting more airline
withdrawals and service cuts to smaller markets. Moreover, US airlines have been replacing bigger planes on routes to Canada with small aircraft that have little cargo space, points out Sam Barone of Ottawa-based aviation and logistics consultancy Transportation Partners.

“That doesn’t bode well for capacity for cargo,” he comments.

At the same time airlines are handing over more functions to third-party operators. Even Lufthansa, one of the biggest international cargo players, appointed a general sales agent for ten North American stations this fall, including Vancouver. The move was made to cut costs, admits Georg Midunsky, the airline’s Cargo Vice President for the Americas.

Gottlieb says that this trend, which has been going on for some time, makes sense in light of the airline’s financial situation. “We’re going to see this expand,” he predicts. Midunsky stresses that this does not entail deterioration in service levels. Gottlieb agrees that such moves do not automatically affect service, but he does see a danger of losing rapport between the airline and its customers, leading to a situation where neither side has a good understanding of the other’s needs.

As the traditional airline model is under siege, Air Canada’s efforts to re-invent itself through the launch of several subsidiaries like Jazz, Tango, Zip and Elite has come under increased scrutiny from carriers all over the world. The transformation of Canada’s national carrier also raises questions about the future role and status of its cargo division.

Morin says that the spin-offs have not made any difference for the cargo set-up. “The spin-offs don’t affect us. They don’t have a cargo product, but we do. We pay Zip a flat fee for every pound of cargo that we put on their planes.

These are big changes for the passenger folks, but we keep a low profile and keep filling those bellies,” he comments.
He says that at the moment there are no plans for the cargo division to become a separate company itself, unless Air Canada were to take on freighter aircraft. In the present situation this is an unlikely scenario, as Morin doubts that international freighter operations can make money at the moment.

Still, some observers reckon that AC Cargo will ultimately become a stand-alone entity. “Given their strategy of setting up different profit centres, it’s likely that there will be Air Canada Cargo as a cost centre dealing with different units. It may also include an all-cargo fleet. Milton has hinted at this,” remarks Barone.

Not everybody shares Morin’s skepticism about flying freighters on international routes. Cargojet, the reincarnation of Canada 3000 Cargo and Royal Cargo, which operates a network of domestic freighter flights, has ambitions to break into that market next year.

According to Cargojet CEO and President Ajay Virmani, it is looking to launch transpacific as well as transatlantic operations, either alone or with partners. On the Asian route, he is looking to mount service between Vancouver and Shanghai. Down the road Virmani is also looking at possible freighter flights to the US, which would go to the hub of an integrated express carrier, he has indicated.
Barone figures the plan can work, provided Cargojet could spread its business across the border and attract US freight.

The Canadian market is finite and probably won’t sustain a fully fledged international freighter operation in its own right, he said, pointing to the ill-fated attempt by Winnport Logistics a few years ago, whose Winnipeg-Nanjing-Shenzhen flights with a 747 freighter lasted a mere two months before they had to be called off. Of the limited number of international freighter flights to Canada, only Korean Air’s three weekly 747F service to Toronto supports itself fully with Canadian traffic. Others, like Cathay Pacific, EVA or Cargolux, use Canadian airports as stops en route between the US and their home markets.

Jamie Porteus, Cargojet’s Executive Vice President of Sales and Service, says that the carrier’s international expansion is still in the planning stage and not likely to get under way within half a year. In the meantime, the airline is trying to boost its international traffic through interline agreements with airlines like Korean Air and Air France. This will allow Cargojet to be more competitive on the pricing side, as it can spread its operating costs across more business segments, such as interline traffic and charter work, Porteus says.

The airline has no intention of raising its prices. “We couldn’t do it. We’d be pricing ourselves out of the market,” Porteus says. However, this does not mean that shippers can expect airfreight prices to fall. Various costs have been nudging up fees on top of the basic rates. “Cost volatility is there, and it’s upwards,” comments Shepherd.

The rise in aviation fuel has pushed up the fuel surcharge, and more hikes on that front are likely, says Tim Speed, President of logistics firm Exel Canada. Then there is a security surcharge, which may go up as a firm set of regulations comes into play. “It’s almost inevitable that this will be passed on,” Speed reckons.
In addition, NavCan announced a 3% hike in its fees effective January 1 next year. Ultimately this should also appear on the bill to the shipper. “I assume the NavCan fee will be pass
ed on. I don’t think the airlines are in a mood to absorb that,” reflects Gottlieb.

He finds this development frustrating for forwarders. “The pricing is getting nuts with all those surcharges,” he says. Since many of them are not transparent, it is unclear if airlines can actually make money on some surcharges. In any case, they are not subject to rate negotiations, so the airlines’ overall revenues are going up. The forwarders, on the other hand, face higher costs – which they may or may not be able to pass on to their customers – but their margins remain at a percentage of the basic rate, he says.

Theoretically this should make forwarders more vulnerable to takeovers by bigger players. Over the past years a number of Canadian agents have been gobbled up by large multinational operators. However, nobody expects any major move on that front. “There’s always the possibility of further consolidation, but not of the size and scope that we’ve seen in the last three to four years,” reflects Speed.

In the climate of sobriety after the crashes of the new economy, companies are less likely to rush into an acquisition; they will scrutinize the bottom line of takeover target more thoroughly, says Gottlieb. Moreover, they can’t raise capital as easily as they used to finance those buy-outs, he adds.