Consolidation sparks change

By Staff -- Purchasing, 2/22/2001

A flurry of airline mergers is raising the question of whether or not international air cargo rates will soon increase. But the mergers also hold out the promise that the surviving, larger players will have greater reach.

Those are predictions from analysts watching the international air cargo industry. It is an industry in a state of flux right now as a bevy of mergers and potential mergers settle in.

Among the recent news:

• American Airlines agreed to acquire most of Trans World Airlines Inc.'s assets for about $500 million in a deal that will bring an end to the financially troubled TWA.

• Northwest Airlines and American Airlines discussed a possible bid by American to buy Northwest.

That's only since January. The industry itself saw merger aplenty in 2000, with mergers between United and US Airways, KLM Royal and British Airways and Air Canada and Canadian, to name just a few.

The mergers are taking place at a time when the need for air cargo service-and international air cargo in particular-has reached peak demands. The air cargo industry saw an increase in demand by 10% between 1999 and 2000. Some analysts believe the industry will see a similar increase-possibly around 13%-this year.

Additional flights

One large reason for this is the increase in demand for shipments from China to Western countries. Here alone, the government has awarded 10 additional flights from China to the United States. Six of these were awarded to the United Parcel Service. Key trade lanes for retail goods and perishables remain an impetus for this demand. But the strongest factor here is the demand for personal computer parts shipped to just-in-time inventory deposits at American factories. Greg Burns, airfreight and logistics analyst for the New York-based Lazard Freres Inc., says this factor has given international air cargo demand the fuel to grow 3% to 5% faster than other transportation modes.

"That lane increased dramatically," says Burns. "Whether it's small packages or cargo, there will be more planes flying from point to point."

"There is a secular demand right now for air freight that has allowed it to grow so much," Burns continues. "Low inventories are profitable for businesses. And as the economy continues to move toward higher-value goods like computer technology and expensive chips, air freight will be well-positioned to participate in the growth of the new economy."

The Internet, as well as the increase in world trade, has also pushed the growth factor in this industry. Many air cargo carriers report that manufacturers are tuning into their Web sites to track and trace shipments and make orders. United Cargo, for example, reports that 3% to 5% of its bookings are now done through www.unitedcargo.com. Almost 25% of the carrier's tracking requests come through that site.

In this busy market, the mergers will certainly leave fewer carriers to choose from. But it will also create larger carriers capable of greater reach and with improved cross-modal capabilities.

"I think the consolidation would be good, because they can capture more volume and become more efficient," says A.J. Bedi, director of procurement for the Vancouver-based Electric Lightwave Inc.

New forces

The consolidation will likewise leave bigger players that can give traditional giants in the industry forces to reckon with. That's something that some shippers are hoping to see. In a consolidating market where steep cargo prices have been made even steeper by fuel surcharges, manufacturers say the international carriers need a reality check-they are not the only large carriers left on the map who can encircle the globe and reach foreign suppliers.

"With the consolidation, there will be more competition against the larger providers," says Dave Biasotti, director of worldwide procurement for the California-based LSI Logic. The company is a semiconductor chip manufacturer that relies on international air cargo to ship materials to and from factory sites in Japan and other countries.

But the other side of the merger impact isn't quite as optimistic. As in other transportation modes, fewer players leave those surviving modes with the potential to hold a monopoly-they can raise rates with impunity.

"The flip side is, will they have a monopoly and will they stick me for the rates?" asks Keith Button, strategic development manager of shared financial accounting services for the London-based Smithkline Beecham Pharmaceuticals. "If they do, where can I go?"

Analysts say the rates are without a doubt going up, at least for now. Burns says shippers can probably expect overall rate increases of 2.5% this year, with some carriers going below or above that mark. One example is UPS, which will increase international air cargo rates by 2.9% this year. This comes after the international arm of the carrier service saw revenues for the first quarter of 2000 rise by 15.6%, and company representatives predict at least a buoyancy in profits this year.

Some carrier representatives say this is going to be a necessary evil in the new international air cargo arena. They argue that rate wars in this fragmented industry have allowed too many of the smaller carrier companies to charge cheap rates. This placed so-called premium-service carriers in a bind.

Lower rates

Howard Jones, director of cargo for the Sweden-based Scandinavian Airlines System, says many carriers have long charged rates that are below what they should be. And the problem, he argues, is that lower rates eventually translate to poorer service.

"We want to keep the rates as high as we possibly can," says Jones. "Not because of the bottom line of profit, but because we are trying to invest in the future. We are trying not to undervalue the product that we have."

And Jones says if the air cargo carriers are merging and growing bigger, it will even the score with the mega-mergers in major manufacturers. He says for too long, giant corporations have had too much bargaining power when they try to ship goods overseas. Such companies, he says, promise to give carriers increased volume if they provide lower rates.

Despite all of the dire rate predictions, some analysts believe it's possible that things won't be as grim for shippers as the new year progresses. Some are pointing to a shift in demand that may be felt later in the year, and they say it might foster a temperance when it comes to rate hikes on the part of newly merged air cargo carriers.

Some carriers, since the second half of 2000, report a definite decrease in demand. The Air Transport Association reports that U.S. air cargo traffic rose 2.6% in November 2000, reflecting the slower growth of the U.S. economy during the fourth quarter of that year. Domestic cargo fell 0.7% to 1.05 billion ton miles, while international freight rose 6.1% to 1.07 billion ton miles.

A fall

The international air traffic numbers show a definite fall off from the beginning of 2000. International air traffic grew more than 20% in January and February 2000, according to the association. And it remained in double digits through May of that year.

But import/export growth fell to single digits in June and July 2000. That growth rebounded to 11.2% in August, but analysts say this may have been nothing more than a blip. A further slowdown in the U.S. economy would certainly be felt elsewhere in the world, leading to less of a demand for international air freight shipments.

"We're seeing a bottoming out," says Burns. "We're finishing with a whimper rather than a bang."

And much of the cost of shipping internationally will of course be impacted by fuel cost trends. Fuel prices are expected to trail off in the first half of this year. And this would be a sharp difference from 2000, when fuel prices regularly soared to $35/bbl. The resulting fuel surcharge wars became commonplace in 2000. But Burns says the wars may be subsiding.

"This may allow pricing conditions to be relatively favorable in the first half of the year," says Burns. "Price and volume should be softer."

The domestic side