container industry value chain

8/6/2019 Container Industry Value Chain

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Latest reportin a multi-issue series covering

value creation in transportation and logistics

INSOMNIAINSOMNIAWhy challenges facing the world container shipping industrymake for more nightmares than they should.BYMERGEGLOBALVALUE CREATION INITIATIVE
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Get advanced copies of MergeGlobal reports by visiting www.americanshipper.com/TF2008

The MergeGlobal Value Creation Ini-

tiative comprisesBrian Clancy, Da-

vid Hoppin, John Moses and Jim

Westphal. Clancy, Hoppin, Moses

and Westphal are managing directors

of MergeGlobal, a specialist firm that

provides clients in the global travel,

transport and logistics industries

with services ranging from financial

advisory to strategic consulting. This

is the latest in a series of reports in

which MergeGlobal will team with

American Shipperfor multi-issue

coverage throughout 2008.

containerships ordered during boom times

cant help their sleep patterns.

During those long plane flights and regu-

lar bouts of insomnia, industry executives

have plenty of time to ponder questions

about the industrys future, including:

How will the recent super-spike inenergy prices impact consumer spending

in the United States and Europe, global

economic growth and the competitiveness

of sourcing from Asia?

If there is a downturn in global trade,

how are we going to fill the ever-larger

containerships joining our fleet? Did we

(and the rest of the industry) order too

many big ships in pursuit of economies

of scale?

Moreover, if economies of scale are soimportant, how come certain smaller carri-

ers seem to be consistently more profitable

than the largest ones?

Longer term, where can I make moneyin this business? Am I in the right markets,

serving the right customers?

These are unset tled times for the world

economy and by extension for the

container shipping industry whose vessels

serve as the floating conveyor belts that

move most of the international merchan-

dise trade. However, we also are mindful

that humans (no matter how credentialed

or experienced) are naturally prone to

give more weight to recent events than we

should when making judgments about the

future. With the recency effect in mind,

Figure 1

Primary containerized ocean freight flows in 2007Billions of laden FEU-Kilometers/a

Source: MergeGlobal SeaFlow model.

NorthAmerica

Asia

Total flows shown: 497

LatinAmerica

North

America

Intra-Asia

Asia

MiddleEast

Africa

Europe

9.1

9.0

3.4

8.1

9.8

10.9

96.8

43.2

10.5

9.2

5.610.7

119.6

54.0

97.3

96.8

43.2

Note: a\ One FEU-kilometer represents a 40-foot ocean container transported one

kilometer. A laden FEU is carrying revenue-generating traffic.

The container shipping industry has never been a goodchoice for executives who need regular sleep. Even

in the best of times, operating a truly global busi-

ness requires liner executives to roam the world, incurring

far more than their fair share of jet lag and sleepless nights.

These days, the lingering prospect of recession in the United

States and Europe coupled with stubbornly high energy

prices, and neatly coinciding with the delivery of super-sized

AMERICAN SHIPPER: JULY 2008 69
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Value Creation in Container Shipping

70 AMERICAN SHIPPER: JULY 2008

we offer a relatively sanguine assessmentof the world containership industrysprospects.

We will provide our answers to theabove questions with supporting analysisand logic. We will also discuss implica-tions for shippers, forwarders, carriers

and other industry participants. Briefly,our views are:

Consumption and production marketsare resilient and will continue to adjustto an environment of higher oil pricesrelative to 2007. The International EnergyAgency recently reported that it expectsworld oil consumption to grow a mere 0.9percent in 2008 (compared to an expected3.8 percent growth in real world GDP forthe year, according to the InternationalMonetary Fund). This suggests swift andgeneralized market adaptation to higher

energy costs.While we offer no point estimates offuture oil prices, we adopt the currentU.S. Energy Information Administrationoutlook of relatively stable prices for thebalance of the year, at about $130 a barrel.Thereafter, and as the global economystarts to climb back up to stable growthof 4.5 percent to 5 percent per year (whichwe believe will be achieved by early2010), oil prices will rise steadily but ata much slower rate than seen in the firsthalf of 2008.

After weak growth in 2007 (and virtu-ally nil growth in many North American

import trades), global container traffic,measured in FEU-kilometers, will continueto grow steadily at about 8 percent peryear over the next two years (2008-2009).For the 10-year period starting in 2010 weexpect traffic to grow at a rate of 6 percentper year, which we believe is close to the

industrys sustainable long-term demandgrowth.

This demand outlook reflects our beliefthat past patterns will repeat i.e., thatpost-World War II economic downturnshave translated into brief declines inlong-distance trade, followed by sharprecoveries and that both consumersand firms will adapt to higher fuel pricesin ways that are less harmful to intercon-tinental trade growth than some predict.For example, available evidence suggeststo us that many U.S. consumers are curtail-

ing spending by foregoing services (e.g.restaurants, long-distance travel) ratherthan physical goods (e.g. clothing or toysfrom China).

It may be a rough ride for many car-riers over the next 24 months. Utilizationrates will soften, especially in Asian exporttrades, but will be somewhat protected bymany carriers decision to reduce steamingspeeds in order to conserve fuel whichhas the beneficial result of constrainingcapacity growth despite the wave of new-build vessel deliveries.

Certain carriers will significantlyunderperform the industry, both in the

downturn and in the subsequent recovery.The root cause of these carriers poorfinancial performance is not big shipsperse, but rather a failure to properly selectand focus on specific market segments andcustomers therein.

Global market share is of little value

or meaning; the winners are those whoachieve strong positions in specific tradelanes and end-customer segments. By thesame token, the industry is likely to see aseries of tuck-in acquisitions that addspecific geographic or customer verticalindustries to the acquirors portfolio, ratherthan large mergers of the Maersk-P&ONedlloyd variety. Based on the above points, shippers will be partially shielded from thesuper-spike in energy prices, as softeningutilization rates make it more diff icult for

carriers to pass on higher fuel costs. Butwithin 24 months their transportation costswill rise (whether through base rates, BAFsor some other mechanism) to fully ref lectprevailing energy prices.

Industry definitionThe global container-shipping network

is the backbone of intercontinental supplychains, carrying some 98 percent of inter-continental containerized trade volume and60 percent of trade value (with the balancemoving via air freight).

We think the most meaningful way to

measure demand and capacity is the concept

Source: MergeGlobal analysis and estimates.

Figure 2

Container shipping industry value chain and segment definition

Customer sales

Shipment routing Capacity procurement

Customer service

Billing

Tracking

Key

Activities

Competitor types Container carriers

Forwarders /NVOCCs

$32 billionTotal revenue

10%Historical growth(Revenue 97-07 CAGR)

Estimated ROCE\b 50%

Shipmentorigination,routing andcapacityprocurement

Providecontainers

Provideand operatevessels

Loadand unloadshipments

Inland delivery\a

Notes: \a Defined as inland portion of itinerary purchased by customer (e.g., port gate to door); does not include transload market.\b ROCE = return on capital employed calculated at EBIT (earnings before intered and taxes) divided by net working capital plus

book value of plant and equipment.

Ownershipof containers

Storage andmaintenance

Repositioning

Container carriers

Container leasingcompanies

$8 billion

11%

9%

Ownershipof vessel

Operationof vessel

Container carriers

Outsourced/third party

Dry leases

Wet leases

$102 billion

7%

3%

Terminal control(ownership or lease)

Terminal operation

Container handling

Container carriers

Captive terminaloperators

Third-party terminaloperators

$35 billion

11%

25%

Control of trucks

Ownershipof railroads

Container handling

Railroads

TL truckers

Drayage truckers

Container carriers(limited)

$28 billion

7%

34%
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of 40-foot equivalent unit (FEU)-kilome-ters, representing one FEU transported onekilometer. In 2007, the global container-shipping network transported almost 600billion FEU-Kms of goods (see Figure 1for a map of the most important trades).Interestingly, the largest trade based onthis metric is Asia/Europe with 174 billionFEU-Kms, which represents 29 percentof global flows. The transpacific, with140 billion FEU-Kms and 24 percent ofglobal flows, is a close second. In terms oforiginated container shipments, intra-Asia

still dominates with 19 million FEUs, butis only the third-largest container trade dueto a much shorter average length of haul.What is more striking is the size of othertrades relative to the Big 3, where thetransatlantic is only 12 percent the size ofAsia/Europe, and Europe/Latin Americais 11 percent.

Industry value chainThe container shipping value chain, i.e.,

the activities required to move a containerfrom shipper to consignee, comprises fivediscrete segments (Figure 2), which have

been defined such that they approximate

standalone industry segments. We discussthe definition, resident competitor typesand financial performance of each of thesesegments below. Our key measure of finan-cial performance, from a value creationperspective, is segment return on capitalemployed (ROCE) defined as operatingincome divided by working capital plus netproperty, plant and equipment.

We should note that, since the value chainsegments are presentedfrom the perspec-tive of a container carrier, segment-levelROCE should roughly approximate that of

pure-play service and capacity providersto the container shipping industry.For example, the best ROCE benchmark

for the shipment origination value chainsegment would be the freight forwardingindustry segment.

Similarly, the provide container seg-ment should be compared to the containerleasing and maintenance industry seg-ment (the North America portion of thissegment includes chassis as well, whichtypically are not owned by container car-riers elsewhere).

Finally, returns for the load and unload

shipments and inland delivery segments

should roughly approximate those of third- party container terminal operators andintermodal marketing companies/truckbrokers, respectively.

Taken as a whole, the ROCE for thecontainer shipping industry is the weightedaverage ROCE across the industrys valuechain segments. We estimate this industryROCE to be 12.2 percent in 2007.

The first value chain segment (shipmentorigination, routing and capacity procure-ment) represents the shipping industrysretail level at which customers contract and

pay for door-to-door transportation of theircontainers. The remaining four segmentsrepresent the industrys wholesale level atwhich transportation providers purchasespecific services from each other. We al-located the industrys retail revenue to thedownstream segments of the value chain based on estimated wholesale prices forthe services provided. We estimate thatthe container shipping industry generated$206 billion in gross revenue last year, ofwhich about half went to cover the cost ofthe actual ocean voyage, with the balanceallocated to on-shore activities.

There are a number of distinct com-

Source: MergeGlobal analysis and estimates.

Figure 3

Container shipping industry cost structure map

Salesforce costper shipment

IT cost pershipment

Customer servicecost per shipment

Key cost driver

metrics

Coststructure


Providecontainers



Inland delivery

Container andmaintenance costper FEU per day

Bunker cost perFEU-Km

Vessel leasing anddepreciation cost

per FEU-Km Port costs per sailing

Terminal handlingcharges perFEU loaded ordischarged

Rail costper FEU-Km

Drayage costper FEU-Km

Barge costper FEU-Km

4%

50%

16%

14%

17%

100%

17%

50%

16%

4%

14%

Variable

Fixed

Local

Regional

Global

Variable

Fixed

Local

Regional

Global


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Source: MergeGlobal primary research.

Figure 4

Sources of economies of scale in the container shipping value chain

Scale impactScale driver

Enables facility scale (through high

local throughput) Improves drayage buying power

High local market share

High global market share Lower unit cost of shared activities(e.g. IT, corporate G&A)

Increased buying power for equip-ment/services purchased on a globalbasis

Enables vessel economies of scale

Improves buying power for line-haulservices, including intermodal unittrains

High origin and destination

market share

Lower sales and customer-facingIT costs

High share of specific

customer segment

Customer/commodity mix Improves LCL profitability throughmix of dense and voluminous freight

Increases capacity utilization becauseof contra-seasonal demand patterns


Providecontainers



Inlanddelivery

Opportunity forscale economies

Limited Significant

petitor types in the container shippingindustry, of which container carriers (alsocalled liner companies) are both themost visible and most integrated across

all five segments of the value chain. Atthe retail level, liner companies competewith freight forwarders for shippers busi-ness. Both competitor types commit toproviding door-to-door transportation, butcarriers use their own ships whereas for-warders rely entirely on other companiesto actually move containers from originto final destination.

In theory, carriers have the advantageof guaranteed access to capacity duringpeak demand periods, whereas forward-ers have the advantage of picking the best

routings and carriers to meet each shippersrequirements. In practice, carriers oftenbuy space on each others ships, especiallyin markets where they lack sufficient traf-fic to support deployment of their ownvessels, so the existence and amount ofguaranteed capacity can be illusory.For their part, forwarders often are morefocused on maximizing their near-termprofitability by buying low and sellinghigh than on providing the best possibleservice to customers.

Returning to the first segment of thevalue chain, which we estimate generated

about $32 billion in revenues in 2007, it is

worth pointing out that this segment hasconsistently achieved the highest returnon capital employed of the entire valuechain. At about 50 percent, the segments

high ROCE reflects the fact that capitalrequired for its underlying activities islimited to the occasionally owned facility,information technology and working capi-tal to cover the timing difference betweenaccounts payable and receivable. (For amore detailed discussion, see ForwarderMomentum, March American Shipper,pages 36-53.)

The second value chain segment (pro-vide containers) comprises the ownership,leasing and maintenance of containers andchassis (mostly in North America). There

are some 11 million FEUs of containersused in container shipping operationsglobally, with 40-foot units comprising66 percent of the fleet. Container carrierseither purchase and maintain containersinternally or outsource these services tothird parties. In almost all cases, carriershave elected to pursue a mixed fleet strat-egy, where they lease and/or outsource themaintenance of a portion of their containerfleet from thi rd-party providers.

We estimate that the industry spent $8billion last year to provide and maintain itsglobal container fleet and liner-operated

chassis fleet. Growth in the container f leet

averaged 11 percent over the last decadeand the segment earned an estimated 9percent ROCE, reflecting the high degreeof capital intensity. About 45 percent of

the industrys container and chassis fleetis leased, with the remainder owned bycarriers. The third party leasing markethas gone through a lot of change over thelast couple of years and has seen severalcompanies go public, including Textainer,TAL and CAI.

The third value chain segment (provideand operate vessels) comprises all resourcesand activities required to operate a shipfrom quay to quay. This includes:

Providing ships either through directownership or leasing.

Procuring and/or performing non-routine maintenance and regularly sched-uled dry docking.

Operating ships with organic crews oroutsourcing to crew leasing companies.

Sourcing and fueling of vessels. Procuring harbor pilot services. Paying navigation charges.We estimate total revenues generated in

containership ownership/leasing, mainte-nance and operations to be $102 billionin 2007.

Vessel ownership/leasing and operationsis a capital-intensive segment, as there

were roughly 4,000 cellular vessels and


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Source: MergeGlobal analysis.

Figure 5

Criticality of properly defining addressable market

Customer market shares

within trade lanes

Market shares are measured withina trade lane, based on commodityand customer characteristics.

Trans-pacific Trans-atlantic Asia/Europe

Weighted average trade lane marketshares are combined (and weight-averaged) to arrive at a globalweighted average market share.

Global weighted average market sharesare compared across the industry.

Weighted average trade

lane market shares

Weighted average

market positions

across industry

Transpacific

Transp

acific

Transa

tlantic

Asia/E

urope

Weightedaveragemarket shareby trade lane

Weightedaveragecapacityshare bycustomerend market

etc.

Maersk APL COSCO

Maersk

APL

COSCO

CSCL

Evergreen

Hanjin

Freight

forwarder

Consumerlarge

Consumersmall

Foodlarge

Foods

mall

Industrial

large

Industrial

small

Intermediatelarge

Intermediatesmall

Primary

large

Primary

small

Weightedaverage

market sharebytradelane

Weightedaverage

marketsharebytradelane

Weightedaverage

marketsharebytradelane

4.8 million FEUs of slot capacity availablefor deployment at the beginning of 2007 with a current replacement value of about$160 billion. During 2007 carriers and

leasing companies were busy both order-ing and receiving new vessels. Accordingto BRS Alphaliner, more than 600 vesselswere ordered in 2007 (which represents1.8 million FEUs of slot capacity). By theend of the year, shipyards had delivered400 vessels comprising 680,000 FEUs ofslot capacity.

Globally, container car riers own and op-erate about 48 percent of their slot capacityand lease the rest from ship charter compa-nies. Several ship-leasing companies havegone public in the last few years, including

Danaos and Seaspan. Similarly, containercarriers have in certain cases decided todivest their ship-owning activities. For ex-ample, Global Ship Lease, a wholly ownedsubsidiary of CGM CMA, will merge witha special purpose acquisition company(SPAC) called Marathon later this year.

The fourth value chain segment (load-ing and unloading shipments) comprisesall activities that occur between quay andport gate. These include:

Providing vessel berthing capacity. Loading and unloading containers

from vessels.

Transferring containers to staging

yards to await pick up. Loading containers onto on-dock

intermodal unit trains. Checking containers in and out of

terminal gates.There are three competitor groups for

container terminal services: containercarriers that self-handle equipment in or-ganically operated terminals, third-partycontainer terminal operators, and integratedport authorities that act both as landlord andas terminal operators. We estimate that 43percent of terminal throughput is handledat carrier operated terminals, 54 percentby third-party operators and 3 percent byintegrated port authorities.

Globally, the container terminal seg-

ment generated $35 billion in revenues in2007, either as a transfer price in the caseof carrier-captive terminals or arms lengthtransactions with third parties. The revenuegrowth has averaged 11 percent over thelast decade and ROCE was an estimated25 percent last year.

The fifth value chain segment (inlanddelivery) covers the movement of contain-ers from shippers to load ports, and fromdischarge ports to consignees. This is theleast integrated part of the door-to-doorvalue chain: container carriers control theseactivities but generally rely on independent

firms to handle and deliver containers.

They thus perceive a higher segment ROCErelative to that of asset-based transportationcompanies.

Competitor groups providing these

services are local and national truckingcompanies, railroads and barge operators.Segment revenues were $28 billion in 2007and have been growing at 7 percent peryear since 1997.

Industry cost structureWhen all of the industry segments

are put together, as shown in Figure 3,it forms an illustrative door-to-door coststructure. About half of total costs are inquay-to-quay vessel operations, followed by terminal handling (17 percent) and

shipment origination (16 percent). Costdrivers vary by segment particularlygeographic but are generally eithertransaction- or volume/distance-driven.For example, shipment origination andterminal handling costs are throughput-driven and insensitive to distance, whilevessel operations and inland deliverycosts are related to equipment capacityand stage length.

The other key characteristics of costsare their fixed/variable relationship andgeographic location. The ratio of fixedversus variable costs is important because

it determines the potential for economies


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of scale and degree of operating leveragewithin an activity or industry segment.Fixed costs are all costs that are insensi-tive to volume at a set output level andtime horizon. In order to correctly definefixed versus variable costs, it is importantto choose the right time horizon.

On the one hand, on any given dayor week especially in transportation

services where capacity is perishable asignificant portion of costs for a containercarrier are fixed, because schedules areestablished months in advance and voyagestake weeks to complete. On the oppositeextreme, over an extended time period allcosts are variable because vessels can besold or eventually returned to the lessor.

For our purposes, we have defined fixedcosts, from the perspective of a containercarrier, as costs that are not sensitive tovolume and cannot be eliminated within anysix-month to one-year window of time due

to service commitments made to customers,contractual commitments made to suppli-ers, and other market rigidities.

In the shipment origination segment mostcosts are variable and sensitive to volumelevels within a range, because much of thecost is labor-related and its indivisibility islow (head count can be resized to matchchanges in volume). The fixed portion ofthis segment is information technology,facilities and overhead.

Container leasing and repair has a highratio of fixed cost due to the capital intensityof the equipment relative to the labor cost

involved in managing and maintainingit; a container carrier must pay for thesecosts regardless of whether the containeris empty or full.

Vessel operations are roughly a 50/50split between fixed and variable costs.Fuel represents half of this activitys totalcost structure and it is sensitive to speed,voyages and port rotations (the latter can be altered in a six-month window whilestill maintaining service and contractualcommitments).

Container terminals have a high ratio of

fixed costs because the cranes and facilitiesmake up a significant portion of the coststructure and are incurred regardless ofthroughput when the terminal is carrier-operated. The cost profile becomes morevariable if the carrier uses a third partythat charges for each box handled, but stillsubject to volume minimums over a specifictime period. Finally, inland delivery is ahighly variable cost activity because mostcontainer carriers purchase these serviceson an as-needed basis in order to completedoor-to-door itineraries.

The geographic location of a cost pool

is important because it determines the

Carrier revenue

$10 billion

$5 billion

Source: MergeGlobal analysis from ComPair Data.

Figure 6

Comparison of ROCE/a versusrelative capacity share/b in 2007

Note: /a Return on capital employed (ROCE) is defined as the estimated EBIT (earn-ings before interest and taxes) for each carriers container business segment,divided by the estimated capital employed (net working capital plus book valueof plant and equipment) of each carriers container business segment. Estimatesmade by MergeGlobal./b Relative capacity share (RCS) represents the weighted average of eachcarriers share of its respective market segments. RCS is calculated in terms ofavailable FEU-Km based on ComPair Data analysis of published schedules for2007 and MergeGlobal analysis. Capacity on alliance services is allocated tomember carriers on a pro rata basis./c - Defined as transpacific, Asia/Europe and transatlantic.

Relative capacity share in main trades (logarithmic scale)/c

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.91.0 2.0

40%

35%

30%

25%

20%

15%

10%

5%

0%

-5%

ROCE

Maersk

APL

Evergreen

HapagCSCL

OOCL

Hanjin

NYK

Hyundai

MOL

Focused on highest valuecustomers

Specialized itineraries

Emphasis on customer service

Specialized equipment

Service guarantees

Focus on reliability and visibility

Customer service (billing accuracy,track/trace, single point of contact)

Generic service

Focused on line-haul

Lane concentration

Cost leadership

Focused on specificgeography

Cost leadership

Sacrifice schedule reliabilityfor lowest cost position andshipment visibility

Economies of scale

ZimCSAV

APL

Maersk

Source: MergeGlobal analysis.

Figure 7

Container shipping strategic options matrix

Note: Upper right-hand quadrant is not a viable strategy, as there are not enough smalland medium sized shippers to support a global network.

Broad, globalnetwork

Custom

erfocus

Focus onspecific trades

Small/mediumdirect customers;

low forwarderexposure

Geographic focus

Large directcustomers;

heavy forwarderexposure
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Value Creation in Contaner Shipping

ability to generate scale economies andrelated cost sharing. The complication isthat segments with a high degree of localcosts can only derive scale benefits at thatlocation. Segments comprising activitieswith a high degree of location-independentcosts, and for which processes can bestandardized, can generate significantscale economies.

Shipment origination costs are mainly

regional because sales force, customerservice and administration resources aretypically located on a regional basis. Ifthe company has a single integrated ITplatform, it can spread these costs acrossglobal volumes instead of volume spe-cific to a region. Container fleets are aglobal cost because they can be deployedanywhere with relative ease, but main-tenance is local and specific to a depot.Vessel operation costs are more regionalin nature because ships are deployed onspecific routes. A route may connect twoor more regions, and within each region

pair there is a collection of origins and

destinations. Certain variable costs withinvessel operations are local because theyare incurred at specific ports. Containerterminal costs, in comparison, are verylocal, with the exception of port operatingcompanies that spread corporate overheadacross multiple terminals. Lastly, inlanddelivery is mostly local and unique tospecific origins and destinations.

Industry economies of scaleEconomies of scale i.e. declining

cost per unit as volume increases donot occur uniformly across a companysbusiness as it grows larger. Rather, scaleeconomies usually arise in specific areas ofthe business (or parts of the value chain,in consultant-speak), and at different levelsof geography (local/regional/global), for avariety of specific reasons. Figure 4 depictswhere and why certain scale economies oc-cur in the container shipping industry.

For example, local market share is animportant driver of economies of scale in

terminal operations and drayage. Having a

high share of volume originating in and/ordestined for a local market lowers containerterminal costs per unit by enabling larger,more efficient and more intensively utilizedfacilities. By the same token, high localmarket shares can reduce drayage costsper box because the container carrier hasmore loads to offer drayage companies ona given day and in a specific area.

Cost segments that benefit from high

global market share or firm size include IT(primarily used in shipment origination),corporate overhead (across all segments)and procurement of resources purchased orleased on a corporate level (like containersand ships). Unique to transportation is theconcept of origin and destination (O&D)market share, which produces traffic den-sity on an intercontinental route wherethe O&Ds use the same ocean leg. HighO&D market share enables carriers tooperate larger vessels that naturally enjoylower per-slot costs than smaller ships. Italso lowers capacity procurement costs

on ocean routes where carriers purchase

Source: MergeGlobal sea freight flow model and MergeGlobal primary research.

Figure 8

Primary intercontinental containerized trade flows in 2007:Relative segment sizeBillions of laden FEU-Km

Customer

classification:

Shipper

type

Transpacific

trade

Asia/Europe

trade

Transatlantic

trade

CommentsAsia/

N.A.

N.A./

Asia

Asia/

Europe

Europe/

Asia

Europe/

N.A.

N.A./

Europe

Commodity

grouping

LargeConsumer(e.g., apparel, consumerelectronics, furniture) Medium /

Small

Food (e.g., refrigerated andnonrefrigerated food, beverages)

All

LargeIndustrial

(e.g., machinery, components,

professional equipment) Medium /Small

AllIntermediate (e.g., textiles,chemicals, metals)

Primary

(e.g., agricultural, minerals)All

Freight

forwarder

Total:

Dominated by department stores andbig box retailers

Mid- and small-sized shippers controlfewer than 1,000 FEU/year (fewer than20/week)

Beverages such as beer and wine andspecialty food are particularly importantin EU/Nor th America market

Dominated by increasingly complexsubassemblies

Increasing reliance on freightforwarders

Includes low unit value commoditiesshipped as backhaul filler freight

Includes only containerized portionof primary commodity trade

Schenker, DHL, and K+N arestrongest in Asia/Europe trade;Expeditors has the biggest marketshare in the transpacific

Key 2007 market size$20 billion$5 billion

97 43 120 5411 9

2913

76 366 4

2 8 3 2 1 1

19 1710 9 2 3

4 0.5 4 2 0.2 0.1

8 1 8 2 0.6 0.4

1 3 3 2 1 0.5

8 0.3 6 0.5 0.3 0.2

0.20.4110125


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slot capacity, and on intermodal routes

where they have sufficient lane density toguarantee railroads and trucking companiesbi-directional loads.

Having high shares of specific customertypes enables spreading of domain-specificintellectual capital across more customers.This resource helps lower shipment origina-tion and inland delivery costs, particularlywhere customization of services for anindustry segment is high.

A final scale driver is the customer andcommodity mix. Carriers with a balancedmix of customers with different seasonalshipping patterns can improve vessel and

container terminal utilization by increasing

the year-round average load factor. In the

case of less-than-containerload services,profitability can be enhanced by havinga balanced mix of voluminous and denseshipments in the same container.

Market position determinesprofitability

It makes intuitive sense that scale driversimprove container carrier profit marginsby enabling economies of scale, as arguedabove. It is crucial, however, to quantifythese drivers in a meaningful way. Scaledrivers are best quantified as a carriers

weighted average market share across

specific markets relative to that of other

carriers, a concept that is commonly re-ferred to as relative market position.When carrier specific demands are not

available, it is possible to use O&D capacityshares, weighted for utilization and customersegment participation, to arrive at a carriersrelative capacity position. While it soundssimple, the definition of a market in con-tainer shipping can be tricky because it isdefined across several dimensions, includ-ing geographic (O&D), customer type andcommodity type. For example, a properlydefined market could be that of large shippers(say, above 1,000 FEUs shipped per year) of

consumer goods in the transpacific. Why is

Figure 9

Historical average revenueand volume growth in majorheadhaul market segments2001-2007 CAGR

Source: MergeGlobal sea freight flow model.

Global18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

USDrevenuegrowth

Figure 10

Forecasted average revenueand volume growth in majorheadhaul market segments2007-2012 CAGR

FEU-Km volume growth

Average: 11.1%

Average:10.6%

Transpacific18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

USDrevenuegrowth


Average: 10.1%

Avera

ge:10.8%

Global18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

Revenuegrowthin%


Average: 6.2%

Average:8.4%

Transpacific18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

Revenuegrowthin%


Average: 3.8%

Average:6.9%

A-E

TP

TA

A-E

TP

TA

Consumer - mid/small

Consumer - large

Food

Freight forwarder

Industrial - mid/small

Industrial - large

Intermediate

Primary

2007 market size

$10 billion$5 billion

Note: Revenue includes port-to-port transportation andterminal handling, and is gross of bunker adjustment fac-tors. Trades and trade segments above the diagonal lineare characterized by rising unit prices; those below thediagonal line are characterized by decreasing unit prices.


10/14



this a proper market definition? Because it isconsistent with the scale drivers illustratedin Figure 4: a strong position along thosedrivers should improve profit margins andultimately create value.

In a global relative market positioncalculation, the numerator should includea carriers global weighted average marketshare in its relevant (i.e., properly defined)markets, and the denominator should bethe share of the carrier with the highestweighted average share (in the case of thelargest player, the denominator should bethe share of its closest competitor).

Figure 5 provides an example of how

we calculate segment-specific shares, usethose to obtain a carr iers weighted averagemarket share and, when compared to thatof other carriers, finally arrive at carrierrelative market position. This matters be-cause, other things being equal, the higherrelative market position a carrier has, thehigher its profitability.

As Figure 6 demonstrates, there is astrong connection between carrier market position and return on capital employed.With the exception of one outlier, profit-ability increases with relative market posi-tion because high share of specific markets

leads to lower costs at higher service levels.

That is, high relative market positions areassociated with profit margin expansion andsatisfied customers. The most significantoutlier, Maersk, reflects the profit impactof a poorly executed merger and does notlead to a broad conclusion about negativereturns to scale. The key point is that big-ger is not better overall, but that bigger isbetter in properly defined markets.

Strategic options for marketposition

Now that we have established the cor-

relation between value and strong market

Figure 9 (continued)

Historical average revenueand volume growth in majorheadhaul market segments2001-2007 CAGR

Figure 10 (continued)

Forecasted average revenueand volume growth in majorheadhaul markets2007-2012 CAGR


Asia/Europe18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

USDrevenuegrowth

Note: Revenue includes port-to-port transportation andterminal handling, and is gross of bunker adjustment fac-tors. Trades and trade segments above the diagonal lineare characterized by rising unit prices; those below thediagonal line are characterized by decreasing unit prices.


Average: 16.4%

Average:11.5%

Transatlantic16%

14%

12%

10%

8%

6%

4%

2%

0%

-2%

-2% 0 2% 4% 6% 8% 10% 12% 14% 16%

USDrevenuegrowth


Average: 7.6%

Avera

ge:2.4%

Asia/Europe18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

USDrevenuegrowth


Average: 9.0%

Average:9.8%

Transatlantic18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

USDrevenuegrowth


Average: 8.6%

Average:4.6%

Consumer - mid/small

Consumer - large

Food

Freight forwarder

Industrial - mid/small

Industrial - large

Intermediate

Primary

2007 market size

$10 billion$5 billion


11/14



position, what are the strategic options acarrier can consider to improve its position(Figure 7)? The objective is for a carrier toconstruct a portfolio of markets where it isable to achieve high relative shares. In somecases, this means avoiding certain marketsegments altogether because it is too difficultto build a profitable competitive position.

The trade-offs a carrier must make refermainly to geographic focus and customerfocus. It is important to remember that these

trade-offs are not binary, but must be definedin terms of varying degrees of concentration.Geographic focus involves network scope(ports served), scale (relative allocationof slot capacity across a network) and thenumber and types of O&D itineraries of-fered to customers (port-to-port versus port-to-railhead mix). Customer focus defines

which customers will be targeted within thespecific O&Ds served. Carriers can seek outthe largest customers in a specific O&D, ormedium and smaller customers. The tradeoff is that targeting large customers requiresless marketing and sales effort, but it alsomeans lower prices due to customer buyingpower. Focusing on small and medium cus-tomers requires more marketing and salesresources, but should generate volumes withhigher average prices.

Deciding how much forwarder volumeexposure a carrier wants is another keytrade-off. Forwarders are direct competi-tors with carriers and are particularly adeptat capturing small and medium sized ac-counts (forwarders control a majority of theless-than-containerload market segment).Carriers with small sales forces tend to rely

more heavily on forwarders than carrierswith larger sales forces able to competefor lucrative small and medium-sizedaccounts.

Broadly, there are three market positionsavailable to carr iers:

Focused geographic scope combinedwith small/medium customer emphasis(e.g., APL).

Focused geographic scope and broadcustomer mix (e.g., Zim).

Broad geographic scope and emphasis on serving larger customers (e.g.,Maersk).

Carriers have the option of building theirmarket positions by growing organically orby acquiring other carriers. Organic growthoften requires ordering new ships to estab-lish presence in new geographic markets.Examples of carriers that used mergers andacquisitions in 2007 to add niche market po-sitions to their network portfolio include:

CMA CGM bought Cheng Lie Navi-

Source: U.S. Commerce Department, Bureau of Economic Activity; Economist Intelligence Unit; MergeGlobal freight flow forecast;Containerisation International.

Figure 11

Key assumptions by trade route, 2007-2012

Asia/Europe Intra-AsiaTranspacific

Macroeconomic

growth factors\1

Trade

factors

Financial

factors

Transatlantic All other

Note: \a - Compounded annual growth rates (2007-2012) of headhaul destination region (e.g., North America for Transpacific trade) .Macroeconomic factors expressed in real terms (net of future inflation)

NM Not measured

GDP

Consumer spending

Business investment

Demand growth\a

Supply growth\a

Load factor growth

Pricing\a

Impact onEBITDA margin

2.7%

2.9%

3.1%

2.3%

2.3%

3.7%

2.7%

2.9%

3.1%

4.4%

3.8%

5.8% 3.5%

2.6%

2.5%

(2.8%)

slightly negative

(0.7%)

neutral

3.8%

positive

2.7%

slightly positive NM

NM

6.9%

8.0%

(3.7%)

9.8%

12.4%

(9.0%)

4.6%

3.7%

3.4%

7.9%

5.8%

7.6% (3.8%)

7.6%

6.2%

Our forecast assumes

that energy prices

remain fairly constant

for the balance of 2008

and then trend to normal

growth levels of about

15 percent per yearwithin two years.


12/14



gation (Taiwan) to provide an intra Asianetwork.

CMA CGM also purchased U.S. Linesto create a strong market position in theU.S./South Pacific trade.

CMA CGM consolidated its positionin the Moroccan market by acquiring Com-pagnie Marocaine de Navigation, which has40 percent local market share.

Hamburg Sud acquired Costa Con-tainer Lines to further consolidate its domi-nance of Europe/Latin America trades andadd an intra-Mediterranean feeder networkto build economies of density.

Relative attractivenessof markets

Picking the right markets to build adefensible competitive position requires perspective. Carriers must identify notonly long-term structural factors that willdetermine the size and shape of the globalsupply chain, but also understand how theindustry cycle will likely behave over thenext decade. Skyrocketing energy priceshave led some analysts to the conclusionthat there will be a reversal in global-ization and that companies will rethinktheir decision to source products in Asiaand bring manufacturing back to NorthAmerica and Europe in order to reducetransport costs.

Our view is that the total landed cost ofproducts with high labor content sourced inAsia for consumption in North America andEurope is still lower than that of products

sourced locally or, in many cases, near-

shored (we addressed this topic in detailin the June 2007American Shipper, pages8-21). The reason is that containerships areextremely fuel efficient when comparedwith other modes of transportation.

Consider the example of a shipment froma factory near Shanghai to a distributioncenter in Atlanta versus a factory in Guada-lajara, Mexico. The Shanghai-Atlanta fuelcost is roughly $700 per FEU, including


Figure 12

Primary containerized oceanfreight flows: 2002-2017Billions of laden FEU-Km

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

7.5%

8.2%

400

Legend 07-12CAGR

EB Transpacific 6.9%

WB Transpacific 8.6%

WB Asia/Europe 9.8%

EB Asia/Europe 6.8%

WB Transatlantic 4.6%

EB Transatlantic 7.9%

Intra-Asia 7.9%

Other intercontl flows 5.7%

5.8%

429470

503547

593644

695749

798850

895947

998

1,062

1,125Forecast

x% 5-year CAGR

63

66

42

31

10659

122

97

120

54

43

119

97

162

65

191

75106

143

214

168

260

10016

17

199

276

135

90


13/14



Figure 13

Capacity utilization and freightrate development in majortrade lanes, 1998-2012

Headhaul utilization

Headhaul rate index

Backhaul utilization

Backhaul rate index

Transpacific220

200

180

160

140

120

100

80

60

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Forecast

100%

90%

80%

70%

60%

50%

40%

30%

Freightrateindex

Utilizationrateindex

Asia-Europe220

200

180

160

140

120

100

80

60

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Forecast

100%

90%

80%

70%

60%

50%

40%

30%

20%

Fre

ightrateindex

Utiliz

ationrateindex

Transatlantic220

200

180

160

140

120

100

80

60

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Forecast

100%

90%

80%

70%

60%

50%

40%

30%

20%

Freightrateindex

Utilizationrateindex

Source: MDS Transmodal, MergeGlobal analysis and estimates.

truck drayage, at todays marine bunkerand truck diesel prices. A truck carryingthe same shipment from Guadalajara tothe same distribution center in Atlantarequires $811 of fuel per FEU, a differ-ence of $111. At $200 per barrel of oil, thefuel cost from Shanghai rises to $1,075,while the cost from Guadalajara shoots to$1,250, for a difference of $175 per FEU.

Trucking is simply more energy intensivethan container shipping. The other factorsaffecting relative total landed cost, mainlymanufacturing labor and the cost of capital,still favor sourcing from Asia, especiallyChina and Vietnam.

In our view, production networks willcontinue to shift and Asia will remain theworlds factory for at least the next two de-cades for products with high labor content.Since raw materials and high-value/lowlabor content products never were candi-dates for offshoring, these segments will

remain the basis of containerized exportsfrom the United States and Europe.

Historical performanceAnnual volume in the three largest

intercontinental trades grew an averageof 10.6 percent, and revenue increased11.1 percent per year, from 2001 to 2007.The transpacific and Asia/Europe trades,which will continue to benefit from con-sumer spending-driven imports, offer awide mix of customer segments to target(Figure 8).

The transatlantic trade is a question

mark, since its anchored by two high-costmanufacturing centers in North Americaand Europe, and is experiencing consid-erable change in its industr ial geographyamid weekly announcements of factoriesrelocating to Asia. This market is the mostmature among the larger trades and willlikely be a tough market in which to gener-ate profitable returns.

Since the last downturn in 2001, theAsia/Europe trade has been the fastestgrowing market in terms of FEU-Kms andrevenue (Figure 9). The largest absolute

increases in volume were generated byfreight forwarders and direct shipper con-sumer product f lows from Asia to Europe.Intermediate materials and components andfood were the two fastest growing customersegments in the transpacific trade for thesame time period.

ForecastIn the near term, we expect the U.S.

economy to recover in 2009 and growmodestly over the next decade, averaging2.7 percent per year. Europes economy willgrow slightly slower at 2.3 percent per year,

while Asia will be the fastest growing with


14/14


4.4 percent real growth (Figure 11).Global container traffic, measured in

FEU-Kms, is forecast to grow at 6.9 per-cent over the next decade. Growth in thenext five years will average 7.5 percent peryear, compared to 5.8 percent per year from2012 to 2017, as the largest markets becomemature and as certain product categoriesreach their maximum import substitution

potential (Figure 12).Among the big three head haul inter-

continental trades, we expect Asia/Europeto be the fastest growing, averaging 9.8percent in volume and 9.0 percent in rev-enue growth over the next five years (Fig-ure 10). We estimate Europe is about fiveyears behind the United States in terms oflarge-scale shift ing of production to Asiaand thus has more import growth potentialrelative to the transpacific trade.

To use a baseball analogy, the UnitedStates is in the sixth inning of network

shift while Europe is in the fourth inning.Forwarders will be the fastest growingcustomer segment in the Asia/Europemarket and will continue to take directshipper business away from containercarriers. Eastbound transpacific marketvolumes will grow slower than Asia/Eu-rope, at 6.9 percent per year, and revenueeven slower at 3.8 percent per year from2007 to 2012. But similarly to the Asia/Europe trade, forwarders will be the fast-est growing customer segment within thetranspacific.

The bad news is that supply growth in

both the Asia/Europe and transpacific willexceed demand growth from 2008 to 2010(Figure 13). The subprime crisis and itsimpact on consumer spending and importscould not have come at a worse time sincethe industry is in the middle of adding arecord number of post-Panamax vessels.This capacity addition will underminecarriers ability to increase rates enoughto fully offset higher fuel costs, with theconsequence that profit margins will besqueezed signif icantly from 2008 to 2010.We forecast that it will take until 2011

for the market to fully absorb the extracapacity and cause rates to rise again. Ob-viously, rates that have a North Americanintermodal leg in the itinerary will be moreresilient because rail capacity is relativelytight compared to ocean capacity.

There are multiple risks to this forecast,both to the upside and the downside. Thetwo leading risks seem to be energy pricesand inf lation. Our forecast assumes thatenergy prices remain fairly constant forthe balance of 2008 and then t rend to nor-mal growth levels of about 15 percent peryear within two years. However, if energy

prices were to continue climbing during

2008, the outlook becomes darker forconsumer spending and general economicgrowth in oil-consuming countries, withnegative implications for merchandiseimport growth. Paradoxically, our forecastfor ocean freight rates would rise due tothe pricing discipline imposed by highenergy prices. The converse would be trueif energy prices were to fall or grow less

rapidly than assumed.The risks from inflation are all to the

downside. Our forecast assumes that futureinflation rates are about 1-1.5 percentagepoints above the levels experienced in 1998-2007, and that central banks in developed

countr ies are not forced to react with inter-est-rate hikes that reduce future economicand trade growth.

ConclusionsWe were not known for wild optimism

during the boom years indeed, some ofour previous forecasts assumed economicslowdowns that never seemed to arrive. By

the same token, we have tried to delivera balanced view of the current economictroubles and their likely impact on the globalcontainership industry. Still, there are likelyto be many more sleepless nights for industryexecutives in container shipping.

container industry value chain

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