mergeglobal behind the numbers
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DESCRIPTIONExplaining what's behind the numbers that drive trade forecasts.
- 1. 8 AMERICAN SHIPPER: JUNE 2007 BehindBehind the numbersthe numbers Understanding the underlying drivers of containerized air and sea trade. BY MERGEGLOBAL FORECAST TEAM Part one of a multi-issue series covering cargo forecasting
2. AMERICAN SHIPPER: JUNE 2007 9 Behind the Numbers we use to think about trade growth with an emphasis on: Why things are changing. A discussion of the shifts in indus- trialgeographythatareshapingthefuture structure of the global trade network for years to come. MergeGlobal uses a demand-pull framework to forecast trade flows. This E veryyearMergeGlobal,investmentbankingresearch groups,andconsultingfirmspublishforecastsoffuture demand and supply for the global containerized air and sea freight industries. The emphasis of these reports is on showing how fast the market will grow, instead of explaining theunderlyingdemanddriversthatcausestructuralchangesin the supply networks of leading manufacturers and retailers. We believe the real purpose of forecast- ing is not to predict the future which is very difficult to do with any degree of accuracybuttothinkaboutitinastruc- tured way and understand the linkages between different pieces of the economy and supply chain. This year we seek to change this by bringing you behind the numbers and sharing the framework that Figure 1 Demand-pull framework Source: MergeGlobal primary research. Decision flow Description Why important? Consumer demand in destination market for consumer products Demand of manufacturers in destination market for industrial products including components, which is driven by consumer demand eventually Share of different types of retailers and manufacturers using different business models to meet end-user demand Two extreme business models are low-cost mass production and responsive differentiation It determines total demand for specific product in destination market It determines consignee segment share of total product demand in destination market Share of import vs. domestic sourcing by retailers and manufacturers Sourcing decision depends on total landed costs, which include product costs, trade-related costs, transport costs, and inventory costs It determines total imports demand for specific product by consignee segment Share of different origin countries from which products are sourced It is driven by total landed costs of specific product made in specific country and transported to final destination market It determines origin country share of consignee import product demand Import shipment size, order frequency and transport mode choice (air vs. sea FCL and sea LCL) It is driven by importers business model to meet evolving end-user demand It determines expected shipment size mix by mode and seasonality of the business Location mix of retailers DCs or manufacturers plants/warehouses It is driven by importers business model, geographic topology and inland transportation infrastructures It determines transcontinental and inland transportation routing Share of different regional routing and transportation modes (e.g. intact MLB, transload MLB and all-water) It is a balance of transit time, reliability and total distribution costs It determines regional transportation mode and routing End user demand in destination market Business model share of end-user demand Import share of total product sourcing Origin country share of import sourcing Regional destination share Routing share to regions Shipment size and modal mix 1 2 3 4 6 7 5 approach is based on the assumption that consumer or industrial demand pulls imports into a country to fill the shortfall in supply not met by domestic production. The ratio of domestically produced to imported supply varies across industries and specific products. But overall import share of supply has been rising in most The MergeGlobal Forecast Team comprises Brian Clancy, David Hoppin, Luis Blancas, Richard Ho- lohan and Clement Zhang. Clancy and Hoppin are managing directors of MergeGlobal, a specialist firm that provides clients in the global travel, transportandlogisticsindustrieswith services ranging from financial advi- sory to strategic consulting. This is thefirstinaseriesoffourreportsfrom MergeGlobal, with further coverage appearinginAmericanShippersJuly, August and November issues. 3. Behind the Numbers 10 AMERICAN SHIPPER: JUNE 2007 Figure 2 Personal consumption has expanded faster than GDP for many years Billions of constant 2000 dollars Source: U.S. Bureau of Economic Analysis. U.S. economy Personal consumption 2.5% 4.1% 3.1% 4.4% CAGR 12,000 10,000 8,000 6,000 4,000 2,000 0 1995 2000 2006 1995 2000 2006 Compound average growth rate (CAGR) between the years indicated on each graph. Figure 3 (Tables 3.1-3.7) Demand-pull based forecast of U.S. footwear consumption 3.1: After a small slowdown, consumption is expected to remain healthy over the next five years. End user demand in destination market 1 U.S. personal consumption expenditure Annual growth, percent 3.0% Forecast 3.1%3.1%3.0%3.0% 2.8% 3.2% 3.5% 3.9% 2.8%2.7% 2.5% 01 02 03 04 05 06 07 08 09 10 11 12 Source: U.S. Bureau of Economic Analysis and MGI Demand-Pull Model. segments. The rising share of import sup- ply as a percent of total end user demand is what we call network shift, and it is the key underlying driver of structural change in trade network demand patterns. Figure 1 shows the seven-step process we use to translate end-user demand for a specific product into an origin-destination product trade flow by mode and network routing. Step 1 is total end-user demand for a specific product in a destination country. End-userdemandcomprisesconsumerand industrial products and can be finished goods ready for final consumption or com- ponents that feed a product process. In step 2, business modal share of end- user product demand determines who the consignee will be for imports. In the retail sector, multiple distribution chan- nels are competing for end-user demand using multiple retail formats. Extremes include big box retailers at one end of the spectrum and high end specialty retailers at the other end. Step3istheimportshareoftotalproduct demand, and measures the competition between domestic and import suppliers. Origin country share of imports in step 4 captures the competition between countries for import demand and reflects therelativecompetitiveadvantageofeach country in terms of its ability to supply specific products cheaper than another country on a total landed cost basis. Total landed costs include product costs, ap- plicable duties, transportation costs and inventory carrying costs, and reflect the balance between lower labor costs and longer transportation length of haul and supply chain variability. Changes in rela- tivetotallandedcostsforspecificproducts between countries determine a countrys future share of origin demand for imports to a destination country. Step 5 is where shipment size and modal mix are determined for a specific import flow. Shipment sizes are a function of numerous tradeoffs between ordering costs and inventory levels, and must be considered simultaneously with mode choice. Ultimately, flows are segregated into sea full-containerload (FCL), sea less-than-containerload and air LCL, and reflect the relative unit values, economic perishability, physical characteristics and theeconomicprocessimpairmentpotential for each product. Step 6 tracks the shifts in regional destination demand for products at the destination country, and reflects shifts in distribution center and manufacturing plant locations. Step7isthelaststep,andiswhereorigin and destination demand by mode is trans- lated into specific flows over the network byassigningdemandtosupplyandsolving for equilibrium where spilled demand is reassigned to the next-best routing until all demand is satisfied. This requires an evaluation of the relative capacity, transit times and prices by route. In the next section, we present this analytical process at work focusing on the U.S. footwear industry. Application of demand-pull framework The best way to better understand the demand-pull framework and how its ap- plied is by example, and for this purpose weve chosen the U.S. footwear market. Again, the objective of the framework is to understandtheprimarydriversoffootwear consumption in a specific market over a period of time, rather than determining point estimates of consumption. Footwear provides a good illustrative example because it is easy to relate to, and at the end of the exercise readers should be able to judge the reasonableness of not only the forecast (e.g., pairs per person 4. Behind the Numbers 12 AMERICAN SHIPPER: JUNE 2007 More than $10.55 per kilo Less than $10.55 per kilo Business model share of end-user demand 2 FEU share vs. value share of U.S. footwear imports Via vessel and air 3.2: Big retailers will continue growing on an FEU ba- sis, but specialty stores are likely to maintain their share of imports by value. 100% 75% 50% 25% 0% Forecast High end Low to medium end 07 08 09 10 11 1201 04 Value share 100% 75% 50% 25% 0% 07 08 09 10 11 12 Forecast High end Low to medium end 01 04 FEU share 3.3: Footwear sourcing is slowly reaching its steady state.Import share of total product sourcing 3 U.S. footwear import saturation FEU, in percent 214 Domestic Imports 01 04 07 08 09 10 11 12 Forecast 225 226 230 236 246 255 267 280 294 312 330 U.S. footwear consumption Thousands of FEU 95 Forecast 00 07 1204 6.4 6.7 8.6 11.1 7.5 U.S. footwear consumption Pairs per person Forecast 100% 99% 98% 97% 96% 87% Imports Domestic 07 08 09 10 11 1201 04 per year), but also the steps we took to get there. We believe this approach is ultimately more useful than a technically sophisticated forecasting framework that produces data that are difficult to assess because of the black box nature of the underlying methodology. Demand-pull, on the other hand, helps usdissectthecriticaltrendsthatult