The Hard Road Ahead for a Budget Shipping Line

This article looks at the rationale for starting a budget shipping line and finds little in common with that of a budget airline which is the presumed model. The article then goes on to suggest four steps for attaining low costs and ends in a plea for some brainpower to be applied to this industry. The main message is that you will not make money unless you are prepared to use the shipping cycle and buy/charter in ships when prices are low and sell/charter out ships when prices are high.

Ever since US Lines forced container freight rates down to rock bottom levels in the mid-1980’s, container shipping lines have thought they operated in a cost conscious environment with low freight rates, so the idea of starting a 'Budget Shipping Line' will raise a few eyebrows. Few lines have made an adequate return on investment despite the phenomenal growth in container traffic. The fact that freight rates can continue, as they are now, for long periods at levels below what lines regard as adequate show that there is a need for a new business model for this industry for profit focussed players.

 

The Budget Shipping Line model that is being proposed is possibly based on the budget airline model. Features of the budget airline model are:

-Low cost service without frills

-Internet booking

-Direct service between secondary airports

-Pricing based on actual bookings over time versus. normal booking pattern, with significant low/high fare differences

 

It is debateable how much of this is directly transferable to the container shipping industry. For example there are not many ‘frills’ offered today by shipping lines that can be cut out to reduce costs. Internet booking is hardly used and there is no universally accepted payment mechanism without which an online booking system does not mean much (especially the idea of losing the ticket money paid in cases of 'no show' or 'late cancellation'). Many shipping lines already offer direct services between secondary ports so a newcomer may not be offering anything new. The one area that could be applicable is the approach to pricing which in shipping lines is still in the dark ages of the container conference mentality. 

 

Shipping lines’ pricing approach gives more weight to what they hear or believe the competition is doing, rather than on how well their own bookings are doing. The airline model focuses on individual flights so that the fares can vary from one flight to the next depending on how the flight bookings are building up against a preplan. If the bookings are below plan, then the low fares category continues, if the bookings are above plan the fares ramp up to the next category level. Shipping lines could do well to adopt this model and focus on profitability of each vessel sailing. This way the freight rates will be more responsive to demand e.g. currently eastbound trades ex Europe are relatively strong yet lines are still trying to get increases on the still weak but traditionally strong westbound trade. Each vessel voyage loss incurred means making an overall profit that much harder. So I would change the pricing mechanism and focus on voyage profitability as a first step.

 

Container shipping lines face a whole additional level of complexity compared to airlines because they also have to manage the fleet of containers that goes along with the vessels. It is like running two different businesses at the same time. So along with the focus on vessel profitability, I would also focus on container profitability. This entails having planned routes for the containers just like the ship has a planned route, and then monitoring that the route was followed and was profitable. Doing such analysis manually would be very difficult (although many NVO’s i.e. companies who operate container fleets with no vessels of their own do this), but fortunately with the advent of computers such analysis is quite easy if the company management so decides. So this is a second step.

 

Of course it is most important to have low costs. Most lines today offer ‘no frills’ services but many have ‘frilly’ overheads. The objective is to run the line with minimal overheads and keep as many costs variable as possible. So no large head office staff, no regional offices and no own sales offices; instead go variable, use sales agents, outsource, and simplify the cost structure to make management very easy. This is the third step.

 

Apart from overheads, the other main avoidable costs are related to a) expenses incurred in sending back empty containers from a port where they are not needed to a port where they are needed b) transhipment costs c) feeder expenses d) high marine and berth hire costs. So prefer shipping to ports or inland destinations where you can book all the containers back out to another port on your service network. Prefer direct service with your own vessel. Keep things simple as a complicated network adds costs and overheads so probably avoid having your own feeder services. In other words try to have direct end to end services between ports which can generate full loads in and full loads out. Prefer ports where the marine and berth hire costs are low; there is a huge variation in these costs between high and low cost ports, try to avoid ports with costs of over US$10,000-15,000 per call (depending on vessel size) as the impact on the cost per TEU then becomes significant. These preferences mean overall market share and size of company ambitions have to be curtailed, but if followed will give the line unbeatable variable costs. The only cost where you will not be number 1 is vessel slot cost, where bigger vessels beat smaller vessels if filled to capacity. Therefore you must aim to be the gorilla on your patch, building up to utilizing tonnage as big as the biggest on your chosen port pairs (I am not envisaging 14,000 TEU leviathans so avoid those port pairs at least to start with!). This whole process is step four.

 

If followed, the above steps should lead to the line at a minimum breaking even over the shipping cycle. Clearly this is an unsatisfactory result, and leads to the conclusion that an additional revenue source has to be sought. The main source of additional revenue, in fact the main game for some players in other shipping segments is capital appreciation i.e. buying ships cheap and selling them dear. If analyzed, there is a significant variation in second hand ship prices over the business cycles and a less pronounced cycle of yard prices. Think how much better your cost structure will be if you enter at the bottom of the cycle when ship prices and charter rates are low compared to some of your competition who bought or chartered vessels at the top of the cycle. Lines can realize the benefit of the trade cycle by buying ships when they are cheap and selling them when they are dear. Simple idea, why do liner shipping companies not do this as a routine activity? Mainly I maintain because they are too committed and focussed on a) being a liner company providing liner services and b) becoming bigger rather than making profit over the cycle. So look at making a sizeable proportion of your net income from trading in ships i.e. buying or chartering in ships when prices are low and realizing a profit by selling or chartering out vessels when prices go up.

 

There are many other more detailed recommendations I can offer, but the above analysis gives an indication of how difficult it is to make a reasonable profit in the area of container liner shipping today. This contrasts with other links in the logistics chain. Ports are a crucial link and are still profitable. Freight forwarders are another crucial link and again are still profitable. Only the liner companies today bear the full brunt of the market fluctuations and swing from barely acceptable profit levels to large losses over the business cycle. It is time for shipping lines to apply some brainpower and conceptualize profitable strategies, rather than simply reacting to the market with old remedies that never worked in the past and will not work now.

 

This author consults with leading institutions through GLG