The big-ship decision
Grow or perish. It’s the oldest business cliché in the book, and a big reason why container shipping lines seem to be voluntarily inching themselves toward the edge of a cliff.
At its core, the liner business is little different than any other. A carrier wants to grow just as a retailer wants to expand. But what form does that growth take? That’s where the difference lies.
A retailer may expand by increasing its number of outlets. Or it may expand an existing outlet. Alternately, it could expand the range of products it sells, or merely increase the number of SKUs within its existing range.
For a shipping line, expansion can really only come in two ways — market share grabs on existing trade lanes or expansion into new trade lanes. Either of those expansions can be accomplished through another two options — deployment of vessels or slot charter on another line’s ships.
All of this is a rather labored way of saying that lines have ordered (and keep ordering) an immense amount of new tonnage to grow, because not growing means perishing.
As one industry executive put it to me recently, the lines that stay on the sidelines while big ships are being ordered are essentially making the decision to leave the business. The scale achieved through these large ships is that important.
In the last month we saw Evergreen Line place an order for 13,000-TEU ships. Long the notable big-ship holdout among the world’s biggest lines, Evergreen now has more capacity on order than any carrier outside of Maersk Line.
The line’s order completes an 18-month run in which every major carrier among the top 20 either has vessels of such size in operation or on order. Even two of the Japanese lines, which are drawing down their fleet sizes, will operate mega-ships in the coming years through charters from their alliance partners.
The context for this period of super-size ship-ordering is that carriers have lost gobs of money in the period since the world economic crisis took hold in late 2008. Debt levels are high, only a couple carriers are truly on firm footing financially, and yet, ships keep coming.
To put the situation in another perspective, imagine owning a lemonade stand. A table, lemons, sugar, a pitcher, and some plastic glasses were all you needed to succeed in years past, because it was always hot on your block.
Then, customers started wanting the lemonade delivered to their homes. Some wanted more sugar in their drink, some wanted more ice. Some wanted a straw and napkin included. Some wanted to pay for a week’s worth of lemonade at the end of the week. Your costs were going up.
Then, the weather started turning slightly colder, just enough to dampen demand for lemonade. And then, the price of lemons started increasing, so much that lemons now accounted for 60 percent of your total costs, instead of 30 percent.
What would be the response to these changes in your business? The liner industry’s response has been to order larger cups. And yet, it’s hard to blame them. The decision to grow and be viable is more desirable than to stand pat and become marginalized.
This is not to suggest that Evergreen decided on the latter. More correctly, Evergreen waited until a point at which ships were at their least expensive — and they also used a financing vehicle (in this case, an investment entity in South Korea) to ease the purchase burden.
The companies which neither rode the front of the big-ship wave, nor waited for bargain basement prices, are the ones who have the most ground to make up.
The good news for them is that big ships are not mobile phones. Nokia lost its grip on the mobile phone market when it failed to predict, and then react to, the smartphone phenomenon. But shippers aren’t dazzled by big ships in the same way consumers are by gadgets. Lines that get these big ships and effectively use them, leveraging their scale without sacrificing revenue, can catch up quickly on a trade lane basis.
That’s not to say Maersk, Mediterranean Shipping Co. and CMA CGM, with scores of these ships already in operation, don’t have a leg up on a global basis. But in a period of recovering demand on the trades where these ships can realistically be deployed, it will be hard for any line to consistently run full. Which means everyone’s pretty much in the same boat.
And that leads back to the initial point: grow or perish. Is the cliché apt? Maybe on a long-term basis (for example, ship-ordering two years down the line) it is. But on a short-term basis, it’s also clear lines who stepped back from unprofitable business performed better than those who sought that business.
Here’s an example: OOCL, one of a few lines that publishes regular operational updates, saw its 2011 Asia-Europe volume fall 29.2 percent. Yet the line’s Asia-Europe revenue fell less dramatically (by 17.1 percent) in the same period. It’s a classic decision by a line that’s been unafraid to step away from unviable business in the past.
In the first quarter of 2012, OOCL then increased its Asia-Europe volume by 3.4 percent over the same period in 2011. The result? A 21.2 percent drop in revenue.
To take another example, March volume for CSAV (another line to offer regular operations updates) was 52.7 percent lower than in March 2011. It was also CSAV’s lowest volume in a single month since June 2009. However, CSAV’s average revenue per TEU in March was higher than in any month since November 2010.
By failing to heed the call to grow or die, CSAV has apparently started living again. Where that leaves the line long-term is less certain. Because it has drawn down its service network, operated fleet, and order book, CSAV is heavily dependent on alliances with MSC and CMA CGM.
OOCL, meanwhile, has maintained its relative place in the pecking order of global carriers, ordering a moderate number of big ships, while reserving the right to selectively turn down business that’s not paying its way. Yet it too is now dependent on a major partnership on the Asia-Europe trade (the G6 alliance between the New World and Grand alliances), the very place where these ships will be deployed.
With the tenuous times ahead, lines will be hoping it’s not a case of grow and perish.