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Logistics insights Expert Column Structural Changes and Responses to Global Supply Chain

Registration dateFEB 10, 2022

Structural Changes and Responses to Global Supply Chain Structural Changes and Responses to Global Supply Chain

Foreword

A businessman, who has been working in the logistics field for a long time, recently expressed his displeasure at the change in the attitude of the shipping industry, saying that in the past, people from shipping companies had come to visit him, but now it is difficult to see his face. In the past, the share prices of container shipping companies were not able to break out of the bottom, and shareholders were not expecting dividends at all.
When the pandemic was declared around March 2020, the global economy expected a sharp cooling phenomenon and a sharp decline in trade volume, but the market reaction was completely unexpected. There has never been a market like today in the 70 years of container shipping history. So, the recent market situation is said to be highly unprecedented. The basic assets of shipping, such as ships, containers, and chassis, are insufficient, and ports, terminals, and warehouses are fully occupied to the extent that they cannot handle the volumes. Land logistics infrastructure, including railroads and trucks, is also insufficient to satisfy demands. The Contrast of the Logistics Crisis
The Confusion and Its Causes

Unforeseen congestion and traffic around the world increased the waiting time of ships at ports, and containers did not return on time due to the bottleneck situation on land. In the case of the Pacific route, despite the maximum capacity being put in, including temporary vessels and ships transferred from other routes, unusable capacity exceeded 10% due to the delay, and the number of unusable containers is also nearing 15%.
The cause of the confusion is the change in the consumer demand pattern after the pandemic, which has shifted to purchasing products rather than services. It was encouraged by subsidies or stimulus packages, and an enormous stimulus package of 1.9 trillion U.S. dollars was at its center. The balance of supply and demand has largely tilted toward demand, and to make matters worse, many ports including China have reduced operation time or closed temporarily due to a shortage of manpower from quarantine measures and infection outbreaks. Moreover, a large container ship ran aground on the Suez Canal, a key logistics hub, in March, and the canal was blocked for a week, further exacerbating the logistics crisis.
Shippers are experiencing triple distress, in terms of reliability of the service, lack of equipment and ships, and difficulty in shipping, even after paying costly ocean freight rates. On the other hand, global shipping companies are making up for their accumulated losses by posting record-breaking operating profits. The top 10 shipping companies are estimated to have an operating profit of 150 billion U.S. dollars in 2021. The operating profit margin of large Korean shipping companies in Q3 is 57% of sales, which is unprecedented in the history of Korean shipping, ranking first among the top 100 companies in sales.
(Source: Lloyds List. Nov. 22, 2021)
[ Operating Profit Rate of Top 10 Shipping Companies ] (Source : Alphaliner, carrier’s financial results)
Due to the skyrocketing ocean freight rates, global import prices increased by 11% and consumer prices rose significantly. Multinational assembly industries such as computers, electronic products, and optical products that require more use of maritime transportation, suffered severely. In the case of low-priced goods such as furniture and clothing, they are facing a crisis to the extent that forces them to forfeit their businesses due to soaring shipping rates. In the case of the United States and Europe, it is predicted that the increase of freight rates by 10% will decrease the production of industrial products by 1%.
(Source: 2021 Review of Maritime Transport by UNCTAD)

The Perspective of Shippers and Political Communities

The United States is one of the countries with the strongest anti-monopoly tendencies. Moreover, it is a common perception among American shippers and politicians that foreign shipping companies are achieving the highest operating profits in history by using their superior dominance as a weapon through shipping alliances due to the inconvenience of the U.S. import and export industry and the burden of U.S. consumers. In the case of the United States, where no container ships are operating on international routes except for the Jones Act fleet that connects cities located in remote locations such as Hawaii, Puerto Rico, and Alaska with the mainland of the United States, the reality is that the transport of import and export cargo is entirely dependent on foreign shipping companies.
Complaints from shippers due to shortage of ships and containers and high freight rates, as well as complaints from American agricultural companies that export routes may be blocked, are flooding the political communities. However, since long-term investment to build logistics infrastructure requires time, there is no appropriate countermeasure that can be mobilized immediately. The only measure that the U.S. politicians can adopt is to demand and pressure foreign shipping companies for a solution.
The Perspective of Logistics Companies Including Shipping

The perspective of the shipping industry is that this logistics crisis is not caused by the strategy of shipping companies, but the fundamental causes are the rapid increase in demand in the U.S. and the structural weakness of the logistics infrastructure. The price of a ship for an ocean route is between 100 to 150 billion won. In the case of the European route, the cost of using 11 ships reaches 1.5 trillion won. It is a very capital-intensive industry that needs to be equipped with terminals and containers. Therefore, it is the top priority of management to minimize delays or congestion and to focus on high-margin services to improve the efficiency of shipping assets.
From the viewpoint of a profit-seeking shipping company, it is natural to focus on high-margin cargo transportation from a commercial perspective, and there is no legal basis for criticism. However, as pointed out by some, the social responsibility of a company before the pursuit of profit cannot be ignored at all. The Chairman of the Federal Maritime Commission (FMC) also commented that shipping companies may claim that they have faithfully observed the letter of the law but are ignoring the spirit of the law.

Forecast of Supply and Demand

The current strong demand cannot be prolonged, but even if demand slows, it will take time to correct the once entangled flow of logistics due to the nature of the logistics supply chain. Although the growing trend of demand has recently shown signs of slowing, it is not immediately leading to a downtrend. It is unclear whether the pandemic will be controlled in the near future, but optimism seems premature given the rapid spread of confirmed cases with the recent emergence of a new strain called Omicron.
It seems that the effect of the government stimulus package is almost exhausted along with efforts of shipping companies to solve the supply shortage such as additional orders for ships and containers, which are the main pillars of the logistics supply chain. The growing trend of demand is likely to be halted. Politicians are also examining institutional measures to supplement logistics facilities, such as investigating the root causes of congestion and suspension, to solve the fundamental problems of the logistics system. The degree of the logistics crisis is expected to gradually ease.
However, despite the recent increase of shipbuilding orders, the basic logistics infrastructure such as ports, terminals, roads, and rail networks, including shipping assets, is usually built based on the normal scenario rather than the worst-case scenario. This is in the same context as a bus, liner, and railroad companies do not secure and operate assets based on special holidays such as Chuseok and Lunar New Year when people migrate en-masse. Consequently, even if additional assets are secured, the fundamental solution is to normalize demand because the scale is based on the optimal balance of supply and demand.

The Prospects of the Future Logistics Market

Global logistics will be affected by pandemics and vaccinations in the short term, but the long-term forecast will be dictated by waves of structural changes in logistics. Ultimately, the hindrance in the logistics chain caused by an unconventional change in demand will serve as an opportunity to reinforce the weaknesses of the logistics supply chain as global trade patterns are normalized. In the long term, it is expected that this will lead to a major change in the structure of the maritime transportation industry.
Meanwhile, while the issue of reshoring or nearshoring manufacturing plants is being discussed, the possibility of a sudden change in the logistics chain is expected to be minimal. This is because reshoring may be accelerated for labor-intensive and low-priced products, but it will not be easy to transfer production bases for mid to high-priced products.
The most significant problem is the congestion of ports. In the case of L/A and L/B ports in the U.S., the waiting period for the berth reaches as much as 25 days. Europe is also slightly better than the West Coast of the U.S., but the waiting period is still 7 to 10 days. As congestion intensifies in the U.S. and Europe, which are the destinations for export cargo from Asia, the impact is spreading to China and Asia’s intraregional routes and branch routes.

(Source : Lloyds List Feb. 10, 2021)

The Transformation of Fundamental Relationship of Shipowner and Shipper

In the past, when there was an excess of bottoms, the shipping market was clinging to the battle of stamina for survival. It is no exaggeration to say that the freight rate in the market was decided by the shipper as the freight conference was abolished and profitability was neglected as they went all-in on the struggle for cargo. As this recession progressed for 10 years, some shipping companies were expelled or went bankrupt. In the past, about 20 companies competed, but now the number of shipping companies has halved.
The shipping market was reorganized into a small number and large-scale by forming a super shipping alliance for survival, called the three major alliances.
Through strong cohesion, shipping companies secured the ability to artificially manage the supply(capacity) according to the demand trend and were able to control the flow of freight by blanking or lay-up at the joint cost of operating alliance carriers. This in turn caused a change in the balance of power between the shipowners and the shippers.

Summarizing the Changes in the Future Global Logistics Supply Chain

ⓐ Liner shipping and network : As the enlargement of ships is promoted in all routes, the ship’s port of call will be gradually reduced, and the transshipment function will be expanded. The network will be gradually simplified, and the merging will progress towards coastal shipping than ocean shipping.
ⓑ Logistics and Freight Market : Global logistics crisis will continue for more than one or two years. Afterward, the freight rate wars of the past will disappear, and the freight rates will stabilize at an upward adjustment.
ⓒ Market Governance : The market power of shipping companies will be further strengthened, and sensible partnerships between shipowners and shippers will be expanded. The positions of small and medium-sized F. Forwarders are expected to steadily slim.

Logistics Strategy that Needs Reconsideration

Instead of a previous era when shippers could control freight rates regardless of excess volume, it is now essential to establish a logistics strategy that prioritizes the delivery of goods to customers on the desired date and place rather than reducing transportation costs. In the past era, when shippers requested a quote from a shipping company, the shipping company immediately rushed to ask for volume instead of responding about the freight rate. The freight rate per container for Pacific or European routes used to fluctuate at the level of $1,000, which was not enough to cover the costs. Such an era should not be expected anymore.
As long as freight charge control is in the hands of the three major alliances, even if the pandemic is resolved, the expectation that the market will return to the same era it was several years ago should also be stopped. The freight rates per container won’t stay in the $5,000 to $6,000 range, but it won’t return to below $1,000 level either.
[ Trend of Freight Charge per Container ] (Source : Lloyds Lists Oct 29, 2021)
If the logistics companies, including shipping companies, linger on the perception of the past, they will steadily become more distant, but the shipping companies won’t come asking for cargoes either, like in the past. Despite not mentioning digitalization and e-commerce, the priority of the shipowner-shipper relationship should be establishing a business partnership to exchange business according to each other’s needs.
Like in the past, a shipping company and shipment were promised, but the corresponding reservation was disregarded (no-show) due to the offer of a low freight charge. Also, a shipper and shipment were promised, but the shipment was delayed unilaterally (roll-over) to the next shipment by securing a better freight charge. It will not help both the shipowners and the shippers to follow old habits such as a no-show and roll-over. Before discussing the legal responsibility for breach of contract, it is crucial to establish a trusting relationship that agrees on the realistic freight charge and respects mutual commitments through accepting changes in the logistics market and negotiating in advance instead of ensuring transportation. This is a priceless lesson, learned by extra-large shippers, forwarders, and shipping companies through the pandemic. Customized service is an option that should be removed from future logistics strategies. Optimization of Logistics Strategy To classify the types of cargo moving on major routes in container shipping according to bookings or contracts, it can be divided into pre-booked cargo (contract cargo) on a quarterly or annual basis, and cargo (spot cargo) that arranges ships right before shipment by observing the market situation. Most shipping companies and large shippers mix these two types in an appropriate proportion according to market trends and prospects, whereas small cargo shippers often place more weight on the spot. Although it seems to be the result of a compromise between stable transportation and freight burden, it was customary that the proportion of spot cargo was high during the shipping recession when there was an oversupply of ships. In the freight market that has skyrocketed due to this pandemic, the cargo that has been severely hit was spot cargo, which was small shippers that preferred lower freight rates.
Recent Contract Status

During the past recession, shippers were able to take advantage of the lowest freight rates through freight rates competition between multiple shipping companies over volume, but the spot rate has risen by 3 to 5 times recently compared to pre-pandemic due to a shortage of ships. As it is predicted that this phenomenon will continue until 2023, shippers, as well as shipping companies, are struggling with contract vs spot ahead of the contract season. Not only shippers, large forwarders, but also shipping companies themselves do not want to secure all cargoes through contract or spot.
Shippers want to ensure that the shipping is secured but attempts to avoid the method of increasing the freight burden as much as possible. On the other hand, shipping companies are pushing forward with contracts in the direction of minimizing the guarantee of ships unless freight rates are raised to a certain level. By tying a certain amount into a service contract, the shipper desires to secure a ship, and the shipping company prefers to secure a certain level of cargo. Meanwhile, both sides want to secure space to apply favorable freight rates according to market fluctuations.

Small Shipper and Forwarder

In light of the current market conditions and prospects, it is expected that the proportion of contract cargo and freight rates will be raised compared to the past, and the contract period will be prolonged. The problem is the balance of contract vs spot. For large shippers, it is possible to maintain the increase in freight rates to a minimum by linking volume and freight rates based on the trust relationship with shipping companies, but this is not the case with small shippers.
In the past, small shippers were able to negotiate freight rates by bundling the volume of several small shippers through forwarders (called the basket rate), but currently, forwarders cannot help but be prudent about contracts. Above all, forwarders are avoiding the risk because the situation of shipping companies is different from the past, and the market situation is unclear.
Since it’s no longer possible to expect a basket rate through a forwarder, the situation varies for small shippers and forwarders that have been looking for cheap fares through the basket rate in the past. If they desire an accurate amount of shipment, then they can agree on the volume and freight rate to choose a contract. Another way is to bet on the spot to reduce freight rates but risk uncertainty of shipment.
For large forwarders, this is not a cause for concern as they accept freight rates increase within a certain range and secure a stable fleet of ships by bundling their quantities through a contract in which the volume and freight are committed at a reasonable level, just as long as they are backed by large shippers with whom they have built trust. In the case of large forwarders, back-to-back contracts between forwarders and shippers are possible, so there is no possibility of a so-called sandwich situation.

Long-term Volume is Rising

Service contract (S/C) normally starts at the beginning of the year and finishes in May; however, this year, the negotiation period is more lengthened as shippers are hastening to sign contracts due to the pandemic. Spot cargo shippers, who have been avoiding S/C by targeting low freight rates according to the market’s supply and demand trends, have learned the lesson about securing a stable transportation network for goods, which is more important than saving freight rates through this logistics crisis. They are actively shifting to reviewing long-term S/C. Maersk, the world’s largest shipping company, has secured more than 40% of long-term S/C volume, which has increased the average freight rate by 50% (equivalent to $1,000) since 2019. COSCO is also negotiating a long-term S/C with clients of large Chinese manufacturers in clothing, vehicles, and machinery, as well as large Chinese home appliance manufacturers such as Midea, Haier, and TCL.
The recent consensus on the necessity for mutual commitment will be beneficial to both shipowners and shippers in that the increased S/C volume will help to stabilize management through an agreed freight rate at a reasonable level compared to the past. This is expected to create a positive effect in the future of the liner shipping market. It is time all global shipping companies are compelled to direct their attention to S/C.
Meticulous Logistics Strategy Required

Although it will vary depending on each situation and the type of goods handled, the future logistics strategy should be able to predict and manage logistics costs in the medium and long term, rather than pursue low freight rates using the short-term market flow, which was possible until 2019. Otherwise, it should be realized that the possibility of encountering unexpected obstacles in relationships with logistics companies including shipping as well as trust with trading partners cannot be excluded.

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Professor Min Hyun Yoon - Previous U.N. Conference on the Adoption of the Convention on Maritime Transportation, U.N. Conference on a Convention on International Multimodal Transport(Korean Goverment Representative), Previously worked in Korea Shipping Corp., Ltd. Previously worked in Hanjin Shipping Co., LtdProfessor Min Hyun Yoon - Previous U.N. Conference on the Adoption of the Convention on Maritime Transportation, U.N. Conference on a Convention on International Multimodal Transport(Korean Goverment Representative), Previously worked in Korea Shipping Corp., Ltd. Previously worked in Hanjin Shipping Co., Ltd