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Condiciones Logísticas Freight Rate Defense Strategy of Ocean Shipping Companies

Fecha de registroSEP 05, 2023

Freight Rate Defense Strategy of Ocean Shipping Companies
Freight rates are determined by a variety of factors, including supply and demand, global economic conditions, oil prices, and ship operating costs. In particular, freight rates decrease when there is an oversupply of ships and a drop in cargo volumes due to the global economic downturn. In such situations, shipping companies adopt various strategies to prevent revenue decline and reduce costs. To understand their strategies, it is important to understand the basic characteristics of the shipping industry.

For hundreds of years, the shipping industry has been going through a cycle of troughs, recoveries, peaks, and collapses. In a nutshell, at the trough stage, freight rates plummet due to a supply glut of ships, making it difficult for shipping companies to make a profit. This leads to a number of strategies, such as blank sailing, idling, slow streaming, scrapping, and general rate increases (GRIs), all in an effort to increase rates. Through these strategies, freight rates reach a "recovery" phase, and slowly move to a "peak" where supply and demand are balanced. As the business cycle of the shipping industry shows, carriers adopt various tactics to defend freight rate when the shipping market is in recession. Therefore, in this column, we will take a look at the freight rate defense strategies of carriers facing recession.
[Cycle of Shipping Industry] Cycle of Shipping Industry (Source: Stopford, 2009[1])
1. Blank Sailing Blank sailing is one of the most commonly used strategies for efficient operation in the shipping industry. To respond to unfavorable market conditions, where low demand and oversupply have resulted in lower freight rates, carriers actively utilize blank sailing. A blank sailing is when a shipping line or carrier skips a particular port or cancels an entire voyage. For example, on a service that calls at three ports in sequence, A, B, and C, a vessel may skip port B on a given day and sail directly from A to C, or it may even cancel the entire voyage. There are also cases where the entire operation is canceled.

The idea behind blank sailing is to balance supply and demand in uncertain market conditions by suspending certain services or operations. When cargo volumes decline for reasons such as a global economic recession, trade wars, economic downturns in certain regions, or pandemics, carriers may cancel some sailings to reduce operating costs. In addition, when oversupply causes freight rates to fall, carriers may cancel some sailings to reduce supply, creating a temporary supply-demand balance in the market. This can help stabilize or increase fares by creating a temporary shortage of supply.
Image of a ship at sea (Source: Getty Image Bank)
A recent report from Drewry illustrates these market trends and the strategic responses of ocean carriers.[2] According to the report, 56 out of 675 scheduled sailings were canceled between weeks 11 and 15 on key routes. THE Alliance canceled 31 sailings and OCEAN Alliance canceled 12 sailings. In addition, 2M canceled four sailings and non-alliance carriers canceled nine sailings. On the trans-pacific route in particular, a whopping 57% of scheduled sailings were canceled. This represents nearly half of the transportation services are being restricted. A significant percentage of sailings were canceled on Asia-North Europe and Mediterranean routes as well, with 34% accounting for blank sailing. Transatlantic Westbound reported 9% of cancelled sailings, which is relatively low compared to other routes, but it still indicates the uncertainty of transportation services. Blank sailing data can be seen as an indicator of how agile carriers are in the current market environment, and can provide important insights into the future of the shipping market and changes in carrier strategy.

Blank sailing also has some drawback as it is designed to react to market changes in the short term rather than long-term planning. In addition, canceling a scheduled voyage can lead to customer dissatisfaction, and frequent cancelations can undermine a carrier's credibility.
[Scheduled Sailings vs Canceled Sailings] Scheduled Sailings vs Canceled Sailings (Source: Drewry[2])
2. Slow Steaming Supply and demand imbalance can be commonly found in the shipping market. With the increasing volatility of the global economy in the modern world, shipping companies need strategies to respond to these imbalances immediately and effectively. As a result, carriers are looking for different ways to control supply and prevent freight rates from falling. One of the strategies that carriers are adopting is slow steaming, which basically means container ships traveling at a slower speed than usual. This will, first of all, significantly reduce fuel costs by consuming much less fuel. Secondly, it reduces carbon dioxide emissions, making it more environmentally friendly in the face of tightening environmental regulations. Thirdly, it reduces the mechanical pressure on the vessel, extending its overall lifespan.

However, these are not the only benefits of slow steaming. Slow steaming also allows shipping companies to react quickly to the changing market. For example, if cargo demand in a particular region is falling sharply, a carrier may choose to slow down vessels on that route to reduce supply by delaying arrival times or adjusting frequency. By doing so, the carrier can save on fuel and maintenance costs while balancing supply and demand.

Additionally, this strategy of controlling supply also plays a large role in reducing downward pressure on freight rates in the shipping market. Controlling supply by adjusting the frequency and speed of vessel operations gives carriers more room to keep freight rates stable, or even increase them in some cases, even in the face of falling demand. Thus, the strategy of slow steaming allows carriers to reduce costs and stabilize rates at the same time.

In the midst of the shipping downturn, carriers have been using slow steaming strategy to defend freight rates. The average speed of container ships this year was 13.88 knots, the lowest on record since tracking began in 2008. This is down about 3% from last year's 14.29 knots and down 4% from 14.49 knots in 2021, when freight rates were particularly high. It is also about 3.5% lower than the pre-pandemic 2019 rate of 14.36 knots. As mentioned earlier, slow steaming of container ships is an effort by carriers to reduce total supply during the recession. Slow steaming can also reduce costs, as slowing down a container ship by one knot can reduce fuel consumption by as much as 10%.

However, there are also downsides to slow steaming. Customers may be dissatisfied with the increased transit time, and if they need their cargo delivered quickly, they may prefer a carrier that offers faster service over one that slows down. Therefore, when applying a slow steaming strategy, it is important to understand customer needs and market conditions to determine the appropriate vessel speed and schedule.
[Average Speed of Container Vessel (Knot)] Average Speed of Container Vessel (Knot) (Source: Shipping Intelligence Network[3])
3. General Rate Increase (GRI) General Rate Increase (GRI) is a strategy used by shipping lines around the world to periodically increase fares on some or all routes. It is usually based on a specific date and is applied when a shipping company sees the necessity to raise fares due to various factors such as an imbalance in supply and demand, changes in the market, etc. GRIs are implemented periodically for reasons such as rising costs.

The purpose of GRI is as follows: The first is to respond to rising costs. By applying GRI, fares are raised to offset costs such as fuel costs, labor costs, and port charges. The second is to improve profitability. When there is oversupply of ships, shipping companies are not profitable due to lower freight rates. To address this problem, they will try to improve their profitability by applying GRI. In other words, they can use GRI to offset the increase in operating costs and stabilize their revenue. The third is to respond to market changes. The flexibility to adjust freight rates according to changes in the market can help maintain or improve competitiveness.
Image of fare increase (Source: Getty Image Bank)
However, GRIs are not always successful. For example, the U.S. West Coast and East Coast routes saw fare increases of $376 and $418, respectively, in the second week of April, but a GRI in May failed, resulting in no fare increases. In the first week of June, the fares increased again, but in the second week, the fares decreased by the amount of the previous increase. GRI has continued to be applied up to date, with major carriers announcing their GRI plans in September. For example, Maersk announced a $350 per TEU, $500 per FEU, $750 per 45-foot high cube, and $1,000 per 40-foot reefer container freight rate increase on the India-North America route.

There are also downsides and risks involving GRI. Consistent and large rate increases can lead to customer dissatisfaction. In addition, an excessively high GRI can cause customers to move to other carriers, which can lead to a loss of market share in the long run. Therefore, carriers need to exercise careful judgment when determining and applying GRIs, taking into account market reactions, customers, and business strategy. 4. Other Strategies As one of the strategies to stabilize freight rates and reduce costs, carriers consider adjusting their vessel capacity or choosing different routes. In recent years, major carriers have significantly reduced their vessel capacity on North American routes compared to last year. For example, MSC reduced capacity by 35%, Maersk by 19%, HMM by 25%, and COSCO by 7%. As a result, weekly supply on the North American route in June fell 23.3% year-on-year to 516,000 TEUs. In another strategy, following the Suez Canal's transit fee hike, carriers have opted to use the Cape of Good Hope in South Africa, where no transit fee is charged, instead of passing through the Suez Canal on the Europe-Asia route. The steady increase in transit fees by the Suez Canal Authority over the past year, coupled with declining volumes, are the main reasons for this decision. Currently, the tolls of the Suez Canal is about $100,000 – $300,000 per container vessel, while bypassing the Cape of Good Hope can save around $1 billion per year including additional fuel costs.

Another strategy for freight rate defense is the introduction and adjustment of surcharges. Container Imbalance Charge (CIC) plays a key role in solving the issue of unbalanced container supply and demand between import and export destinations. The CIC enables an efficient response to the supply and demand of empty containers. In addition, Bunker Adjustment Factor (BAF) enables carriers to respond to rapidly fluctuating global oil prices. This surcharge mitigates the burden of fluctuating oil prices and serves as a basis for carriers to adjust their fuel costs. The BAF allows carriers to effectively overcome the instability of oil prices and mitigate the burden of rising fuel costs. Exchange rate instability also has a significant impact on shipping companies' business. To minimize the risk of exchange rate fluctuations, many companies have introduced Currency Adjustment Factor (CAF) to minimize the exchange rate risk of international payments. In addition, Emergency Bunker Surcharge (EBS) is utilized to quickly respond to unexpected and sudden increases in fuel prices, and Emergency Cost Recovery Surcharge (ECS) to cover urgent operational costs or incidental expenses incurred in unusual market conditions. The introduction of these surcharges provides carriers with effective protection against declining freight rates, while giving them the flexibility to respond quickly to various cost fluctuations. 5. Conclusion Many shipping companies are making efforts to respond to freight rate volatility in the market by adjusting their supply. In response, shippers need to forecast their demand thoroughly to efficiently manage their supply chain. While shippers may demand short lead time for urgent shipments, they can find opportunities to reduce costs by using slower container ships or services that call at multiple ports for other shipments. The key is to properly weigh the cost versus the service value to determine most suitable operational strategy.

With the anticipated downturn in the shipping market, carriers will continue to adopt various strategies to control supply. In the current market, freight rates are relatively low which is favorable for shippers, but there is no guarantee that this will continue. Small and medium-sized shippers, in particular, may be more susceptible to volatile market. Therefore, it is essential to have a thorough demand forecasting and supply chain management system in place, which will allow shippers to flexibly respond to market changes and operate stable business. # Reference [1] Stopford, M. (2008). Maritime economics 3e. Routledge.
[2] Drewry, Sea Intelligence Sunday Spotlight issue 605.
[3] https://sin.clarksons.net/

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