Category Archives: Trade

Burdened by Bigness

Suppose your company invested billions of dollars in new equipment. And suppose now, very shortly after taking delivery, you’ve discovered that your investment was misguided. The machines you’ve bought are threatening to destroy your business. What would you do?

That, in essence, was the subject of a conference I spoke at in October at the Copenhagen Business School. Shipping is a very, very big business in Denmark, and of course Maersk Line, the world’s largest container shipping company, is headquartered on the Copenhagen waterfront. Maersk itself built the first of the megaships — ships that carry as much cargo as 8,000 or 10,000 trucks — back in 2006, when it launched what it called its E class (hence such clever ship names as Emma Maersk and Evelyn Maersk). There are now roughly 150 vessels this big or larger on the seas. More are on the way: the South Korean government just agreed to finance ships the size of 12,000 trucks. This is not something the world needs.

I’ve been spending some time of late studying how the megaships came to be, and I’m convinced that they are a colossal error. The ship lines that commissioned them, by and large, were transfixed by the idea of economies of scale: if you can actually fill one of these giant vessels, they can carry a single container for about 30 percent less than a ship half the size. But filling them has been a persistent challenge. Moreover, the people obsessed with achieving economies of scale at sea largely ignored the fact that these behemoths would create diseconomies of scale on land. With fewer ships calling but each ship discharging and loading many more boxes, ships spend more time in port, the ports are half-buried beneath mountains of containers, and service for the manufacturers and retailers who ship goods in containers has become much less reliable. These days, when a containership arrives in port, it’s behind schedule nearly half the time, and when the goods will reach their final destinations is anyone’s guess.

The ship lines have been praying that international trade will grow faster, as it did before 2009, and fill up all those half-empty ships. Some thoughtful people, including the experts who monitor shipping for the United Nations Conference on Trade and Development (UNCTAD), think this will happen. My own view is that it’s highly unlikely. The world economy itself is likely to grow more slowly than it has in recent decades; China’s years of 10% annual growth are over. Adding to that, the gradual shift of manufacturing closer to end markets and the desire of manufacturers and retailers to minimize risks from malfunctioning supply chains will suppress demand for container shipping. Managers of ship lines, in my view, need to think very hard about where they’re going to make money, because they are probably not going to make much from operating ships.

Many of the people I met in Copenhagen, including the authors of a new McKinsey study envisioning the shipping industry of 2043, seemed to agree with my analysis. There was much discussion about the digital future. What that seems to mean is that ship lines might figure out how to use information technology to provide higher-value services to their customers. In other words, they might become logistics managers, coordinating the efficient flow of goods around the world for individual customers, rather than simply selling cheap transportation. It’s an alluring vision. Many start-up companies are now pursuing similar strategies, without the burden of owning all those money-losing ships. Ocean carriers have to figure out how to turn their underutilized floating assets into a competitive advantage even as they transform themselves into technology companies — and given the fairly bleak profit outlook for the shipping industry, some of them may not have much time to get it right.

Setting the Standard

The Australian National Maritime Museum, in Sydney, has mounted an unusual exhibition about the history and consequences of the shipping container, a subject near and dear to my heart. Appropriately enough, the exhibition is housed in containers spread around the museum’s grounds.

When the organizers asked me to write a post for the museum’s blog, I took the opportunity to explain why standardization has been so important to the growth of container shipping — and asked readers to imagine how tangled world trade might be if the same basic 40-foot container was not in use everywhere. The first containers used aboard a ship in Australia were 16 feet 8 inches long. No ship in any other country has ever carried boxes of that size, and you can imagine how difficult it would be for Australia to engage in international trade if its containers couldn’t easily be used abroad. The post is here. Many thanks to the museum’s staff for coming up with some great pictures and drawings to illustrate it.

Globalization in a Pickle

This morning, a crisp and lovely morning in Washington, I hopped on my bicycle and pedaled over to a farmers’ market a mile from my home. My modest goal was to buy a quart of half-dills from Number One Brothers, who turn cucumbers into terrific pickles.

The stand was open for business, stocked with pickled beets, pickled kale, and cauliflower and carrots pickled with ginger. There was not a half-dill in sight. The woman in charge told me that the last cucumber pickles of the season were sold in mid-October. Number One Brothers won’t have any more until June.

As I pondered this annoyance on the way home, I realized that it’s yet more evidence of what the shipping container has wrought. I, like most people, have come to expect the food I want when I want it. I don’t see why the end of cucumber season in the mid-Atlantic states should give rise to a pickle shortage. Aren’t farmers somewhere in the world now harvesting fresh cucumbers that can be piled in a container, shipped my way, and dumped into brine?

The answer, of course, is yes. Pickles from some far-off place may not be quite as good as the Number One Brothers half-dills, but I don’t need to wait until June to get my pickle fix. Some pickle factory somewhere is making cucumber pickles right this minute, and the container brings those pickles to me at an extremely modest cost. While buying them at Costco may not be as virtuous as buying directly from the maker at a neighborhood market, Costco never runs out of pickles.

What Happens After the Container Shipping Crisis?

Until 1978, dozens of airlines flew the U.S. skies. Then, with the passage of the Airline Deregulation Act, competition increased and profits became scarce. Decades of consolidation followed, as Allegheny, Eastern, Frontier, Ozark, Pan Am, and many other venerable names were merged out of existence or went bust. When the turbulence finally subsided, four giant carriers—American, Delta, Southwest, and United—controlled 70 percent of U.S. domestic passenger traffic and, through agreements with foreign carriers to share services, dominated international routes as well. Such measures have enabled the airline industry to rake in profits as never before.

Something similar is now going on in the world of container shipping. Excess capacity and slow-growing demand are forcing down the price of shipping, driving companies deeply into the red and bringing a wave of bankruptcies, mergers, and joint ventures. The August bankruptcy of South Korea’s Hanjin Shipping, the world’s seventh-largest container carrier, and the announcement, in September, of the restructuring of A.P. Moeller-Maersk, by far the world’s largest, are signs of a consolidation process that still has far to go. And although the industry is likely to remain troubled in the short term, in the long term, today’s troubles will lead to less competition among those carriers adept enough to survive. That in turn will mean higher rates for shippers, increasing the cost of moving goods around the world.

I’ve recently written an article laying out why I think this will occur. You can find the full text over at ForeignAffairs.com.

Strawberries in Winter

In our globalized world, many people hold firmly to the belief that local is better. That conviction is particularly strong when it comes to food. In Washington, where I live, farmers markets are crowded with shoppers (including myself) who are prepared to pay outrageous prices for a basket of apples or a pound of cheese if it originated at a nearby farm. We convince ourselves that what we eat is fresher, purer, or more environmentally virtuous because it was grown or manufactured on a family farm close by.

I recently had the chance to participate in an unusual radio program, produced by the BBC, that takes a look at the booming international trade in food. Called The Food Chain, the program asks why long-distance shipments of food are growing so quickly. Part of the answer, it will not surprise you to hear, is that low transport costs and high reliability make it feasible to import goods that would not be traded if freight rates were higher, a story I tell in my book The Box. But an even more important cause of increased trade in food, I suspect, is changed consumer preferences. We expect to eat the foods of our choice when we want to eat them, and if that means importing strawberries from Mexico or Chile when local berries are out of season, so be it.
Those of a certain age can remember when life was otherwise. In the town where I grew up, in the U.S. Midwest, having fish for dinner meant popping a box of frozen fish sticks in the oven. Fresh fish was something our supermarket simply did not carry, because it had no means of bringing it in. Now, the town boasts several sushi bars. Thank modern logistics, including refrigerated containers and air freight, for providing diners with an option that previously did not exist.

One current line of attack on such variety in our food supply is that long-distance shipments of food are “unsustainable.” By this, the critics usually are taking aim at the large amounts of greenhouse gases supposedly produced while transporting food internationally. Part of my contribution to the BBC program was to point out that “local” is not at all the same as “sustainable.” International trade in food often involves huge economies of scale, which means food produced on another continent may be transported far more efficiently than food produced nearby. Moving 40-foot containers of fruit great distances in a large containership can result in much lower emissions per ton than carrying smaller quantities a hundred miles in a diesel truck.
The BBC has taken an unusually sophisticated look at the food trade. I hope you’ll have a chance to listen.

Supply Chain Insurance

As of this writing, 47 people have been killed and many more injured by the earthquakes that have struck the Japanese island of Kyushu since April 14. These tragic events have had economic ramifications as well, offering a reminder that business risks can be hard for outsiders to evaluate.

The complicated industrial supply chains that are routine today began to develop in the 1970s, in good part because the spread of container shipping drove down the cost of transporting parts and components from one place to another. As I discuss in The Box, low transport costs made it practical for big manufacturers to decentralize: instead of running vast factories that churned out all sorts of inputs and assembled them into finished goods, they could farm out much of the work to specialized factories far away. Large retailers have done much the same. These long supply chains were seen as having two main advantages. Companies were able to draw on low-wage labor in developing countries, and they could gain economies of scale because a supplier might make just one or two components in enormous volume instead of lots of different things in small quantities. The result was lower costs—or so it seemed.

Invariably, though, the beancounters who made these calculations were afflicted with a dangerous myopia. Supply chains can lower costs, but they can also create risks that aren’t always visible. Some of these risks are reputational: if a supplier is accused of being a bad actor by polluting the water or by running an unsafe workplace, consumers may blame the better-known company that contracted out the work. There may be legal risks if the supplier’s shoddy work results in unsafe goods. And then there is the risk of supply-chain interruption. Interruptions aren’t high-frequency events: in a well-organized supply chain, most goods get where they’re supposed to be almost all the time. But when goods aren’t delivered due to weather, labor unrest, electricity cutoffs, or earthquakes, the cost can suddenly become extremely high.

The Kyushu earthquakes have halted plants that supply critical parts for many other consumer goods. But from what is known so far, the costs of this interruption may be less than might have been expected. The reason is that, with little publicity, companies like Toyota, Sony, and Honda seem to have reduced their potential losses by making sure that Kyushu is not their only source of critical inputs. While some of their plants will be shuttered, in some cases for several weeks, many of the key components produced in the earthquake-hit region are also made elsewhere. Those supply chain links will continue to function normally.

After the Fukushima earthquake and tsunami in 2011, factories around the world shut down for lack of components made only in the devastated region. Major industrial companies appear to have drawn lessons from that experience. Some of them have protected themselves against earthquake-related disruptions by developing redundant supply chains, so that an event such as the Kyushu earthquake won’t cripple their operations. This undoubtedly reduces efficiency and raises the firms’ normal operating costs. But supply-chain redundancy is not a frivolous expense. Like most insurance, it seems wasteful only until you need it.

Boxed In

There may be few business decisions more treacherous than buying a new containership. These aren’t purchased off the shelf; a ship line must make educated guesses about size, engine characteristics, propellers, and dozens of other factors—and then hope that its choices prove wise over a useful life of three decades or more. Once constant since the start of container shipping 60 years ago is that ship lines that guess wrong about which vessels to buy end up dead.

One of the questions shipping executives now ask their crystal balls is, “How fast should our ships go?” This was not a great concern in 2008, when the high price of oil and a slump in the amount of cargo first led ship lines to slow down their vessels, as it was assumed that speeds would be raised once business returned to normal. Since then, though, most of the dozens of new containerships that have come on line have been built to steam at 18 or 19 knots (roughly 33-35 kilometers per hour) rather than 24. This slashes fuel consumption and reduces emissions. It also sops up the excess capacity that ship lines have created by ordering mammoth new vessels, since more ships are required to provide the same frequency of service on each route.

Ship lines may love slow steaming and ships that carry 10,000 containers apiece, but their customers don’t. Megaships can take longer to load and unload than smaller vessels, and slow steaming means that it takes three to five more days to move a container across the Pacific than it did a decade ago. All of this increases longer transit times, which means that shippers must hold on to their goods for a longer period before selling them, raising costs. For companies moving time-sensitive products, such as apparel, longer transit times also increase the risk of losing sales when a product becomes “hot” and consumers are hungry for more.

Slow steaming looked brilliant when oil sold for more than $100 per barrel, as it did in 2008 and again from 2010 to 2014. Megaships seemed attractive when the demand on key containership routes was growing six or seven percent per year. With oil below $40 and the world economy heading into what looks like a prolonged period of slow growth, neither circumstance applies today. Which leads to the question of whether ship lines will again pay the price for having guessed wrong.

If It Can’t Go On Forever, It Will Stop

The American economist Herb Stein, whom I had the privilege of meeting a few times before his death in 1999, is famed for the aphorism, “If something can’t go on forever, it will stop.” I found myself thinking of him often a few weeks ago during my first trip to Dubai.

Dubai has the feel of a boomtown. The airport, of course, is one of the world’s largest — and yet not large enough, for a second airport, to be even larger, is under development a few miles away. The container port, also among the world’s largest, has just opened its third terminal, and plans for terminals four, five, six, and seven are on the drawing board. Forests of skyscrapers would leave Manhattan in the shade. Dubai Mall, reachable by riding no fewer than seven automated sidewalks from a station on Dubai’s automated metro, boasts Bloomingdale’s, Galleries Lafayette, Marks & Spencer, a two-story walk-through aquarium, an ice rink, a dozen stores selling high-end wristwatches and two dozen selling diamonds, and even a bagel shop.

And the boom is isn’t over. Construction cranes are visible in every direction. An entirely new freight railroad linking the United Arab Emirates and Saudi Arabia is under construction. When one of my interviews fell through and I decided to go to the beach, I found that much of the beach was closed for refurbishment. I mean that literally: the municipal government fenced off not just a few hundred yards, but five or six miles, effectively rebuilding the emirate’s entire beachfront in one go.

It’s all extraordinarily impressive. And it’s successful because Dubai has positioned itself as a place that works in the midst of a lot of countries — South Asia on one side, Africa on the other — that don’t work so well. If India were ever to have smoothly functioning infrastructure and Tanzania to develop an honest and efficient customs service, Dubai might be a much less busy place.

Dubai is also a relentlessly optimistic place, at least at the official level. Doubts and doubters are not encouraged. Yet one can’t help but wonder whether a shakeout is coming in the oasis business. A few miles to the northeast, Dubai’s sister emirate, Sharjah, has its own international airport, its own container port, its own dreams of expansion. A few miles to the southwest, Abu Dhabi has much the same. All of this is happening at a time when the growth of international container trade is slowing and the price of oil spiraling down. Since many of the big investments are being undertaken by entities that don’t publish reliable financial statements, it’s hard to know which parts of Dubai’s investment boom are paying off. But Herb Stein’s words offer a useful caution: the boom can’t go on forever, and at some point it will stop.

The Panama Canal’s Next Century

This month marks the hundredth anniversary of the Panama Canal. Work on a major expansion is in full swing. If all goes well, deeper channels and a third set of locks, wider, longer, and deeper than the two constructed in the early 1900s, will enable larger ships to cross the isthmus by the end of 2016. As I saw on a recent visit, the $6 billion or so being spent on canal construction and the billions more going to build a new metro system are fueling an economic boom. Yet as Panamanians celebrate the canal’s centennial, concerns about the future are not far below the surface. The canal’s next century may be a challenging one.
To start with, it’s no sure bet that enough ships will use the enlarged canal to cover the cost of construction. The expansion was conceived at a time when world trade was growing about 7 percent per year, as it had done since the aftermath of World War II. But the growth of trade has slowed considerably since economic crisis arrived in 2008, meaning that there will be far fewer ships passing through the expanded canal than its promoters envisioned. In addition, a growing number of manufacturers are concluding that Mexico is a better location from which to serve the North American market than Asia. While many ships carrying Japanese-made cars to the U.S. East Coast transit the Panama Canal, Japanese models produced in Mexico will move to U.S. and Canadian dealers by road or rail.
Then there is the matter of competition. For many decades, the Panama Canal had no competition. Starting in the 1970s, large volumes of cargo bound for the East Coast began moving through West Coast ports, and the water/rail route became a direct competitor to the canal’s all-water route. More recently, some ocean carriers have been moving cargo between Asia and the U.S. East Coast via the Suez Canal, which can accommodate larger vessels than the Panama Canal. According to some estimates, more than one-third of the container traffic between Asia and the East Coast now moves through Suez rather than Panama, a shift encouraged by steep increases in Panama Canal tolls. And now there is serious discussion of a Chinese-backed canal through Nicaragua. While it seems unlikely that such a canal could be completed by 2019, as its promoters promise, a Nicaraguan canal could siphon off Panama’s traffic at some point in the next decade.
How will Panama respond? One possibility would be to cut tolls. The Panama Canal Authority has yet to disclose how much vessels will have to pay to transit the enlarged canal, but comparatively low rates could draw carriers back from the Suez route and also make life hard for the sponsors of the costly Nicaragua project. Trouble is, lower tolls could squeeze the Panamanian government, which receives a large share of the Canal Authority’s profits.
Another option would be to give ship lines inducements to use the canal. The canal is now 100 percent owned by the government, and selling shares to ship operators seems to be out of the question for political reasons. Nor are there discussions about offering bargains to carriers that would sign contracts guaranteeing to use the canal; the Canal Authority has never done this. But the Canal Authority is toying with the idea of offering volume discounts, so that carriers moving large amounts of cargo through the canal would enjoy lower tolls per unit of cargo. This concept involves some complications. For example, many carriers participate in alliances in which they book blocks of space on other carriers’ ships in addition to running their own vessels, and it would have to be decided which cargo would count in determining the volume discount. But volume discounts might be a way to tie some ship operators more closely to Panama and to discourage them from using a competitive routing.
It is the third response, though, that seems most promising. Manufacturers are making increasing use of Panama not just as a transit location, but as a place to do final manufacturing of products destined for multiple markets in the Caribbean and Latin America. Shoes from Vietnam and drugs made in Mexico are offloaded in the port of Colon, at the Atlantic end of the canal, and the products inside are then customized for individual markets within the region. This can mean anything from adding price tags in Venezuelan bolivars or inserting warranty documents compliant with Costa Rican law to making physical modifications. In many cases, the cargo is repacked on pallets for individual retail outlets. The pallets headed to each country are then stowed in separate container, so that when the container arrives in-country, the local distribution center needs only to load the pallets aboard delivery trucks. This kind of value-added work creates jobs in Panama. But it also gives shippers reason to insist that their cargo move through the Panama Canal, assuring that the expensive new facilities will see a steady flow of freight.

The World’s New Workshop

Sometimes a single number can reveal a great deal about economic change. Last week, I learned of one such number from Tsuyoshi Yoshida, the head of the American business of the Japanese ship line MOL: in 2013, more than half the waterborne cargo from Asia to the U.S. East Coast passed through the Suez Canal.

Why is this important? For the past 20 years or so, China has been the world’s workshop, shipping out tens of millions of containers stuffed with everything from acrylic resins to zippers. If they are destined for the Eastern United States and traveling by ship, almost all of those containers cross the Pacific Ocean and pass through the Panama Canal to ports along the Atlantic and Gulf coasts. Cargo from China to North America doesn’t move via Suez, because the Pacific route is much faster.

But now, China’s manufacturing sector is struggling, with factory output at an eight-month low. As wages in China rise and credit gets harder to come by, makers of labor-intensive goods such as clothing and toys are relocating to cheaper locations in Southeast and South Asia. From newly industrializing countries like Cambodia and Bangladesh, the fastest route to the U.S. East Coast is through Suez, not across the Pacific. In just four years, according to Mr. Yoshida, the proportion of East Coast-bound cargo from Asia that transits the Suez Canal has risen from 39% to 52%, indicating how quickly the shift away from China has proceeded.

This shift has to be worrying to the Panama Canal Authority, whose ongoing expansion project will allow larger ships to pass through the canal by 2015 or 2016. The canal widening, which may end up costing $6 billion or so, is premised on an increasing flow of cargo from Asia to the East Coast. But if other Asian countries supplant China as sources of U.S. imports, the Panama Canal may face a challenge meeting its traffic forecasts.