Air Cargo: Challenges Ahead

With the globalization of manufacturing and companies increasingly incorporating the movement of their parts and products by air, projections for the air cargo industry are optimistic. In fact, experts tracking the movement of airfreight globally, particularly Boeing and Airbus, project roughly 6 percent growth per year through 2025. So far this year, however, air carriers are not realizing this growth. In fact, some are reporting stormy weather ahead.

Certain factors and challenges are weighing heavily on the air cargo industry that now have a direct impact on capacity, yields, and rates. At the very top of the list are concerns about high fuel costs and the fact that capacity is growing faster than tonnage—the new 777-300 passenger aircraft, for example, offers a whopping 25 tonnes of space.

Carriers servicing China, once regarded an easy and lucrative market for outbound shipments, are particularly vulnerable. The Asian market, especially Hong Kong, has suffered as a result of overcapacity following a host of new market entrants, which has, in turn, seen prices drop and yields decline.

“One year ago, when you’d open the doors of freighters coming from Asia you’d find them full. Now that’s not happening. Now there’s pressure on yields both on the outbound and inbound into Europe,” says Nils Haupt, Lufthansa Cargo AG spokesman.

The good news is the industry is still growing. However, says Haupt, at 2.7 percent for First Quarter 2007, Lufthansa Cargo’s growth rate is less than expected.

Neel Shah, sales and marketing vice president for United Airlines Cargo, reveals that with volumes growing 2 to 3 percent so far this year, UA’s cargo figures are not in sync with industry growth projections. The reason he gives is pretty simple: It’s China.

“It’s getting harder and harder,” says Shah. “There’s a lot more capacity, and this has caught up with demand.” Where once opportunities in China seemed bountiful, now carriers like UA are having to scrap around to fill their planes. Having aircraft positioned on the right trade lanes helps, adds Shah; plus, United doesn’t operate cargo freighters. “If we did, it would be an uglier picture,“ he states. “We generate every dollar of revenue in the belly. It’s a very important piece of United’s overall profitability.”

Across the Pacific even carriers like Korean Air, which benefit from their geographic proximity to China, are seeing new challenges. “Our advantage of having China next door is temporary,” says Giulio Battaglini, marketing head of Korean Air. “Thus, maintaining a reasonable yield level is an important task.” He expects cargo rates to remain stagnant for the time being.

Building Global Links

To counter the problem, Julian Cobley, British Airways World Cargo (BAWC) network development manager, finds that in some markets, such as Asia, carriers are pricing for short-term cash and volume returns. “But this does not address the long term challenges that cargo carriers are facing,” he states.

Some carriers link various global markets to improve yields. BAWC, for example, offers flights between China and India. “We currently operate two weekly B747-400F services from India to China/Hong Kong and eight weekly B747-400F services between Hong Kong/China and India,” Cobley says.

Passenger carriers UA and American Airlines fly between Asia and South America via their U.S. hubs. “We can sell Shanghai-San Paolo with the quickest same-day connection. No one else can match it,” Shah says.

United Airlines’s global service is particularly beneficial to companies such as Intel that source components from China and move tons of microprocessors for final assembly in Brazil, adds Shah. “Its quick connections bring a unique value proposition to the market for such high-tech manufacturing businesses,” he says.

Emirates Airlines will make its South American debut by adding Brazil to its route network on Oct. 1, 2007, with six-a-week, non-stop services to Sao Paulo.

“This is the first-ever non-stop service between South America and the Middle East,” says Emirates Divisional Senior Vice President of Cargo Ram Menen.

The service will offer up to 18 tonnes of cargo capacity and give Emirates a foothold in all four BRIC (Brazil, Russia, India, and China) economies. In December, Emirates will also commence its second gateway in the United States with non-stop service between Dubai and Houston. Emirates will fly its new Boeing 777-200LR on the route, offering up to 18 tonnes of cargo capacity.

The good news for many carriers is that performance on the North Atlantic is strong. Carriers are experiencing substantial growth both eastbound and westbound across the Atlantic. “Our Atlantic volume year over year is up close to 16 percent with very little new capacity,” Shah exclaims.

The U.S. domestic freight market, however, presents a mixed bag of results. UA reports its business has picked up, although volumes are still slightly down system wide. United operates in a number of strong transcontinental markets such as Chicago and critical West Coast cities.

Southwest Airlines, which recently entered the domestic cargo business, is taking delivery of 37 new Boeing 737-700 aircraft in 2007. By year’s end its fleet will total 520 aircraft, a chief milestone for a small startup airline that began with three aircraft in 1971. This August, Southwest will begin re-service to San Francisco, its 64th city.

“Southwest Cargo customers depend on Southwest adding new markets, flight schedules, and aircraft capacity to complement and extend their logistic supply-chain reach and value-added services to their customer base,” reports Southwest Director of Cargo Marketing Dave Hinderland.

Oil Fueling Mode Mix

Yields may be a major issue, but of bigger concern is the high cost of oil and its impact on the airline industry as a whole. Simply put, every additional $1 per barrel of oil costs an airline roughly $50 million. For Fiscal Year 2006/2007, BA’s fuel bill totaled approximately $3.82 billion. “We expect this to grow further in the coming year,” BAWC’s Cobley says.

As in other modes, surcharges have helped to cover the costs. In June, for example, United Airlines began charging customers a surcharge of 55 cents a kilo, a nickel off its historic highs. But carriers find these charges very painful as do their customers who are weighing every nickel and dime of their logistics costs.

“For every nickel you go up, other modes of transportation, such as ocean, become more attractive,” Shah says. This is especially true for Pacific routes. Consequently, increasing amounts of products that traditionally go by air are now being transported by sea.

Another factor turning consigners to ocean freight is exchange rates associated with the weak U.S. dollar. For many products, cost competition is steep and reducing logistics costs is a major cost reduction strategy.

“This is not a temporary trend, but one that is expected to last for a while,” says Korean Air’s Battaglini.

Still, air cargo offers the perfect solution for time sensitive or specialist consignments. “This is why air cargo still gets the lions share of valuable secure consignments,” states Cobley. “On some occasions we combine the benefits of sea and air freight for our customers by collecting consignments from container ships and then transport them to their final destination by air. This type of business is growing out of the Middle East.”

Service Improvements

What keeps airlines aloft during these turbulent times are their ever evolving service offerings. While yields have generally been declining across the industry over the last year, BAWC’s overall yields for Fiscal Year 2006/2007 were up 4.6 percent. “This growth in yield can be primarily attributed to the success of our premium product offering, launched in 2006,” Cobley comments.

That product is the $30 million premium handling facility BAWC opened in September to handle Constant Climate, Prioritize, and airmail products. Along with new facilities and products, BAWC also made significant investments to its network. In January 2007, BAWC increased the number of its short-haul freighter services by 40 percent following a multi-million dollar investment to deliver 45 weekly wide-body services across 11 European destinations.

“The three B747-400F freighters we operate are fairly new aircraft and are more efficient than many others in the market,” Cobley states. In the past 10 years, British Airways World Cargo has also invested nearly $1 billion in systems, capacity, and facilities at its London Heathrow hub and across the global network.

Emirates, which operates one of the world’s youngest fleets, is also continuing to invest in new, technologically-advanced aircraft. In addition, Emirates SkyCargo offers new customized products and services to help differentiate itself. Its Cool Chain, for example, is designed for the movement of temperature sensitive products.

SkyCargo’s Priority Service assures on-time delivery throughout the world, while the extensive trucking and off-line partner networks ensure comprehensive coverage where customers need it most. SkyChain, the carrier’s website, enables customers to obtain information as well as transact business online.

The Emirates SkyCargo Centre at Dubai International Airport, with its state-of-the-art semi-automated systems, allows the flexibility required by the company’s large redistribution requirements.

Swiss WorldCargo, which sets high quality standards for service, speed and reliability, is particularly successful with its niche express, temperature sensitive, and valuables products.

Korean Air, which transports 80 percent of its cargo on freighters, is building a flexible global network by aggressively developing new routes and providing differentiated service items. Beginning in 2010, the carrier will introduce into service five Boeing 747-8F’s and five Boeing 777F’s. Not only are the new freighters much more fuel efficient, but Korean Air executives believe they will give the carrier an edge on cost competitiveness.

While there is a trend in the air cargo industry toward freighters as opposed to belly hold capacity, particularly between Asia and Europe, many carriers contend that there will always be demand for belly hold. The reason: its strong destination mix and the high frequencies it offers.

However, the jury is out as to the impact increased freighter business will have on cargo volumes for belly hold. Emirates is evolving its freighter operations from supplementing its belly hold capacity to becoming its own network.

Ultimately, however, service quality will be the deciding factor of future competition.