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Response to IoT surprises September 2015 Download PDF

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The integrators — FedEx, UPS and DHL — account for about 50% of the global cargo fleet, but their air traffic growth has been slow or non-existent in recent years and they currently have no plans to expand the size of their fleets although they will still need to acquire aircraft for replacement (for example, FedEx recently ordered 50+50 767Fs but its overall fleet plan for the next eight years shows a slight decline in aircraft capacity). Volume growth has predominantly come from the ground segment of their businesses. Yet 10 years ago the integrators were confident about 10%-plus pa traffic growth, and FedEx and UPS both placed major orders (subsequently cancelled) for the freighter version of the A380.

Internet communication and, specifically, video-conferencing was supposed to pose a serious threat to Business travel; in the event there has been little discernible impact on passenger demand, or at least the effect has been dwarfed by cyclical factors. By contrast, 10-15 years ago the integrators were hugely optimistic about IT developments; FedEx at one point branded itself the “Official airline of the Internet”. It was more than plausible — transactions would be increasingly be conducted online and, for example, Amazon, the new electronic bookstore might carve out a small niche for itself in the publishing market, while FedEx was perfectly positioned to provide rapid physical transport for goods ordered through websites.

A number of IT trends have impacted the Integrators’ air business, developments which now seem obvious but were not evident ten years ago.

  • Delivery method: CDs were once dispatched, now music is universally downloaded; books shipped from publishers have to a large extent been replaced by downloads to Kindles
  • Miniaturisation: One old Desk Top Computer equals 200+ Tablets, 500+ I-phones
  • Documents — legal, governmental, business — are now universally transported by email, worries about “electronic signatures” long forgotten
  • Software updates and replacements are now always provided by downloads not by physical discs in polystyrene-insulated boxes

There have also been structural changes:

  • Falling production costs for IT products and for industrial components have increasingly tended to shift the mode from of transport for these goods from air to surface.
  • Just in Time (JiT) inventory control became a largely defunct concept with improvement in IT and process control.
  • The Internet of Things (IoT) has replaced JiT as the dominant strategy. It is admittedly difficult to pin down exactly what this means in its totality, but it applies, in the transport sector, to the integration of communications, control, and information processing across various production systems, primarily through computers communicating among themselves. In practice, an algorithm is designed to monitor inventory levels, demand patterns, alternative supply sources, and then predict where a product should be located in order to get it to the purchaser in the minimum time. The decision to move a product from a warehouse to a distribution centre is made before the purchasing decision is made. Amazon call this “anticipatory shipping”.

The strategies being implemented by Internet giants — Amazon and Google — to control distribution networks themselves further undermine the airfreight business. Amazon is decentralising its warehouse network away from its Seattle base, building new facilities in, initially, San Francisco, New York, Boston and Chicago and ultimately targeting the top 50 urban markets. Wall-Mart is doing something similar. The additional cost of the new facilities will, Amazon expects, be outweighed by savings generated by cutting FedEx and UPS out of the distribution chain and using its own, franchised local delivery companies under the Amazon brand. Fulfilment costs, which are mostly transport-related, have now risen to 15% of Amazon’s revenues, up from 11% in 2009. Amazon’s ultimate aim for Amazon is to guarantee one day, or even one hour, delivery to customers — as close to physical shopping as possible. Google is moving inexorably into this market with a slightly different concept — here the customer orders online and a local courier company, branded Google Express, picks up the good from the shop and delivers it to the customer’s home.

Both the internet giant companies, plus the other established and emergent internet distributors are, in effect applying IoT strategies which tend to circumvent the air express operations of the Integrators.

Maritime perspective

Rapid delivery no longer necessarily means air delivery. IT developments have enabled rapid delivery using lower cost maritime, alternatives.

Total containers shipped have grown significantly more strongly than air cargo in recent years: by 7.2% in 2011, 2.9% in 2012, 4.9% in 2013, 6.1% in 2014, with projected growth for 2015 of 6.7%, according to Clarksons, a leading shipbroker.

From a maritime perspective the key characteristics of this industry are:

  • JiT, whereby air transport appeared to be required to transport urgently needed components, has been supplanted by much more efficient supply chain management and peak demand planning, meaning that even time-sensitive goods can be cost-effectively delivered by containership.
  • Containerships operating on a regular circular schedule can be regarded as floating warehouses delivering a continuous stream of goods.
  • Even launches of new high-tech products, IPads for example, are not primarily transported by air from their manufacturing base in China or Korea but are shipped and trucked to distribution centres near to the main demand areas prior to launch.
  • With containers usually being transferred rapidly, using advanced crane technology from ship to ground (truck or railway) at ports, the freight rate in effect includes a warehousing element during the voyage, whereas airfreight is logistically more complicated and expensive with actual warehousing needed at airports at both ends of the flight.
  • When comparing air and freight modes, the important factor may not be whether an aircraft can deliver goods within 24 hours against a ten day voyage for a containership but the “conveyor belt” concept — maritime transport can often deliver the same goods every 24 hours.
  • Maritime container rates have exhibited volatility: peaks resulted from the late 1990s global upturn and the China import boom; troughs were caused by the collapse of dotcom in the early 2000s and the global recession in 2009. However, the global average freight rate per container is more or less the same today as it was 20 years ago.
  • More importantly, the difference between air and maritime freight rates is very wide. According to a regular survey by HP Drewry, shipping consultant, the ratio of air freight per kilo to maritime containerised freight per kilo is currently about 13:1 on the key Europe-Asia route.
MARITIME CONTAINER TRAFFIC: GROWTH RATES Produced by GNUPLOT 5.0 patchlevel 0 -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F Asia-US Asia-Europe Asia-US Asia-Europe

Source: Clarksons

FEDEX AND UPS PACKAGES BY CATEGORY 2014 Produced by GNUPLOT 5.0 patchlevel 0 Sh Sh US Domestic Air 14% US Domestic Ground/Deferred 78% International 8%
AIR FREIGHT RATE AS MULTIPLE OF SEA FREIGHT Produced by GNUPLOT 5.0 patchlevel 0 0 5 10 15 20 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Air to Sea ratio Mult 2014 2015

Source: HP Drewry. East-West Container Index compared to East-West Airfreight index both expressed in $ per kilo carried

FEDEX AND UPS TRAFFIC GROWTH TRENDS Produced by GNUPLOT 5.0 patchlevel 0 80 100 120 140 160 180 200 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2004=100, Weekly Package Volume US Domestic Air US Domestic Ground/Deferred International Total US Domestic Air US Domestic Ground/Deferred International Total

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