Gearing up for the future

posted on 9th April 2019
Gearing up for the future

The biggest issue driving the renewal of Lufthansa Cargo’s Frankfurt freight hub is the need to modernise and develop new ways of handling and processing cargo fit for the digital age, CEO and executive chairman Peter Gerber tells Stuart Todd

Lufthansa Cargo increased both revenue and yield by 7% in 2018, posting the second-best operating profit figures in the company’s history, in terms of adjusted EBIT. However, following two exceptional years, the air cargo sector is now confronted with tougher market conditions amid a backdrop of economic and political uncertainty, acknowledges CEO and executive chairman Peter Gerber.

But there are plenty of other items on the German combination carrier’s agenda in 2019, which include continuing its fleet renewal programme, finalising plans for the €400 million upgrade of its cargo hub at Frankfurt Airport, and developing a distinctive e-commerce offering – while further driving its digital transformation.

Market trends and outlook

Commenting on the first quarter of 2019 and what the remainder of the year was likely to bring, Gerber says: “I think it’s pretty clear that the market has cooled somewhat. The start to the year was a softer one than we expected, but if you go back to December 2018, this was the first month in two-and-a-half years where the market shrank year on year. January and February followed a similar trend, but perhaps the good news is that the shrinkage is slowing down.

“Also, another important factor to take into account is that the market is shrinking from a very high level. If you remember in December 2017 and the following months, we had a capacity crunch where there was so much demand that we could barely handle it. Clearly, the shrinkage is a concern, but when you consider where the market has come from, it’s not catastrophic either, and I we should keep this in mind.”

Gerber notes that the softness of demand in the early months of 2019 could probably be attributed to the cautious stance adopted by many of Lufthansa Cargo’s customers in response to what he describes as “the turbulence around the world”, a reference to US-China trade tensions and other significant factors contributing to economic uncertainty such as Brexit, rather than the initial signs of an impending economic slowdown.

Shipper caution

“It’s psychological,” he says. “Shippers are cautious and what this means, to a certain extent, is that as long as there is no good news, they will put off their decisions. And if decisions are not made, the production (of goods) is affected, with the knock-on effect on the transport business.

“What we are seeing is that the market is getting a little bit better, in view of the normal spring peak, but at the same time it is difficult to say what’s going to happen in the second half of 2019. One could presume that if there is some resolution on the trade disputes and the UK leaving the EU then we may well see a good second half of the year. If not, it will be not so good.”

Fleet renewal

This year sees Lufthansa Cargo take delivery of four new B777 freighters, the next stage in the carrier’s ongoing plans to replace its fleet of MD-11Fs. Two B777Fs have already arrived and are in service and a third was set to join late-March. The fourth one is scheduled to be ready for the end-of-year peak.

“By the end of 2019, Lufthansa Cargo will have 11 B777Fs in service, which will include four operated by AeroLogic, (the cargo airline’s joint-venture with DHL Express). We also have options with Boeing for a further three B777Fs,” Gerber explained.

It currently operates 12 MD-11Fs, but two are scheduled to leave its fleet this year. “The idea is to do a complete roll-over to the 777 freighter. The cost advantages from having a fleet composed of a single type of aircraft are considerable,” he notes.

Gerber confirms there is a plan to phase out the MD-11s completely by around 2025, noting: “The Lufthansa Group’s policy is not to fly aircraft that are more than 25 years old, and we got the last (MD-11) production freighter in the year 2000, so by 2025 everything should be over. We could decide to shorten the timeframe for the full retirement of the MD-11s, or maybe we could prolong their utilisation a little bit. It will all depend on the market situation and secondly, if the MD-11s continue to deliver on operational stability. This is the flexibility we have with this roll-over process and we are quite glad to have it.”

Lufthansa Cargo continues to see the 777 as the best freighter on the market for its needs; but looking long-term, Gerber says the company wouldn’t say ‘no’ to a newer, better version of it if one came on to market, or another type offering similar performance.

Customer dynamics

Asked about the prospect of major consolidation in the forwarding space and whether this will lead to the emergence of larger groups with greater bargaining power when negotiating capacity and rates with airlines, Gerber replies: “That’s perhaps a question for them. But when you look at the market share of forwarders – and on the airline side for that matter – it’s quite fragmented. Nobody has a big market share: it might represent at most 8%. So, if you compare air cargo with other business sectors, this consolidation is a normal development. But regardless of what’s happening on the M&A front with forwarders, the primary question for us remains, how can we fulfil the needs of customers 100%?”

On the question of digital disruption, Gerber acknowledges that one forwarder to capture the headlines of late is ‘digitally driven’ Flexport, which has secured investment of $1 billion to fund its development.

“They (Flexport) have built a real ‘front-end’ for customers and are pretty strong there. However, a lot of other things that Flexport does is rather like those of a ‘normal’ forwarder. They perhaps have a little bit of a different vision of how the business will look in the future, but they still share a lot of the normality of other forwarders. It’ll be very interesting to see whether this transformation into a ‘digital’ forwarder functions in all parts of the production chain. This would be something quite new, but for the moment we haven’t seen it.

“I look forward to seeing how the company develops and obviously they have received a great boost with the $1 billion in fresh capital. Of course, as they grow, we would like to get more business from them.”

One area where Flexport has followed in the steps of some traditional forwarders is in operating its own dedicated freighters, a tendency among forwarders that Gerber is generally skeptical about.

“We’ll have to see in the end if this works out (for Flexport),” he notes. “Some forwarders have done this for a time – some still do. But in my experience, when the markets are no longer that strong and become softer, it’s really difficult to operate the aircraft if you are not an airline.”

Frankfurt hub

Gerber explains that Lufthansa Cargo is undertaking “a more or less complete renewal” of its cargo centre at Frankfurt Airport, refitting the existing buildings at the site with state-of-the-art handling equipment, on a multi-phase basis running to 2024, at a total cost of €400 million.

“This year will see the full plans drawn up for this project, with work starting in 2020,” he notes. “Capacity isn’t the biggest issue driving the renewal of our Frankfurt centre, but rather the need to modernise and gear up for digitalisation and the new ways of handling and processing cargo in the 21st century, which will also add to our competitiveness.”

Growing air traffic congestion at some of the world’s major airports has raised the question of whether scope exists to relieve some of the pressure on flight schedules by transferring some freighter operations to secondary airports, operating 24-7.

But Gerber insists this is not an option he expects Lufthansa Cargo to have to consider at Frankfurt, either in the foreseeable future or longer-term – nor a feasible one.

“First of all, I think there is enough capacity at Frankfurt and that in general, when such an issue does emerge, it can usually be managed successfully when all of the parties, both passenger and cargo, take a sensible approach on the operational side.

“But in any case, using secondary or all-cargo airports on a regular basis would not really be an option for us because it would mean splitting our operations and trucking freight from A to B, resulting in a significant loss of time while also raising service-quality issues. We continue to believe we can do everything in Frankfurt and it will remain the hub of our freighter operations. Of course, we do have hubs in Munich and Vienna and a smaller set-up in Brussels, which cater for regional markets.”

E-commerce

Like many air cargo carriers, Lufthansa Cargo is looking to seize the opportunities from the boom in e-commerce.

“It’s very difficult to see how big e-commerce is for us already and what percentage of our business it represents due to the fact that it’s included in our normal products. It could be on a pallet of standard cargo, be shipped express cargo, or go via mail. So, there are lots of different products where you see it,” he explains.

But Gerber sees scope for Lufthansa Cargo to play a distinctive role in the segment beyond that of a simple transporter of goods sourced on the internet, with the offer of value-added services to e-commerce players. However, he preferrs not to go into too much detail at this stage.

“E-commerce is straightforward enough as long as it’s incorporated in our current product range and can be treated like other cargo,” he notes. “But if some customers have specific or special needs, for example, dedicated handling, customs services, and to-door delivery, we maybe have to think about developing a completely new offering outside of Lufthansa Cargo.”

He highlighted how Lufthansa Cargo had moved successfully into a different business line with its Time:Matters unit, which operates as a forwarder specialising in time-sensitive and time-critical cargo. “We’ll have more to say about our e-commerce proposition in the very near future,” he adds.

Continuing in the e-commerce space, the rapid development of Amazon’s own freighter fleet has posed the question of whether the online retail giant could become more a direct competitor of integrators such as UPS, FedEx and DHL rather than just a customer – and in time even rival cargo carriers such as Lufthansa Cargo.

“At the moment, we clearly see them as a customer,” Gerber notes. “Its airline operations are limited to the US and may one day be in Europe. But I don’t see them flying intercontinental routes. With e-commerce getting bigger and bigger, what I’d really love to do is to give Amazon a good offer so that they don’t have to build their own long-haul fleet.

“Intercontinental e-commerce is growing rapidly and the question of air transport provision to accommodate such growth will come up sooner rather than later – and we intend to be ready with the solutions that companies such as Amazon and Alibaba can be satisfied with,” Gerber says.

Transformative change in the sector

Nevertheless, Gerber expects transformative change within the air cargo industry in the next 5-10 years, driven by digitalisation.

“There will be a ‘technical overhaul’, with communication between businesses becoming much more digital,” he notes. “To a certain extent, there will be a direct connection through API (Application Programming Interface) to big customers, sales-channelled via platforms, and a prominence of e-data clouds where all of the information about a shipment can be seen by all of the partners in the transport chain. These are significant changes which will come about in the next few years. It’s not the nature of the business that will change but the way it is carried out which will be completely different.”

On Lufthansa Cargo’s readiness to make the digital leap, Gerber remarks: “You can always be better prepared, but we have done quite chunk of work  already and would like to think of ourselves as one of the frontrunners of digitisation in our sector as we believe it does two things: it saves on costs and also raises the quality of service, which is very important to our customers – while also enabling a third: speed; we have to get faster again for standard cargo and digitisation provides the means to do this.

“In short, we are working relentlessly in adopting a digital approach because it clearly makes our product better.”

Paperless booking

Gerber says Lufthansa Cargo was one of the first airlines to offer its customers “completely paperless booking and handling for standard cargo”, while the company’s new, fully digital PreCheck process “will now significantly accelerate and simplify handling processes for our customers”.

He continues: “And we will also continue to roll out the eDGD electronic dangerous goods declaration so that even more customers and shippers will be able to benefit from this digital solution.”

Joint-venture progress

The coming years are also likely to see Lufthansa Cargo deepening its joint ventures with airline partners in Asia and North America, which Gerber describes as “a kind of secondary consolidation”. He concludes: “These tie-ups – with ANA on Europe-Japan routes, Cathay Pacific on Europe-Hong Kong routes, and United Airlines on Europe-US routes, have given us a market-leading position on major trade lanes.

“They will allow us to enhance our offering to customers while at the same time provide a means to reduce costs and look into capacity and pricing together. Of course, there’s a lot of work to be done over the next few years to really harmonise on IT, our sales teams, and products to the benefit of customers.”