Reasons to be cheerful

posted on 4th April 2018

Despite the multiple challenges and changes facing air cargo, Cathay Pacific’s Mark Sutch sees much cause for optimism, including growing opportunities from e-commerce, pharma, and perishables demand, writes Will Waters

With stagnating global markets, mounting overcapacity, and new restrictions on the carriage of lithium batteries, 2016 doesn’t seem, on the surface, to be shaping up to be a great year for air cargo carriers. But despite the many challenges and changes, Cathay Pacific’s Mark Sutch, general manager for cargo sales and marketing, sees considerable cause for optimism.

For one thing, the drop in fuel prices over the last 18 months is a significant benefit on the whole, even though its effects are mixed. It becomes a lot easier to make money, even when freight prices are lower, but it also means there is less capacity discipline in the market, particularly among those operating older aircraft. Sutch says B747 ‘classic’ freighters and MD-11s have “suddenly become a lot more viable again, assuming you are not hedged”. He adds: “It’s not necessarily people bringing aircraft back from the desert, although that may well come… But they are getting much higher utilisation now.”

The other major capacity issue, in this case part of a long-term structural change, has been the success of the B777 passenger aircraft – the so-called ‘mini freighter’. “Boeing has developed an aircraft that has really changed air freight,” Sutch says.

“To give you an example, our first freighter was a B707 converted aircraft back in the 1970s. It could take 35 tonnes, with 13 maindeck positions. We operated a B777 passenger flight from Manchester to Hong Kong about a year ago that had 36 tonnes of cargo in the belly. And it was a pretty full flight on the passenger front too – incredible.”

That may not be typical: it was pretty dense cargo – ‘Scotch’ whisky and baby milk powder – but the 777-300 ER will easily average 20 tonnes on a normal mission, including Asia-Europe longhaul flights. “And if you get the right mix of cargo and maybe a lighter payload of passengers, you can push that up,” Sutch notes.

“We have got five flights a day between Hong Kong and London, so that is equivalent to a 747 freighter a day just of belly capacity. And if you look at the population of the 777 today, it sold fantastically for Boeing, so that’s just capacity constantly coming on to the market. So, cargo is growing but it’s just the capacity is outgrowing the growth and demand at the moment.”

Downsizing freighters

As an operator of freighters and B777 passenger aircraft, that trend has had positive and negative implications for Cathay. “We have got 23 freighters now but we are going to get rid of a couple of the older ones; by the end of this year we will have 14 B747-8 freighters and six 747-400ERFs,” Sutch says.

These are predominantly used on “freighter-heavy routes”, with the Transpacific being Cathay’s key freighter market, the freighters providing flexibility as well as volume. “We will manage that capacity on a week-by-week basis. If you have got 33 frequencies a week and you can only fill 30, you cancel three; you consolidate them. You’re not actually delaying anyone’s cargo,” he notes. “So, it’s about optimizing that mixture between freighter and belly and how we feed the freighters.”

The other key freighter market is intra-Asia, particularly “the China feed”. Asia-Europe used to be a big freighter route, but is less so now for Cathay. “Back in 2008, Cathay had 32 freighters a week; we’re now down to seven,” Sutch says. “But at the same time all of our passenger aircraft were changed to 777s. So five a day to London; adding a sixth to London (Gatwick); double-daily Paris; Frankfurt, Amsterdam; Rome; Milan – all of it 777s. So you have got huge amounts of capacity coming in.”

Backhaul growth

Last year brought some growth in eastbound Europe-Asia traffic, although eastbound is still very much the backhaul. “That said, we’re getting lot of pharma coming out of Europe now,” Sutch says. “Europe has always produced a lot of pharmaceuticals, which have traditionally gone to the US, but with the growing middle classes in India and China and their desire for pharma products, we are going to see that continue to grow.”

Pharma is mainly a belly-hold commodity because of the schedules and the connectivity, “although quite often our freighters we will be taking pharma in the lower section of the freighter, depending on the schedule.

“In general for Asia-Europe, the capacity for cargo planes is still driven by the outbound from Asia. But again it’s a bellyhold game now, with a lot of stuff coming in from the Middle East, a lot of good connections over the Middle East, and on the passenger side, a huge amount of capacity.”

That obviously puts a lot of pressure on pricing, combined with “slow, if any, demand growth” currently. But this is just a continuation of a gradual trend, although, given the drop in fuel prices, yields have held up surprisingly well in the last 15 months.

Sutch says comparisons between the first quarters of 2016 and 2015 are not worth making, because of the “huge impact” of the US west coast port strike last year. But compared with 2014, prices are pretty flat. “So, it’s not that bad,” he notes.

That is in terms of an all-in rate, including fuel costs. “Really, nowadays we’re all looking at the all-in rate. I certainly look at the oil price, since some of the markets we have an all-in price and in others we have a regulated fuel surcharge. But at the end of the day we know that (all-in) rate; we know what the cost of carriage is; we know what we need to charge; and we know what we can hopefully make on our margin.”

Commodity patterns

In terms of commodity and demand patterns, for Cathay’s top trade – the Hong Kong-China Transpacific market – remains mainly electronics. There is also other traditional air cargo commodities such as automotive parts, although those “come more as projects than anything else now”.

Sutch continues: “What we’ve seen, quite interestingly, is more inbound into China, for example. We’ve got quite a few countries in our network, particularly Mexico now and Australia, as well as New Zealand, that have signed free-trade agreements with China.” This has been driven by concerns in China about the provenance of domestically produced food, following various scandals.

Free-trade agreements

As China gets richer in terms of people’s purchasing power, he expects this inbound perishables trade to continue growing. “So we’re trying to make that process of transit from Hong Kong into China as easy as possible, particularly from countries with free trade agreements, so now we’ve got now a facility in Hong Kong that can help them with their VAT clearances. It’s really going to be key moving forward.”

As well as providing welcome traffic on what are often backhaul routes, Sutch says perishables do pay a decent yield and tend to be quite dense cargo. And Cathay already has the physical infrastructure and processes to handle cool-chain products.

“Over the years we have built ourselves quite a bit of capability in cool-transit solution, mainly driven by pharma. But a lot of what you do there can go across to the perishables traffic – in terms of the processes and keeping the containers cool. Obviously we provide electric cool containers if people are willing to pay for that, and more importantly the cool-room solutions. So pretty much everywhere in our network has got cooling facilities.”

From Cathay’s “new” hub facility in Hong Kong, as well as offering “pretty impressive” cool facilities, the carrier has now also got a “cool truck system” –refrigerated bonded trucks going into Southern China, “which is really growing as well. The Greater Shenzhen catchment area is a fairly wealthy part of China, so they can afford to import these things.”

Macau-mainland road link

Another opportunity will come from a new road between Hong Kong and Macau, which continues on around 80km into southern China through the western part of the Pearl River Delta towards Zhuhai. “When that is done, suddenly trucking in Southern China via flying into Hong Kong will be a hugely attractive,” he says.

“If you can get into that western part via Macau on the Zhuhai road, you’ll be off the aircraft and be basically to Zhuhai on a truck in 45-minutes.”

And he says the whole road system in China is getting better anyway, which helps expand Hong Kong’s catchment area within Southern China. “And the Chinese quarantine and customs authorities are being quite proactive in promoting a couple of import zones, particularly Zhengzhou in China, where they produce most of the Apple products.

“Zhengzhou has huge aspirations as an airport, and they’ve been very proactive in making that a quarantine landing point, one of only two: I think there’s Shanghai and Zhengzhou. So if you want to import beef from Australia or chilled lamb or whatever it is, Zhengzhou and Shanghai have become very proactive in cutting through as much paperwork as possible.”

This again helps to boost inbound cargo on what is principally an outbound market.

New hub benefits

Meanwhile, the opening three years ago of Cathay’s own cargo handling terminal at its home airport has also further improved transhipment as well as import and export processes.

“Hactl was a good terminal, but I was just one of their 40 customers. This gives us the ability to really tailor solutions – a good example being the whole idea of merge in transit.” Although most pallet-building in Hong Kong is done off terminal, Cathay has now got the space and ability to build and break pallets within its terminal zones.

“So we are working now on helping a couple of forwarders who may have shipments coming out of Vietnam or Malaysia, Thailand, Southern China, and Northern China, but not full pallets. We now have the ability to bring cargo into Hong Kong, merge it within the terminal, build up mixed pallets, and then those will go off direct, one pallet to LA, Atlanta, Dallas, etc. We are working with one particularly big forwarder, doing trials, and it’s really working for them.”

It has also allowed better throughput and cut-off times. “We’ve been able to go faster on transit times and our import times, particularly for perishables, are very fast now,” he says.

Although Hong Kong’s volumes have grown more slowly than anticipated over the last few years, the facility is gradually filling up. “The terminal capacity is 2.2 million tonnes and last year we did about 1.8 million. There is a Phase 2 that could be built, but we are not there yet.”

Cathay and Dragonair remain by far the biggest customers, but there are also a handful of third-party airlines handled there, including EVA and AirAsia. “We are talking to other airlines as their contracts come up at either AAT or Hactl, to see if we can offer something. But there is a lot of cargo handling capacity in Hong Kong now, which makes it pretty competitive,” he notes.

E-freight: taking the lead

While other Asian carriers have been slow to embrace e-Freight, Cathay has been number 1 globally in terms of e-AWB penetration since January 2011, after deciding “to take it very, very seriously. At the close of last year, 70.3% of our entire network was e-AWB, which was great,” says Sutch. “Our target for 2015 was 70%, so we hit that.”

One of the challenges with increasing e-AWB penetration has been that Hong Kong is a big co-loading market. But a trend towards less co-loading “will also fix that”, Sutch says. “We’re seeing a big change in that locally, as people want to contract direct with the airline.”

In the past, small forwarders had found it difficult to get a good deal direct with airlines. “But I think airlines now are a bit more open to dealing with smaller people as well, direct, so that we can ensure the quality.” For Cathay, this is partly “because of the whole lithium issue – we really want to know who we are working with. In a co-loading environment, you can have a master AWB with 20-30 different people co-loading with them. So that is something key for us, visibility in the whole chain.”

The other challenge with e-AWB penetration is managing off-line stations, which often means dealing with GSAs that represent 20 or 30 airlines. “But that’s just a small part of our business,” says Sutch. So that’s something for the next phase.

While Sutch wants to get to 100%, he notes: “We’re a long way ahead of the number 2, I think.” But he is encouraged by the recent progress and commitment made by carriers such as Lufthansa. “The more airlines take it as a key thing, the better for us. It makes our job easier with the forwarders.”

He says most forwarders, particularly the big multinationals, have supported Cathay’s efforts. “The problem is so many have got legacy systems,” Sutch notes. “A lot of the large forwarders got there by acquisition, so they have different IT platforms globally. They may have one IT platform in Europe that can switch over to a Cathay e-air waybill overnight, but then they have got a legacy system in US where it will be more difficult to do so.”

Sutch says Cathay has invested a lot of resource to educate customers and make sure its IT team is able to get the necessary message connection. “It’s not easy, but we’ve done well. We think it is the way. In Hong Kong we moved overnight to e-AWBs. We are strong enough in the Hong Kong market that we can say: ‘If you want to work with Cathay, then you have got to do it’. There was a bit of grumbling to begin with, but now everyone pretty much sees the benefits.”

Cathay moved over to 100% e-AWB out of Hong Kong about two years ago, and has mandated that in a couple of other countries, eg the US. “Sometimes it’s easier to mandate it and then have a couple of side conversations with big partners who clearly can’t do it, and come to an interim arrangement and say: ‘We’re not going to charge you for a paper air waybill for the next six months, if you show us your roadmap. And if they tell us it’s going to be 8 months, fine – just show us what you’re doing. What we can’t accept is just no movement in that direction. And we have been quite successful having that approach.”

Sutch says there are definite benefits in terms of data accuracy and visibility on where goods are – which leads to better operations efficiency generally. “If you have data inaccuracy, which is rife in this industry, you get a lot of holdups in customs, at the build-up stage, or DG declarations, etc. That to me is where we have got to go.

“And what we’re trialling now in April into Hong Kong is eliminating the forwarder pouch on general cargo, which is also part of IATA’s e-freight initiative.”

Mail visibility

Another thing Cathay is doing from a digital point of view is a mail project geared towards attracting e-commerce-related traffic, which it rolled out internally about a year ago. “Mail is a big part our business – single digits, but growing,” says Sutch. “And as e-commerce grows, mail grows, of course, because mail is an important channel for ecommerce. And the way mail clears customs is very different from cargo on an AWB.

“But in order to facilitate that, we have now got a mail tracking process that tracks mail containers, which then links to our Easy-post system, so the general post office gets greater visibility.”

He believes this is rather pioneering within air cargo. “Postal companies are appreciative of what we are doing, and also they are trying to move down that path where now they start applying penalties to people who can’t track their mail. We’ve recognized that and we want to be part of that solution.”

One such company is the US Postal Service, which needs greater visibility to compete with the integrators. “When it comes to technology and tracking of packages, Fedex, UPS, and DHL are streets ahead of everyone; that is really their USP. FedEx has got thousands of people working on IT alone because they see the importance of that.

“Post offices, which tend to be, or have their origins in, government departments, are trying to become more commercial. They see the benefit.”

E-commerce bid

Sutch says a lot of people ask about e-commerce and how air cargo carriers “are going to get into it. But the reality is we are already in it big time, mainly through consolidation. So we will be carrying pallets under an air waybill from a forwarder that will be hundreds if not thousands of boxes. But we tend to charge for it as general cargo at a general cargo rate, whereas the premium tends to be charged down there to whoever is paying for it.”

Sutch would like to work “a little bit more closely” with the likes of Amazon and Alibaba “to see what we can do as an airline to give them visibility of their shipments. Now Amazon is taking this giant step of leasing aircraft. I think that is because they just look at the growth of their business and believe the people that they like to work with, the integrators, will not be able to meet their growth based on their current plans.

“But I would like to work with Amazon and say: ‘We are happy to work with you on whatever solutions you think you might require’.”

He continues: “I really don’t believe Amazon wants to be flying Transpac 747 aircraft. They’d much rather those whose core business it is do that. But what they want is complete control over their capacity; that is key for them.” This is natural, because as e-commerce grows, customers are getting more and more demanding – particularly in terms of visibility, he says.

Closer links with shippers

One option may be that if a company like Amazon sets up its own freight forwarding subsidiary– and it has already received its own NVOCC licence in China – there is maybe an opportunity to work them like a freight forwarder.

Or does he mean freight airlines will work directly with the shippers in the not so distant future – and will forwarders be accepting of that?

Sutch responds: “I used to work on the passenger side of the business, and the reason the travel agent all but disappeared is because they never offered any real value, in the modern way. Freight forwarders still offer absolute value. As an airline, we are airport to airport. We are not interested in the business beyond that.”

He believes forwarders will continue to grow in strength. “But I believe they have got to allow (airlines) a little more contact with the end users, the shippers, so that we know what it is they are really trying to achieve.”

That does happen with certain big shippers such as Apple, “and if a forwarder has an objection, they will say: ‘We want to talk to the airline. We want to understand their security protocol; we want to understand what they are doing in terms build up; how they can help us with x, y and z.’

“Now, we are not interested in contracting with them directly; we would much rather do that via a forwarder,” Sutch insists. “But for me it is important that they (shippers) understand what Cathay can do so they can differentiate me from x, y and z.” This kind of direct contact happens a bit in pharma as well, because pharma products are so vulnerable.

Sutch says e-commerce is definitely a growing business for Cathay, but it can be frustrating because a lot of it is volumetric cargo – including a lot of wasted space from inefficient packing. “So they need to get smarter with that, or they need to pay for it. But it’s tough; it’s growing, but rates are under pressure – put it that way. They are good negotiators.”