Sebastiaan Scholte, CEO of Jan de Rijk Logistics, discusses the opportunities and challenges for the air cargo and logistics sector arising from the changing global demographic and trade patterns
By 2050 there will be more than 9 billion people on this planet. Taking into account current and future economic shifts, where emerging economies will mature and, therefore, global wealth will increase, this implies that the world needs to produce 70% more food than today. We are already facing difficulties feeding the world population today − currently one in every seven people is hungry worldwide − hence any improvement in food logistics would be more than welcome.
According to a study by the UN, one third of perishable food is lost or wasted globally. This represents 1.3 billion tonnes per year. Problems in the cool supply chain are a major concern in this respect. Huge amounts of resources are used to produce and transport these perishables, which also has a tremendous cost impact. This loss also affects the environment. Agriculture accounts for roughly 14% of all global CO2 emissions. If one third of the food loss can be eliminated, this would result in a large reduction in total global emissions.
Balancing global food supply shortages and surpluses will be a key challenge for logistics service providers and, therefore, local and global supply chains must be better integrated in a sustainable way.
A larger global population, combined with economic growth and an apparent increase in their frequency, means that natural disasters will have more impact on global supply chains than in the past. The tsunami and earthquake in Japan and the flooding in Thailand last year had a tremendous impact on supply chains all over the world. JP Morgan estimates that the flooding in Thailand alone decreased global production by 2.5%. Munich Re, a reinsurer, estimates the total economic cost of all last year’s global disasters at US$378 billion, a record number historically, and unfortunately an increasing trend over the last 30 years.
On one hand, relief logistics offers opportunities for logistics service providers, since goods need to be moved to areas sometimes difficult to access in the short term. But on the other hand, the production slowdown and other negative economic effects caused by natural disasters will eventually outweigh the occasional relief logistics benefits for service providers.
Of the 9 billion people in 2050, the share of older people will only increase. In 1970, the average family had four or five children; it is now 2.45 worldwide. In general, people are living longer and therefore the dependency ratio (the number of non-working people, including children and seniors per 100 working adults) in many societies will increase, putting a burden on global social healthcare systems.
The pharmaceutical industry will play a very important role in these demographic challenges. Since people will live longer and the population will grow in absolute numbers, the pharmaceutical industry will probably outperform many other industries in terms of growth. For logistics service providers this industry will be very interesting since it is demographics and to a lesser extent economic trends that influence the volumes. Also, the effect of seasonality is much less than in other sectors − such as perishables, where the seasonality varies much more than in general cargo.
The patents of many blockbuster drugs will expire soon and there seems to be less development in the pipeline. In the next two years, six of the 10 top-selling drugs will lose their patents, meaning other companies can make the medications and sell them at reduced prices. Of course this will benefit consumers and give a bit of relief to the social healthcare challenge faced by many debt-burdened countries.
On the other hand, the increase of generic drugs will also increase competition between pharmaceutical companies, where cost differentiation will play a more important role. Logistics is a small fraction of the total cost for a pharmaceutical company, but is essential in the supply chain in order to get the products to the end consumer. Any disruption in this supply chain can have huge consequences for people’s health.
The shift to more generic drugs will most likely not change the high standards required for logistics, but might have an effect on modality. Where nowadays many of the patent drugs are transported via air freight, some of the competing generic drugs might chose a different modality, like sea transport, due to the fact that cost of inventory will be lower. The increased competition might also force the logistics service providers to cooperate more closely in order to bring the cost down and be more efficient, of course always keeping the same high standards of quality required.
Cool chain requirements
In general the reduction in food loss and the improvement of the supply chain of pharmaceuticals will lead to less hunger, more health, reduction of inflation and therefore also a contribution to global economic growth. In order to achieve this, logistics service providers need to cooperate more. This will require both vertical and horizontal collaboration. However, some supply chain and purchasing managers of the shipping companies should treat logistics less as a cost centre and more as a value centre, where value in the combined chain should be achieved and where this value should be shared among all players.
Unfortunately we still need to overcome some inefficiencies in the industry that hinder further growth and overall prosperity, especially in Europe.
Changes in economic cycles have a leveraged effect on logistics volumes. If trade and GDP levels grow, logistics volumes by air, sea, train, and road freight will grow at a higher rate. But the opposite is also true if economies shrink. The last years of economic slowdown have had a huge negative effect on global logistics. It is therefore important to be flexible and react to these market changes.
Regrettably, European labour laws do not allow companies to react quickly to market changes. The US has much more flexible labour laws, which explains why their economy is recovering better than Europe’s at this moment. This leads to higher unemployment because no firm wants to hire if they know it will be too costly to adjust their labour force in a downturn. This is a vicious circle in Europe and leaves it uncompetitive against the US and especially emerging economies that are much more adept to changes in the market. European logistics companies need to able to adjust their operations according to the economic cycles just like their counterparts in emerging economies.
Bankruptcy laws are another way to accomplish flexibility to market changes. Unfortunately the European bankruptcy laws are not as flexible as for example in the US, where chapter 11 gives the debtor a fresh start, subject to the debtor’s fulfillment of its obligations under its plans of reorganization.
Some of Europe’s legacy airlines need to readjust their operational costs due to the increased competition from the Middle and Far East. A process similar to chapter 11 would help some of these European airlines bring down their crew and other overhead costs, which have increased over many years and are therefore way higher than many of the younger airlines from the Middle & Far East. If they are not allowed to reduce these costs, they will inevitably lose market share and consequently most likely more jobs would be lost.
Even though aviation is more liberated than in the past, through more global access to traffic rights, complete open skies will also allow airlines worldwide to make use of all traffic rights and as a result create a level playing field where cost and prices will come down, and thus will contribute to more economic growth. Since 1992 the inter-European liberalization contributed to a rise of 33% in European air travel, which resulted in 1.4 million extra full-time jobs and growth of $85 billion.
However there are still some countries in the world that prefer to protect their flag carriers, rather than improving the overall welfare of the broader public interest. This places European carriers in a relative competitive disadvantage, since Europe is more deregulated than certain other areas in the world.
Ownership rules in the aviation industry in many countries limit necessary integration and therefore further growth. For example the US, China and Brazil are some of the large markets that restrict foreign ownership. Eliminating these ownership rules would result in a unified global and fully liberalized market for the aviation industry. It would also result in further necessary integration, where inefficient national airlines will no longer distort the mechanisms of an open market economy in which consumers benefit from better service and lower prices.
Notwithstanding its impact on the European economy, the current air transport system is not operating in an efficient way, resulting in additional costs, delays, noise, and CO2 emissions. The main reason for this is that the standards and systems are still based on the situation approximately 50 years ago when the aviation industry was completely different than it is right now.
Currently, aircraft in Europe fly pre-defined routes that are managed by air traffic controllers of each member state. As a consequence of this inefficiency, each flight is about 50 km longer than needed, which results in unnecessary emissions of around 5 million tonnes of CO2 per year.
Fortunately, the Single European Sky (SES) initiative and its technological pillar, SESAR, will address these issues in the future, especially given the fact that demand for air travel in Europe will grow by over 70% in the next 20 years. The implementation of SESAR should lead to a reduction of 10% per flight, an equivalent of nine minutes, as well as 50% decrease in cancellations and delays within Europe. These reduced flight times will subsequently result in an elimination of 50 million tonnes of CO2 during the period 2013-2030.
Another challenge Europe faces, according to the roadmap commissioned by the European Commission in 2011, is increased road congestion and hence worsening accessibility in Europe.
According to this roadmap, congestion costs are projected to increase by about 50% by 2050, to almost € 200 billion per year. In the Netherlands alone congestion caused a cost of €400 million for transport companies and around €1 billion to businesses in general in 2010.
The US is facing a similar problem. A study by the Texas Transportation Institute claims that the cost of congestion to hauliers in the US – measured as wasted fuel and delay – amounted to $23 billion in 2010. On top of that, according to the World Economic Forum, 24% of all trucks drove empty within the EU due to positioning and imbalances in 2009. Moreover, the average load factor of the non-empty kilometres was just 57%.
This waste of economic resources and CO2 emissions can only be reduced through more cooperation, extension of cabotage regulation and, of course, general economic growth. The EU already has given more access to the domestic market for transport companies from member states. Currently hauliers from member states are allowed to carry out up to three domestic transport operations in another country of the EU as long as it is combined with another international route within a seven-day period.
Ideally cabotage should be allowed without any restriction, resulting in fewer empty kilometres, higher load factors and therefore lower carbon emissions and operating costs.
Capital asset management
Unfortunately the order cycle of aircraft and large ships is still far from perfect. Traditionally aircraft and ships are ordered after some time of economic growth, where first of all management and then, after some time, shareholder boards are convinced that the markets are growing. They subsequently order large quantities of aircraft and ships based on the present market situation, which will then be delivered some years later, on many occasions when there is an economic downturn. Ideally, new aircraft and ships should be ordered in a recession, when prices are low, and they will be delivered when there is sufficient growth to make economic use of these expensive assets. However this countercyclical investment behavior will require different cash-flow management, where savings in good times will be used to acquire assets in an economic slowdown.
Many asset-heavy logistics companies in Europe are still being kept alive artificially by their banks, which choose not to sell devalued assets at even bigger losses, hindering the Darwinian natural-selection effect in the market. The big question is whether these banks have made sufficient provisions to eventually cater for these losses; otherwise this could be another bubble.
Nevertheless, S&P predicts that the percentage of European companies going bankrupt will increase from 4.8% in 2011 to 6.1% in 2012, so hopefully some necessary Darwinian adjustment will be made in this market.
Studies have shown that when average income reaches a threshold of US$16,000 per capita in emerging economies, double-digit economic growth is no longer achievable. China is currently close to this threshold, and hence consumption will most likely rise, but production will become increasingly expensive. This will also affect the current (im-)balance of trade, where imports to China from the US and Europe will outgrow exports from China in the future.
The traditional dominant trade lanes such Asia-Europe, Asia-US, and transatlantic, will remain important, but increasingly growth and volumes will shift onto routes between Asia, Africa and Latin America. Hubs such as Singapore in Asia, and Dubai, Abu Dhabi, and Doha in the Middle East, will benefit from these trade developments. Near-sourcing will also fuel growth in eastern Europe. More aircraft and ships are going directly to airports and ports in eastern Europe instead of via hubs in western Europe. Hence western Europe might lose its position as a global logistics hub.
Shift happens; emerging economies, in general, will mature eventually. The economic balance of power will shift, and if Europe does not become more competitive on a global level, it risks losing global market share.
Backed by sovereign wealth funds and by more favorable economic conditions in their home markets, companies in emerging economies will eventually be acquiring more companies in Europe. If European logistics service providers will not be allowed to be more competitive on a global scale, in the future the European logistics market could be dominated by Asian and Middle Eastern companies, some of them supported by sovereign wealth funds. From an open market perspective this is perfectly fine, but an economic balance of power is also desirable.