Shippers Will Pay for Cargo Screening

Shippers Will Pay for Cargo Screening

Unfavorable yet far-reaching consequences of 100 percent screening
on the shipper community seem inevitable.

Studies following the debate over risk of terrorist attack through ocean containers suggest only one in every 20 containers entering U.S. ports is currently screened. Considering this low percentage, the unease among carriers and shippers about the supply chain implications of the 100 percent security mandate approved in August is not unexpected.

Looking at the entire spectrum of international and domestic freight services/segments, the impact of these initiatives seems largely negative. However, there are segments that are set to benefit due to their positioning within the transportation sector. Further, different time frames set for implementation of the 100 percent screening for passenger airlines (within the next three years) and ocean containers (by July 2012) implies that some segments need to react more quickly than others. Beyond these ramifications for transportation companies, the ultimate burden of cost escalations will fall on shippers and consumers.

About 30 percent of the air cargo destined for the United States is handled on passenger aircraft. All-cargo airlines and parcel integrators serve the other 70 percent of the market. Although cargo revenue forms a small percentage of passenger airline revenue, it has been a key element in improving airline profitability in recent years. Following the security mandate, passenger airlines risk losing cargo to the all-freight carriers. Also affected will be the international air freight forwarders, who control the majority of cargo moving on passenger airlines.

Traditionally, parcel integrators own their freight aircraft, while forwarders depend on commercial airlines to tailor shipments based on shipper pricing and service requirements. Integrators make use of regional air hubs in channeling shipments from origin to destination. In contrast, forwarders provide faster transit times by tendering shipments to commercial airlines, which in most cases present direct routes between locations. Leading air freight forwarders cite that up to 80 percent of their air freight forwarding volumes move on commercial airlines. Evidently, longer lead times due to security regulations at commercial airlines could reduce this transit time advantage. This would negatively impact forwarder yields and result in loss of freight to integrators.

In anticipation of these developments, some forwarders are already moving away from "nonasset" models to an "asset under control" model. Demonstrating this strategy is DHL's stake in Polar Air Cargo, which involves a 20-year block space agreement guaranteeing DHL capacity on trans-Pacific routes. While other forwarders have ruled out the possibility of owning cargo freighters in the near term, they do rely on dedicated capacity. For example, Panalpina moves about 20 percent of its air freight volume on dedicated freighters.

Alternate solutions to contend with a 100 percent screening directive will involve scaling up security systems to expedite the current screening process. However, procurement and operation of screening systems will involve greatly increased expenditures. Complexities in cost sharing between the regulatory authorities, airlines and forwarders will place hurdles in implementation of such measures, though it could favor the large forwarders over the smaller ones.

Domestically, screening initiatives will help the ground carriers on short-haul lanes and integrators on long-haul lanes. Eighteen percent of domestic cargo volume on passenger airlines travels less than 500 miles and is most susceptible to substitution by ground-based shipping. Deferred ground airport-to-airport carriers like Forward Air will be the leading beneficiary from such a shift. Air cargo with delivery commitments that can be matched by LTL transit times will benefit those carriers. As this cargo is considered a "deferred" air product, entailing a premium over standard LTL rates, it can also aid the profitability of LTL carriers.

Ocean import volumes into the United States have grown at 9 percent over the last five years. While the ocean carriers will not experience any shift to other modes due to the screening initiative, high dwell times of ships at foreign ports will result in lesser utilization of their fleets. Also affected will be the terminal operating companies managing the ports in Asia and Europe for U.S. inbound traffic. While facing the prospect of investing capital in inspection and surveillance technology, these operators will have to deal with escalated port congestion and the consequent decrease in operational throughput.

As often is the case, the shippers who extensively rely on global logistic networks will bear the brunt of the security initiatives. The top 50 importers, including Wal-Mart, Home Depot and Target, account for about 25 percent of ocean import volume into the United States. Considering the costs associated with surcharges, adjustments to inventory management and supply chain delays, the unfavorable yet far-reaching consequences of 100 percent screening on the shipper community seem inevitable.

-- Vikas Pawar is a research analyst with SJ Consulting Group, a transportation and logistics consulting firm based in Sewickley, Pa.