Impact of the Alliance of Maersk and Msc on Freight Rates

Impact of the Alliance of Maersk and Msc on Freight Rates Analysis of the impact of the alliance of Maersk and MSC on freight rates on the Asia-Europe route Yixiang Zhang Content Abstract  (Jump to) 1. Introduction 2. Market share and structure of container shipping market 3. Alliance of Maersk and MSC 4. Impact of freight rate by 2M 5. Conclusions References Abstract The economic crisis took place in 2008 resulting in a great depression in shipping market. The demand in container shipping market declined rapidly and the overcapacity made the freight rate much lower which may not compensate the operation cost of the shipping companies. The three biggest shipping alliances(CKYH Alliance, Grand Alliance and CKYH Alliance) took series of solutions such as decrease of the capacity and in number of services routes to reduce the loss in their best effort. In this recession circumstances, ML(Maersk Line) and MSC(Mediterranean Shipping Company) which were known as 2M formed co-operation agreement on VSA(Vessel Sharing Agreements) on Asia-Europe route and this agreement last for 10 years. ML will devote 1200,000 TEU which counts for 55 percents of its overall capacity in the alliance and MSC is going to devote 900,000 TEU which counts for 45 percents of its overall capacity. Through the co-operation, 2M intended to promote the efficiency of operation and p rovided reliable shipping services to consumers on a lower price by sharing shipping network, infrastructural equipment and provide more straight service lines and the number of ports of call. In this way, other medium or small shipping companies who cannot achieve the economics of scale or better quality services as 2M managed to do will become uncompetitive and then have to exit the market when there is overcapacity in the shipping market. In this strategy, 2M will gain much more market share and consumer loyalty to make more profit although there is monopoly restriction. 1. Introduction With the rapid development of the international economy, the amount of export and import grew fast in the past few years. Shipping companies play essential role in the worldwide trade by providing satisfactory services to consumers. Shipping companies attempt to be more competitive than the others and reduce the risk which is considered high in maritime transportation by co-operate with each other or form an alliance. The ocean shipping industry is among the first to apply alliance to make their profit. Before the demotion of the conference system in 1998 (Shashi Kumar, 1999), maritime transportation market can be regarded as monopoly because the operation of a shipping company is at high risk and governments want to induce more firms involve in maritime transportation. However, with technology improvement and fast growing of shipping industry, the exemption from anti-trust rules was issued by the EU in 2008. Shipping companies have to set up new kinds of alliances to gain advantage and share risk in this dynamic market (Fusillo,2006). It is obvious that in present shipping alliances vessel sharing agreements and slot sharing agreements are widely used. The vessel sharing agreements or â€Å"VSA† can make container companies co-operate with each other to share their space on their container ships to acquire higher capacity to fight their lower capacities in certain trade lanes. The agreements allow for the shipping lines to keep freight costs lower since they do not need to account for empty spaces on their ships (source: http://www.containerquote.com/vessel-sharing-agreement). Slot sharing agreement require a fixed percentage of vessel capacity to be exchanged between the carriers over a given time period. This type of arrangement may be beneficial when two patner companies have vessels deployed on the same route with different departure time schedules (Panayides Wiedmer, 2011). Shipping alliances become a trend especially during the recession when the advantages that alliances can bring to us are clear. Even the top two large liner companies ML and MSC who used to act as â€Å"soloists† also choose to co-operate with each other, which can be regarded as a great move in shipping industry because together they count for nearly 30 percents of the whole market share. The paper aims at analyzing the impact of the alliance of Maersk and MSC on freight rates on the Asia-Europe route step by step as below, Section 2 will give a description of the whole shipping market. Section 3 focuses on ML and MSC alliances about the strategies they use. Section 4 will discuss about how the strategies 2M use will influence the freight rate. 2. Market share and structure of container shipping market This section shows who are the main players in the game and what are the connections between them. Table 1 illustrates the characteristics of top 20 shipping companies including total capacity, vessels operated in the market and actual market share. Table 1 Container fleet characteristics of Top 20 liner shipping companies Operator TEU Ships MS Operator TEU Ships MS 1 ML 2078507 556 15% 11 MOL 383042 99 2.5% 2 MSC 1683723 421 13.3% 12 NYK 365304 95 3% 3 CMA CGM 1096622 384 7.6% 13 OOCL 347988 77 2.4% 4 APL 591306 148 4% 14 Hambrg.sud 336811 108 2.3% 5 Hapag-Lloyd 582520 133 3.4% 15 K Line 324441 80 2.5% 6 Evergreen 567636 156 4.1% 16 Zim 322989 97 2.2% 7 COSCO 512060 134 3.3% 17 Yang Ming 315798 77 2.3% 8 CSAV 502619 135 2.4% 18 Hyundai M.M. 279446 54 2% 9 Hanjin 461087 100 3.2% 19 PIL 231941 127 1.4% 10 CSCL 455328 127 3.3% 20 UASC 206940 52 1.4% Source: Alphaliner.com, as of 28/06/2010 It is clear that ML together with MSC count up for 28.3% market share which is less than the monopoly restriction 30%. New World Alliance whose main partners are APL, MOL and HMM counts for 8.5% market share. Grand Alliance whose main members are NYK, Hapag-Lloyd and OOCL counts for 8.8% market share. CKYH whose main partners are Hanjin, Yang Ming, K Line and COSCO counts for 11.3% market share. In this way, there are four cartels whose market share counts up to 75.6%, which indicates the fact that the container shipping market on the Asia-Europe route is oligopoly. As a result, a decision made by any of these four alliances could bring an enormous influence to the others. That is also the reason why I would like to discuss about the impact on freight rate by 2M, because they have the market power to influence others. 3. Alliance of Maersk and MSC From the above analysis of container shipping market, it is clear to tell that ML and MSC have the top 2 capacity on Asia-Europe route. However, when focusing on the efficiency that both of them perform, the situation changed somehow. Table 2 presents the market share based on the vessels operated in the market. Table 2 Market share in different regions based on number of vessels operated Geo AF ANZ AS CA FE ME MiE ML 26.5% 20.1% 3.5% 19.5% 12.9% 22.3% 18.2% MSC 12.7% 15.4% 5.8% 17.1% 8% 20.7% 23.1% GEO NA NE SA TOTAL MS Delta ML 16.1% 15.4% 13.1% 15.6% 15% 0.57% MSC 11.9% 20.6% 14.1% 13.3% 10.9% 2.39% Abbreviations: AF Africa; ANZ Australia, New Zealand, South Pacific; AS Asia; CA Central America; FE Far East; ME Mediterranean; MiE Middle East; NA North America; NE North Europe; SA South America; MS Market Share; DELTA difference between company’s share of world-fleet minus actual market share. Source: Alphaliner.com, as of 28/06/2010 Depending on Tabke2, it is clear that Delta of both ML and MSC is positive which indicates that their shares of vessels operated in the market are both higher than their actual market share. This phenomenon can be explained in this way. Suppose all the other shipping companies except for ML have their vessels loaded up to 80% on average and ML only can load their ships around 60%, ML need to devote more vessels into the market to keep the same market share with other companies. In this way, it can be inferred that both ML and MSC have not fully taken advantages of their ships in the market. They have to find a way to promote their efficiency of their carriers. From the analysis above, it should be clearly explained that the motivation of ML and MSC the Top 2 giants in the shipping market to become alliance. Shipping alliance indeed brings series of advantages to both of them. The most important agreement between ML and MSC is vessel sharing agreements known as â€Å"VSA† which means that the collaborating companies work together to fulfill demand and also try to fully load their ships. Actually once â€Å"VSA† performing well, ML and MSC could devote some of their ships on another route because fewer ships can fulfill the demand due to the high utilization of container ships. In this way, the operation cost of vessels in the market can be reduced. 4. Impact of freight rate by 2M As discussed above, vessel sharing agreements enable ML and MSC largely promote their ships utilization to reduce the operation cost. It can be imagined that the total cost to provide satisfactory services as before becomes a little bit lower after 2M established. From author’s aspect, 2M can take advantages in two different ways as below: First strategy is to remain the same price as before but provide better services to their consumers. In this way, 2M could gain more consumer loyalty and attract more consumers to accept their services. However, in author’s opinion, other alliances such as New World, Grand Alliance and CKYH will not stay at where they are and do nothing. They may choose to reduce freight rate to attract consumers in order to not lose market share. Somehow to what extent they decide to cut freight rate depends on how well 2M performs and also the loss they are able to bear. Second strategy is to lower the freight rate but remain the same services quality as before. In this way, 2M can attract more consumers with their low price of freight rate. It is illustrated about how it works as below Figure 1. Figure 1 It can be easily inferred that when 2M choose to low their price, their initial supply curve S1 will shift right to S2 and D1 stays the same if no strong fluctuation occurs. So the quantity which can be seen as the number of consumers who choose 2M service increases from Q1 to Q2. In this way, 2M will get more market share to make much more profit when the global economy recovers from the crisis. Furthermore, the second strategy also has large influence on other shipping companies on Asia- Europe route. It will result in the shutting down of some shipping companies on Asia-Europe route whose average variable cost is lower than the freight rate 2M set. In the short run, the shipping companies’ supply curve is their marginal cost curve. If the freight rate is below P1, they have to shut down because the revenue they make cannot compensate their cost which means they are losing money all the time. In this way, 2M will gain this share of market by lower the freight rate. The way it works is illustrated in Figure 2. Figure 2 The second strategy can also force some companies not only shut down but also exit the market in the long run aspect. The way it works is illustrated in Figure 3. Figure 3 From the figure above, if 2M reduce the price below P1, shipping companies whose average total cost is higher than P1 will exit market because they will never take back their initial investment if freight rate continues to stay low. 5. Conclusions As the alliance between ML and MSC has been taken into practice, vessel sharing agreement is vital to improve their service quality and the efficiency of ships operation. So with vessels utilization optimized, together with the economies of scale, 2M is able to reduce their operation cost in a large extent because there is indeed a big gap to be improved which is explained in the analysis of difference of actual market share and total capacity. It has to be clear that high efficiency operation of ships as well as the strategies 2M may use can be regarded as a way of increasing supply in the market, which in turn will make the fright rate on Asia-Europe route drops. References Photis, M.P. Robert, W. (2011). Strategic alliances in container liner shipping. Research in Transportation Economics 32 (2011) 25-38. Shashi Kumar, N. (1999). The US OSRA of 1998: an analysis of its economic impact on carriers, shippers and third parties. In proceedings of the IAME 1999 Halifax conference (pp. 7-29). Halifax, Canada: Centre for International Business Studies, Dalhousie University. Fusillo, M. (2006). Some notes on structure and stability in liner shipping. Maritime Policy Management, 33(5), 463-475.