Recent advancements in technology can help ocean carriers find the right mix of owned, chartered and spot rate vessels even in a highly volatile rate market, according to Michael Zimmerman and Josh Brogan of global management consulting firm A.T. Kearney.
On Feb. 10, 2016, the Baltic Dry Index (B.D.I.) had the wind taken out of its sails when it hit rock bottom at 290 points, a nearly 98 percent decrease from an all-time high of 11,793 in May 2008, when the dry bulk shipping market was frothing.
The B.D.I. is a composite index that tracks rates for hauling dry commodities like iron ore on key trade routes like Brazil to China. It indicates the health of the global dry bulk shipping market by mirroring the industry’s supply and demand fundamentals. The popular adage, “If there is one more ship than demand, prices will drop; if there is one less ship on the seas than required, prices will rise,” is perfectly encapsulated by the B.D.I.
What does a 98 percent decrease in the B.D.I. mean for carriers? Well, for companies engaged in the carriage of iron ore and coal, the 98 percent tumble translated into a calamitous drop in daily ship hire rates, on select routes, from around $200,000 per day to around $2,000 per day, far below vessel operating costs. For a carrier bound by a long-term contract, this could mean losing tens of thousands of dollars to the market each day, as well as the risk of a pricing disadvantage relative to competitors.
But this kind of price drop is not sustainable long term, even given the remarkable short-term volatility of the B.D.I., with percentage month-over-month changes frequently in double digit territory.
As a barometer of economic activity, the B.D.I. is heavily influenced by the policy actions of certain countries, namely China, due to its outsized role in trade as the world’s largest consumer of commodities. Moreover, in the case of China, a lack of reliable data on production, inventory, and ship-building activity exacerbates the uncertainty in the B.D.I., complicating the planning of maritime operations. This uncertainty-driven difficulty in planning is further compounded by the archaic practices of the industry. In some circles, for example, the telephone and fax machine are still considered “state of the art.”
Asset Mix Optimization. Diversification is the corner-stone of Modern Portfolio Theory, seeking to optimize returns at a given level of risk, and postulating that higher reward is inherently risky. So, just as an effective investment strategy includes cash, bonds and stock, so too an effective maritime portfolio should comprise an optimal mix of owned vessels, time charter agreements and spot buys to maximize returns in a choppy shipping market.
Long-term time charter agreements with fixed pricing mechanisms provide all-around security, ensuring the carrier has reliable capacity, and the ship owner has a predictable cash flow from locked-in rates. The flip side of long-term agreements, however, is that they prevent both sides from opportunistically exploiting the volatility of the Baltic Indices – the ship owner leaves money on the table when the Index crests, and the shipper when the Index troughs. In that regard, time charter agreements are much like treasury bonds – low risk of default, but also low yield.
Going from stem to stern of the risk boat, you have spot market buys, which are analogous to stocks – i.e. higher risk, but also potentially higher yield. The decision of allocating capacity between time charters and spot buys at any given time is a one confronts both ship owners and carriers. In our experience, one way decision makers resolve this quandary is through a spectrum of decisions ranging from a risk-averse approach of investing heavily to secure capacity, all the way to having an arbitrary split between the two instruments.
Instead, what we recommend decision makers do is to make an informed decision using an analytical framework that blends market intelligence with simulation to optimize an allocation strategy. Using this approach, we have seen carriers unlock savings in the 2 percent to 4 percent range over longer horizons.
Schedule, Route Optimization. Ever notice that off late Uber will assign you to a driver “completing nearby trip”? Sure, you might have had to wait a little longer for your ride to arrive, but for Uber, doing so minimizes the dead miles driven by a driver thereby driving up productivity. The idea here is to maximize the revenue earning potential of an asset without having to create a “new” asset by calling a driver from elsewhere who must drive empty to pick you up.
In a time charter, cost is incurred for every day of the charter, and therefore, the focus should be on minimizing the non-productive time spent traveling empty.
The problem with conducting this kind of optimization is that it is far too complex to manage on a spreadsheet. Moreover, making such maritime planning decisions involves looking at inventory levels, production levels, and the general impact on one’s supply chain, meaning that multiple “what-if” scenarios need to be assessed and analyzed – a task much better suited for an optimization software. Typically, we see organizations that successfully deploy optimization techniques gain 3 percent to 6 percent in value.
Negotiation Improvements. Continuing the Uber analogy, one of the disruptions it brought to transportation was the disintermediation of middlemen, or the dispatcher in the case of the taxi industry.
In the maritime world, this role is fulfilled by brokers who have thrived on controlling the flow of information and thereby market transparency. While brokers themselves can be invaluable resources to carriers, the nature of their role – dually representing ship owners and charterers – represents a fundamental challenge, primarily that of information transparency between interested parties (or lack thereof!). Besides misaligned incentives, no matter how sophisticated or global a broker is, they can only offer a partial picture of the marketplace, because no broker has visibility or relationships with all ship owners.
Today, however, with the power of technology and communication, a carrier no longer needs to rely on the limited knowledge and relationships of individual brokers. Earlier this year, a major mining company launched an in-house e-auction platform to directly connect their cargo with ship-owners, disintermediating the brokerage function, and attesting that time, tide, and technology, waits for no one. Even without going to such an extreme, a charterer can deploy a battery of tools and tactics to enhance their sourcing execution, from auction formats that increase broker competition to the automation of low-level sourcing tasks. We have seen clients use these methods to reduce their shipping cost by between 2 percent and 5 percent, even in the face of a rising Baltic Index.
And applying advanced analytical tools and technologies to maritime operations is only the first step in building a truly world class maritime organization. While many companies excel in certain areas, finding an organization that is world class on all the three fronts described above is extremely difficult. We find that while many organizations try to change, where they run aground is in changing management and governance. Without the organizational structure and policies to gain buy-in and cross-functional alignment amongst stakeholders in supply chain, production, finance, sales, etc. no amount of technology adoption will bring about the desired benefits.
Since the lows of February 2016, the B.D.I. has trended higher to a prevailing position of around 1200 points. However, this trend has been anything but smooth sailing, and the index components have shown more volatility than the usual seasonality, further underscoring the need to plan for uncertainty. For instance, the recent uptick that has propelled the Index past 1000 points was thanks to a 176 percent jump in the Capesize component, driven by a surge in Chinese demand.
With ongoing geopolitical changes adding to uncertainty and buoyant global markets leading to a resurgent Baltic Index, now is the opportune time to set maritime strategy on an even keel, and prime it to weather the stormy waters when they unexpectedly arise – anchors aweigh!
Michael Zimmerman is a partner in A.T. Kearney’s Procurement and Analytics Solutions practice. He is based in New York City and can be reached at Michael.Zimmerman@atkearney.com.
Josh Brogan is a Vice President in A.T. Kearney’s Procurement and Analytics Solutions practice. He is based in Atlanta and can be reached at Joshua.Brogan@atkearney.com.
The authors would also like to thank Lakshman Lakshmanan and Kushal Fernandes for their contributions to this piece.