The cargo business may once have languished as the Cinderella of the airline industry, perpetually under the shadow of its more glittering cousins in the passenger business. But those days have long since passed.

Not only is air cargo now recognised as a lucrative market in its own right, with growth rates averaging double those of the passenger business, but the stakes are getting higher. Where once the major passenger airlines were content to see belly hold operations as a side-line, today they are having to decide over whether to settle for being simple providers of capacity or seek out the value added to be had further up the logistics chain.

In part, their hand is being forced by the emergence of some formidable competition. The US integrators, originally born out of the express parcels revolution, have since begun to compete in every segment of the market with their seamless global logistics networks and value-added door-to-door service. The old distinctions have gone, with integrators offering overnight service for ever larger consignments and competing in the airport-to-airport sector that was once the preserve of the passenger combination carriers.

Freight forwarders, the airline's traditional customer, too are starting to respond by raising their game. The risk for airlines is that they will be squeezed in the middle, left with a commodity product sold only on price.

Some of the major carriers, at least in Europe, have already taken up the challenge, building direct relationships with customers and offering new levels of service. Airport-based packaging and storage operations have sprung up for all types of goods, including perishables, ready for collection.

There is a sound business case for seeking out this higher-value business. Not only does it offer bring rewards in the good times, but it should help cushion against tumbling yields when the going gets tough. A broader logistics network can also answer that perennial cargo dilemma of how to fill aircraft on the return leg.

There is another factor that is making the market still more interesting to watch. The creation of global alliances among the passenger airlines has opened up the prospect that cargo operations could follow suit with their own versions. Lufthansa's Star Alliance and the newly formed oneworld partnership launched by British Airways could offer the framework for global cargo networks too.

So far much of the running is being made in Europe, where the cargo arms of many of the largest combination carriers have begun to assert their independence as businesses in their own right. Lufthansa Cargo, Swisscargo, KLM Cargo and BA World Cargo, have all emerged from under the wing of their passenger carriers as distinct operations.

Lufthansa pushed the logic further, spinning off its cargo arm into a separate group subsidiary, and the SAirGroup has followed suit separating out Swisscargo from the sister Swissair passenger airline. Others like BA and KLM have remained within the fold alongside their passenger carriers, but both now operate as separate profit centres, purchasing 100% of their parent carrier's belly space.

The lure of logistics

Across the Atlantic, there appears to be greater reluctance to pursue the cargo business down the logistics route, despite the presence of some substantial combination carriers. United and Northwest Airlines rank among the world's top 10 cargo carriers, with American and Delta Air Lines not far behind. While Northwest even owns a handful of pure freighters, the core business for all remains the sale of belly capacity to forwarders.

According to Brian Clancey, a principal with consultants MergeGlobal, the US carriers may be right to stay out of competition with the forwarders, who still buy some 95% of the industry's international line haul capacity.

He acknowledges the hefty capital returns being achieved by the large forwarders are a strong motivation for the European carriers as they try to "reclaim a larger share of the industry's profit pie" by moving into value-added services. "The question is can they? Do they have the power to dislodge the middle man?" he asks.

Clancey adds that the massive investments needed in assets and facilities may not be justified by the return on capital these operators can achieve in what remains a price-driven business manipulated by the forwarders. "I appreciate the goal, but my critique is that this is still a 90% price-driven business," he says.

Clancey does concede, however, that the US majors have largely been deterred from attempting vertical integration by the presence of big US integrators like Federal Express and UPS on their home turf.

He adds that some US carriers have nevertheless attempted to set up cargo as a separate cost centre using various approaches to cost allocation.

Others believe that the airlines are right to defend their turf. "My perspective is to supply a better product to the air transport shipper. Otherwise they will lose business to the integrators," says Chris Foyle, president of the International Air Cargo Association and founding chairman of the UK's niche cargo charter carrier Air Foyle.

Foyle adds that it may not be enough to rely on combis or belly space alone in this new market. He argues that freighters are needed to provide lift where the shippers want it in a time-definite manner. "Freighters have to be made available, otherwise cargo is just an adjunct to the business of flying," he says, adding that while only 35% of cargo is currently flown in freighters, that figure could climb to half the market with in the next decade. For those not keen to own their own freighters, there is plenty of independent capacity on offer from cargo wet-lease specialists like Atlas Air in the USA or independent operators such as Cargolux and Polar Air.

Forwarders consolidate

It is not only the threat from integrators that is spurring the airline's change of tack. Consolidation within the once fragmented freight forwarding sector too is creating some sizeable global players.

Among them is Europe's Panalpina, now bidding to control its own air lift. According to Foyle, the group has taken Boeing 747 freighters from Cargolux on a whole-risk basis, dedicating them to individual customers. Seven Cargolux 747s a week are operating into Huntsville, Alabama, on behalf of Panalpina, which is developing the airport as a hub for onward truckers. Other big forwarders like Schenker & Kuehne and Nagel have considered similar moves, he adds.

Not all of the newly independent cargo operations see the need for their own freighter fleet. Although ranked among the top five international cargo airlines, BA has studiously avoided freighters. Arif Zaman, market and industry analyst at BA World Cargo, says this is a deliberate strategy. Instead, the operation supplements belly capacity by leasing-in freighters where and when they are needed. "The flexibility this gives us in terms of flexing up and down is absolutely vital," he says.

BA is earning an increasing portion of its cargo revenue from the perishables business, which has grown by more than 15% a year over the last three years and generates £45 million ($75 million) a year for the operation. A new dedicated facility is due to open at London Heathrow by next April at which perishable goods will continue to be stored and packaged. They are then either forwarded to or collected by the customer.

But BA is not alone in targeting perishables: they provide a neat way of filling capacity on return flights from regions which offer little in the way of manufactured goods. Lufthansa Cargo has pioneered the market in developing countries, flying out with industrial goods and returning with local produce. Switzerland's SAirGroup has gone further than most in building a logistics service, creating a division called SAirLogistics. As the name implies, it covers all the functions needed to provide door-to-door services. Swisscargo is just one of four SAirLogistics businesses, sitting alongside a trucking operation, the Cargologic handling company and the Jacky Maeder freight forwarding business, which also has stakes in other forwarders. Jacky Maeder channels business onto Swisscargo flights, while Cargologic does the tracking and tracing. Chemical company Novartis is one example of a major direct customer and is guaranteed service, whenever it needs it.

Pursuing the value chain

Swissair also recently purchased a 33.7% stake in Cargolux from Lufthansa and, longer term, aims to make the operator its main supplier of freighter capacity, says Ludwig Bertsch, Swisscargo's chief executive. At present all Cargolux's capacity is committed elsewhere, but more 747-400Fs are due to arrive next year and the carrier expects to convert some of its outstanding options on the types to firm orders. "In the longer term we will probably commit to between two and three aircraft," says Bertsch.

So far Swisscargo has taken over the entire belly capacity of SAir's passenger airlines, including regional subsidiary Crossair and charter operator Balair. It is also marketing the capacity of Swissair's 49%-owned partner Sabena and the Belgian carrier's charter arm Sobelair, plus part of the belly hold of Sabena's affiliate, the long-haul start-up Citybird. In addition, Swisscargo wet-leases three McDonnell Douglas DC-10 freighters from Washington-based Gemini.

KLM Cargo is probably further down-the-door to door track than any other carrier, with a massive 30-35% of its business falling into this category. The business uses partly its own forwarding solutions through its own offices worldwide and markets the belly space of what will eventually become the "KLM group of carriers", comprising KLM, KLM uk, Transavia, Martinair and Cityhopper, says Boubby Grin, director strategy and governments. The operation has only two 747Fs of its own but leases in freighter capacity.

Since making the pioneering break from its passenger parent in 1995, Lufthansa Cargo has not faced the smoothest of markets. But last year the company proved that it could make money, showing a modest net profit on its sales of DM3.9 billion ($2 billion) So far this year the business has managed to sustain yields despite the Asian crisis. Its first half profits were up.

The German giant has the largest freighter fleet of any passenger carrier-owned operation, with 11 747-200Fs. The carrier has been careful to give itself flexibility, however. In early November it takes five slightly smaller Boeing MD-11 freighters on a lease deal, with nine more due from Boeing by 2001. "We will have two fleets and will be much more able to control capacity," says a source at Lufthansa Cargo.

The carrier buys all Lufthansa's belly space as well as those of charter operator Condor, the Cityline operation and some from the airline group's partners. The company has built 10 long-term business relationships with forwarders to provide shippers like BMW or Sony with a reliable worldwide logistics chain. It still sees flying as its core business, however.

Global alliance partners

Each of these major European cargo players is linked to a global passenger alliance and some are already reaping the benefits of these relationships. But global cargo alliances are unlikely to be exact replicas of their passenger counterparts, because of the different cargo philosophies, says Lufthansa Cargo. Clancey at MergeGlobal concurs, taking the example of Northwest/ KLM: "You have got bi-polar market strategies. Northwest wants to work with the forwarders, while KLM wants to take them on. So how can you optimise the cargo alliance?" From an operational point of view, cargo markets will be much more difficult to work out than on the passenger side. "They are fundamentally different markets," he adds.

Clancey does believe, however, that if successful, the building of unified global cargo networks could help cargo operators shift the balance of power away from the forwarder. "If you have a global airline network and a coordinated approach, and you can control that, you are starting to level the playing field with the forwarders."

Some cargo alliances are already under discussion or in place, as the players seek to build those global networks. In the words of one industry insider: "If you have a global network for cargo, then you are unbeatable."

Lufthansa Cargo is understood to be sounding out Star Alliance partners SAS and United, as well as Lufthansa partner Singapore Airlines. With SAS, there are plans for joint capacity and freight handling, joint marketing and a common European express delivery product to be launched in early November.

Both SAS and Lufthansa have time definite express products and the aim is to rationalise the two operations. "Lufthansa would collect the express cargo of SAS and deliver it where they are strong, for example in Germany and middle and eastern Europe. They would deliver Lufthansa's product where they are strong," says one source. Talks are also under way with United. "We need their network. They are very strong on the Pacific and they could give us capacity on their passenger aircraft. Or they could get more freighters and we could share the capacity," he says.

KLM Cargo also stands to reap substantial benefits from the Dutch carrier's partnerships with Alitalia and Northwest Airlines. In Italy the opening of the new Milan Malpensa airport is a golden opportunity for KLM/Alitalia to take a major slice of the cargo markets in northern Italy, Germany, France and Switzerland. At present, some 70% of all air cargo originating in northern Italy travels by road to rival hubs in Frankfurt and Zurich, making Alitalia a modest player in the air cargo market.

The new Cargo City logistics centre at Malpensa could change that and the two airlines are busy making plans. "We need to redesign our hub in Europe from a one hub to a two hub situation," says Grin at KLM. "Once one has a hub in southern Europe other possibilities exist - we are missing markets which cannot be hauled over Schiphol while Alitalia cannot tap into other markets," he says.

A shuttle between the two hubs would be necessary to connect the freighters to the system, he adds. He says, however, that there is "no way" that KLM could take over Alitalia's cargo capacity in the manner of Swissair/Sabena.

Talks are also in train with Northwest to structure the network in a more efficient way with new hubs points under examination. Grin rejects speculation that the long awaited common cargo strategy between the two has been held up by different basic philosophies. "We are leaning towards direct customer relations and Northwest is forwarder orientated, but that does not mean we will clash over strategy," he argues.

At Swisscargo, work is under way to "build a global network with partners", says Bertsch. Under the two-year contract with Sabena Swisscargo markets the Belgian carrier's entire belly capacity, assuming all the risk. Talks are also under way with the other members of the Qualiflyer group, which includes AOM of France, Turkish Airlines and Austrian Airlines. Swisscargo will only take over the capacity in areas where it is strong, says Bertsch. Alternatives would include joint revenue accounting and back office functions.

The current drive to standardise electronic data interchange (EDI) - required to track and trace shipments - is crucial to such alliances, adds Bertsch. "It is a prerequisite to offer a seamless system to our forwarders; we have to establish those connections," he says.

On a global scale Swissair is building on its marketing alliance with Delta Air Lines, jointly offering cargo capacity across the Atlantic. "We represent them in Europe and they represent us in the USA," says Bertsch.

The airlines are also establishing a link between their host systems which will allow both to see each other's flights.

Last, but not least, the fledgling oneworld alliance says the cargo divisions of the five partners are working on a series of initiatives to improve service to customers and eventually conclude a "multilateral arrangement'.

In the face of all this activity, there is one certainty: the integrators will not stand still. "The competition will be between the larger integrators and the global cargo network systems. There will be four to five, possibly six to seven, large global cargo networks, some from traditional airlines, some from the integrators," says Grin at KLM.

As the air cargo business battles to gain competitive advantage, it is in danger of making the passenger business look dull.

Source: Airline Business

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