Air freight is often seen as an unfashionable part of the business, but it is winning more attention in the boardroom as a key profit generator
Where does cargo fit into the airline business? Is it just a useful source of incremental revenue, or a strategic activity? Can Boeing's bullish forecasts of cargo growth be relied upon, or will cargo revenue be undermined in coming years by falling yields or security restrictions?
Certainly on the face of it, cargo ought to be a good business to be in. The latest Current Market Outlook from Boeing forecasts a 6.1% rise in air cargo over the next 20 years, while passenger travel will grow by just 4.9%. Cargo also has the advantage that it can be carried in the bellies of passenger aircraft at relatively little incremental cost.
On the other hand, since the cargo business is growing faster than passenger, belly carriers will inevitably be condemned to commanding smaller and smaller shares of the market, losing out to operators that invest in freighters. At the same time, air cargo's customers - the freight forwarders - are consolidating and limiting their purchasing to preferred carriers.
Given such dynamics, David Hoppin, principal at MergeGlobal consultancy, reckons pure belly carriers have three options: "They can accept a smaller share of each forwarder's spend they can rely on fewer, larger customers, which means their risk will be less diversified or they can combine with other carriers or hand their capacity over to third parties to sell," he says.
Capacity wholesalers
Examples of such third-party organisations include Leisure Cargo International in Frankfurt or Lufthansa subsidiary Cargo Counts. The clients of such capacity wholesalers tend to be smaller, low-cost or leisure carriers, however. To date the concept has not caught on with any mainstream airline.
Instead, many carriers that once were seen as having a marginal approach to cargo are now taking it much more seriously. An example is American Airlines, which, despite dating its origins back to Charles Lindbergh's airmail service and being the first carrier to operate scheduled freighters, has long been seen in the cargo industry as the archetypical marginal belly carrier.
Not so, insists its president cargo, Dave Brooks. Despite cargo accounting for only 4-5% of total revenue, he insists it is taken very seriously within the airline. "The days of thinking of cargo as just a nice add-on are past," he says. "You can't be competitive if you treat cargo as pocket money. Customers are now smart enough to realise how serious an airline is about handling freight. You have to do better than the other guy, and you can only do that if you invest in the business."
There is also now a realisation that without cargo, many of American's long-haul routes would be unprofitable, which is being underlined by newer-generation aircraft such as the Boeing 777. "These aircraft have substantial belly space, and are designed to carry a lot more than just passenger bags," Brooks points out. "If you don't have a load of air freight in your belly, it will be that much harder to make money."
So these days, cargo competes equally with other parts of American for investment capital, and executives take an interest in cargo's performance, getting monthly updates on numbers, service quality metrics and safety issues.
"Our senior leaders also love to meet customers, and I always make sure they come to customer functions," says Brooks. "The value of that is that they stay engaged in the business, so when we need something, we can talk shorthand."
Cargo even has an influence on route decisions from time to time, as happened recently on the Chicago to Miami route. Brooks and his team were getting good loads from Shanghai into Chicago, but were unable to connect them to potential onbound markets in Miami because the route was operated by narrowbody 757s. "So we told them this was a network priority," says Brooks. "After some persuasion, they upgraded one of the daily flights to a 767."
Another carrier seen as being increasingly interested in cargo is British Airways. The BA board has invested some $500 million in the cargo business over the past 10 years. This includes a new handling centre for the carrier at London Heathrow Airport, and recently $57 million was spent on a new premium products operation.
"Our chief executive Willie Walsh is fully committed to the cargo business within BA," says Gareth Kirkwood, managing director of British Airways World Cargo. "It is a key contributor to the airline's profitability and played its part in the airline's turnaround since 9/11.
"Cargo's operating margin target equates to the 10% operating margin target that BA has set corporately. Provided this level of performance can be met or exceeded in the future, cargo will continue to attract investment commensurate with its contribution to BA's overall profitability."
The fact Kirkwood and his team have a margin target might even have helped justify the investment. One perennial concern for cargo departments is falling yields for general cargo. Claude Morin, vice-president cargo for Air Canada, sees a relatively gloomy picture here. "Each new Boeing or Airbus is better at carrying cargo. For example, the 777 has three times the cargo capacity of some of the aircraft it is replacing. So rates will probably go down rather than up."
Many carriers are responding to this by stressing higher-rated premium products in their belly cargo. In BA's case, the new premium cargo centre is focused on temperature-controlled pharmaceutical shipments, courier traffic and mail. At American, Brooks says express products such as its Expeditefs are aimed at specialist shippers and are particular suitable for narrowbody bellies.
American has also invested to retain the US postal service business that many other US majors has recently lost when new contracts were signed at the end of June. "It is probably worth an extra $100 million in revenue, but to get it we had to make a strategic decision to stay in the game," Brooks says.
Premium products
The archetypal premium products belly carrier is Swiss, which has made a speciality of this ever since it was founded. Oliver Evans, its chief cargo officer, unusually spent a spell as head of passenger sales and marketing at the same time as holding down his cargo brief.
He says cargo is valued at Swiss because it complements the cycles of other parts of the business. "It is still cyclical, but its cycles are different," he says. "We saw that dramatically during the SARS crisis, when passenger numbers were hit, but cargo was not. In 2002/3, when Swiss was struggling with light passenger loads, it also played a major role in keeping the company alive."
Swiss illustrates how in some European airlines, cargo is fully integrated with strategic decision-making by the airline as a whole. "My chief executive is an ex-cargo man. I report direct to him, and take part in management discussions about the future of the airline," Evans says. "My passenger colleagues are also keen to know cargo developments."
Evans reckons cargo has such influence precisely because it is not split off into an independent company. Contrast that with Air Canada Cargo, now a fully independent profit and loss division within the airline, where Morin says his passenger counterparts and senior executives are only interested in how much he can generate for the bottom line.
"I don't tell my passenger colleagues what business-class meals to serve, and they have no say whatsoever in how we conduct our business," he says. "If we decide to get into pharmaceutical or live animal shipments, that is up to us."
Airlines seem equally split on this issue of independence for cargo. Top executives at Lufthansa Cargo, which in many cases started the trend, insist that being an independent company since 1995 has allowed it to take the bold decisions needed to build its business. Carriers such as SAS and Singapore Airlines have followed suit, and several others - for example Saudi Arabian Airlines - are considering such a move.
But many leading airlines are also resisting. At Korean Air, where cargo is 30% of group revenues, the idea was considered two years ago and rejected.
Though Korean Air Cargo is a profit centre, and free to decide its own strategy, its president Ken Choi says it could see downsides in becoming an independent business. "It would mean that we would have to pay internally for things like cockpit crews and maintenance, and our calculation was that we would pay more than we do now, when we share these resources," he says.
Instead, he says, cargo plays the same percentage of the total costs of the company as its contribution to group revenue, a formula he admits probably includes paying for things that have nothing to do with the cargo business.
One thing that independent cargo departments inevitably have to pay for is belly space. Morin says Air Canada Cargo pays per available tonne kilometre, with adjustment for headwinds and passenger loads that might restrict belly space. Nevertheless, he says it is a "constant challenge" to know what capacity he will actually have on the day on any particular flight, with belly space on one route varying from three to 10 tonnes, depending on weather conditions and passenger loads.
Route choice
No cargo division in this situation gets to pick and choose about which routes it buys capacity on. Marc Boudier, executive vice-president cargo at Air France, admits the cargo business has to pay for space on routes where there is no cargo business whatsoever. "That can be hard, but the more you accept these rules, the more you are able to participate in strategic decisions," he says. "If you are marginal in payment, you are marginal in decision-making too."
Cargo is an integral part of decision making at Air France-KLM too, insists Michael Wisbrun, Boudier's counterpart at KLM and chairman of Air France-KLM's cargo management committee.
He also is one of eight members of the strategic management committee of Air France-KLM's holding company, and takes part in all strategic discussions about the airline. He bridles at the description of the holding company as being the parent company. "We are fully part of the airline, not a subsidiary, but one of the three pillars of its business," he says.
He adds cargo has shown it can develop as a profitable business: "The passenger business is also not able to grow profitably without cargo."
Relying on cargo to keep passenger routes profitable does have some dangers, however. One is the prospect of a terrorist incident prompting cargo to be removed from passenger aircraft altogether.
When in August there was a security scare at London Heathrow, cargo's heart skipped a beat. A mysterious explosion mid-Atlantic could easily have been blamed on cargo, and would have given hawkish elements in the US Congress the ammunition they needed to ban belly cargo altogether.
Hoppin says this scenario has to be taken seriously by airlines. "If there was a bomb, pressure for a ban could become irresistible," he says. "Even 100% physical screening could double the marginal cost of handling cargo. It could deter traffic, or shift cargo to other modes. As it is, it is logical for shippers to be already planning for a world in which this contingency has come to pass."
Cargo managers generally do not even like to think about such a turn of events, but for Brooks, it means security is a regular topic of discussion with his senior management. He says the carrier also spends a lot of time persuading members of Congress that what he calls "the gaping hole rhetoric" of some politicians does not reflect the reality of actual cargo security measures.
"But most commercial airlines are convinced that their cargo business is run safely, and if we truly felt we were exposed to carriage of unsafe cargo, we would not be in the business," Brooks adds. "After all, our children fly in our aircraft too."
Wisbrun says security is also increasingly a focus. "One thing we can be sure of, is that things will change faster in the future than they have in the past," he says. "We have to be ready for that, for example by having a proportion of our fleet on flexible leases, so we can take that capacity out at short notice and at low cost to our operation."
Other worries for cargo managers include airport capacity, high fuel prices and the growing power of their forwarder customers. "Forwarder consolidation really is an unknown quantity, as most mergers and acquisitions are at the early stages of their evolution," says Chris Bosworth, general manager commercial development at British Airways World Cargo.
For Evans at Swiss, it is the growing imbalance in traffic flows, not just to Asia, but also on the North Atlantic, that needs watching. "That is why our strategy based on belly capacity and premium cargo is absolutely the right one," he says. "In low-volume, high-value areas of the business, we see fewer imbalances across our network."
On the other hand, he sees a certain threat to premium product growth from high fuel prices. "No one likes to see price increases, and while certain commodities at the premium end have to fly - in contrast to lower-end products that can use other transport modes - there is not unlimited elasticity," he says.
At Korean, the world's largest conventional cargo carrier, Choi also has a warning that should be taken seriously by all cargo operators - and it is most of them - who have been relying on Asia as the engine of their growth in recent years.
"Asian carriers are really scrambling to increase their cargo capacity, and I am sure that in the next three to four years, we will reach saturation," he says. "Overcapacity will make some carriers pull back, and the only way to survive will be to be economically strong, and to cut your costs."
The most important way to do this, Choi reckons, is to eliminate older, gas-guzzling freighters. This message has not been lost on other airlines. Boudier points out that Air France will be dedicating 18% of its fleet investment over the next five years on 777 freighters to replace its 747-200Fs, and Morin got his parent carrier's approval to buy two of the same aircraft.
Of course, purchasing expensive new aircraft to ensure competitive advantage in a world of incipient overcapacity might be also be seen as a somewhat risky strategy, but Choi is not fazed by the contradiction. "It is like being on a bicycle," he says. "When the road gets steep, you have to pedal harder, or else you will fall off."
Source: Airline Business
