The Air Freight Revolution A Way Ahead

Speech Made to Air Freight Show in Chicago. (Details will be shared in class.)

Today I attempt to interpret the past explain how many carriers have met the
environmental challenge over the last decade and have become market leaders
and finally I will chart a successful way forward to the next century.

The critical change in the market over the years is that it has moved from product to
market driven and the focus has moved from despatch to delivery.

The initial reliance of the scheduled carriers was on the carriage of air mail the
American and Canadian domestic networks and the European carriers long haul
networks were built on the back of post office mail contracts.

Air Cargo then slowly evolved as a by-product of increasingly dominated passenger

operation initially only high value and emergency cargo were carried they were
often scheduled by sea but due to production problems were then diverted to air.

Post World War 2... with the release onto the market of military aircraft capacity not to
mention the progressive improvement in aircraft capability brought about a large
expansion in the market this was fuelled by price reductions... increasing attention on
worldwide distribution and active selling by airlines and forwarders.

The negatives were that this capacity was basically produced as a by-product of the
passenger operation and did not always relate to customer needs.

The advent of the wide bodies coupled with the development of trucking had a
significant effect on the cargo market.

Aircraft lift was dramatically increased with the 747 because it had the capability of
carrying 50% of the uplift of a pure 707 freighter in addition to a full passenger load.

On the long haul routes the wide bodies had the capability of carrying by size
90%... and in their COMBI versions up to 95% of the traffic offered on short haul
routes increasingly sophisticated trucking systems were able to carry freight at a
fraction of the cost within competitive time frames.

Airlines in general were very slow to see the opportunities offered by these
advantages and reacted negatively to the opportunities the additional lift gave them
having a production rather than marketing outlook they wholesaled this space in
consolidations their objective was to minimize cost by a forwarder selling the space
for the airline presenting a fully loaded container and one piece of paper.

The reality was that competitive pressures because such that the shipments were
often presented loose but at the lower consolidation rate the large forwarder became
increasingly an intermediary and the airlines found they had delegated their
marketing to third parties.

It became an experts market and the shipper had the choice of becoming expert or
using an intermediary to look after his interest.

However the intrinsic speed advantage of air versus other transport modes and
their similar expert/closed shop marketing meant that air freight whilst not fulfilling
its full potential... continued to grow and in many peoples eyes grew satisfactorily.

As the customer perception of the speed advantage waned the growth curve flattened
in the 70s.

Then came the integrated operators in North America Federal Express

internationally an On Board Courier Led by DHL and on the ground in Europe
TNT/IPEC.
They:

Identified customer needs

Generated schedules to meet these needs
Offered service integrity
Similarly simplicity
Guaranteed delivery within a given time frame
One price total service
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Clearly showing that success can be achieved by identifying and meeting market
requirements.

The industry had now entered an era of the strategic utilization of freight
transportation and ever increasing customer expectations from both business people
and consumers.
Key areas of opportunity now presented themselves

Time based competition and just in time techniques to obtain market edge and
minimize distribution and inventory costs
Global marketing of newly developed products to quickly obtain market
dominance.
Transportation of seasonal perishable goods to meet the growing expectation of
the consumer to be able to buy increasingly exotic products all year round.

This was the environmental backcloth as we entered the decade of the 1980s which
commenced with a recession thus preoccupying the minds of airline management.

Many airlines re-evaluated the need for freighters and it quickly became apparent that
long haul freighters were only profitable in the following areas:

Where there was a shortage of belly hold capacity for example in the far east
Very strong regional markets feeding into hubs high yield cargo for
example in Hong Kong
Where an operator can retain an adequate share of the total return from the sale
of premium door to door products for instance integrated operators
Niche specialist operators such as the U. K. heavylift operating Belfasts
Regional feed to long haul services

Except where the above criteria applies or the national interest was involved many
carriers dramatically improved their bottom line by cutting back and eliminating
freighters although only a few like British Airways obtained the full benefit from
taking this course of action.

Taking the three prime geographically areas in turn... the following scenarios evolved:

In the States the carriers took on the integrated carriers but burnt their fingers and
with one or two exceptions withdrew from being serious participators in the added
value market.

Many continued to earn sizeable revenues but this was a function of lift and their
product became increasingly commoditized only American of the large domestic
operators developed a sophisticated computer system while 90% of all domestic
traffic went to the integrated operators may carriers cargo revenues amounted to less
than 5% of total revenues this was liveable whilst the carrier was basically a domestic
operator and adequate profits could be generated from passenger traffic notable
exceptions were Flying Tigers who although after running full cost freighters
against marginally costed joint production aircraft did a marvellous job of surviving for
so many years.

In the end an ever shrinking customer base plus the capital requirements to replace
aircraft develop sophisticated computer systems etcetera forced them into the
arms of Federal Express Northwest Airlines also continued to profitably run
freighters although understandably have focused on the higher yielding Pacific
routes.

Of all the North American passenger carriers only Air Canada has always showed
through the years a deep commitment to cargo and they endeavoured to add value to
its products by offering both wholesale and retail door-to-door services this wholesale
express service which delivers any weight shipment the same day within Canada
still remains unique today Air Canada also continued to run a domestic freighter fleet
utilising the aircraft on a marginal basis on international routes at week-ends.

The far east carriers took full advantage of the area becoming the workshop of the
world with all the principal operators having a deep commitment to cargo and
because of rich passenger and cargo flows on freighters and passenger aircraft with
minimal use of COMBIs.

In line with the trade-led philosophies of their respective countries both Lufthansa and
Air France invested heavily in both freighter and COMBIs.

KLM with a small home market but with the positive international commercial attitudes
of the Dutch showed a way to the industry of how to build a viable international
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network by maximising the synergy between transfer passenger and cargo traffic with
the building of the Schiphol hub and the extensive use of 747 COMBI aircraft.

British Airways during this period came from nowhere to become a market leader
given the opportunity to run cargo as a business in its own right they showed what
could be achieved with focus and flexibility once the decision to get out of freighters
had been made Necessity became the mother of invention.

A successful strategy has evolved to overcome capacity limitations and a home base
with constrained market growth and trade moving from long haul into Europe.

The strategy which will become a classic business school case with minimum capital
and maximum people involvement was based on stretching joint production
capacity extending market presence yield control and maximum use of
information technology adding value to products and controlling distribution channels.

The result was that British Airways became arguably the worlds most profitable cargo
carrier with cargo contributing a significant percentage of the operating profit.

This decade saw a significant rationalization of the distribution system U.P.S. and
Federal entered the international arena and became significant competition for both the
premium and traditional cargo operators in the international market the end of the
decade saw the top fifteen international forwarders controlling half the worlds cargo
business.

I would now finally like to turn to the future carriers are now increasingly looking to
cargo as a key area of opportunity to meet their financial goals.

This change of attitude has been brought about by realisation they cannot survive
internationally on passenger traffic alone the huge cargo potential revealed by the
integrated operators and success of carriers like KLM and British Airways. Cargo
from being a backwater is becoming increasingly frontline with the requirement to
treat cargo as a business in its own right and professionals to head these businesses.
In the last year both KLM and Lufthansa have re-organized and American Qantas
have head-hunted vice-presidents.

By the year 2000 the world freight market will rival the passenger business market
this accelerated growth will be primarily in the premium cargo market which will
overtake the traditional cargo market.

Three giant markets the Far East Europe and the Americas will account for 80% of
the world freight market.

Europe will progressively become one huge domestic market - equally in size and
environment progressively mirroring that of the States. The Far East will outgrow
both the Americas and Europe and become the worlds major workshop it will
remain largely a group of domestic markets and will not experience the degree of
integration/rationalisation seen by the USA and Europe.

The international shipping customer base will grow dramatically with many more
small and medium size firms involved in international markets we are ten years into a
logistics revolution with firms increasingly attacking costs by moving plants to low cost
areas and the extensive use of just in time techniques distribution is the last frontier
of cost control.
Information Technology
Competitive Advantage most industries will become information intensive from a
customer perspective.

Automation will decisively influence the distribution system those companies who
have invested wisely will have an overwhelming competitive advantage over the field.

Increasingly the post office monopolies will be curtailed and many privatised the
more enterprising postal administrators will combine to form their own world system.

The integrated operators will rationalise and only two or three will survive on a global
scale the traditional forwarder will be left with only the lower yielding goods they will
have the choice of remaining in a lower yielding market but expanding horizontally
utilising buying muscle to force lower rates from airlines in becoming consolidating
intermediaries (agents- agents) the number of truly international forwarders remaining
by the end of the decade will be in single figures.

The smaller carrier/express /agent operators surviving will have exercised one of the
following options identifying and exploiting a niche becoming a satellite of a major
forwarder or being a true agent of an added value carrier offering a total range of
services.
The following range of services will predominate worldwide:

Same day and next morning delivery of documents and small dutiable
packages up to 30 kilos the mode used (dependant on customs) will be a mix
of both Courier and Express as Express replaces Courier so the weights will
go up for instance the Canadian Domestic System

Door to door delivery of heavier non and dutiable freight with two grades of
service next day and 2/3 days

Traditional or hard freight within consolidation is moving airport to airport by

scheduled carriers

Dedicated operators for major shippers for example Lufthansa and Alitalia
with General Motors

The airlines are dividing into two those who dump cargo and those who add value
to their product.

The dumpers treat cargo as a commodity and a by-product for which they seek to obtain
whatever revenue contribution they can for a minimum outlay The dumpers will
increasingly find life is becoming progressively harder they will not become mega
carriers and their customer base of consolidators will contract these consolidators
in turn will increasingly be under pressure from integrated operators progressively
eroding higher yielding shipments.

The value adders are the carriers who have recognized that with careful attention to
the cargo product and a sensible degree of investment a commercial return can be
made that is necessary for the carriers continuing profitability.

The value adders have common characteristics in firstly maximising the carriage of
freight in the belly hold of passenger aircraft then growing via the use or COMBI
aircraft the number dependent on the mix of passenger/cargo flows. To ensure
product integrity they will utilise freighters either by purchase of space on other
operators or their own low cost subsidiaries.

The increasing problem experienced by carriers having large in-house freighter fleets
is having to cover full cost but compete with carriers who marginally cost with joint
production aircraft and/or low cost subsidiaries and marketing policies based on the
use of volume producers these are the players most under threat from the integrated
operators.

The value adders have invested heavily in automation and will offer unparalleled
range of booking-tracking and information services complimentary to the services
provided by automation they will offer a complete range of wholesale express and
traditional consolidation services these wholesale services will act as a lifeline to the
small and medium sized carrier/express/traditional agents and provide a beneficial
service to the large agent on thin routes.

The surviving players in the industry now have the ability to sell the complete range of
cargo services irrespective of whether their origins were in the carrier/express or
traditional end of the market.

For the added value carrier the best of both worlds will be a large customer base of
agents supplying the all-important service to the customer backed by the airline
resources the world is too big to go it alone so added value carriers will maximize
behind the scenes co-operation particularly in computery, purchase of space with
competition coming from the range and quality of host services offered.

If a passenger carrier wishes to develop a successful international operation and

eliminate domestic cross subsidisation he will have to become a value adder

Some companies are showing commitment to developing their cargo operations in

general however North American carriers have not shown a similar commitment to
cargo as the leading Far East and European carriers the truth of the matter is
that with their richer passenger domestic markets up to now they have not needed
to.
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There is however a great opportunity in that many carriers like British Airways
have reached watersheds in optimising their return from cargo which is central to their
continued profitability.

With very able cargo managements they will still increase their contribution but the
relatively easy part of the operation has been completed with the filling of joint
production aircraft investment will have to be made to buy in additional capacity
move down distribution channels and add value to their products to increase yield per
kilo rather than in the past yield per aircraft.

This will not be easy as even the most successful players over the last decade
(including the integrated operators) have not been able to resist unit yield erosion.

On the other hand the carriers particularly North American who have been able to
maintain good profits whilst treating cargo as a commodity have a great opportunity to
really enhance their profits by treating cargo as seriously as the value adders do
they will not do this unless they treat cargo as a business rather than an incremental
opportunity.

As previously mentioned it will be a key to extended international operators and

becoming a mega carrier, that ladies and gentlemen is my interpretation of the
past and projection into the future.

I am quite sure I have not been visionary enough and understated the dynamics of
change particularly in the area of automation.

What is absolutely vital is that we must in the industry see change as the norm
not the exception.

We must identify change see where it is leading and endeavour to get there first
but not try and control it.
Hopefully this paper will be seen as a step in this process.

Geoff Bridges
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