Key Principles to Avoid Business Disruption

Two recent back-to-back ocean freight articles involving Maersk Line caught my attention. According to an article published in Journal of Commerce, “Maersk Line has suspended bookings on its North Europe-Asia services effective immediately as it battles to clear up a backlog of containers at clogged European terminals.” In addition, Financial Times reported that Maersk had earlier decided to cut capacity on the Asia-North Europe route by 9 percent, citing that over-capacity has pushed rates down considerably. Maersk said it expects to accept bookings again in early May after it has tackled an unprecedented buildup of cargo caused by consecutive vessel cancellations following the Chinese New Year.

My View

With a significant over-capacity situation in ocean freight, Maersk’s decision could allow them to take the capacity without having to sacrifice market share. In fact, in the same article announcing the capacity cuts, Søren Skou, CEO of Maersk Line, essentially revealed their reasoning: “Since demand is low, reduce capacity and operate the rest of the vessels at near full and still maintain the market share.” While this strategy makes sense and may very well prove to be a catalyst for instilling the much-needed capacity discipline in this industry, as a revenue management practitioner, I’m left wondering how Maersk could have better managed this situation.

The truth is that all freight (in any mode) suffers from this demand/capacity imbalance because all freight suffers from unbalanced directional flows. This should come as no surprise to anyone. However, companies need to anticipate and have a contingency plan in place to avoid business disruptions and customer service. With proper analysis, they would have had the information in their hands to announce the likely impact on the Europe-Asia demand when they announced the capacity reduction in the other direction. Could revenue management have helped?

Understanding Revenue Management

Revenue management is the art and science of deciding how you will sell your product to the right customer at the right time by planning the right capacity to be available at a profitable rate at the right place. Air cargo companies have been adopting revenue management techniques for well over a decade now and some leading, innovative carriers use them as the basis of all decision making when it comes to demand, capacity, bookings and pricing. Applied to ocean freight, revenue management has three main steps:

1. The first step is to forecast customer demand, which should be the basis for any planning function. This isn’t just about algorithms and statistical techniques; it is also about effective collaboration across all divisions and stakeholders to understand demand in the market at any given time. With an easy-to-view-and-understand network-wide forecast, it would be clear to all stakeholders the impact a decision in one corner of the network has on the rest of the business.

2. The second step is to understand your asset inventory and plan accordingly (vessels and containers). Based on demand forecasts, companies can optimize asset plans so that the right asset is positioned in the right location or port at the right time. The goal is to not only minimize empty container moves, but more importantly to improve customer service levels. The result of this step is an overall capacity plan that maximizes network profitability, even if some vessels/containers move empty sometimes.

3. The third step is to optimize the rates to offer, whether for an individual quotation/deal, or for the spot market. Demand forecasts from step one would estimate the impact of price changes in demand while asset optimization from step two would provide the costs including opportunity costs of using the assets. Rate optimization would use both these as inputs to figure out the optimal rates to maximize overall profitability.

Moving Forward

I believe that Maersk could have benefited by having these key principles and practices in place. First, assuming capacity reduction was a given, Maersk would have had an early and accurate view of the demand on the Europe-Asia corridor. It would have known how much demand it would spill with less capacity than usual and could have planned for it. Second, it would have been able to determine a pricing strategy to manage the excess demand. By balancing demand against the reduced capacity, revenue management would have set rates that would attract only the best demand. If OOCL can earn higher rates while reacting to the capacity cut, think how much better Maersk should have been able to capitalize on its foreknowledge.

But more importantly, with revenue management, Maersk would have understood the booking pace it needed to adopt, perhaps even before the capacity reductions were announced, to avoid backlogs and never get to a situation where it accepted too many bookings to begin with and then ended up with closing bookings off altogether. A top brand like Maersk cannot afford to put its brand reputation at risk.
The ocean freight business is asset intensive, over capacity and operating on thin margins. Capacity discipline like Maersk’s is ultimately necessary, but such decisions should be taken in the context of overall business profitability, demand for its offerings and ultimately customer service. Supply and demand go hand in hand, and those carriers that know how best to balance the two consistently and profitably will be the winners in the long run. It is time for this industry to embrace revenue management, much like its sister industry, air cargo, has done.

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