Pricing Power in a Cargo Bazaar: Does Revenue Management Add Value?

Those were the good old days. Logistics Service Providers (LSPs) were the center of the cargo transportation universe and the shippers were fully reliant on them for all their logistics needs. Air and ocean freight carriers were reliant on these LSPs to provide them with a view of the market; in most cases they had no transparency into the shipper’s needs and thus were completely cordoned off from the true source of demand. LSPs shopped around for the best rates, played one carrier against another and continuously put a downward pressure of market rates. Carriers did the best they could, leveraging surcharges in some cases to ensure they had a decent rate on offer, but never had any pricing power.  A true cargo pricing bazaar was the result.

Fast forward to present day. Shippers have begun reversing the outsourcing trends and are planning their own logistics needs through the use of advanced logistics planning platforms. Technological advances are allowing these shippers to plan relentlessly, do scenario planning and decide the likely transportation services they need for moving their products. They partner with LSPs for organizing specific services around their transportation choices; services such as procuring the transportation, generating documentation, managing bills and invoices, monitoring shipment progress, customs clearance and settlement services. But the transportation modes are being increasingly determined by the shippers themselves.

Companies like Ericsson are leading examples of this trend who are even going one step further. They want the LSPs to bring the carriers with them to the table when discussing their logistics needs; they want direct access to the carriers as after all it is these carriers that transport their shipments. The idea is not to cut out the LSPs; rather it is to create a win-win-win partnership between the shipper, LSP and the carrier to ensure a successful outcome for all parties. Some leading carriers, sensing this change and recognizing that it is the shipper that is truly the “center of the supply chain universe,” are making the same demands of the LSPs, with some even taking the extreme step of not wishing to do business with LSPs that do not include them in the logistics planning exercise with the shipper. These conditions create a perfect storm for the carriers to break out of the cargo pricing bazaar. With increased transparency into the shipper’s demand and the ability to plan the service the shippers want, carriers can use Revenue Management to more accurately forecast the demand for their business and gain pricing power by optimizing their pricing commensurate with the service on offer in a profitable manner.

But this is easier said than done. Even if all of the above were commonplace, bazaar conditions still prevail. Excess capacity, sliding rates and weak markets in both air and sea freight continue to make this a buyer’s market. As much as these carriers wish to flex their pricing muscles, shippers and LSPs, spoiled for choice, can always choose the cheapest carrier. In such an overcapacity/underprice situation, the least cost providers dominate the price conversation. Steve Gunning, CEO of IAG Cargo, commenting on the 2014 first quarter losses incurred by his group, lamented that some carriers’ willingness to offer “loss-making rates” in the face of overcapacity contribute to irrational behavior in the market and perpetuate the bazaar conditions. So how can carriers escape this situation?

Truth is that the only way out of such a bazaar is for a carrier to gain control of their rate offer. A well-executed revenue management capability helps the carrier understand the demand for their services, the true flows in their network and their value proposition. Most importantly, revenue management supports a systematic understanding of which traffic to accept and which to reject (for example, through hurdle rates). But carriers can do this only if they are price makers in at least one core market where they can control price and raise it without going out of business. And if a carrier is not a price maker in even a single market, then they would be best advised to focus on operational efficiencies, drive the price discussion by being a low cost provider, gain market share, develop a differentiated service offering and only then turn to revenue management to control the market impact of their value proposition.

However, given the lack of capacity discipline in the market, and in the case of air freight the lack of control on capacity offer to the market due to the diktats of the passenger divisions, there will always be many routes where any given carrier, however big or small, will find itself being a price taker. Consequently carriers will be well placed to expand their revenue management investments to include price optimization. By being price takers in certain markets, these carriers automatically create price sensitivity in the market. Price optimization techniques help estimate these price sensitivities and determine the likely demand at different price points. This will help the carrier determine the best course of action with regards to pricing: should they match the market price or should they offer a lower, but loss-minimizing, price to meet their strategic goals?

The answer to the opening question therefore continues to be that revenue management does add significant value to carriers but in markets where they are price makers. To increase that value though, the time has come for these carriers to assert themselves to gain transparency to the shipper needs, understand their own value proposition, be honest about where they are price takers and determine the strategy they wish to follow and execute that strategy with discipline. It is a given that this industry lacks capacity discipline. Now it is time for the carriers to make up for that weakness by enforcing operational efficiency, superior service levels and pricing discipline. Then and only then do they stand a chance of beating the thin margins and low yields trends that drive this cargo bazaar.

What do you think?

This post was co-authored by Jamison Graff, senior director, product management, JDA Software.

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