Investing in container port infrastructures: choosing the right competitive strategies

SEVEN giants are dominating container shipping industry and represent 70% of the total market.

Seven giants are dominating container shipping industry and represent 70% of the total market. And the process is not over. Nine of the former 20 largest shipping companies from five years ago will disappear by the end of 2018, according to Hapag Llloyd CEO. Rates have not followed the consolidation process stopping the long lasting downward trend, and starting June 2017, have started to retrench and only recently we have assisted to an upward trend. Still deliveries of new vessels in 2018 are creating a new risk and rates might be far from being stabilized. Not many would have expected this latest turn of events. But in actual fact it is simply the predictable outcome of a no-holds-barred price war which started in 2011, when fuel costs were sky-high and the largest companies decided to start building 18-21,000 TEU mega ships to bring shipment prices down, allowing them to win slices of the market at the expense of smaller rivals.

The events leading up to naval transport on a gargantuan scale are only grinding to a standstill today, in a way that reflects the new normal: 2017 was by all means a positive year showing a 3,4% growth, but in 2016, demand was merely up by 1%, and in 2015 it dropped by 4% (Drewry). Supply side was more optimistic on market development. Deliveries of new ships enabled to surpass 21 mio TEU in terms of overall capacity at year end 2017, and Alphaliner reports that additional 1,5 mio TEUs are due to delivery in 2018 with half of the new capacity in the region of 14.000-21.000 TEUs vessels. Demand growth has smoothened the effects of the idle capacity, still around 0,5 mio TEU. (IOC). The defining dynamics of the container shipping industry have a bearing on business in ports, which are being faced with the new infrastructure requirements from shipping lines which involve major investments. The first consequence of the combined increase in ship capacity and slowdown in frequency on the routes.

In 2017 the average vessels size increased by 4,3%, while weekly frequencies offered on the Asia-Europe routes fell by 10%% with those removed all being operated by the alliances. The second consequence is linked to the investments ports have to make to bring infrastructures into line with the new size ships. In the Mediterranean and Northern Range, considerable investments are planned to bring the size of docks, gantry cranes and other equipment in transhipment and gateway ports into line with the size of the new ships. Examples include TangerMed, connected to 174 Ports and handling 3,3 Mio TEU (+12% in 2017 vs 2016); Piraeus, where Cosco will be investing around USD 500 mio; Valencia and the various investments in Italian container terminals in the upper Tyrrhenian and upper Adriatic. In addition Chinese State-Owned enterprises represent 10% of total capacity: as an example Zeebrugge Port has joined forces with China Development Bank and launched a rail service to China, while Vado Ligure Port in Italy was acquired 40% by COSCO from APM.

The third consequence to be taken into account is the effect of falling shipping prices on port tariffs. In spite of increased pressure on shipping company margins, port companies have always displayed greater resilience when it comes to profitability. Ports are not immune to the volatility of profits and margins: nonetheless, even in annus horribilis of 2009, when the volume of port traffic dropped globally by 9%, the main port companies at least managed to maintain profitability in percentage terms. Their profitability, even at its low in 2015, was not below 4% (source: S&P Global Ratings) These aspects, particularly the drop in the number of calls, lead us to the issue of port competition. The gateway ports are slightly more immune: they have stronger links with the hinterland area they serve, generally spanning 300km, and they have always had more stable links with shipping businesses. It is keenly felt, however, in transhipment ports which are structurally exposed to price competition. At times they see a rollercoaster effect on the volumes served, as is the case of Marsaxlokk grown to 3.1 Mio TEU at the expense of Gioia Tauro, losing ground over the years and showing a reduction by 11% in the first 9 months of 2017 vs 2016 . Others, such as Piraeus (+6,4% in 2017) Tangier, and Valencia levered their favourable geographic position in serving ships bound for Northern Range ports by minimizing detour. Some solutions for achieving competitiveness appear only partly effective, or impossible to apply. Cooperation between the same ports in a given area, particularly within the gateway port sector, is possible but unlikely to be enough to solve the problem on its own. The rise in pricing to cover increased costs is hampered by the cash flow situation faced by many maritime companies. There is no one simple solution.

Doubtless it will be necessary to face the fact that margins will be lower than in the past. Against this changed backdrop, competitive strategies need to be carefully planned to ensure indiscriminate development does not turn into disastrous results for shareholders. The investment decisions made by port terminal managers have to take into account a complex set of exogenous factors, such as the macro-economic variables for the port concerned. This is the first element for assessing the competitive capacity of a port or entire port system. The main elements chiefly include growth of exports and imports in surrounding industrial areas, and generally speaking the GDP of the countries served. Some catalysts can be linked to the decisions adopted by States and local Authorities as well as supranational organisations regarding the decision-making set up, and the range of parties entitled to take decisions concerning port development and coherence in the laws and regulations issued [for example, there are 24 port authorities in Italy]. In addition, infrastructural investments in connections and accessibility will also need to be assessed, in particular those for railways which permit rapid feeding and defeeding of ports (in Europe Alptransit, Brennero etc.), or those of a regulatory kind such as customs free-zones or simplifying customs clearance procedures on land, or those concerning customs procedure regulations. A third competition factor concerns access to shareholder or public funding, such as EU funds, for initiatives to develop port infrastructures in the same area: the presence of first movers can influence the competitive strategies of other players, relegating them to serving specific segments of traffic to avoid creating over-capacity situations if new investments are made.

The background elements mentioned above will provide a guide to the choice of competitive positioning and defining the investment plan and pricing policies applied. The investments can be made both for adaptation purposes and to increase port productivity in operations on the ground. It is necessary to create a delicate balance between the duration of the concession, infrastructure parameters which already exist or can be achieved (e.g. depth, dredging needs), investments made, port tariffs, additional services (e.g. cold chain), respect for demand dynamics, market pricing, the decisions made by direct and indirect competitors who can benefit from a different level of system investments and more favourable regulations. Finding a solution to this difficult system of equations is only possible if the sustainability of different competitive strategies is assessed in relation to each.

On a strategic level, for each port there are in fact three potential options: A) the decision not to invest in infrastructural adaptations, B) co-investing with a shipping business, C) investing on the free market of container ports. In the first case, the handler opts not to adapt its own port for use by large container ships. This decision might prove to be correct, but it is not without risks. Anyone taking this decision might be forced by technical difficulties, such as those linked to problems in guaranteeing sea beds at least 14-15 metres deep, not to mention costs that would make the measure anti-economic. But the choice might prove correct if the risk that the main clients opt to shift a significant part of traffic not served by feeder ships is deemed limited. The risk of reducing volumes can be counteracted if the geographical area behind the port can count on the strength of the traffic basin, or if freight forwarders in the area limit the impacts caused by the growth of competing facilities, or if there are margins to reduce pricing. In the second case, co-investment in the port by shipping businesses such as COSCO at Piraeus would create the opportunity of reducing the investment risk and limiting variability in volumes. With this model, the dynamics might still differ. Maersk, through its subsidiary APM, is investing in a port system which will operate with a competitive approach on the market, exploiting its greater profitability, whilst the MSC port model is generally viewed by many observers as being more integrated with the shipping line business. In both cases, the volumes are critical; not just those generated by the investor but also of the alliance of which it is part, which must generate sufficient volumes to guarantee a return on the investment.

The third case, market investment by a port terminal operator, is without a doubt the most important from the entrepreneurial standpoint. But at the same time it is the option with the greatest risk. It is certainly the recommended solution if it is felt that the new facility will be able to attract a sufficient number of mega ships, whilst managing to keep the following factors under control:

•Tackling the announced reduction in port calls and accordingly greater competition for acquiring volumes: following the last reshuffling of alliances occurred in Spring 2017, now 2M alliance, The Alliance and Ocean Alliance, the numbers of weekly calls from Europe to leading Asian Ports of Singapore, Port Kelang and Hong Kong were lowered from 55 to 49 . From this standpoint, greater risk in the business has been generated: less calls will presumably favour ports with strong basins, adequate dock infrastructures at competitive prices, and efficient connections on land with greater volumes and accordingly a concentration of risk

•Being able to count on a pricing system which does not suffer from the competition of nearby infrastructures of the same standard, and is not affected by the delicate situation affecting the carriers

•Presence of legislation clarifying which investments can be made in a given context, as well as procedures, e.g. efficient customs

•Access to public funding, such as EU funds, which in some cases cover a third of construction costs and can make the project financially sustainable. Conclusion: proper investment choices by port operators, at a time when conditions are far more complex than in the past, calls for a complex analysis of the macroeconomic, local, sector, competitive, technical and financial phenomena needing to be tackled with proper professional means.

* Francesco Calvi Parisetti (Roland Berger)

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