The Effects of Asset Management Strategies- Who Really Owns Accountability for Overall Risk Management?
Industry supply chains have constantly had to respond to business needs for overall cost reduction. This author can recall numerous supply chain executive surveys dating back to the early part of this decade, all pointing to supply chain cost reduction as one of any top three organizational challenges. While the severity of such pressures tended to vary, the extreme being the global of recession that began in 2008-2009, they have since established numerous structural supply chain changes. These changes included transferring more cost risk into lower tiers of the supply or value-chain as well as the shedding of assets. The consul of CFO’s was to avoid, as much as possible, the ownership of hard assets. A clear byproduct of the implications of shedding assets or outsourcing asset management was who owns overall accountability for risk management.
This relentless pressure to improve return-on-assets has, as this community well knows, led to far different industry supply chain structures. Shedding of capital-intensive manufacturing related assets led to the resurgence of the contract manufacturing model. Today’s dominant contract manufacturers hold production plants in multitudes of countries and regions. In semiconductor related manufacturing, the termed fabless model emerged where many semiconductor suppliers shed their super highly expensive capital intensive chip manufacturing plants into today’s smaller concentration of global fabricators such as TSMC. Fabless semiconductor firms’ in-turn, outsourced chip assembly and test to other lower-cost Asian locations.
Similar asset transfer trends occurred in logistics and transportation. Manufacturers and retailers shed transportation assets to third-party logistics providers (3PL’s), and have since added technology and services augmentation which are the basis of termed fourth-party logistics providers (4PL). Each of these providers themselves discovered enhanced opportunities for profitability growth by transferring transportation assets to mega-carriers or IT infrastructure to leasing or IT hosting firms.
Like any game, the unwritten gaming rules seem to be, hold no assets.
In this specific commentary, we want to focus on a current development capturing the attention of general and business media that being the U.S. railroad industry. By its nature, this industry is completely capital-intensive and ROA driven and must further adhere to continual regulatory standards and practices.
In April of 2011, a Supply Chain Matters commentary focused on how U.S. railroads were attempting to bounce back from years of industry setbacks as well as severe recession across the economy. A previous decade or so of asset transfer and outsourced maintenance strategies had the bulk of railcars, especially those related to the transport of bulk cargo, under the ownership of leasing, financial services or bulk shippers themselves. In essence, the railroads served as service providers to ship customers’ bulk cargo, utilizing primarily non-owned bulk transport railcars. In 2009, railroad shipments had declined by a whopping 64 percent, the worst year since 1988. An estimated 28 percent of rail fleets were parked and idle storage on unused track, some stretching as much as 30 miles in places. The crisis of asset management was acute and leasing companies and railroads jointly bore the brunt of that crisis. Another reality was that a large percentage of the bulk transport railcar fleet remained dated and proper maintenance did not appear to be financially viable in times of severe downturn.
That brings us to today and in particular the current manufacturing and energy boom occurring across the United States. The U.S. economy is rebounding and utilization of bulk transport railcars has now increased significantly to the point of periodic lack of availability. The massive new discoveries of shale oil deposits and the new technologies of fracking have led to today’s oil exploration boom, but with a certain bulk transportation challenge. The existing north to south oil pipeline networks existing across the United States did not account for current booming sources of crude oil production such as the Bakken region in North Dakota. That region alone is producing what is estimated to be 1 million barrels of crude production per day. In December alone, rail transport accounted for nearly three-fourths of crude production stemming from the Bakken region. With the lack of pipeline infrastructure, and with new options for higher profitability depending upon which refinery or which port ultimately receives such crude, energy companies have now re-discovered rail as the preferred shipment mode.
The rest of this story has occupied general and business media headlines, namely a tragic series of tanker car explosions and fires endangering property and human life. There have been revelations that Bakkan crude is far more volatile and unstable than allegedly believed. The railroads have been finger-pointing toward tank car owners for holding liability for such accidents. Two major railroads have filed lawsuits against asset maintenance contractors over who is liable for derailments caused by broken axles. Of further contention is which entity is responsible for proper safety inspections and which is responsible for necessary safety modifications to strengthen railcar axles and to contain a potential tank car explosion from spreading to other cars. Maintenance contractors claim the railroads are far exceeding weight limits and overlooking the hazardous nature of today’s crude oil shipments. Both are balking at who will pay the overall expense, with the implication being which party is accountable for risk?
This entire situation has resulted in an oil safety deal reached in mid-January when federal regulators were forced to step-in and demand railroads and energy companies agree to forms of voluntary changes to improve the safety of tanker rail cars. Railroads must now take more proactive steps to avoid derailments, reduce speeds and reroute tanker laden trains around high risk areas such as major cities. Both parties agreed to come up with recommendations for improved safety of tank car fleets.
One railroad is going a step further. The BNSF railroad is seeking bids for investing in 5000 next-generation tank cars that will meet higher safety and cargo load standards. However, for the current remainder of the rail industry, and perhaps many industry supply chains, is an open question of which party holds ultimate risk when the bulk of assets and asset management services are outsourced. We believe it is a timely and rather important question, one that will occupy the mindshare of CFO’s, insurance providers and industry supply chain leaders in the months to come.
What’s your view? Does outsourcing of assets and asset management include the outsourcing of risk accountability? Is the current trend sustainable?
The CEO of A. P. Moller-Maersk, operator of the globe’s largest ocean container shipping line as well as various oil exploration and transport services interests, has declared to the company’s investors that the firm will likely experience flat profitability growth through 2016.
Maersk has elected a business strategy to reduce its dependency on the current turbulent ocean container shipping segment by currently investing in oil production, ports and bulk shipping activities. According to a Reuters published report, CEO Nils Smedegaard Anderson once again declared, as was the case in October 2013, that over-capacity remains prevalent across ocean container shipping and that it will be not until at least 2016 until the industry compensates.
Maersk is currently investing in its oil related businesses but profits in the line’s oil and drilling segment are expected to fall in 2014, adding additional challenges to its overall business strategy. However, Anderson declared that Maersk Line, its ocean container unit, still aims to be more profitable than other industry competitors, targeting its profit margins at a rate that is five percent higher than other ocean container shipping operators. In essence, Maersk is declaring that it will make money even if the rest of the industry has zero or negative profits. According to Reuters, during 2013, average freight rates for the Maersk Line segment decreased by 7.2 percent while volumes increased by 4.1 percent. Overall fuel consumption was reduced by 12.1 percent which contributed to lower operating costs and profitability.
The proposed P3 Network that pools the capacity and shipping assets of the top three ocean container operators is still awaiting regulatory clearance from various maritime review agencies. One of the prime motivators for formation of this alliance was to assist the top three lines container lines in terms of volume with alleviating over-capacity and allow for reduced operating costs by saving on fuel and other operating costs. While that may have been the declared collective goal, the Maersk Line’s stated profitability goal stated for its investors seems to fly in the face of the goals of this network alliance.
One of our Supply Chain Matters predictions for the current year called for increased momentum in re-structuring of global surface transportation networks. That prediction is holding true when the ocean container industry leader declare it will exceed the profitability of all its competitors, in spite of industry over-capacity and attempts to consolidate fleet scheduling and shipping operations.
Something has got to give, as shippers continue to be caught in the middle of conflicting business goals.
What’s your view?
There is positive news to report regarding the previous stalemate that could have led to a significant delay in the planned expansion of the Panama Canal.
Reports indicate that the Panama Canal Authority and the consortium of European construction companies who are responsible for the widening have agreed to end their ongoing dispute. A deal was reached Thursday night and calls for independent arbitrators to help determine which party should pay for the incremental construction costs needed to complete the project. According to a published Bloomberg report, the “conceptual” deal, still needs to be signed, with the Canal Authority and construction firms each providing $100 million to enable work to resume at its normal pace. The canal won’t pay the companies’ claims for cost overruns, while it may extend a moratorium for the repayment of advances until 2018, when added canal revenues begin to flow.
As part of the reached agreement, the locks must be completed by December 2015, a year later than the initial completion date, which was originally set to coincide with the waterway’s centennial. However, other news reports quote the head of the canal authority as indicating that the canal widening will not be finished until early 2016, while the construction consortium indicates that completion hinges on the final outcome of arbitrations.
In any case, global shippers and U.S. east coast ports can breathe a little easier this weekend, knowing that they were not facing a potential two or more year delay in the canal widening.
There are a lot of critical global logistics strategies that were riding on the timely widening of the canal, allowing both mega container and bulk cargo carriers to more expeditiously traverse voyages from the Asian ports to the U.S. east coast and Gulf ports. It further provides U.S. east coast port operators a better, albeit a bit more delayed, sense of timing for completing individual port infrastructure upgrade projects to be able to service more mega-ships.
Yesterday, President Obama continued in his intentions to make 2014 a year of action, in spite of political stalemate in the United States, by announcing two new public-private manufacturing innovation institutes.
According to the White House Blog, one will be located in Chicago and the other in Detroit. The goal is to have each of these institutes to serve as a regional hub for bringing together efforts from universities, government and private industry for applied research and product development. The White House terms these institutes as a “teaching factory” where manufacturers, large and small, students and workers of all levels can access advanced manufacturing processes and equipment.
The Lightweight and Modern Metals Manufacturing Innovation Institute headquartered near Detroit will pair 34 aluminum, titanium and high strength steel manufacturers with universities and laboratories pioneering technology development and research. The Digital Manufacturing and Design Institute headquartered in Chicago will spearhead a consortium of 73 companies, along with universities and other research labs in areas of enhanced digital product lifecycle management capabilities including additive manufacturing and 3D printing techniques.
The President’s goal is to eventually create 15 Manufacturing Innovation Institutes across the United States.
The President further announced a new competition for an Advanced Composites Manufacturing Innovation Institute, to be led by the Department of Energy, which will award $70 million over five years to improve U.S. manufacturing abilities in advanced fiber-reinforced polymer composites for use in clean energy products.
In the lens of Supply Chain Matters, each of these new institutes are examples for the potential of positive partnerships among private industry, government and universities. They can serve as added impetus for the ongoing renaissance of U.S. manufacturing. While President Obama addressed these ongoing initiatives in the context of manufacturing jobs, our community knows darn well that manufacturing is supported by vibrant value-chains and ecosystems of suppliers and services providers. It is all about re-building a competitive and vibrant collection of industry supply chains that can compete on a global scale.
While on the topic of supply chain, U.S. Transportation Secretary Anthony Foxx, in a recent speech before the U.S. Chamber of Commerce, again urged Congress to refrain from past practices for funding short-term transportation and infrastructure projects and move toward a longer-term window of strategic investment in U.S. transportation infrastructure needs. The Secretary reminded the audience that The American Society of Civil Engineers estimates that the overall infrastructure renewal needs for the United States are $3.6 trillion by 2020. That addresses needs other than bridges, roads and transit. The Secretary urged Congress to think out of the box on methods to fund infrastructure needs, other than the traditional fuels tax. It seems obvious that current trends of greater fuel economy among trucks and automobiles leads to less fuel consumption, hence there needs to alternative forms of funding for these needs. Perhaps this is another area for potential private industry and government partnerships. With the current resurgence in U.S. manufacturing and energy products export activities, logistics and infrastructure needs cannot be ignored.
We say amen to all of these efforts, they are all long overdue.
What’s your viewpoint?
In June of 2013, the three largest ocean container shipping lines announced their intent to establish the P3 Network that pools vessels operated by Maersk Line, Mediterranean Shipping Line (MSC) and CMA CGM. This alliance would oversee a pooled capacity of vessel routings among the most traveled global trade routings. That includes up to 40 percent of total sea cargo capacity along with an an estimated 43 percent of ocean container shipping from Asia to Europe, 24 percent from Asia to the United States, and 41 percent of trans-Atlantic routings. Such an alliance requires the approval by the combination of Europe, China and U.S. regulatory groups. In our last Supply Chain Matters update, we noted that such approvals were expected to be completed later this year.
The Wall Street Journal reported today (paid subscription or free metered view) that the U.S. Federal Maritime Commission (FMC) is likely to approve the alliance but will attach conditions to ensure fair treatment for smaller competitors, freight forwarders and fuel providers. China and European regulatory approval is not likely until the U.S. weighs-in on its ruling.
The WSJ quotes familiar sources as indicating that the FMC views P3 as a partnership rather than a merger of shipping lines, and if safeguards for fair competition are agreed to, the alliance will likely be approved. The report further confirms that the customers of ship operators are campaigning to block the alliance because they believe they would lose negotiating influence with container shipping lines. Supply Chain Matters has previously voiced similar concerns for manufacturing and retail shippers.
The open question is now what final conditions will be attached by the U.S. agency.
If our transportation, logistics and procurement supplier sourcing readers were not aware, the Spanish-led consortium of construction contractors led by Spain’s Sacyr S.A., and Italy’s Impregilo SpA, along with the Panama Canal Authority have been at a stalemate regarding a reported $1.6 billion of cost overruns involving the planned expansion of the Panama canal.
Talks to resolve this growing dispute broke-off in January and threaten to significantly delay the overall expansion.
The original 2009 contract called for $3.9 billion in construction costs but the contractors are now charging that geological studies performed by the government were faulty, forcing the current cost overruns. The canal authority has been taking a reported firm stance in ongoing negotiations, insisting that contractors finish the project on-time, and within the original cost agreement.
The concern is that a threat of a significant delay to the canal’s expansion plan would cause a significant delay for international commerce, including plans for newer mega container and bulk commodity ships to be able to traverse the 50 mile canal. Container vessels with capacity in excess of 12,600 TEU’s were expected to be able to take advantage of a widened Panama Canal, including faster direct transit times from both Asia based ports Eastern United States ports.
The original milestone called for the expansion to be completed by 2015, and reports indicate that the expansion effort is upwards of 70 percent completed to-date. Complicating matters is that the panama Canal Authority is a semi-autonomous agency not directly affiliated with the government of Panama. It derives revenues from fees charged to vessels that utilize the canal, but its cash balance is not large enough to fund such a level of cost overrun.
Besides placing many construction jobs at-risk, the current stalemate raises some additional political tensions among Spain, Italy and Panama. During the recent severe financial crisis impacting Europe, construction firms looked to international projects such as the Panama Canal to keep their firms operating and profitable. The government of Panama also stands to benefit from increased revenues when the canal is expanded. A Bloomberg article published in early February reports the President of Panama indicating that the expansion would be finished, even if the current talks fail.
This is obviously and interesting development and bears continued monitoring in the coming weeks.