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SHIFTING BALANCES - The effect of demographics and inefficiencies on Logistics

SHIFTING BALANCES - The effect of demographics and inefficiencies on Logistics

Overall global demographic developments have a big impact on economics and therefore on trade and transport flows. This will bring opportunities mainly for emerging economies and challenges for mature economies, especially for Europe, where the population is aging. 

DEMOGRAPHICS

Food sustainability

By 2050 there will be more than 9 billion people on this planet. Taken into account the current and future economic shift where emerging economies will mature and therefore global wealth will increase, this implies that the world needs to produce 70% more food than today. We are already facing difficulties to feed the world population today. Currently 1 in every 7 persons is hungry worldwide. Hence any improvement in food logistics would be more than welcome.

According to a study by the UN 1/3 of perishables is lost or wasted globally. This equals 1.3 billion tons per year. Problems in the cool supply chain are a major concern in this respect. Huge amounts of resources are used in vain to produce and transport these perishables, which subsequently have a tremendous cost impact. Besides a higher cost this loss also affects the environment. Agriculture accounts for roughly 14% of all global CO2 emissions. If 1/3 of the food loss can be eliminated then subsequently this would result in a large reduction in total global emissions. 

Balancing global food supply shortages and surpluses will be the challenge for logistics service providers and therefore local and global supply chains must be better integrated in a sustainable way. If losses in the food supply chain are being reduced, these cost savings will not necessarily result in more profits for certain players within the supply chain but it most likely will create a level playing field where cost will be reduced and therefore consumer prices will go down.

Relief logistics

A larger global population combined with economic growth is resulting in a wealthier world where there is more wealth at risk. Natural disasters will therefore have more impact on global supply chains than in the past. The tsunami and earthquake in Japan and the flooding in Thailand last year had a tremendous impact on supply chains all over the world. J.P Morgan estimates that the flooding in Thailand alone decreased global production by 2.5%. Munich Re, a reinsurer, estimates the total economic cost of last year’s disaster at USD378 billion, a record number in history and unfortunately an increasing trend over the last 30 year.

On one hand relief logistics offer opportunities for logistics service providers, since goods need to be moved to areas sometimes difficult to access at a short term. But on the other hand the production slowdown and other negative economic effects caused by natural disasters will eventually outweigh the occasional relief logistics benefits for the logistics service providers. 

Pharmaceutical developments

Of the 9 billion people in 2050, the share of older people will only increase. In 1970 the average family had 4 or 5 children, it is now 2.45 worldwide. In general people are living longer and therefore the dependency ratio (the number non-working people, like children and seniors per 100 working adults) in many societies will increase, putting a burden on global social healthcare systems. 

The pharmaceutical industry will play a very important role in these demographic challenges. Since people will live longer and the population will grow in absolute numbers, the pharmaceutical industry will probably outperform many other industries in terms of growth. For logistics service providers this industry will be very interesting since it is demographics and to a lesser extension economic trends that influence the volumes. Also the effect of seasonality is much less than in other sectors, like perishables where the seasonality varies much more than in general cargo.

The patents of many blockbuster drugs will expire soon and there seems to be less development in the pipeline. In the next two years, six of the 10 top-selling drugs will lose their patents, meaning other companies can make the medications and sell them at reduced prices. Of course this will benefit the consumers and give a bit of relief to the social healthcare challenge faced by many debt burden countries.

On the other hand the increase of generic drugs will also increase competition between pharmaceutical companies where cost differentiation will play a more important role. Logistics is a small fraction of the total cost for a pharmaceutical company, but is essential in the supply chain in order to get the products to the end consumer. Any disruption in this supply chain can have huge consequences for people’s health.

The shift to more generic drugs will most likely not change the high standards required for logistics, but might have an effect on modality. Where nowadays many of the patent drugs are transported via airfreight some of the competing generic drugs might chose a different modality, like sea transport, due to the fact that cost of inventory will be lower. The increased competition might also force the logistics service providers to cooperate more closely in order to bring the cost down and be more efficient, of course always keeping the same high standards of quality required.

Cool chain requirements

In general the reduction in food loss and the improvement of the supply chain of pharmaceuticals will lead to less hunger, more health, reduction of inflation and therefore also a contribution to global economic growth. In order to achieve this, logistic service providers need to cooperate more. This will require both vertical as horizontal collaboration. However, some supply chain and purchase managers of the shipping companies should treat logistics less as a cost center but more as a value center, where value in the combined chain should be achieved and where this value should be shared amongst all players. 

INEFFICIENCIES

Unfortunately we still need to overcome some inefficiencies in the industry that hinder further growth and overall prosperity, especially in Europe. 

Logistics workforce

Changes in economic cycles have a leveraged effect on logistics volumes. If trade and GDP grow, logistics volumes in air, sea, train, and road freight will grow higher but the opposite is also true. The last years of economic slowdown have had a huge negative effect on global logistics. It is therefore important to be able to be flexible to react to these market changes.

Regrettably European labor laws do not allow companies to react quickly to market changes. The U.S. has much more flexible labor laws, which explains why their economy is already doing better than Europe’s at this moment. Moreover at the end this is causing more unemployment because no firm wants to hire if they know it will be too costly to adjust their labor force in a downturn. This is a vicious circle in Europe and leaves it uncompetitive against the U.S and especially emerging economies that are much more adept to changes in the market.

European logistics companies need to able to adjust their operations according to the economic cycles just like their counterparts in emerging economies. 

Air transport

Bankruptcy laws are another way to accomplish flexibility to market changes. Unfortunately the European bankruptcy laws are not as flexible as for example in the U.S. where chapter 11 gives the debtor a fresh start, subject to the debtor’s fulfillment of its obligations under its plans of reorganization. 

Some of Europe’s legacy airlines need to readjust their operational cost at par with the increased competition from the Middle and Far East. A similar chapter 11 exercise would help some of these European airlines to bring down for example their crew & other overhead cost which has increased over many years and is therefore way higher than many of the younger airlines from the Middle & Far East. If they are not allowed to reduce these costs they will inevitably lose market share and consequently most likely more jobs would be lost.

Even though aviation is more liberated through more global access to traffic rights than in the past, complete open skies will also allow airlines worldwide to make use of all traffic rights and as a result create a level playing field where cost and prices will come down and thus will contribute to more economic growth. Since 1992 the inter-European liberalization caused a rise of 33% in European air travel, which again resulted in 1.4 million extra full-time jobs and a GDP growth of $85 billion.

However there are still some countries in the world that prefer to protect their flag carriers, rather than improving the overall welfare of the broader public interest. This places European carriers in a relative competitive disadvantage since Europe is more deregulated than certain other areas in the world. 

Ownership rules in the aviation industry in many countries limit necessary integration and therefore further growth. For example the U.S, China and Brazil are some of the large markets that restrict foreign ownership. Eliminating these ownership rules would result in a unified global and fully liberalized market for the aviation industry. It would also result in further necessary integration where inefficient national airlines will no longer distort the mechanisms of an open market economy in which consumers benefit from better service and lower prices.

Notwithstanding its impact on the European economy, the current air transportation system is not operating in an efficient way resulting in additional costs, delays, noise and CO2 emissions. The main reason for this is that the standards and systems are still based on approximately 50 years ago when the aviation industry was completely different than it is right now. 

Currently the aircraft in Europe are flying pre-defined routes that are managed by air traffic controllers of each member state. As a consequence of this inefficiency each flight is about 50 km longer than needed, which again results in unnecessary emissions of around 5 million tons of CO2 per year. 

Fortunately the Single European Sky (SES) initiative and its technological pillar, SESAR, will address these issues in the future, especially given the fact that demand for air travel in Europe will grow by over 70% in the next 20 years. The implementation of SESAR should lead to a reduction of 10% per flight, an equivalent of 9 minutes, as well as 50% decrease in cancellations and delays within Europe. These reduced flight times will subsequently result in an elimination of 50 million tons of CO2 during the period of 2013-2030. 

Road transport

Another challenge Europe faces, according to the roadmap commissioned by the European Commission in 2011 is the increased road congestion and hence worsening accessibility in Europe. 

According to this roadmap, congestion costs are projected to increase by about 50% by 2050, to almost € 200 billion per year. In the Netherlands alone congestion caused a cost of €400 million for transport companies and around €1 billion to businesses in general in 2010.

Also the U.S is facing a similar problem. A study by the Texas Transportation Institute claims that the cost of congestion to hauliers in the US – measured as wasted fuel and delay – amounted to $23 billion in 2010. On top of that, according to the World Economic Forum, 24% of all trucks drove empty within the EU due to positioning and imbalances in 2009. Moreover the average load factor of the non empty kilometers was just 57%.

This waste of economic resources and CO2 emissions can only be reduced through more cooperation, extension of cabotage regulation and of course general economic growth. The EU already has given more access to the domestic market for transport companies from member states. Currently hauliers from member states are allowed to carry out up to three domestic transport operations in another country of the EU as long as it is combined with another international route within a 7 day period. 

Ideally cabotage should be allowed without any restriction, resulting in less empty kilometers, higher load factors and therefore less carbon emission and lower operating cost. 

Capital asset management

Unfortunately the order cycle of aircraft and large ships is still far from perfect. Traditionally aircraft and ships are ordered after some time of economic growth where first of all management and then after some time shareholder boards are convinced that the markets are growing. They subsequently order large quantities of aircraft & ships based on the present facts which will then be delivered some years after, in many occasions when there is an economic downturn. Ideally these planes and ships should be ordered in a recession when prices are low and they will be delivered when there is sufficient growth to make economic use of these expensive assets. However this countercyclical investment behavior will require different cash flow management where savings in good times only will be used to acquire assets in an economic slowdown. 

Many asset-heavy logistics companies in Europe are still artificially being kept alive. Many banks are not taking their losses. The banks are hindering the Darwinian effect in the market by keeping loss making asset heavy transport companies alive instead of taking the hit and sell devalued assets at even bigger losses. The big question is whether these banks have made sufficient provisions to eventually cater for these losses; otherwise this could be another bubble. 

Nevertheless S&P predicts that the percentage of European companies going bankrupt will increase from 4.8% in 2011 to 6.1% in 2012, so hopefully some necessary Darwinian adjustment will be made in this market. 

Economic Shift 

Studies have shown that when average income reaches a threshold of over USD 16,000 per capita in emerging economies double digit economic growth is no longer achievable. China is currently close to this threshold and hence consumption will most likely rise, but production will become increasingly expensive. This will also affect the current (im) balance in trade where imports to China from the US and Europe will outgrow exports from China in the future. 

The traditional trade lines, like Asia-Europe and Asia-US are shifting towards more transport volumes between Asia and Africa & Latin America. Hubs in Asia, like Singapore and in the Middle East, like Dubai, Abu Dhabi, and Doha will benefit from these trade developments. Near sourcing will also fuel growth in Eastern Europe. More aircraft and ships are going directly to airports and ports in Eastern Europe instead of via hubs in Western Europe. Hence Western Europe might lose its position of global logistics hub. 

Shift happens; Emerging economies in general will mature undoubtedly. The economic balance of power will shift and if Europe does not become more competitive on a global level it risks losing global market share. 

Backed by sovereign wealth funds and by more favorable economic conditions in their home markets, companies in emerging economies will eventually be acquiring more companies in Europe. If European logistics service providers will not be allowed to be more competitive on a global scale, in the future the European logistics market could be dominated by Asian and Middle Eastern companies some of them supported by sovereign wealth funds. From an open market perspective this is perfectly fine, but an economic balance of power is also desirable. 

Sebastiaan Scholte

CEO of Jan de Rijk Logistics (www.janderijk.com

Secretary General of the Cool Chain Association (www.coolchain.org)