transport logistic

8/6/2019 Transport Logistic

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Spring 2009

3 The Complex Future of the North American RailNetwork

10 From the Mine to the Sea:Optimizing Multi-PartyLogistics

16 The Liner ShippingDownturn: Business asUsual or Something New?

23 Dont Chance It: GettingMore Out of Risk Modeling

27 Factoring Risk intoTransportation andLogistics Sourcing

32 Cracking the YieldManagement Code

n To Our Readers

Oliver Wyman (formerly Mercer Management Consulting) is pleased tounveil our redesigned Transport & Logistics journal. In this issue, we havefocused on topics that are particularly relevant to the current adverse eco-nomic climate, with a view to offering some perspective for both providersand users of transportation and logistics services.

Our first article looks at the future of North American freight rail, with afocus on structural changes that will test railroads ability to evolve theirbusiness designs. As the importance of intermodal increases and there ismore demand for network capacity, how will railroads maintain and growtheir franchise value?

The next article considers the situation of multi-party logistics chainswhere investment needs are imminent. An extended case study demon-strates that it is possible to optimize capital deployment across the entirelogistics chain through an iterative, collaborative process.

Our third perspective looks at the impacts of the economic downturn onliner shipping, and by extension, ports. We believe there are opportunitieseven now to develop a baseline for future growth, including greater part-nering and adjusting the product/service mix.

We next offer up a pair of articles related to risk management. The firstexamines the broad dos and donts of using modeling to assess risk; thesecond focuses on how shippers can reduce risk in their supply chains.

Finally, we end with a discussion of yield management. Although widelyapplied in the travel industry, it is still often challenging for freight.Making certain changes to the process, however, can turn yield manage-ment into a valuable tool to better manage variable costs and enhancerevenue.

Transport & Logistics


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Transport & Logistics / Spring 2009


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The Complex Future of the NorthAmerican Rail Network

3Transport & Logistics / Spring 2009

Rod CaseRod Case is a Toronto-based partner of Oliver Wyman. He can be reached [email protected].

It can be difficult to remember, in the midst of todays tough economicnews, that we are in the second golden age of North Americanrailroading. In the past several years, all of the Class Is have seenincreased profitability and service levels, even in the face of some traf-fic reductions (Exhibit 1-1).

It can be argued that renewal has been driven by stronger railroadbusiness designs and enhanced by the increasing attractiveness of railtransportation. The future of the railroadsand the role they can playenvironmentally and economicallycontinues to be of intense inter-est not only to shippers but to government, private equity investors,

and the public at large.Exhibit 1-1 Class I Operating Income and Carloads Originated,1998-2007

While railroad performance to date has been strong, structural chang-es now arising out of both the market and political worlds will likelytest railroads capacity to evolve their business models while retainingor enhancing the value of their franchises. Two key structural changesdiscussed hereinthe evolution of intermodal and the uses of networkcapacityare being driven by fundamentally different concerns, butboth offer the possibility of profound shifts in terms of how railroadswill operate, maintain, and expand their networks:

The intermodal business, the engine of growth for railroads over thenpast few years, is poised to evolve into a market of smaller lanes

0

10

20

30

40

50

60

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Operating income ($ billions)

Carloads originated (millions)

Source: Railroad Facts, 2008 Edition, Association of American Railroads.


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the typical daily volumes from a one million TEU port generate manysmall blocks that will need to be combined into a network of trains toremain commercially viable.

Exhibit 1-2 Typical Daily Volumes or a One Million TEU East Coast Port

Domestic intermodal traffic is actually holding its position in a fallingtransportation marketa clear signal that such service is now struc-turally integrated in the transportation marketplace. Domestic inter-modal business however is likely to evolve in a fashion very similar tocontainer imports: comprising blocks of traffic (not full trains) movingover short distances, increasing operational complexity. The upsidehowever is the opportunity for railroads to generate revenue fromwhat is still a fairly new and growing market segment.

The future North American intermodal market may look much morelike existing European intermodal markets. (Exhibit 1-3 shows the cur-rent US versus European market.) While European railroads supportsignificantly shorter distances, they manage to create large revenuebases through high volumes and higher rates per container. While it istrue that European trucking costs are also higher, many operators havecapitalized on the congestion of European highways to entice volumes

from road at attractive rates even for short distances.Changing intermodal markets could lead to significant networkrestructuring in North America to capture new shorthaul revenuesources. It is important to highlight that this is not completely newterritory, and that mature markets like Europe have developed largerevenue bases in these highly competitive markets.

K e y

l a n e s

f o r

t h e p o r t

Average feet of train per day

0 1,000 2,000 3,000 4,000 5,000 6,000

A

B

C

D

F

G

H

I

J

K

L

Dominant railway

Other railway

Typical train capacity

Source: Oliver Wyman analysis.


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6 Transport & Logistics / Spring 2009

Exhibit 1-3 US versus European Rail Market: Revenue, Volume, andAverage Distance

Network Capacity: Improving Usage, Increased DemandsOver the past three decades, Class I railroads worked diligently toreduce their overall network, primarily by spinning off lower-densitylines to shorthaul partners. The rally in freight traffic over the pastdecade however has exposed bottlenecks in the system and createda need for capacity expansion. Such expansion is now being compli-cated by emerging public needs. While the freight railroads possess asimilar mindset for negotiations around shared networks, the publichas a very different set of objectives, and that gap has grown into acore strategic question that many railroad executive teams are stilldefining.

The recent experience of the CN acquisition of the EJ&E (in which CNwas required to fund noise mitigation, safety fencing, and emergencyresponse for two towns in Illinois), and the coming tsunami of pas-senger rail investment clearly demonstrate that network capacity isbecoming an increasingly local issue. These very public interventionson the use of network capacity require sophisticated solutions thatexceed the flexibility of most existing network sharing models. Inresponse, the Class Is will need to ask themselves three key questions:

Is owning all of the network still relevant to the business model?n

What further joint access capacity arrangements can be achievednbetween railroads on commercial terms?

Major European railroads A n n u a

l r e v e n u e

( $ m

i l l i o n s )

Average length of haul (miles)

0

200

400

600

800

1,000

1,200

1,400

1,600

0 500 1,000 1,500 2,000

North American Class ls

Bubble size indicates total volume(loaded shipments)

Source: 2007 annual r eports, Oliver Wyman analysis. Includes CSX, CP, DB, Cargonet, and UK carriers asrepresentative railroads.


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How much more capacity can be generated from the existing net-nwork; in particular, to support expanded passenger rail services?

Determining Network Ownership and Control RequirementsThere was a time when railroads thought that they had to own orcontrol all of the network over which they operated. But mergers andthe proliferation of short lines have dramatically grown the level of

joint access, and network sharing is now geographically widespread,involving most North American railroads. Many key mainlines areshared and even some of the most competitive corridors have morethan one railroad on the track. These arrangements have been arrivedat through commercial negotiations and terms, which have beenused to expand the shared network well beyond any forced accessrequired by the STB due to mergers.

The success of joint access raises the question of whether it is neces-sary for a railroad to retain exclusive control of the network on whichit operates. While many rail executives insist that such control is stillnecessary, the general trend illustrates that is no longer an absolute.Longer-term, railroads are likely to see even more sophisticated net-work sharing models capable of ensuring efficient operations.

Increasing Joint Access on Commercial TermsAlthough the expansion of joint operations was, for a time, driven bynetwork reductions, recent developments of joint operations are beingdriven more by efficiency gains or overall growth opportunities. Therapid expansion of agreements in both scale and number suggeststhat openness to joint access is increasing significantly.

Norfolk Southern (NS) for example has recently sponsored two inno-vative, commercially-based joint operations models that will squeezemore capacity out of existing networks:

Cooperative agreements that include investments in main line net-nworks not owned by NS, including with CN (MidAmerica CorridorInitiative), Pan Am Railroads (Patriot Corridor), and Kansas CitySouthern (Meridian Speedway)

In an attempt to foster the growth of short haul traffic, NS has pro-nvided access for its short line partners in upstate New York to inter-change traffic directly with one another over NSs lines.

These examples indicate that commercial terms can be successfullybroadened to improve the use of existing regional networks. Further,the MidAmerica Corridor Initiative (in which CN and NS will sharetrack between Chicago, St. Louis, Kentucky, and Mississippi to estab-


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lish shorter and faster routes for traffic moving between the Midwestand Southeast) is providing the industry with a model for usingregional networks creatively to unclog urban areas. This model maybecome increasingly important as expanding local train operationsfurther congest large urban areas. It will be critical for Class I's to inte-grate commercially driven, regional-network based solutions into anyfuture negotiations about capacity expansion.

Expanding Capacity on the Existing NetworkIt should not be surprising that US railroads have some of the lowestrail rates in the world and accordingly operate some of the largestfreight trains to compensate. What may not be as well known is thatthe North American network carries far fewer trains overall comparedto countries with similar network structures.

As shown in Exhibit 1-4, the difference in train volumes per year isdramatic, reflecting the varying roles of these networks: whereas theNorth American network runs primarily freight trains with limitedpassenger/commuter rail services, countries such as Germany and

Japan run extensive, high-frequency passenger services in addition tofreight traffic. What the exhibit does not show of course is that manyof these other networks are highly subsidized and their freight opera-tions are largely uneconomic.

Exhibit 1-4 Complexity and Intensity o Major Rail Systems

This is an important point to keep in mind, as a new focus of publicscrutiny in the US and Canada is determining what capacity is avail-able from a given network or corridor to support both freight and pas-senger train service. Certain North American corridors do run high-

0%

20%

40%

60%

0 5 10 15 20 25 30 35 40 45

C o m p

l e x

i t y

( s h a r e o

f d o u

b l e t r a c k

( o r m o r e

) / l i n e - k m

)

Intensity (000 train-km/line-km)

RussiaGermany

Kazakhstan

Hungary

US / CANChina

France

Czech Republic

Ukraine

Japan

Australia

Spain

India

Italy

Source: UIC: International Railway Statistics 2006, Oliver Wyman analysis.


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intensity mixed passenger and freight services (more than 10,000trains per year), such as Toronto-Montreal (CN and VIA) and theCalifornia Capital Corridor between Oakland and Sacramento (Amtrakand UP). But these operations are only successful if the freight owneris sufficiently compensated for physical improvements and mainte-nance, and a high level of service for freight customers is maintained.

As governments and communities seek to expand passenger rail ser-vice, it will be important for Class Is to develop an objective processto explain the tradeoffs between increased train counts caused bynew passenger operations and the resulting impacts on network andassets that will not show up in a simple train count/capacity analysis.If the Class Is hesitate too long, the weight of global case studies,together with recent pro-passenger rail regulatory changes, maycreate irreversible impacts on their financial and operational perfor-mance.

Steaming Ahead of the CurveThe changing marketplace for intermodal and the profound changescoming in terms of rail network capacity demands require that rail-roads evolve their business models in preparation for a world of morecomplex train operations with more partners. In the short term, therecession is making it more challenging for the industry to maintainprofitability, but it does offer a silver lining in the form of a brief respite for railroads to work through needed strategic decisions andset their long-term business objectivesbefore they find these objec-tives being set for them by others. v


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From the Mine to the Sea:Optimizing Multi-Party Logistics

Asset-intensive industries, including mining and industrial products,are often dependent on transportation and logistics assets thatare owned or controlled by third parties. Developing an efficient,coordinated program to fund capacity expansion across each entitycan involve a complex range of potentially conflicting objectiveswithin each of these parties.

Optimizing multi-party logistics chains usually requires a high degreeof investment coordination, as the individual parties will have differ-ent levels of access to capital and pricing power (i.e., ability to passthrough costs to the ultimate customer). These disparities can lead tocompeting investment hurdle rates, which frequently impact contractnegotiations over the amount, timing, and allocation of responsibilityfor necessary capital improvements. There are often opportunities,however, to optimize capital deployment throughout the entire logis-tics chain by working together in collaborative processes.

Recently, Oliver Wyman has advised clients in projects involvingmulti-party, asset-intensive logistics chains on developing a struc-tured, analytically driven, and objective process for addressing theseinherent challenges and opportunities. Key components of this pro-cess include:

Leveraging international experience to establish utilization, capac-nity, and cost standards, adjusted for local conditions

Ensuring that robust analytical methodologies are deployed tonassess all of the logistics chain components and interfaces

Assessing the relative benefits and risks of alternative investmentnand ownership/control options

Examining opportunities to coordinate investment programs byneach of the stakeholders, in order to identify alternative capacity

expansion mechanisms that reduce the total capital required toachieve desired goals

Developing and facilitating multi-party agreements that alignninvestment objectives across all involved parties and provide coor-dination, transparency, and the ability to apply best practices (e.g.,project structure and information sharing, relationship manage-ment, performance metrics and incentives)

Allan KaulbachManny Hontoria

Jeffery Elliott

Robert Reid

Partners Allan Kaulbach and Robert Reid arebased in Boston. Partners Manny Hontoriaand Jeffery Elliott are based in Dubai andNew York, respectively. They can be reachedat [email protected],manny.hontoria@ oliverwyman.com,

[email protected], [email protected].


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A Case Example: Growing Capacity for Export As an example, a large and growing mining company sought toincrease its mining production by 50 percent over the next 10 years totake advantage of global demand for raw materials. This plan essen-tially resulted in a tripling in demand for capacity along the existinglogistics chain, which involves material moving from mines via rail toa port terminal, where it is loaded onto vessels for export.

The railroad and port facilities are both owned by a transport holdingcompany, which operates them as separate entities with individualcharters and objectives. This separation has often led to conflict, aseach entity has attempted to maximize its individual performance,developed expansion plans that influenced its own required capitalinvestment, and competed for internal resources.

In this case, each developed a plan to meet the mining companysexpanded transport capacity needs, but the resulting costs threat-ened the commercial viability of the mines expansion. Accordingly,the mining company sought an objective assessment of the capitalrequired to meet the increase in throughput, based on relevant bench-marks and best practices adjusted for local conditions. It also soughta mechanism to allocate investment by each of the parties at a com-mercially viable rate of return. Finally, it wanted to redesign thecommercial relationship between itself and the rail and port serviceproviders to allow for more visibility and constructive feedback fromthe mine to continually improve the performance of the logistics

chain.

A three-step program was developed to help the client constructivelyengage in capacity expansion discussions with the transport entities,with a focus on required capital and appropriate allocation of risk.

Exhibit 2-1 Phase I Multi-Party Capacity Expansion Approach

BenchmarkingBenchmarking is an essential first step in determining the practi-cal incremental throughput that can be achieved for a given level of

Comparison of capexforecast by transportentities against globalbenchmarks

Benchmark

Collaborativedevelopment andtestingof opportunitiesto actually achievecapital cost reductions

Test opportunities &reach agreement

Examination ofpotential commercialmanagement andpayment structures

Develop frameworks1 2 3


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investment in capacity enhancement. Benchmarking should focus onthe productivity of individual assets and unit costs and their respec-tive interdependence to ensure that the logistics chain is responsiveto demand requirements.

In this case, international experience conclusively demonstrated thatcurrent utilization of rolling stock and the port terminal, adjustedfor local conditions, was well below benchmarks. It was clear thatimproving utilization of these assets would significantly reduce thecapex required for capacity expansion. Also, the initial proposed unitcosts for purchasing additional rolling stock and the overall costsfor port expansion were not supported by comparable benchmarks(Exhibit 2-2 above). The data-driven benchmarks furthermore provideda basis for the transportation entities to negotiate lower unit costswith their suppliers and to launch an in-depth technical feasibilitystudy of the proposed capital expansion.

Testing Opportunities and Reaching Agreement

Assessing and testing the technical feasibility of operational changesmust be accomplished with the involvement of all parties through theestablishment of joint teams (across entities and functions). Theseteams should be comprised of individuals with the requisite experi-ence and collaborative know-how to develop and execute the projectapproach, timeline, and analyses, in order to ensure buy-in from allparties on the resulting findings and recommendations.

Port expansion benchmarkingCapital expenditure (US$M) versus incremental throughput

Rail utilization and cost benchmarkingNormalized to transport entitys proposal

Y%

X%

100%

0%

20%

40%

60%

80%

100%

Car cycle times Car costs Locomotive costs

Actual Benchmark

Port 2 Port 7

Port 4

Port 6

Port 4

Port 3

Port 5

Port 1

1,000

0 10 20 30 40 50

Potential rangefor client

expansion cost

500

250

750

0

Incremental throughput: million tons per year

$M


Exhibit 2-2 Benchmarking to Establish Capital Expenditure Requirements


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The teams in return should report to a steering committee made upof representatives of the project stakeholders who have requisitedecision-making authority to resolve the inherent conflicts that canarise throughout the process.

In this case, the focus was on closing the gaps between benchmarks/best practices and the existing performance levels driving the origi-nal capex proposals from the railroad and the port. On the rail side,technical feasibility studies uncovered operating issues (e.g., trainschedules and operating performance, equipment availability, andutilization) that threatened throughput targets and inflated capi-tal requirements. On the port side, the team identified throughputenhancements that would improve current performance and deter-mined alternative capital expenditures that were needed to de-riskthe planned operation and ensure reliability (Exhibit 2-3). These find-ings laid the groundwork for reaching subsequent commercial agree-ments and highlighted key decision and investment points.

Developing Frameworks to Address Project Requirements

The third stage of the process involves formalizing the new operatingmodel, finalizing estimates of operating expenses and capital expen-diture requirements, building financial models to support negotia-tions, and developing protocols and agreements to support thecoordination of long-lived capital investment programs.

In this case, based on the prior two work steps, the team developed anestimate of the tariff charges needed to support the level and timingof the proposed capacity-related investments and to provide a reason-

Increasing capacity: Port simulation results Free digging rate and berth occupancy required to reachtarget throughput

Reducing capex: Rail cycle time comparisonIndividual revision impact

Shiploading capacity (MPTY)

Original Revised modelingconstraints andprocess times

X

Y

T u r n a r o u n

d t i m e

( h o u r s

)

Port terminal

Mainline

Mining terminal

Swing set impact

65% BO 70% BO 75% BO 80% BO

F r e e

d i g g i n g

r a

t e

( t p

h )

42 44 46 48 50 52 54 56 58 60

5,000

5,500

6,000

6,500

7,000

7,500

8,000

Increasing BO to X%

IncreasingFDR to Y tph


Exhibit 2-3 Results o Options Testing


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able rate of return for the transportation entities. In addition, optionswere developed around commercial terms between the parties thatwould minimize operational risks (Exhibit 2-4), as an input to devel-oping a tariff model and a range of commercial and contractual risk-sharing and performance incentive options.

ResultsThis collaborative effort led to an agreement on investment cost andfunding mechanisms that were acceptable to both parties and pro-vided the basis for a new commercial contract. The project was ableto reduce the proposed tariff that the mining company would pay bynearly 40 percent and the overall capital required for the expansion

by more than 20 percent, while still generating an attractive rate of return for all parties. The project also led to a better understand-ing of the real capacity constraints of individual components alongthe entire logistics chain, which became the basis for an agreementbetween the parties to form a joint operational team focused on opti-mizing the capacity of the entire export channel.

Exit options

Option 1 Option 2 Recommendation

Short-termTypically 5-10 yearsPrimarily service oriented

Long-termTypically 15-30 yearsHigh capital intensity

Long-termGoal: long-term partnershipHigh capital intensity

Fixed (no risk sharing)Lump sum tariff rate for fullduration of contract

Variable (risk sharing)Tariff based on throughput,performance (incent. / pen.)

Variable (risk sharing)Numerous parties involved, tariffshould reect usage

One-timeSingle payment for services provided OngoingContinuous payments based onactual usage

OngoingVariable usage-based tariffFlexibility for change

StaticLimited performance monitoringduring term

ContinuousAgreed performance criteriaMetrics for term fulllment

ContinuousPartnership approachClear performance metrics

SteadyNo changes to term length,structure, or payments

Periodic adjustmentChanges based on events,milestones, volumes, etc.

Periodic adjustmentFlexibility for change (demanductuations, etc.)

EscalationArms length relationshipsPolitical environments

ArbitrageClose partnerships / win-winTimely resolution / decision

ArbitrageWin-win relationshipTime is of the essence

Buy-outBuy-out of equipment / operationsby one party

RenewalExtension of contract termsAdjustment for changes

RenewalContinuity of partnershipLong-term win-win situation

Tariff structure

Payment scheme

Performancemonitoring

Contract reviewand adjustment

Conict resolution

Term length

1

2

3

4

5

6

7

Exhibit 2-4 Developing Frameworks: Options or Commercial Terms


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Summary: Rethinking Complex Logistics ChainsThe example above focuses on capital expansion issues for a logisticschain dominated by materials throughput and involving multipleentities. Operational coordination issues and the need for tradeoffsbetween capital and operating costs can arise both within a capital-intensive firm and between parties with large capital requirementsthat are part of the same logistics chain. The key to developing aresult that maximizes effectiveness is to understand the operatingand capacity relationships across all individual components of thelogistics chain. Performance and capital benchmarking, a detailedunderstanding of the factors impacting optimization of the consoli-dated logistics chain, and an iterative process for framing and testingoptions can produce significant scale benefits for all parties involvedand ensure the best use is made of scarce capital resources. v


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The Liner Shipping Downturn:Business as Usual or Something New?

The liner shipping industry over the years has become used to highcyclicality, driven by major swings in demand, capacity, and pricing.Currently, the industry is not only well into a major downturn, butfacing what many view as its largest crisis in memory. The causesare not only a worldwide recession, but a current and pending majorincrease in capacity, recently projected to grow by 9 percent per yearfrom 2008 to 2012 (although this rate is now likely somewhat lowerdue to cancellations and order delays) (Exhibit 3-1).

The headlines in the trade press are full of bad news:

Asia-Europe spot box rates dropped to an unheard-of zero dollars,n

with cargo owners just paying for fuel.

Container volumes have dropped sharply: Singapore, the worldsnlargest container port, handled only 1.9 million TEUs in February2009, a 20 percent drop versus the same month a year ago.

Containership charter rates dropped by about 50-60 percentnbetween August and December 2008 (Exhibit 3-2).

Manny HontoriaKristina Gerteiser

Manny Hontoria is a Dubai-based partnerand Kristina Gerteiser is a Munich-basedsenior associate of Oliver Wyman. They canbe reached at [email protected] and [email protected].

Volume shipped in 2007(million TEUs)

Capacity (current and order book)(000 TEUs, as of February 2009)

Capacity Order book378

361

470

488

486

616

451

988

1,483

2,041

279

125

196

123

440

155

584

638

387

4.2

4.6

4.7

5.5

5.7

6.2

7.3

7.7

10.0

13.7

Hanjin/Senator

OOCL

APL

Hapag-Lloyd

COSCO

Evergreen Line

CSCL

CMA CGM Group

Mediterranean

APM-Maersk

Source: DVB/Dynamar, Alphaliner.

Exhibit 3-1 Top 10 Container Lines: Shipping Volumes and Capacity


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The creditworthiness of liner shipping companies has suffered; asnan example, France-based CMA CGMs credit rating was cut fromBBB- to BB+ by Standard & Poors.

Most lines are restructuring services, cutting capacity, slow steam-n

ing and laying up ships. For example, Maersk by the end of 2008 hadlaid up over 50,000 TEUs (8 vessels x 6,500 TEUs) of capacity in itsAsia operations and more lay-ups are expected.

The only small piece of good news was a reduction in bunker fuelprices through the first quarter of 2009, after the peak in mid-2008.For example, according to Tankerworld, Singapore 380 centistoke (cst)bunker fuel prices plummeted 64 percent from July 2008 to January2009.

A couple of questions come to mind:

Is this current downturn similar to those that occur in the industryn

every several years, or is it severe enough and driven by signifi-cantly different circumstances such that liner shipping companiesshould be considering a fundamental rethink of their strategies inorder to survive?

An interesting related question is: Will the well-publicized new EUnregulation that denied a block exemption for liner shipping confer-ences as of October 2008 exacerbate the impact of the downturn?

0

5,000

10,000

15,000

20,000

25,000

30,000

Aug Sept Oct Nov Dec

725 TEU (8000 dwt, with cargo gear, 15.0 knots)

1000 TEU (14000 dwt, with cargo gear,18.5 knots)



2750 TEU (without cargo gear)

3500 TEU (without cargo gear)

Source: Clarksons Containership Rates, Internationale Transportzeitschrift.

US$/day

Exhibit 3-2 Sample o Containership Rates, August-December 2008


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The End of Conferences: More Price Competition?Lets focus on the impact of the change to conferences first: Whilethe specifics vary by trade and geography, conferences have long sincemoved from their price fixing function (often with quite limitedeffect) to broader discussion agreements. Overall, changes in whatconferences could or could not do to coordinate pricing in recentyears had a relatively small impact on the level of overall competition,as lines continued to fight for share. This would suggest that the finalabolition of conferences (and thus of their ability to price fix and regu-late capacity) will add little to the impact of the downturn.

It is interesting, however, to consider the issue of surcharges (espe-cially for fuel) in this context, as these represent a huge part of totalfreight rates, both for air and liner shipping. Some of the liner confer-ences still offered the capability to levy set surcharges and therebykept these out of competitive pricing. Formally and legally, this willno longer be the case. Will liner shipping companies now competeon surcharges and the pass through of fuel costs? Even if they dontin principle, will the potential lack of a clearly set reference point forfuel and other surcharges mean that dramatic price swings for thesecharges might not be passed through as efficiently as they were in thepast, potentially leading to a significant negative cost impact at a timewhen margins have all but disappeared?

While this is certainly a new area, we do not believe, despite rapid andongoing price cutting by lines, that shipping lines will utilize surcharg-

es in an aggressive, competitive way. Freight rates are highly sensitiveto market conditions and there is still room to maneuver in the nego-tiable part of freight rates, though that room has been greatly reducedof late, given how low rates have fallen. In addition, a number of lineshave implemented fairly transparent pricing, which will further limitopportunities to hide additional revenues in the surcharge portionof freight rates. Margins are simply too thin (i.e., non-existent) and theimpact of rapid changes in fuel prices too great, for lines to risk, evenfor a short-term increase in volume, changing the industrys competi-tive dynamics in such a potentially dangerous way.

A Bigger, Badder Downturn?This brings us back to the broader question of whether the currentdownturn is so severe that it will force lines to rethink the fundamen-tals of their business, or whether a short to mid-term focus on costand capacity reduction will be sufficient to enable lines to weather thestorm. While it is impossible at the moment to judge the full extentand timing of the global recession, we currently believe thatdespitesurely painful years aheadthe liner shipping industry as a whole


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will continue to be viable long term. (For example, although stockprices have dropped in line with the overall market, they have stabi-lizedsee Exhibit 3-3). There will likely be some shifts in manufactur-ing that could reduce shippingalthough we think that these muchtalked about shifts will not be many, given the complexity and costsinvolved. But at some point, consumer spending will come back andglobal trade will start to move again. In the meantime, the contractionin the industry is also having a fairly dramatic impact on related sec-tors, such as ports and port operating companies, shipyards, charter-ers, etc. (See sidebar on competitive challenges for ports.)

Exhibit 3-3 Indexed Stock Prices o Listed Container Shipping Lines,Feb. 2008-Feb. 2009

Shippers, though experiencing their own recessionary pain, maybe viewed as the primary beneficiaries of reduced rates. Before theexpressions of glee get too loud, however, cargo owners should con-sider the potential risks to their overall supply chains should a turn-around in liner shipping fortunes not come soon. At some point, evenif business failure is not the result, the pain in specific trades couldwell become too high as even marginal costs are no longer covered.Capacity also cannot be pulled down perfectly smoothly to matchdemand. Therefore, shippers may well find that certain origin-destina-tion pairs are simply no longer served, with major implications for awell-functioning transport and distribution chain.

Some smaller or poorly capitalized lines likely will not survive.A number of dry bulk carriers have already filed for protection,

Average of Evergreen, CSCL, MOL,NOL, and NYK stock prices

40

50

60

70

80

90

100

110

Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

Container Shipping LinesDAX

DOW JONES

Source: Thomson One Banker, Oliver Wyman analysis.

February 20, 2008 = 100


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e.g., Ukraine's Industrial Carriers, New York-listed Britannia Bulk,Copenhagen-based Atlas Shipping, and Armada Singapore. There ismuch speculation around which liner shipping and charter companieswill follow. Recently, Hong Kongs Great Ocean Container Lines (GOCL),which began providing a Far East-Europe service in April 2008 throughslot buying, closed after less than a year of operations.

Strengthening Alliances and Getting Back to BasicsSo, what should be the short-term strategy of liner shipping compa-nies? Clearly, a focus on costs will be paramount, including furtherrestructuring in terms of staffing, asset purchases, etc. We do not seerestructuring leading to or being driven by further major consolida-tion in the sector, given the expected poor performance of lines overthe next several years, as well as a lack of available financing. Thewell publicized pullback of NOL from a potential acquisition of Hapag-Lloyd is an indication of this.

Furthermore, the next couple years might be a good time for lines tothink more about increasing the impact and capabilities of strategicalliances, by pushing for stronger operational coordination and furtherexploiting economies of scale. Some recent examples of new levels of cooperation include:

Pacific International Lines and Wan Hai Lines cut their transpacificnservice and joined K Lines existing PSW-1 service at the end of February 2009.

Grand Alliance (GA) and New World Alliance (TNWA) teamed up onntheir Asia-US operations; New World Alliances New York Expresswill move from an eight to nine ship loop, with the TNWA and GAproviding five and four ships, respectively.

Grand Alliance recently teamed up with Israels Zim to continue tonserve eastern Mediterranean and Black Sea destinations directlyfrom Asia, through a slot charter arrangement with Zim.

As these examples show, there are opportunities out there to exploit

the power of partnerships. Lines will need to exercise some caution inhow they utilize alliances, however, so as not to be accused of circum-venting the abolition of the block exemption or pursuing forbiddenantitrust activities on a different playing field.

Beside a focus on costs and operational efficiencies, we believe thetime is ripe for liner shipping companies to think more carefullyabout their product and service mix. This would include more careful


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selection of origin-destination pairs to increase the utilization of assets and market share for individual port pairs. Increasing returnseven on a small percentage of the business is likely much moreimportant now than offering broader geographic coverage in thehopes of carrying a few more TEUsparticularly with much slowergrowth in volumes projected over the next 15 years (Exhibit 3-4).Lines should also probably re-address the question of low-cost versushigh-cost service, as it is becoming more and more difficult to justifypremiums for high-cost service in general, a difficulty compounded ina recessionary climate.

Exhibit 3-4 Projected Container Tonnage Through 2024

As is generally the case in this highly competitive and commoditizedbusiness, over the course of the next several difficult years majorstrategic moves will be less likely to ensure survival than a dedicatedfocus on improved execution of the basics and the building of a deep-er understanding of customer segments. Gaining that understandingto enable a more finely tuned service offering (without adding costswhich cannot be recovered) could represent an investment that willpay off well into the next recovery cycle. v

0%

2%

4%

6%

8%

10%

12%

14%

16%

2 0 0 22 0 0 4 2 0 0 6 2 0 0 8 2 0 1 0 2 0 1 2 2 0 1 4 2 0 1 6 2 0 1 8 2 0 2 0 2 0 2 2 2 0 2 4

Change in metric tons

Source: Global Insight.



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The current global economic downturn, coupledwith rising energy prices, deteriorating infrastruc-

ture, and growing ship overcapacity, is leading tochanges in sea trades that also will challenge portsand port operators to move beyond business asusual if they are to compete effectively in a moredemanding world economy.

Three key issues that Oliver Wyman believes willhave an accelerating impact over the next few yearsare:

Economic downturn and shipping sector volati-n

lity: Increasing proximity to customers andclosely monitoring and reducing transportationcosts will become more important to the mari-time sector during the downturn, particularly withthe very low switching costs faced by shippers.More generally, the industry will likely experi-ence increasing volatility, with rapid changes inthroughput volumes, trade directions, and freightrates. In this environment, North American portswill find themselves under increased scrutinyand facing renewed demands for cost efficiencyas government budgets tighten. Equally, theywill need to focus on greater flexibility to ensurethe best use of their assets, tied to a commer-cial approach that aggressively pursues the bestbusiness opportunities. Potential options couldinclude key account management based on seg-mentation of customer throughputs and profit-ability, or pricing and incentive schemes thatstrike a balance between customer profitabilityand dependency.

Shifting manufacturing and demand patterns:n Another trend for ports to watch is the shiftingof supply networks closer to home. In particular,volatile fuel and transportation costs, rising pro-duction costs in developing countries, and con-cerns about energy conservation are leading somemanufacturers to move their activities closer toend customers/domestic markets. The impact onports may likely be more emphasis on capacity

to meet regional and local needs, i.e., they willneed to offer efficient connections to domestic

transport modes, such as rail and truck, and mayneed to investigate value added services that willappeal to local producers, such as warehousing.

Continuing capacity bottlenecks:n Althougheconomic downturn may ease the congestionproblem slightly over the near term, capacity andoperational bottlenecks will continue to be anissue for major North American ports, particu-larly the vital gateways of Long Beach and LosAngeles. This may create opportunities for other

ports to develop specialized or niche traffic, suchas has been done successfully at Baltimore and

Jacksonville. Gulf Coast ports could also capturemore incremental traffic, but doing so will requireensuring that they have necessary infrastructureand transportation connections in place to offercompetitive service.

These trends will make it necessary for ports tothink about both their short- and long-term busi-ness models, and which strategic options will pre-

serve their market share, e.g.:Increasing flexibility to deal with short-termnchanges (customer-mix, pricing structure, trafficplanning, etc.)

Strategic/marketing/commercial alliances withnother ports and transport providers

Increasing use of public-private partnerships, e.g.,nsharing of port assets and facilities

Reducing dependency on a few major customersn

Increasing operational efficiency and reducingn

costs to respond to decreasing traffic volumes

More sophisticated capital spending, evaluation/nprioritization techniques

Countering pressure for increased regulationn

For smaller ports, focusing on the competitivenadvantages of shipping lines operating morepoint-to-point traffic and less transshipment v


Competitive Challenges for Ports


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Dont Chance It: Getting More Out of Risk Modeling

Risk analysis and modeling can be an important tool to supportdeeper, more insightful management discussions about a wide rangeof strategic, operational, financial, and hazard risks. But it is often usedimproperly and poorly understood by senior managers. Promoting andembedding risk analysis into core management processes, however,can help resolve issues earlier (when they are usually cheaper tofix), enable better development of contingency plans that permit arapid response to crises, and potentially identify opportunities toturn negative risks into avenues for future growth. Risk modelingand analysis should be an integral part of strategic and operationaldecision making, not a specialized expertise outside the mainstream

of management processes.Room for Improvement Risk modeling and analysis have become very sophisticated, thanks inpart to continuing increases in computing power. Emphasis in model-ing has shifted away from deterministic, single-answer models toprobabilistic models such as Monte Carlo simulations, which enablea user to fully understand a range of outcomes and the probability of certain outcomes occurring.

As Exhibit 4-1 shows, a Monte Carlo model not only provides anestimate of the most likely outcome, but can provide answers thatscenario-based analysis using a deterministic model cannot. What isthe probability of an unacceptable outcome occurring (in the examplebelow, a rate of return less than four percent)? What is the probabilityof a rate of return greater than seven percent? A deterministic modelmay tell you what combination of factors may lead to such a result,but not the probability of that combination of factors occurring. Unlessmanagement asks these types of questions of their risk analysts, how-ever, the power of modern risk analysis will not be tapped. Despiteimprovements in modern risk analysis, there is plenty of evidencethat companies are still failing to fundamentally progress in terms of how they manage risk:

Investors in collateralized debt obligations (CDOs), for example,nfailed to understand the cascading of risk that would occur in theevent of a downturn in the housing market and increased defaultsby high-risk homebuyers. 1

1 See for example, Behind AIGs Fall, Risk Models Failed to Pass Real World Tests, Wall

Street Journal, October 31, 2008.

Pablo Wangermann Jim Bohlman

Pablo Wangermann and Jim Bohlman areDallas-based partners of Oliver Wyman. Theycan be reached at [email protected] and [email protected].


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The delays in development and production of the Airbus A380 andnBoeing 787 are both examples of risk management failures. For theA380, Airbus failed to identify and manage the key risk of design-ing the wiring using different CAD systems in different plants. Forthe 787, Boeing failed to identify and manage the risk of creatingits first lean and globally distributed supply chain system, and thenthe risk of accepting incomplete deliveries at its plant in Seattle.

Structured finance products, such as aircraft securitizations, havenfallen far short of their expected revenues despite analysis of therisk of these notes by ratings firms such as S&P and Moodys, indi-cating incomplete or deterministic risk modeling.

A key problem is that any model, no matter how sophisticated, re-quires a great many assumptions as part of its construction, e.g., aboutstatistical data, about future changes in systems, about what is/will beimportant to model, analyze, and track. The output from a risk modelthus can never be considered fully accurate and finishedratherrisk modeling generates an estimate of the probabilities of differentoutcomes based on the assumptions made in the modeling process. Assuch, it functions best as an ongoing input into robust discussions

80%

0%

20%

40%

60%

100%

P ( v a

l u e 7% ) = 17.1%P ( IRR < 4% ) = 2.9%

Catastrophic Scenario a portfolio has the

potential to drasticallyunderperform against

expected returns

Provides the mean and median (not the same forasymmetrical distributions)

Crucially, shows theprobability of a certain levelof performance beingachieved or not achieved

Illustrative


Exhibit 4-1 Example Probabilistic Model: Monte Carlo Simulation


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between the various parts of an organization. Those discussionsshould include regularly revisiting assumptions to check that they arestill valid.

Good Risk Modeling: Lessons LearnedEven simple readouts from the results of a risk modeling tool suchas a Monte Carlo simulation can yield great insights into a portfoliospotential performance and risk profile. If the model is well construct-ed, actual performance should never be outside the range of modeledresults. In the example shown in Exhibit 4-2, actual performance of an asset-backed financial instrument was outside the range of alloutcomes generated by the Monte Carlo model. An appropriately con-structed Monte Carlo model should, if run a sufficient number of iter-ations, generate results that cover the full range of potential real-lifeoutcomes. In the case shown, the result was significantly outside therange indicated by 5,000 iterations of the model in question, stronglyindicating serious flaws in the modeling process.

Key lessons learned for constructing a good model include:

Clearly lay out model assumptions, discuss which ones are critical,nand regularly return to them. Part of the challenge, given the num-ber of assumptions made at different levels in constructing a model,is to review assumptions in a meaningful and insightful way.

P ( L P n e

t i n c o m e 10%)

Med. risk (1-10%)

Low risk (


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periods of excess capacity, such as we are experiencing now. Thesesavings are typically driven by a mix of actions, including but not lim-ited to:

Carrier consolidationn

Mode mix optimizationn

Rate benchmarking and lane-by-lane cost reductionsn

Reduced expediting of freightn

Network and physical flow rationalizationn

Third-party outsourcingn

In addition to providing cost savings, a holistic approach increases

strategic control and can lead to more integrated relationships withkey carriers, thus helping to minimize the risk of supply chain disrup-tion and ensuring that shippers continue to deliver cost-competitive,reliable service to their customers. When the current economicdownturn ends, such strengthened relationships and the associatedconfidence in the supply chain will continue to deliver benefits, bysupporting future growth and expansion. v


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Cracking the Yield Management Code

Declining traffic volumes, fuel cost variability, and increasing laborcosts have made the past year a rough ride for freight transportationindustries, and the near future appears even more uncertain. Theone upside of the current situation is that while demand is a bitsimpler to manage, this may be a good opportunity to focus on somefundamental structural changesnamely, the application of yieldmanagement principlesthat could help freight transporters bettermanage variable costs and enhance revenue.

Yield management has been widely applied in the travel industry,including by airlines, cruise lines, and lodging and rental car com-panies. And while these concepts seem to be a natural fit for otherindustries with large, long-lived asset bases, adapting them to actuallywork outside the context of transactional, reservation-based busi-nesses has often proven challenging, particularly given key differencesin the freight transport environment.

As discussed in this article, these differences do not make yield man-agement irrelevant for freight transport, but they do manifest them-selves in a need for greater cross-functional integration and differenttypes of data than is customarily used in yield management decisionmaking. Freight operators also must pull a different combination of levers to balance supply and demand, and resulting decisions willhave a broader scope and longer-term impact than is generally thecase for transaction-based industries.

What Yield Management Can DoYield management certainly has the potential to increase freightoperator profitability. First, the freight industry, like many others thathave benefited from yield management, has an extremely large fixedasset base. Every moment these assets are idle is a lost opportunityto produce revenues; in this sense, the freight industry has perish-able resourcesby now a familiar characteristic of yield managementapplications.

Second, freight industries are frequently capacity constrained: Aircargo for example has both weight and volume limits varying byroute, time-of-day, and season. Wherever there is fixed capacity, thereis an opportunity to increase yields when demand is high and drivevolumes when demand is low.

Scot Hornick James Rider

Gilles Roucolle

Scot Hornick is a Toronto-based partner.Gilles Roucolle is a Paris-based partnerand James Rider is a London-based associ-ate partner of Oliver Wyman. They can bereached at [email protected],[email protected] and [email protected].


33/40


With such perishable resources and capacity constraints, the freightindustry would seem a natural place to apply yield management prin-ciples. But the freight industry is also fundamentally different fromthose industries that use conventional yield management. Key chal-lenges in applying yield management for freight transport include:

Flexible capacity:n How should yield management account for thefact that resources and capacity can be resized and redeployed todynamically balance demand, and that the variable costs of doingso are not negligible?

Deep customer relationships and contractsn : How do we apply yieldmanagement concepts in a non-transactional business, one wherecustomer relationships are long and multi-year contracts constrainfluid pricing?

Uncontrolled access:n How do we manage demand without reser-vations or other methods of controlling access? How do we selecthigher-revenue demand in a world of first come, first serve?

The remainder of this article discusses our experience in overcom-ing these challenges by applying yield management principles to thefreight industry, and the solutions that can deliver success.

Challenge 1: Flexible CapacityTraditional yield management assumes that demand is fixed. Butwhile a passenger aircraft cannot tack on a few extra rows of seats

to meet excess demand for a particular flight, railroads can add carsand locomotives to extend a train and extra sections of trucks can bedeployed to meet unexpectedly high demand on a less-than-truckloadnetwork. (Air cargo would appear on the surface to be more similarto passenger aviation; however, the concentration of customers andlumpiness of demand means the economics of shifting capacity tomeet demand is often attractive.)

This being the case, yield management tools, processes, and organiza-tion must be designed to both optimize pricing changes in a world of flexible capacity and to optimize this flexible capacity as well:

Tools:n Yield management algorithms and tools must be developedthat correctly understand the variable cost of flexing capacity andthe lost opportunity costs of capacity shifts, versus revenue gainsfor different capacity deployment scenarios. In our work with onefreight railroad, for instance, we developed a directional/equipmentpricing tool (see Exhibit 6-1) that considered the variable costs of deploying additional equipment in a particular freight lane,


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including the round-trip costs of circulating that equipment backwhen freight flows were directionally imbalanced.

Process/organization:n Pricing and revenue management must befully integrated with other customer-facing functions, as well aswith operational planning and capacity deployment functions. Thecritical lever here is a process that brings together the customerand market knowledge of the sales teams with the cost and capac-ity knowledge of service designers and asset managers, not merelyover a longer-term, strategic planning horizon, but also on a week-to-week, tactical planning basis. Such cross-disciplinary lane teamplanning discussions can be used to rapidly and flexibly developshorter-term capacity redeployments and/or tactical pricing initia-tives to better balance demand with supply. The organization cansupport the process by assigning staff with specific responsibilityfor major asset classes and by developing robust margin reporting.

Challenge 2: Deep Customer Relationships and ContractsMost freight transportation businesses have deep customer relation-ships, with terms and pricing defined by multi-year contracts. Forexample, some freight rail contracts with steamship companies canhave terms of 15 years or more, and extend across a very broad net-work of freight types. In the air cargo industry, for instance, freightforwarders are increasingly putting network-wide bid packages out totheir core carriers, looking for the deal with the best overall networkeconomics. Such decisions defy the simplicity of the traditional trans-actional decisions that get made in the travel industry with respect tosingle passenger bookings.

This complexity calls for yield management discipline to be appliedmuch earlier in the processlong before a customer initiates a trans-

Train operations statistics

Cost information

Revenue information

Price elasticity estimates

Market fencing

assumptions

Equipment recirculation

assumptions

Inputs

Assessment of impact of ow imbalance

Optimal price levels by type of equipment

and direction

Setting price-oor levels

Estimates of incremental contribution

over the period modeled

What-if analysis

Sensitivity analysis

Prioritization of market growth initiatives

Response to competitive actions

Decision support

Exhibit 6-1 Illustrative Directional/Equipment Pricing Tool


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action to ship goodsto ensure that contracts do not limit the car-riers ability to price dynamically or to say no to a shipment whencapacity is too tight. This can be achieved in a number of ways:

Develop bid evaluation tools:n One key idea is to develop supporttools tailored specifically to the decisions at hand when negotiatinga contract. Such tools can consider and model diverse factors, suchas the network cost and service impact of taking on new demand,the effects on asset/equipment flow in the network, and the pro-pensity of customers to buy (or not) at a higher price. For example,a major US airlines cargo subsidiary has developed a sophisticatedbid evaluation tool to evaluate RFPs, which can assess the displace-ment cost impact of any given contract and analyze the operatingcost implications (including for example special handling require-ments, such as for perishable goods).

Track historical bid wins/losses:n Another enabler is simply track-ing what has happened in historical bidding situations, so as tobetter assess win probabilities and freight realization rates as afunction of the quoted price. A company can make better decisionsregarding the optimal price levels in a given market by evaluatinghow different levels of pricing competitiveness have impacted pastsuccess. Importantly, success should be defined as the winning of profitable contracts, and this should provide insights on how toprice to avoid contracts with poor levels of return (for example, dueto low volumes or high delivery costs).

Prioritize strategically important customers:n Yield managementdecisions in the travel industry are typically made on a tactical,transactional basis. But it is also important to factor in long-termcustomer value and strategic importance. Considerations mayinclude rates of growth, counter-cyclical shipping patterns (e.g.,more value assigned to shippers/forwarders who are more activeoff-peak), and support for particular target lanes.

One of the more significant implications of these challenges is thatthe sales force is very much a part of the yield management pro-cess in a freight organization, unlike in a reservations-based travel

business, where yield management decisions are made behind thescenes and are largely invisible to the sales force. As a consequence,the sales teams performance goals should include yield-manage-ment-oriented metrics. As an example, one of our air freight clientsgradually shifted its compensation scheme for the sales force towardan account contribution metric and away from an account revenuemetric, to steer the team toward contribution maximizing behaviors.


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Challenge 3: Managing Demand Without Controlled AccessToo often, freight companies lack any real freight reservation system.In rail intermodal, for example, shippers often are told that as long asthey can get their shipment to the ramp by a trains designated cut-off time, it will be loaded and transported to its destination according tothe railroads scheduled timetable. On peak days, however, demandcan exceed capacity and freight must then be rolled until the nextscheduled train. If too much rolled freight accumulates, the railroadmay try to work in an extra unscheduled train around scheduled ser-vice. Either way, the result can be expensive, either directly, in termsof higher operating costs, or indirectly, in terms of disappointed cus-tomers. The resulting uncertaintieseven for relatively more reliableintermodal servicecan drive service-sensitive customers off the railsand onto the highways.

Similarly, many air cargo carriers still operate without a freight reser-vation system, to limit shipment commitments according to the spaceor payload capacity available on a carriers flights. This can make itdifficult to deliver priority service to preferred customers or to createdifferentiated priority products, if operationally there is no way toensure that shipments sold as priority are actually delivered that way.

Some approaches to dealing with the issue of uncontrolled accessinclude:

Reservations systems:n One obvious solution is to simply imple-ment a reservations system and create premium services thatleverage the ability of the system to provide more time-definite ser-vice commitments. The belly cargo operations of many passengerairlines have done this to great effect. More recently, some freightrailroads have introduced premium services in selected intermodallanes that allow a customer to reserve a slot on a train and, if needed, an intermodal container for time-definite transit across therail network. Shipments of less service-sensitive (and usually moreprice-sensitive) customers can then be slotted around premiumservices.

Steering demand through price elasticity:n Another approach is toadjust prices on a somewhat more static basis to modulate demandaccording to available capacity. To do this properly, a freight car-rier must have a sense of the elastic response of demand by servicetype and by shipping corridor. Options for gaining such insightsmay include analyzing market response to historical price movesto better understand price elasticity, building up a database of estimated elasticities by market, and determining optimal futureprice moves in the presence of capacity constraints. Needless to


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say, freight demand can be chunky, as one customer decision mayshift large pieces of business, and getting price levels exactly rightso that demand and capacity are evenly matched remains a chal-lenge. Price elasticity insights, however, can be an invaluable tool inachieving better demand/capacity balance.

Case ExamplesOliver Wyman has recently worked with a number of freight com-panies to develop enhanced pricing and yield management solu-tions, not only as a means for carriers to improve performance in anincreasingly challenging cost environment, but also to directly addressthe challenge of passing on variable costs (such as fuel cost) to cus-tomers in the most economically advantageous way.

Repricing Airline CargoAs an example, Oliver Wyman worked with a major US passengerairlines cargo division that was suffering from poor financial per-formance, with significant underpricing in many of the markets itserved. The sales and marketing group lacked a centralized pricingmanagement structure; instead, the field sales force negotiated spotprices based on past pricing practices, without determining whetherthe prices actually reflected the true all-in cost to provide the serviceor the actual value of providing the service to the client. Add in main-tenance and fuel cost pressures, and contribution margins for certainroutes and customers were significantly in the red.

Oliver Wyman identified the most troubled routes and customerrelationships, built a new activity-based cost model to support bothshort-term pricing decisions and medium-term revenue and yieldmanagement, and refined core yield management processes that cutacross the organization. This project focused on three work streams:

Analyzing systemic mis-pricings that were resulting in routesnwhere price drivers actually had a negative correlation to price (i.e.,it cost less to ship a package more miles). Targeted price increaseswere then recommended on a per customer and route basis.

Assessing price/cost misalignment at the market level. The sumn

of all shipment costs was higher than the total revenue generatedin certain markets; analysis determined this was likely due to theunder-utilization of freight assets. Price increases and incentivesto increase volume were recommended to increase profitability inthese markets.

Repricing outliers in the data set. Shipments were segmented innvarious wayse.g., by customer, market, and productto determine


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the combinations that should be repriced when possible, and priori-tized (Exhibit 6-2).

As a result of improving a core element of effective yield manage-mentprice rationalizationand implementing basic analytical toolsand a formalized management process, the cargo division was able toachieve a dramatic turnaround in profitability, with margins increas-ing from -5 percent to 15 percent in a year.

Exhibit 6-2 Illustrative: Prioritizing Outliers or Repricing

Pilot Program for Rail IntermodalIn another case, a major North American railroad was producing poorfinancial results. A merger had led to a service crisis, which paralyzeda large sector of the network and adversely impacted customer rela-tions. Difficulty in integrating the cultures of the two companies fur-ther limited the ability of the combined entity to improve operationalefficiency. Company management realized that it had to increase rev-enue and profitability in order to improve stock performance.

Oliver Wyman worked with the railroad to develop a pilot yield man-agement program in its intermodal business, as a means of testingthe applicability of such concepts to the railroad industry. As shownin Exhibit 6-3, we used screening criteria to develop six high-potentialopportunities. Through more detailed analysis, we then recommendedpursuing two opportunities for the pilot: intermodal day-of-week/directional pricing and empty car repositioning.

Suggested repricing approach:

Target high opportunity,easy implementationoutliers

Evaluate high opportunity,harder to implementopportunities

Look to moderate payoff,easy implementationopportunities

Required averageprice increase

Highestrepricingpriority

1

2

3

Easy

High

Moderate HighRepricing opportunity

= individual customers

0%

10%

20%

30%

40%

50%

$30 $40 $50 $60 $70 $80 $90 $100

Total repricing opportunity ($000)

E a s e o

f i m p

l e m e n

t a t i o n


3

2

1


39/40


The returns from the pilot (the first of its kind in the freight railindustry) were compellingyield management for one corridor alonegenerated more than $1.3 million in incremental contribution over sixmonths. Oliver Wyman then worked with the railroad to expand theprogram to the entire intermodal network and to plan for full yieldmanagement capabilities, including a complete suite of yield manage-ment applications, a new yield management organization, and newbusiness process. The railroad credits the program with a significantpart of the $112 million improvement in annual contribution from its

$1.9 billion intermodal business over the past two years.

* * * * *

Yield management still remains a challenging endeavor for the freightindustry. But in this increasingly difficult economic environment of high costs and slowing demand, freight transporters can no longerafford to wait for someone else to crack the code. The application of better pricing and revenue tools can greatly enhance the fundamen-tals of marketing and selling freight services, resulting in rapid marginimprovement regardless of economic conditions. v

AgriculturalProducts

IndustrialProducts

Intermodal

Business Team

Empty Car Repositioning

Premium Manifest Ag. Products Train

Cross-Market Flow Balancing

Intermodal Slot Allocation

Intermodal Day-of-Weekand Directional Pricing

Car Bidding

Yield ManagementTechnique

Car Bidding

Cross-Marketing

Directional Pricing

Time-Based Pricing

Slot Allocation

Empty CarRepositioning

Exhibit 6-3 Illustrative: Yield Management Opportunity Identifcation


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Oliver WymanWith more than 2,900 professionals in over 40 cities around the globe, Oliver Wyman is the leading managementconsulting firm that combines deep industry knowledge with specialized expertise in strategy, operations, riskmanagement, organizational transformation, and leadership development. The firm helps clients optimize theirbusinesses, improve their operations and risk profile, and accelerate their organizational performance to seizethe most attractive opportunities. Oliver Wyman is part of Marsh & McLennan Companies [NYSE: MMC].

Oliver Wymans Surface Transportation Practice Oliver Wymans Surface Transportation Practice, part of the Manufacturing, Transportation, and Energy (MTE)unit, is one of the largest consultancies in the world dedicated to the transportation industry, with a profes-sional staff of more than 100 partners and consultants worldwide,. It provides a comprehensive set of servicesand capabilities to transportation carriers, and to the users and regulators of transportation services, across thefull range of the transportation sector.

Oliver Wymans Corporate Finance and Restructuring Practice Oliver Wymans Corporate Finance and Restructuring Practice, part of the Manufacturing, Transportation, andEnergy (MTE) unit, provides a range of services to support investors and debt providers in transactions relatedto the automotive, manufacturing, transportation, and energy sectors. Our capabilities include support in M&A,structured finance, project finance, restructuring/workouts, and post-transaction integration.

For more information, please contact:

n Gilles Roucolle, Transportation Practice [email protected]

n Allan Kaulbach, Corporate Finance & Restructuring Practice [email protected]

www.oliverwyman.com

transport logistic

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