It’s a challenging time for air cargo carriers: Over-capacity in key markets and the US domestic slow down now rippling across the global economy are exerting intensive pressure on yields, while on the cost side, record high fuel prices are biting hard at the bottom line. While Singapore Airlines (SIA) Cargo is not immune to these pressures, a strategic review of its network and capacity management has readied the carrier for a ahead.
"It’s a challenging business environment," SIA Cargo president Goh Choon Phong starts in an interview with Payload Asia. "From the yield side the industry is under pressure largely because a fair bit of capacity has been added in the major markets – whether it’s India,China or elsewhere.
"You can see that there is a fair bit of excess capacity in general and then there is also the effect of movement to sea freight," he said.
Goh, who joined SIA’s cargo subsidiary about a year-and-a-half ago from group’s passenger side, says this same yield pressure which has been a feature of 2007 will continue through this year, but with the added feature of the US slowdown.
"If the US slows down further or worse, slips into recession, Asian goods will obviously be effected and that is something we have to watch quite closely," he said, noting that an already weakening US dollar has made Asian exports more expensive.
Bottom line pressure has also been a key feature for the last year-and-a-half as a result of the high cost of fuel. "This continues to be a big challenge for us, because for cargo carriers fuel is an even bigger component of our costs than say for a passenger carrier, although they have other passenger related costs," Goh said.
Fuel costs typically range around 30- 35 per cent of total costs for a passenger carrier, while on the cargo side its closer to 40 per cent.
"These are some of the challenges we face in 2008, some of which are continuations from 2007 and some, like the US slowdown is an additional factor."
Business review leads to new strategies
Perhaps seeing the writing on the wall, the cargo division – which markets the entire belly-hold space of SIA’s fleet of 94 passenger aircraft along with its own fleet of 14 B747-400 freighters, giving it a network of 75 destinations in 39 countries – undertook a strategic review of its operations from mid-2006 through 2007.
"We began to look at series of initiatives on how to meet the coming challenges. Specifically, was there a better way to manage our capacity and alsoour network," Goh said.
This resulted in far-reaching changes in how SIA Cargo viewed its capacity management, moving from an essentially static, market driven way of viewing capacity management to what Goh describes as a variable frequency deployment model.
"In cargo there are fairly distinct peak and off -peak periods," said Goh. "So in our BOP (business operations plan) we now have different frequencies serving destinations at different periods. And these are scheduled frequencies not cancellations etc.," he added.
In essence the cargo carrier has now formalised a structure of operating variable frequencies dictated by the seasonal demand.
"The idea is to better match our capacity deployment with the actual demand that is needed in the market, which is obviously a good thing because, especially in this regime of high fuel costs, you don’t want to operate capacity that’s not needed by the market."
The other key area the group looked at was its network, which also underwent signifi cant restructuring.
A key driver for the network restructuring was the indication that over time the pattern of cargo movement was clearly shifting. Markets like Taiwan and Korea, for instance, were not producing the same cargo demand as previously.
This was in a large part due to the electronics and other manufacturing activities moving out to lower cost and increasingly technologically capable centres like China and Vietnam. "At the same time we see some of the emerging markets that we can serve with our capacity," Goh added. The result was a "fairly extensive network restructuring," which saw freighter services to Korea and Taiwan, and pulled in their place new services added like Nairobi, Kenya.
SIA also moved to add capacity on its Brussels service to take advantage of the new 7th freedom rights recently negotiated between Belgium and Singapore. With 7th freedom rights relatively hard to come by, this first for a Singapore carrier is clearly a feather in not onlythe carrier’s but Singapore’s cap.
"We see a very good opportunity to use resources more effectively with the 7th freedoms," Goh added, noting that for each return trip from the US or Europe there was no longer a need to return to Singapore before picking up more cargo. This helps address some of the directional imbalances that often sees freighters returning to Asia with less than optimal payloads.
Also discontinued were freighter services to New York, although SIA Cargo still runs freighters into Chicago and Dallas/Fort Worth. "All this resulted in much better match of our capacity deployment with actual demand – both on seasonal basis and by market and that helps to better manage operating costs," according to Goh.
One thing that remained untouched was the reliance on two key European hubs: Brussels and Amsterdam. "Because Europe has a very efficient trucking system we fi nd that serving much of the continent through two hubs has been fairly efficient for us and so we’ll continue to grow them," he said. Aside from the two key hubs, SIA Cargo also runs freighters into Dublin (Ireland), London and Copenhagen (Denmark).
"We have a very good and balanced connectivity through Singapore which enables us to, in essence, have a very diversified market support for our European routes, both coming from Europe going to rest of Asia and Australia and also coming from Asia consolidating, and going to Europe."
This helps stabilise the business he said, because if one particular market weakens the group can leverage a different market strength.
The review also touched on the crucial area of making their operations more cost effective, an area which Goh said the group adopted an attitude of "no item is too small".
As a result SIA Cargo was able to squeeze its cost efficiencies, wringing out more than a 3 per cent cost reduction in the first nine months (Apr-Dec) of the current 2007/08 financial year.
The fruits of Cargo’s labour
Clearly the strategic restructuring paid off , as the cargo division of Singapore Airlines turned in a net profit of US$73 million for the period, up nearly 40 per cent year-on-year. But the real story is in the details.
SIA Cargo’s freight traffic (in tonne kilometres) for the third quarter was down 2.6 per cent year-on-year; about in line with the decline in cargo capacity of 2.4 per cent.
As a result, cargo load factor declined marginally by 0.2 percentage point to 62.9 per cent, but with a cargo breakeven load factor of 57.9 per cent, 2.4 percentage points lower on higher cargo yield (+2.8 per cent) and lower unit cost (-1.3 per cent) – ample evidence as to the wisdom of the capacity and network restructuring and effective cost control efforts.
But this isn’t the end of the story for Goh. "We will continue to push along these lines. Because the market is so dynamic the key is to see how we can be very flexible and nimble in how we react to the market, because there are always opportunities there."
Goh said the key thing he realised when he shifted from the passenger side to cargo, was the nature of the demand characteristic. While passengers can book seat a year ahead, or more typically months ahead, cargo is often booked just a few days ahead and even that can change at the last minute.
"So at the operational level there are still a lot of efficiencies and cost effectiveness that we can drive out by being more nimble and flexible in reacting to sudden volatility in the market."
China and India: The overcapacity issue
In the meantime, the issue of overcapacity and future expansion will continue to pose a challenge for the carrier. While acknowledging the China market is suffering from overcapacity,Goh remains optimistic about SIACargo’s future there.
"The good thing about China is that while there are a lot of people adding capacity there, there is still a quite a bit of growth coming out from China."
"Yes there is, especially in some cities more than others, capacity issues, but overall we still see that the traffic growth in China is healthy and certainly a market we believe will have continuous growth and we want to continue to grow in that market," he said.
While SIA Cargo has freighters into Hong Kong, Macau, Tianjin and Xiamen, much of its future growThis likely to be centered around its 25 per cent stake in all-cargo carrier, Great Wall Airlines. Singapore Airlines’ main shareholder, the investment arm of the Singapore government, Temasek Holdings, also holds 24 per cent through an investment subsidiary. Currently Great Wall – the first local- foreign partnership airline to take flight in China – has scheduled services to Manchester via Amsterdam, Incheon and Mumbai/Chennai with a fleet of three B747-400 freighters. Goh said the Shanghai-based carrier plans to expand its routes in Europe, as well as the US in due course.
Overall he said there are pressures in China, "but because of the growth in freight volumes the situation is quite manageable."
That is not the situation however, over in the other much talked about emerging economy, India.
The capacity in some of the major cities like New Delhi substantially outstrip demand, particularly on the export side, Goh said. Add to that an explosive market for domestic passenger and cargo airline startups and you have a recipe for a very tenuous market.
"In cities like Delhi there is a lot of pressure on the yield side and with domestic competition coming up rapidly, we’re watching the market very closely."
Goh also added that many people overlook the injection of belly hold capacity because they tend to look only at the passenger traffic, "but there has been tremendous cargo capacity injected into the market through the belly hold capacity, especially with some of these aircraft like the 777-300ER, which has a very healthy belly hold payload, so we have to look at it in totality."
Infrastructure is also a key issue. "In the long term potential of India there is no doubt, the question is how best to manage our growth into India in a way that does not pose additional problems in terms of the actual cargo movement.
"Infrastructure is one aspect we have to watch very closely to see that it does support effectively and efficiently the type of growth we want to be able to carry in terms of exports," he added. "Because of the long-term potential for India we will obviously be watching for opportunities, either to increase our own capacity there, or if there are other possibilities we will evaluate them." This could include JV’s or other strategic tie-ups with domestic players he said, adding "there’s nothing obvious right now, but its something we will continue to watch and see how best to participate."
Fleet expansion
As far as fleet expansion is concerned, SIA Cargo is content with its current belly and dedicated freighter capacity – which is currently a 50-50 ratio in terms of its overall capacity – and with its near-term plans to convert three of the passenger side’s B747-400s into freighters over the next five years.
With a fair number of new aircraft entering the passenger fleet, including 20 B787 Dreamliners from 2011, as well as 17 more A380s in addition to the two already in operation, there is ample belly capacity available to the cargo side, although Goh notes that most of the A380s will simply replace the capacity being taken out as the B747s are replaced.
"Our requirements for the next five years will be met with the three incoming 747s and a fair bit of growth on the belly capacity side because of the number of passenger aircraft coming in and when we look at it we have to balance both," he said.
But SIA Cargo will be looking into capacity expansion over the next few years to fill its medium-term needs after this five-year period.
Goh couldn’t say at this point whether this would be fulfilled through conversions or newbuilds, but said when that point comes, all options will be open.
"New build 777 freighters, that is something we will look into in the next request for tender (RFT) and if there was an A380 freighter we would certainly look at that as well if it was available and B747-8 freighters would be an option too."
With one of the largest B777 passenger fleets in the world, the cargo side could benefit from Boeing’s musings that it may begin a freighter conversion programme earlier than expected because of the popularity of the aircraft type.
"That is something quite interesting for us to look into and we would want to know more about it, but there are no definitive plans at this stage," Goh said.