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8 AMERICAN SHIPPER: JUNE 2007
BehindBehind
the numbersthe numbers
Understanding the underlying drivers
of containerized ai...
AMERICAN SHIPPER: JUNE 2007 9
Behind the Numbers
we use to think about trade growth with
an emphasis on:
• Why things are ...
Behind the Numbers
10 AMERICAN SHIPPER: JUNE 2007
Figure 2
Personal consumption has expanded
faster than GDP for many year...
Behind the Numbers
12 AMERICAN SHIPPER: JUNE 2007
More than $10.55 per kilo Less than $10.55 per kilo
Business model
share...
Behind the Numbers
14 AMERICAN SHIPPER: JUNE 2007
3.5: FCL will continue to dominate the sector,
but LCL and air freight w...
Behind the Numbers
16 AMERICAN SHIPPER: JUNE 2007
3.6: The West has the highest share of imported
footwear traffic, primar...
Behind the Numbers
18 AMERICAN SHIPPER: JUNE 2007
10 years, with imports now comprising
nearly 40 percent of all furniture...
AMERICAN SHIPPER: JUNE 2007 19
Behind the Numbers
(because of their small size relative to their
value),finalassemblycanbe...
Behind the Numbers
20 AMERICAN SHIPPER: JUNE 2007
congested port complexes like Savannah,
Ga., will likely be very competi...
AMERICAN SHIPPER: JUNE 2007 21
Behind the Numbers
as a result obstacles to overseas sourcing
are slowly being overcome pri...
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MergeGlobal Behind The Numbers

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  1. 1. 8 AMERICAN SHIPPER: JUNE 2007 BehindBehind the numbersthe numbers Understanding the underlying drivers of containerized air and sea trade. BY MERGEGLOBAL FORECAST TEAM Part one of a multi-issue series covering cargo forecasting
  2. 2. AMERICAN SHIPPER: JUNE 2007 9 Behind the Numbers we use to think about trade growth with an emphasis on: • Why things are changing. • A discussion of the shifts in indus- trialgeographythatareshapingthefuture structure of the global trade network for years to come. MergeGlobal uses a demand-pull framework to forecast trade flows. This E veryyearMergeGlobal,investmentbankingresearch groups,andconsultingfirmspublishforecastsoffuture demand and supply for the global containerized air and sea freight industries. The emphasis of these reports is on showing how fast the market will grow, instead of explaining theunderlyingdemanddriversthatcausestructuralchangesin the supply networks of leading manufacturers and retailers. We believe the real purpose of forecast- ing is not to predict the future — which is very difficult to do with any degree of accuracy—buttothinkaboutitinastruc- tured way and understand the linkages between different pieces of the economy and supply chain. This year we seek to change this by bringing you behind the numbers and sharing the framework that Figure 1 Demand-pull framework Source: MergeGlobal primary research. Decision flow Description Why important? • Consumer demand in destination market for consumer products • Demand of manufacturers in destination market for industrial products including components, which is driven by consumer demand eventually • Share of different types of retailers and manufacturers using different business models to meet end-user demand • Two extreme business models are low-cost mass production and responsive differentiation • It determines total demand for specific product in destination market • It determines consignee segment share of total product demand in destination market • Share of import vs. domestic sourcing by retailers and manufacturers • Sourcing decision depends on total landed costs, which include product costs, trade-related costs, transport costs, and inventory costs • It determines total imports demand for specific product by consignee segment • Share of different origin countries from which products are sourced • It is driven by total landed costs of specific product made in specific country and transported to final destination market • It determines origin country share of consignee import product demand • Import shipment size, order frequency and transport mode choice (air vs. sea FCL and sea LCL) • It is driven by importers’ business model to meet evolving end-user demand • It determines expected shipment size mix by mode and seasonality of the business • Location mix of retailers’ DCs or manufacturers’ plants/warehouses • It is driven by importers’ business model, geographic topology and inland transportation infrastructures • It determines transcontinental and inland transportation routing • Share of different regional routing and transportation modes (e.g. intact MLB, transload MLB and all-water) • It is a balance of transit time, reliability and total distribution costs • It determines regional transportation mode and routing End user demand in destination market Business model share of end-user demand Import share of total product sourcing Origin country share of import sourcing Regional destination share Routing share to regions Shipment size and modal mix 1 2 3 4 6 7 5 approach is based on the assumption that consumer or industrial demand “pulls” imports into a country to fill the shortfall in supply not met by domestic production. The ratio of domestically produced to imported supply varies across industries and specific products. But overall import share of supply has been rising in most The MergeGlobal Forecast Team comprises Brian Clancy, David Hoppin, Luis Blancas, Richard Ho- lohan and Clement Zhang. Clancy and Hoppin are managing directors of MergeGlobal, a specialist firm that provides clients in the global travel, transportandlogisticsindustrieswith services ranging from financial advi- sory to strategic consulting. This is thefirstinaseriesoffourreportsfrom MergeGlobal, with further coverage appearinginAmericanShipper’sJuly, August and November issues.
  3. 3. Behind the Numbers 10 AMERICAN SHIPPER: JUNE 2007 Figure 2 Personal consumption has expanded faster than GDP for many years Billions of constant 2000 dollars Source: U.S. Bureau of Economic Analysis. U.S. economy Personal consumption 2.5% 4.1% 3.1% 4.4% CAGR 12,000 10,000 8,000 6,000 4,000 2,000 0 1995 2000 2006 1995 2000 2006 Compound average growth rate (CAGR) between the years indicated on each graph. Figure 3 (Tables 3.1-3.7) Demand-pull based forecast of U.S. footwear consumption 3.1: After a small slowdown, consumption is expected to remain healthy over the next five years. End user demand in destination market 1 U.S. personal consumption expenditure Annual growth, percent 3.0% Forecast 3.1%3.1%3.0%3.0% 2.8% 3.2% 3.5% 3.9% 2.8%2.7% 2.5% ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 Source: U.S. Bureau of Economic Analysis and MGI Demand-Pull Model. segments. The rising share of import sup- ply as a percent of total end user demand is what we call “network shift,” and it is the key underlying driver of structural change in trade network demand patterns. Figure 1 shows the seven-step process we use to translate end-user demand for a specific product into an origin-destination product trade flow by mode and network routing. Step 1 is total end-user demand for a specific product in a destination country. End-userdemandcomprisesconsumerand industrial products and can be finished goods ready for final consumption or com- ponents that feed a product process. In step 2, business modal share of end- user product demand determines who the consignee will be for imports. In the retail sector, multiple distribution chan- nels are competing for end-user demand using multiple retail formats. Extremes include big box retailers at one end of the spectrum and high end specialty retailers at the other end. Step3istheimportshareoftotalproduct demand, and measures the competition between domestic and import suppliers. Origin country share of imports in step 4 captures the competition between countries for import demand and reflects therelativecompetitiveadvantageofeach country in terms of its ability to supply specific products cheaper than another country on a total landed cost basis. Total landed costs include product costs, ap- plicable duties, transportation costs and inventory carrying costs, and reflect the balance between lower labor costs and longer transportation length of haul and supply chain variability. Changes in rela- tivetotallandedcostsforspecificproducts between countries determine a country’s future share of origin demand for imports to a destination country. Step 5 is where shipment size and modal mix are determined for a specific import flow. Shipment sizes are a function of numerous tradeoffs between ordering costs and inventory levels, and must be considered simultaneously with mode choice. Ultimately, flows are segregated into sea full-containerload (FCL), sea less-than-containerload and air LCL, and reflect the relative unit values, economic perishability, physical characteristics and theeconomicprocessimpairmentpotential for each product. Step 6 tracks the shifts in regional destination demand for products at the destination country, and reflects shifts in distribution center and manufacturing plant locations. Step7isthelaststep,andiswhereorigin and destination demand by mode is trans- lated into specific flows over the network byassigningdemandtosupplyandsolving for equilibrium where “spilled” demand is reassigned to the next-best routing until all demand is satisfied. This requires an evaluation of the relative capacity, transit times and prices by route. In the next section, we present this analytical process at work focusing on the U.S. footwear industry. Application of demand-pull framework The best way to better understand the demand-pull framework and how it’s ap- plied is by example, and for this purpose we’ve chosen the U.S. footwear market. Again, the objective of the framework is to understandtheprimarydriversoffootwear consumption in a specific market over a period of time, rather than determining point estimates of consumption. Footwear provides a good illustrative example because it is easy to relate to, and at the end of the exercise readers should be able to judge the reasonableness of not only the forecast (e.g., pairs per person
  4. 4. Behind the Numbers 12 AMERICAN SHIPPER: JUNE 2007 More than $10.55 per kilo Less than $10.55 per kilo Business model share of end-user demand 2 FEU share vs. value share of U.S. footwear imports Via vessel and air 3.2: Big retailers will continue growing on an FEU ba- sis, but specialty stores are likely to maintain their share of imports by value. 100% 75% 50% 25% 0% Forecast High end Low to medium end ’07 ’08 ’09 ’10 ’11 ’12’01 ’04 Value share 100% 75% 50% 25% 0% ’07 ’08 ’09 ’10 ’11 ’12 Forecast High end Low to medium end ’01 ’04 FEU share 3.3: Footwear sourcing is slowly reaching its steady state.Import share of total product sourcing 3 U.S. footwear import saturation FEU, in percent 214 Domestic Imports ’01 ’04 ’07 ’08 ’09 ’10 ’11 ’12 Forecast 225 226 230 236 246 255 267 280 294 312 330 U.S. footwear consumption Thousands of FEU ’95 Forecast ’00 ’07 ’12’04 6.4 6.7 8.6 11.1 7.5 U.S. footwear consumption Pairs per person Forecast 100% 99% 98% 97% 96% 87% Imports Domestic ’07 ’08 ’09 ’10 ’11 ’12’01 ’04 per year), but also the steps we took to get there. We believe this approach is ultimately more useful than a technically sophisticated forecasting framework that produces data that are difficult to assess because of the “black box” nature of the underlying methodology. Demand-pull, on the other hand, helps usdissectthecriticaltrendsthatultimately determine consumption patterns. In so doing, it provides us with metrics that fa- cilitatetheassessmentoftheforecast.Most importantly, as we build the framework, we become intimately familiar with the factors that are most likely to affect the forecast going forward. As a result, we can dynamically adjust the forecast as new information becomes available. The first step begins with personal consumption. Personal consumption ex- penditure (PCE) has been the main engine of growth of the U.S. economy for many years (Figure 2), growing rapidly through the 1990s before pulling back in the wake of the dot-com bubble bust in 2001. Since then, PCE has recovered smartly, driven in part by capital gains stemming from booming stock and housing markets. More recently a cooling housing market and growing concerns over the U.S. trade deficit have worried economists, but most observers expect any economic slowdown to be short-lived. In fact, drilling down to a more granular level,wecanseethatfootwearconsumption in America has been very healthy, indeed. Thenumberofpairsoffootwearconsumed annually in the United States grew at an averagerateof3.4percentperyearoverthe 11-year span of 1995-2006 (slightly faster thantheeconomyasawhole).Overthepast three years, however, footwear consump- tion has really hit its stride: growth since 2003 has averaged 6.1 percent annually. Understanding the secular trends behind Source: U.S. Department of Commerce and MGI Demand-Pull Model. Source: U.S. Department of Commerce and MGI Demand-Pull Model. this rapid growth is a critical part of the demand-pull paradigm. Step2ofourframeworkbeginstosuggest thatevenintheeventofaslowingeconomy, the impact on footwear demand would likelybelimited.ThisisbecauseAmerica’s footwear consumption, like many other consumer goods, is bifurcated. Atoneendofthespectrumaremass-mar- ketprivatelabelbrandsofferedatrazor-thin marginsintheaislesofthelocalWal-Mart. Similarly, branded footwear is offered at substantial discounts by off-price retailers like TJ Maxx and Ross Stores. At the other end, original equipment manufacturers(OEMs)operateresponsive supply chains with the stated purpose of deliveringbetterserviceanduniquequality at a premium price. As it turns out, Americans want both. Consumers are happy to pay a premium for certain products that are meaningful to them, while “making up for it” by saving money at the no-frills outlets of so-called big-box retailers. In footwear, Payless ShoeSource and DSW Shoes inhabit the former end of the spectrum, while Nike, Pradaandsimilarhigh-fashion,high-qual- ity participants occupy the other. While strategically very different, these two contrasting areas of the bifurcated footwear industry share one important characteristic: they rely on offshore manufacturing and require the capability to operate extended supply chains. At the low end, nationwide retailers
  5. 5. Behind the Numbers 14 AMERICAN SHIPPER: JUNE 2007 3.5: FCL will continue to dominate the sector, but LCL and air freight will slowly gain share. Source: U.S. Department of Commerce and MGI Demand-Pull Model. Shipment size and modal mix 5 Compound average growth rate (CAGR) between the years indicated on each graph.CAGR Other Ocean FCL Ocean LCL Air U.S. imports of footwear by mode Thousands of FEU +5% +3% ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 205 218 221 227 233 243 253 264 278 293 310 329 Forecast source from a handful of countries where raw materials and labor are both abundant and cheap. China is by far the preferred origin, commanding close to 90 percent of the American imports market by weight. At the high-end, China is also the origin of choice, not only because of its cost-competitiveness but also because of the footwear manufacturing expertise China’s manufacturers have accumulated over the past 25 years. In other words, and contrary to popular belief, China’s attractiveness as a sourcing center is not onlyafunctionofcostadvantagebasedon laborabundanceandgovernmentsupport, but it also stems from how good they are at making shoes. Nevertheless, country-level share of high-end footwear production is indeed more diversified than that of the low-cost market, with Italy offering an obvious ex- ampleofaproductioncenterdifferentiated by quality, know-how and brand names. The conclusion: since Chinese costs are unlikely to experience dramatic increases over the coming years, and as experience andknowledgeofcustomertastescontinue to accumulate, the cost of footwear on a per-pair basis is unlikely to rise and hence American footwear demand is unlikely to soften — even in a slowing-economy scenario. The next two steps of the framework, Steps 3 and 4, are closely related. In the caseoffootwear,thesestagesoftheanalysis delve further into the issues of offshore manufacturing in general and of China’s growing dominance in worldwide shoe production in particular. Offshore footwear sourcing has been goingonfordecadesintheUnitedStatesin order to avoid the high landed costs associ- ated with domestic production. Going first to Japan, then to Taiwan and South Korea and, since the 1980s, to other economies such as Indonesia, Thailand and China, Asia’sfootwearmanufacturingexemplifies the region’s export-led growth “miracle.” In the meantime, imports have steadily taken share from domestically produced footwear in the United States and, though approaching the saturation level, show no signs of reversing the trend. Whatmaychange,however,isthecoun- tryshareofU.S.shoeimports.Forexample, whileChinahasrecentlyexperiencedlabor shortages and other sources of cost pres- sure, Vietnam has been firmly gaining shareofU.S.footwearimports,goingfrom effectively nothing (0.02 percent) in 1995 to almost 4 percent in 2006. Moreover, as firms diversify their supply base for risk management purposes, and supply chains become more capable of dealing with geographically dispersed nodes, China’s share of U.S. footwear imports may likely be reaching a plateau. Shipment size and modal mix have also been part of the transformation of the footwear industry as it underwent an unprecedentedbifurcationledbyconsumer preferences.Forexample,theriseofthebig retailers drove a decline in air freight use for footwear shipments during the 1990s in favor of FCL ocean freight. It would be reasonable to expect, however, that as the Country share of U.S. footwear imports Pairs, in percent 3.4: China will continue to dominate the market, while Vietnam will gain share from other nations. Origin country share of import sourcing 4 U.S. non-Chinese imports of footwear Pairs, in percent Brazil India Indonesia Italy Mexico Taiwan Thailand Vietnam Rest of the world 100% 75% 50% 25% 0% Forecast Other countries China ’07 ’08 ’09 ’10 ’11 ’12’01 ’04 100% 75% 50% 25% 0% Forecast ’07 ’08 ’09 ’10 ’11 ’12’01 ’04 Source: U.S. Department of Commerce and MGI Demand-Pull Model.
  6. 6. Behind the Numbers 16 AMERICAN SHIPPER: JUNE 2007 3.6: The West has the highest share of imported footwear traffic, primarily due to growing value-added warehousing and transload operations in that region. Source: MGI Importer Location Database. West 35% Southeast 32% Midwest 17% Northeast 16% 2007 estimated U.S. distribution center destinations of imported footwear FEU, in percent Regional destination share 6 35% 16% 32% 17% market becomes more bifurcated and as aircraft become more fuel-efficient, air freight will begin to regain share over the comingyears,albeitslowly.LCLshipments should also increase. Ocean carriers and their inland transport partners are increas- ingly interested in segmenting the ocean freight market by offering faster service at premium rates that are still much cheaper than airfreight. Faster transit times are possible not only because of newer and faster vessels, but also because of infor- mation technology systems that allow for seamless special handling of “hot boxes” at origin and destination. LCL should be particularly attractive for footwear due to the commodity’s relatively high unit val- ues, and density characteristics that favor ocean freight. Finally, regional destination share and specific routing decisions round out our understandingoftheprimarydeterminants ofU.S.footwearconsumption.Largelydue to its proximity to Asia, U.S. West Coast ports have seen unprecedented growth over the last 15 years, particularly in the Los Angeles Basin. This in turn has led to a much greater use of rail intermodal (on both ISO and, of more recent expansion, domesticequipment)asasubstituteofhigh- cost over-the-road transportation. However, the growth of the West comes at the cost of congestion in the U.S. trans- portation network. Class I railroads, for example, have asserted that redundant capacity has been completely exhausted along key routes. Railroads are aware of much-needed investments, but lead times on infrastructure projects are long, and the basic need to recover the cost of capital implies that funding sources might be insufficient. These congestion problems havebolsteredtheuseofall-waterroutesto reach the consumption centers of the U.S. East Coast, both via the Panama Canal (in the case of footwear, mainly for Chinese and Southeast Asian imports) and the Suez Canal (in the case of footwear, mainly for Indian imports). To be sure, the trends in inland routing operations highlighted above affect Asia- originatedimportsacrosstheboardalmost evenly. But a closer look at footwear and its intrinsic characteristics might reveal commodity-specific patterns that are of interest to the demand-pull analyst. For instance,footwearisa“staple”commodity consumed in every household. In fact, an average of 7.3 pairs per person were con- sumed annually in the United States over 2000-2006, according to U.S. Commerce Department figures. This implies that the endU.S.destinationoffootwearshipments is likely to closely match the geographi- cal distribution of both population and retail sales. Thus, the mini-landbridge vs. all-water split of ocean shipments of foot- wear should be expected to be close to the national average across all commodities. Moreover, the dominance of nationwide retailers in the sector, the relatively high value per pair, and the reliance by many footwearshippersonvalue-addedservices such as bar coding and labeling all point to an expected high incidence of transload operations at West Coast ports relative to that of other commodities. Figure3presentsourdemand-pullbased forecast of U.S. footwear consumption for 2007 to 2012. Point estimates — rarely ac- curateregardlessoftheforecastingmethod used — are in this case the result of a logi- cal chain of analysis that takes us from the end customer back through the value chain to the original producer. As a result, the forecastanditsunderlyingdrivers,aswe’ve outlined,areeasiertounderstandand,most importantly, easier to assess. In addition, the framework equips the analyst with a short but meaningful list of “sources of impact” that can be men- tally traced as he reacts to news and data from trade publications, competitors’ actions, primary research, public policy announcements, and the general press. In short, the demand-pull derived forecast is actionable. Demand-pull characteristics for major commodity groups Having applied the demand-pull con- ceptstoaspecificindustry,wecannowgen- eralize the framework to other industries, bothintheconsumerandindustrialproduct categories. We will do so by examining the primarydemanddriversforthemajorcom- moditygroupstradedbetweenAsiaandthe United States. Our thought process at each step is summarized in Figure 4. Furniture. The broad furniture com- modity can be broken into two categories, office and residential, and as the names suggest,thegoodstypicallyendupineither an office or a home. Consequently, real estate trends serve as a primary driver for furniture demand, which in turn tends to correlate with broader economic activity: as the economy grows, new homes and offices are built, and those structures need to be furnished. Lowinterestratesandavibranteconomy have led to a boom in new home and office spaceconstruction,drivinganextendedrun of greater-than-GDP growth in furniture consumption.Layeredontopofthiscyclical growth are unique secular trends as well. For residential furniture, the trend toward increased ownership of ever-larger homes has added to the already strong cyclical trends. Office furniture demand has been enhanced by the continued evolution of the U.S. economy from manufacturing- centric to increasingly white-collar and service-centric. Furniture retailing has also morphed. Competitors such as Rooms To Go have employed innovative business models that source heavily from Asia and use regional distribution centers to stage merchandise for relatively rapid order fulfillment. Other, vertically integrated retailers such as Ashley Furniture have rapidly shifted production to China and now actually own facilities there. These retailers’ efforts to re-engineer their supply chains have en- abled them to take advantage of China’s low production costs and Chinese imports to satisfy a rapidly increasing share of domestic U.S. furniture demand. Furniture has seen one of the most dramatic shifts of sourcing over the past
  7. 7. Behind the Numbers 18 AMERICAN SHIPPER: JUNE 2007 10 years, with imports now comprising nearly 40 percent of all furniture con- sumed in the United States, and China as the main beneficiary. The labor-intensive nature of furniture manufacturing made it particularly well-suited for import substi- tution. Further, China has ready access to furniture’srawmaterials:hardwoodtimber, steel, textiles and plastics. The exodus of furniture manufacturing from the United States occurred after China had “arrived” in international trade (using its December of 2001 admission to WTO as a rough esti- mate of its “arrival”). As a result, furniture manufacturing never made the intermedi- ate stop in other Asian or Latin American countries,andtheincreasedtradehasnearly all accrued to China instead. U.S. destinations for furniture follow population distribution patterns, with greater growth in regions that are grow- ing their population share (such as the Southwest) versus those that are losing population share (such as the Northeast). A unique characteristic of furniture trans- port is a higher level of all-water service to East Coast destinations versus intermodal transit by way of West Coast ports, in order to minimize handling that can lead to damage. Apparel. Domestic apparel shares simi- lar demand characteristics with footwear, driven by personal consumption and a divide into two categories: lower cost, mass-produced clothing and higher-value, fashion apparel. By weight, domestic per capita con- sumption of apparel has grown at about 1 percent per year since 1995. However, the per capita dollar value of apparel has actually dropped by more than 1 percent peryear,illustratingthedeflationaryeffect cheaper imports are having. Import penetration has largely reached full saturation, with about 86 percent of domestic apparel consumption originat- ing overseas. However, country shares of importsareshiftingsignificantlyfollowing theexpirationoftheMultiFiberAgreement in 2005. MFA was a trade agreement that setU.S.apparelimportquotasforindividual countries, and had the effect of artificially fragmenting production among many na- tions in order to avoid exceeding these import quotas. When it expired in 2005, production began to shift to China from relatively higher cost countries in Latin America and elsewhere in Asia. Recently, apparel retailers have focused on becoming more responsive to shifts in styles and fashion, with meaningful impli- cations for the modes of transport that are used.Forexample,severalapparelretailers make use of deconsolidation facilities lo- catednearWestCoastports,allowingthem todelayfinalshipmentallocationstostores orregionsuntilafterthetwo-to-three-week ocean transit, and therefore two to three more weeks of visibility into customer buying patterns and inventory levels. Aswithfootwear,apparelretailingbusi- ness models have largely bifurcated into high-endmodelsfocusedonflexiblesupply chains that can respond quickly to chang- ing tastes and styles, and low-end models focused on achieving the lowest possible deliveredproductcostsbyleveragingscale. This has led to a variety of supply chain prescriptionsrangingfromFCLoceanship- mentsmovedintacttoregionaldistribution centers, to the use of high-cost air freight to minimize response time to last-minute shiftsinconsumertastesaroundtheChrist- mas season. Hybrid solutions have also proliferated incorporating ocean freight, in order to minimize transpacific transit costs, and deconsolidation facilities on the West Coast in concert with expedited LTL service, in order to maintain flexibility in inventory balancing. Computers And Components. De- mand for computers has both a personal consumption component and a business investment component. A high-growth commodity for years, the segment saw a significant slowdown in 2001 and 2002 as businesses postponed new purchases. But demand rebounded quickly as increased processor power and lower prices spurred demand for data processing equipment. Recently the rollout of Microsoft’s new power-hungry operating system, Vista, has started a new hardware upgrade cycle that should bolster personal computer shipment growth for the next one to two years. Computer sales growth will remain subjecttoeconomiccycles,particularlythe corporate component. But secular growth willoutpacebroadeconomicgrowthdriven bycontinuedexpansionoftheservicesector and software technological innovation. For years, Dell has been considered the best-in-class retailing model for personal computers: direct sales are driven through its Web site and desktop computers are built to order at U.S. assembly plants from imported components delivered through a tightly knit supply chain. More recently, laptops have taken share from desktops, emphasizing a distinct supply chain structure. Because laptops typically involve less customization and lend themselves to expedited air freight Source: A: U.S. Department of Commerce and MGI Demand-Pull Model. Source: B: MGI Network Flow Model. A: U.S. ocean imports of footwear, by coast of access FEU, in percent Routing share to regions 7 Forecast 100% 75% 50% 25% 0% ’95 ’00 ’07 ’12 West East & Gulf 3.7: Over the coming years, all-water services and West Coast transload routings are likely to take share from intact mini-landbridge routings. MLB 42% WC local* 23% All-water 23% WC transload 12% 12% 23%* 23% 42% *WC local includes local intact moves, as well as local transload operations. B: 2007 estimated routing share of U.S. imported footwear FEU, in percent
  8. 8. AMERICAN SHIPPER: JUNE 2007 19 Behind the Numbers (because of their small size relative to their value),finalassemblycanbeaccomplished by manufacturers such as Quanta in China and then shipped either to a distribution center for repackaging or even directly to the consumer. Imports represent most of the comput- ers consumed in the United States, having largelyreachedsaturationlevelsintheearly 1990s. However, here again China is tak- ing an ever-larger share of the import pie from other Asian nations such as Korea and Japan. Thefinaldestinationsofcomputership- ments are also changing, affected by the shifting mix of laptops versus desktops, and the sales channels that are used to deliver them. ConsumerElectronics. U.S.demand forconsumerelectronics,epitomizedbythe ubiquitous iPod, has also grown at levels well above domestic GDP. New technolo- gies such the mp3 music format and the proliferation of wireless data products continuallydrivedemandforthenext“gad- get.” In many ways, consumer electronics demandmirrorsthatfortheretailsideofthe personal computer market (i.e. excluding the more cyclical corporate component), though typically at lower price points and through a broader product variety. Sales channels for consumer electronics have shifted over the past 20 years, first fromspecialtyshopstobroadlineretailers, and from broad line retailers to “category killers” such as Best Buy and Circuit City as well as purely Web-based retailers like Dell and Amazon. Like computers, imports account for nearly all of U.S. consumer electronics consumption and import penetration reached its saturation point more than a decade ago. However, country shares are shifting,havingalreadymovedfromJapan to the Asian Tigers in the 1990s and now increasingly moving to China. Since the end of the go-go tech bubble of the late 1990s, transpacific transport has seen a significant shift from air to ocean as large retailers, laser-focused on squeez- ing costs from the system, have increas- ingly downgraded the service level of their freight. Routing has remained primarily through West Coast ports though. Auto Parts. Automotive parts can be thought of in two categories, components for new cars and replacement parts for ex- isting cars, the former being significantly more cyclical than the latter. During the 2001-2002 economic slowdown U.S. auto- makers, desperate to prop up sales, offered free financing and other sales incentives across their product lines. While the ini- tiatives worked temporarily, they did not addressthefundamentalcostdisadvantages of U.S. manufacturers. Several years later, and in dire finan- cial straits, the U.S. auto manufacturers are putting enormous pressure on their suppliers to reduce costs, and their sup- pliers, in turn are looking to China. We are only recently seeing the first signs of what may be a major shift in auto parts sourcing from domestic manufacturers to overseas providers. In order for auto manufacturers to tap the low-cost labor pool in China, however, specialized transport services will need to be used to ensure time-definite delivery. This must involve the use of ocean freight service, to maintain the cost advantage gained through sourcing from China. And once the parts arrive at the domestic port, an expedited ground service must be employedtoavoidtheunpredictabledelays that have plagued the western intermodal rail networks in recent years. In addition, all-water service to less
  9. 9. Behind the Numbers 20 AMERICAN SHIPPER: JUNE 2007 congested port complexes like Savannah, Ga., will likely be very competitive for parts bound for U.S. Southeast assembly plants. While still in the early stages, the auto parts segment is expected to be a major source of import growth over the next several years. Industrial Machinery. Of the com- modities discussed here, industrial ma- chinery is unique in that it is the only one driven primarily by corporate investment rather than consumer demand. Clearly, there is a derivative element of consumer demand, but orders for new industrial machinery are more directly associated with lumpy increases in industrial capac- ity — a new production line or a new plant — than with the ebb and flow of consumer demand. As such, industrial machinery tends to show the most cyclicality of the traded goods examined here. While changes in industrial business models are not as obvious to the casual observer as, say, the rise of Wal-Mart and Amazon, innovations such as lean or just-in-time manufacturing can have a meaningful impact on the level of import penetration. JIT processes, for example, depend on having components on hand when they’re needed, and supply chains that extend across the Pacific have been thought of as incompatible. As a conse- quence, imports represent a relatively small percentage of domestic industrial equipment consumption. However,therearesignsthatthingsmay be changing. Intense global competition is forcing manufacturers and industrial serviceproviders—thepurchasersofsuch equipment — to examine and optimize every element of their cost structures. And Source: MergeGlobal primary research. Figure 4 Demand-pull characteristics of major commodity groups Import demand driver Apparel Consumer electronicsFurniture • Unit price deflation is stimulating demand in all product categories • Customers upgrading to flat-panel TVs and other appliances • Near-term growth slowing due to housing market slowdown • Long-term growth strong End user demand in destination market 1 Business model share of end user demand 2 Import share of product sourcing 3 Origin country share of imports 4 U.S. region destination mix (DC locations) 6 Routing/service level share 7 Shipment size and modal mix 5 • Specialty big box retailers like Best Buy continue to take share from traditional channels • Bifurcated market with high price branded products and low cost private labels controlled by large retailers • High-end products • Nontraditional manufacturers like Ashley and Rooms to Go taking share • Import sourcing has been 70% of total demand • Key change will be retailers taking control of inventory upstream • Already high, and will continue to rise• Import sourcing increased significantly in last few years • China, Malaysia, Korea• Quota sunset is causing dramatic shift in origin country shares where China has captured majority of incremental growth • China is largest import source and furniture is single-largest commodity • Southeast Asia also continues to be key supplier market • Combination of ocean FCL and LCL; Air freight LCL used for both strategic and operating purposes • Combination of ocean FCL and LCL; Air freight LCL used for both strategic and operating purposes • Primarily ocean FCL due to unit value and density characteristics • DC locations driven by population concentrations • Apparel is large user of deconsolidation on West and East coasts • DC footprint varies by competitor • Traditional manufacturers still clustered in the Carolinas • Heavy flow through West coast ports • Products with high value density, such as iPods, will still move by expedited air, but medium value density products, like flat panel TVs are increasingly moving by ocean • Apparel will continue to flow to eastern DCs via MLB off West coast deconsolidation for large retailers • All-water to Gulf Coast, South Atlantic and North Atlantic port range preferred to avoid damage and high MLB prices • Volume growth in line with population growth • Demand growth in terms of value will stabilize and begin to rise slowly (vs. recent declines), as import saturation is reached and the defla- tionary effect of import substitution subsides.
  10. 10. AMERICAN SHIPPER: JUNE 2007 21 Behind the Numbers as a result obstacles to overseas sourcing are slowly being overcome primarily by better supply chain collaboration. Boeing is a case in point. Both compo- nents and fully assembled sections of its next-generation787Dreamlineraircraftare shippedtoafacilityinEverett,Wash.,from around the world. The key to coordinating such a complex supply chain has undoubt- edlybeenthetechnologicaltoolsthatallow for seamless communication among sup- ply chain partners. This strategy is likely to encourage manufacturers of much less sophisticated industrial machinery to look for cutting costs by going global, just as consumer product manufacturers have done for decades. ‘It is better to be roughly right than precisely wrong’ In spite of advances in highly techni- cal econometric sciences, John Maynard Keyneswordsarenolessapttodaythanthey weremorethan60yearsago.Forecastsrarely provideahighlyaccurateviewofthefuture, but they can serve to help us understand the reasons why certain things are more likely to unfold one way rather than another. Trade forecasts are no different, and we have attempted to show, by example, the logical mechanics behind our own efforts in this area. When these assumptions and their linkages to the output are better un- derstood, the forecast becomes dynamic and more useful as a tool for evaluating unanticipated events. Over the years, we have come to believe thatwhilepointestimatesareoftenthefocus ofattentioninforecasts,theirtruevaluelies inthethoughtprocessesbehindtheassump- tions. We hope the reader will agree. ■ Industrial machinery • Upgrade cycle underway in consumer and business markets stimulated by Microsoft Vista release • Unit price deflation continues and laptop share continues to climb • Historical growth constrained by intellectual property concerns and JIT manufacturing time-definite delivery requirements • Prospective growth accelerating as pricing pressures force increased overseas outsourcing Auto partsComputers & components • Near-term demand to slow with rising interest rates • Long-term demand will continue • Dell undergoing a radical rethink on product, channel and logistics strategy • Industrial manufacturers are experimenting with longer supply chains in order to enable more cost-competitive components • U.S. industry restructuring is several years from completion • Product line and component sourcing strategy expected to change • Low value components have been sourced offshore for years • Intel is increasing building fabrication capacity in China • Historical import shares have been constrained by intellectual property concerns and time-definite delivery requirements of JIT manufacturing systems • However, price pressures driven by overseas competition are forcing manufacturers to increase overseas sourcing • Offshore sourcing of certain components expected to increase significantly • Large share shift of component manufacturing from southeast Asia to Shanghai over last couple of years • Laptop assembly is almost exclusively in China, with the notable exception of Dell in Ireland and Malaysia • Remaining assembly in U.S. may ultimately move to China • China is best positioned to capture significant share in this vertical • Concerns over intellectual property remain an obstacle, but modularization and competitive pressures will reduce the perceived relative risk • China will experience large increase in component demand from U.S. manufacturers • Brazil will also continue to increase share of U.S. imports • Combination of ocean FCL and LCL; Air freight LCL used for both strategic and operating purposes • Mostly ocean FCL in combination with time-definite inland transport; Air freight used only to meet operating challenges • Mostly ocean FCL in combination with time-definite inland transport; Air freight used only to meet operating challenges • Final product distribution patterns similar to those of consumer electronics • Component distribution driven by final assembly plant locations (e.g. for Dell: Austin, Texas; Lebanon, Tenn.; Winston-Salem, N.C.; Oklahoma City, Okla.) • Upper Midwest manufacturing and assembly facilities • Southeastern U.S.are where most recent auto plants have been sited • Significant but less concentrated flows to areas for natural resource extraction, such as the Gulf Coast (energy) and the Pacific Northwest (paper and timber) • Primary destinations are assembly plants and footprint is relatively stable • Recent auto assembly plants have been sited mainly in the U.S. Southeast • Progressive downgrading from air to ocean. • Computer components through Dell’s supply chain move intact intermodal to VMI hubs. • Other computer makers assemble in Asia, and move smaller lots of finished products to retailers’ or their own warehouses • Routing is likely to follow a pattern similar to new car parts and components: heavy flows to Midwestern and Southeastern manufacturing locations • Time-definite delivery will be an important factor in determining service level and modal choice • Components for new cars will follow relatively concentrated routes, generally to assembly plants in the Midwest and Southeast. Time-definite delivery will be an important factor in modal choice/service level. • Spare parts follow more dispersed inland distribution patterns, similar to retail goods

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