North America terminal operators will be under financial pressure in 2023. We expect container terminals and container operators’ margins will be eroded in the next two quarters, in part due to ancillary revenue being reduced in tandem with excessive SG&A, other fixed costs, and large CapEx pipelines which have been historically hard to shed.
In this article, we discuss the key recent trends in the container shipping industry, the findings of our recent survey with AlixPartners importer/exporter clients, and the implications for terminal operators and container carriers.
Things goin’ on
Today’s North American container terminal operations are a far cry from what many saw as the record-breaking profit machines of 2020 and 2021. Elevated volumes coupled with constrained supply chains resulted in two profitable years with unprecedented results for these companies’ financials, as we explored in AlixPartners’ 2022 Container Shipping Outlook.
During that time, port operators dealt with substantial fluctuation in volume, overwhelming congestion at their sites, vessel backlogs, equipment and labor shortages, as well as multiple bottlenecks throughout the inland supply chains. When we look at what 2023 could bring to this industry, our outlook returns a much different scenario, estimating a potential flip in the supply-demand mismatch as soon as 2023. It’s looking more and more like we got that forecast just about right.
As COVID-related restrictions began to expire, we have observed softer cargo volumes across several marine trade lanes, as the National Retail Federation forecasts declining US imports at least for the next several months as the current inflationary market has slowed down overall consumer discretionary spending. Likewise, US imports from Asia have declined in recent months, and are likely to continue declining into 2023 if the ILWU and West Coast terminal operators fail to reach a contract agreement in Q1 2023 after eight months of ongoing negotiations.
In that context, we recently attended the Containerization & Intermodal Institute conference in December 2022, where we heard a somewhat similar sentiment from terminal operators, container handlers, and 3PL executives around potential erosion of container volumes and non-core revenue entering 2023. This sentiment appears to be anchored on the continuing pressure on global seaborne trade volumes coupled with push back on accessorial costs. In our conversations, we were able to further understand what trends appear to be driving specific sectors like consumer goods and industrials, and what larger players are requesting from their operators and freight forwarders.
With that in mind, we have reached out to a sample of AlixPartners clients to investigate the other side of the value chain. More specifically, we set out to understand how these companies managed their container volumes and accessorial costs in 2022 relative to 2021, and what are the expectations coming into 2023.
To assess these areas objectively, we elected three dimensions for our survey that contrast 2022 and 2021 and one that looks forward into 2023, gauging their expectation around detention and demurrage cost in comparison to their 2022 expenses:
- Time containers are stored at port (2022 v. 2021)
- Time containers kept outside port (2022 v. 2021)
- Total detention and demurrage cost (2022 v. 2021)
- Expected detention and demurrage cost (2023 v. 2022)
Don’t ask me no questions!
Well, that is exactly what we decided to do. We observed that operators’ non-core revenue went up during COVID-19 in 2020 and 2021. Two factors appear to have driven this increase: (i) Beneficial Cargo Owners (BCOs) were not fully equipped to turn their operations around during the COVID pandemic, often relying on urgent loads and ship-to-order strategies; (ii) the widely reported supply-demand mismatch for logistics services, including container shipping and handling.
When it comes to surveyed companies, respondents span across five major sectors that are heavy users of import/export services and operators: Consumer Products (40% of respondents), Retail (27%), Industrials / Manufacturing (20%), and Transportation (14%).
Observing the survey results, the overall sentiment in the industry appears to be pessimistic from a container volume and accessorial revenue perspective. Container Storage Time – a key metric for demurrage and detention revenue – has shown sequential erosion between 2021 and 2022, 38% of respondents indicating shorter time spent at the port in 2022 versus the previous year, and 56% indicating shorter time spent outside the port (see Figure 1). Additionally, the amount of spend with Container Demurrage and Detention Cost seems to have decreased between 2021 and 2022 at 63% of respondents, with expectation of accelerated decline in 2023 (Figure 2).
While many factors drive the observed behavior, the reasons identified in the survey commentary can be categorized in three areas:
- Effort to renegotiate base freight rates and accessorial rates and terms (i.e., free days) with container operators, 3PLs, multimodal providers, and freight forwarders
- Effort to improve operational efficiency through better load consolidation, better freight planning (thus mitigating the effect of expedited shipments and urgent loads), or change in trade lanes and lane mix, ultimately resulting in less overall volume in the network
- Effort to improve operational agility, enhancing internal processes, leveraging data to improve visibility, and implementing a stronger diligence to take containers out of the ports faster and – upon reaching its destination – unload and revert the container as quick as possible, thus potentially avoiding unnecessary detention and demurrage fees.
Gimme three steps
With the perspective described above and the expected decline in ancillary revenue coming into 2023 (either from reduced volume or reduced rates), we understand that terminal operators can adopt three basic strategies to help insulate their financials from these ongoing trends:
1. Improve operational efficiency.
- Moving away from 2021 and 2022 also means leaving behind the overwhelming congestion observed at North American ports, which did not operate as efficiently under an unexpected volume surge. Terminals in the West Coast were particularly affected by low yard and gate productivity in face of extreme utilization (i.e., above 85%), which either generated or catalyzed crew overtime, low equipment availability, limited planning visibility, longer wait times, and even operational issues such as shrinkage and maintenance overload.
- Moreover, while container yards and gates effectively act as lungs to the operational body, we also see opportunity for container terminals to invest time and effort on marine, rail, and maintenance operations, ensuring they are well planned and as productive as possible since those are large drivers of labor cost. Lastly, while the expected decrease in volume might have an impact in the overall operation of terminals and 3PLs, these companies must use this opportunity as a window to boost operating metrics back up to pre-Covid levels and unlock cost opportunities, which should mitigate some of the EBITDA erosion in the horizon.
2. Avoid non-strategic CapEx commitments.
- The current inflationary environment, coupled with high capital costs, an ever-increasing labor cost, and risks of strikes makes infrastructure investments even more financially challenging. We see successful operators investing time into adequating their cost base for the next 12 months rather than committing to a pipeline of large CapEx trenches such as berth expansion and equipment acquisition, for example. Areas such as maintenance, utilities, direct and indirect procurement, and SG&A should be key targets on the agenda for 2023.
3. Hold onto specialized niche services or markets.
- A potential hedge against rate fluctuation and ancillary revenue erosion might lie in service specialization, as operations tend to be more reliant on additional charges such as transloading, demurrage, and detention. However, as evidenced by our survey, large shippers might have ongoing initiatives to mitigate such operational constraints through their own internal decisions and process improvements, which makes this not a long-term solution. All in all, developing value-added services such as express gate lanes and improved yard visibility for pick ups can be profitable avenues for operators looking to differentiate themselves from peers on the same coast or region in 2023.
I know a little
Of course, the strategies above are not mutually exclusive. It’s crucial for terminal investors and owners to know specifically where their competitive strength lies, and to determine whether their challenge is to begin making initial efforts and investments or to double down on previous moves so they can fully exploit the opportunity to improve the business.
For most investors, the bottom line is that there’s still plenty of opportunity to create value in this market despite the changes that have reshaped the industry in recent years and the potential obstacle we’re seeing on the road. These phenomena are nothing new to the shipping and terminal industry, but it might require active work after two years of overearning and overspending during a disruptive pandemic. It will require sharp analysis, difficult choices, and a commitment to rigorous, disciplined execution. And although it might not be good news for terminal operators worldwide, it is something that should be planned for and addressed now.
Now after reading this, what do you think. Were we right or wrong?