Air Cargo Industry Andreea Popescu, Pinar Keskinocak, and Issam Al Mutawaly

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208 | Intermodal Transportation: Moving Freight in a Global Economy 7

The Air Cargo Industry Andreea Popescu, Pinar Keskinocak, and Issam al Mutawaly

7.1 Introduction

Air cargo is defined in North America as anything other than persons or per- sonal baggage traveling by air. Compared with other means of freight transportation, such as ship, rail, and surface vehicles, air cargo is the newest addition to the freight sector. Since its start just after World War I, the air cargo industry has become an indispensible part of the world’s global economy, holding an important niche in the transport of lightweight, high-value commodities. Us- ing the infrastructure largely put in place by public agencies for air passenger travel, such as airports and air traffic control systems, air cargo services con- nect to almost all parts of the world. This chapter examines the characteristics of the air cargo industry. Section 7.2 describes the historical development of air cargo services and the role they play in today’s world. Section 7.3 describes the major players and the different business models found in the air cargo industry. Section 7.4 presents key de- scriptors of the air freight network and service characteristics, such as the use of major hubs and different aircraft types. Section 7.5 discusses the economic importance of global trade to the industry, with Section 7.6 discussing the different elements of successfully managing air cargo. Section 7.7 presents different global events that have shaped the industry. Section 7.8 identifies current challenges, and the final section identifies potential research topics on issues of importance to the air freight industry.

© 2010 Eno Transportation Foundation. www.enotrans.com | 209 Reprinted from Intermodal Transportation: Moving Freight in a Global Economy. 210 | Intermodal Transportation: Moving Freight in a Global Economy

7.2 History of Air Cargo

Although limited air freight services were tried prior to World War I, it was not until the end of the war that such services were first offered in any significant way. Primarily due to the availability of surplus airplanes and trained military pilots, most of those early commercial services were made possible by subsidies provided by national governments, most directly by postal services. Allaz (1) notes that four important lessons arose from these early years of air freight services, as follows:

• Military aircraft were not suitable for commercial air service. Although the cost of purchasing surplus military aircraft was very low, the maintenance costs, especially for engines, were prohibitively high.

• Safe air travel during this period needed infrastructure—e.g., airfields, traffic control systems, weather services, marshalling yards. Very little of this was in place.

• The transport of mail was the major, if not the only, source of income. From 1919 to 1939, post offices around the world provided commercial aviation companies with more than half of their revenues.

• Commercial aviation was not a profitable business unless government subsidies or favorable postage rates were used to prop up the service.

Although there were similarities between how air cargo developed in Europe and the United States, there were also some important differences.

7.2.1 Europe

In Europe, civil aviation grew rapidly after the end of World War I, fueled primarily by demands from national postal services. The first cargo-only, scheduled commercial air company began service between Paris and Lille (France) in July 1919. Aircraft that transported passengers during the day were often used for mail and freight transport at night. Lufthansa, founded in 1926 in Ger- many, started dedicated air freight services in 1928. Great Britain, France, and the Netherlands still had colonies during the 1900s, which gave their governments a vested interest in maintaining reliable and relatively fast connections. However, a government study in Great Britain in 1923 concluded that a myriad of smaller companies were not economically suited to fulfill the national goal of linking all parts of the empire into one air transportation network. With the promise of major subsidies, many smaller airlines agreed to merge, forming Imperial Airways Limited. Imperial Airways soon operated in all corners of the British Empire, transporting mail and goods between London’s Croydon Airport and destinations such as Cairo, Sydney, The AIR CARGO Industry | 211

Delhi, and Basra. In 1939, after the outbreak of World War II, Imperial Airways was nationalized and merged with British Airways Limited to form a new airline, British Overseas Airways Corporation (BOAC), a predecessor of today’s British Airways. Because European governments considered air cargo a matter of national security and sovereignty, those airlines starting as private entities were eventu- ally nationalized. They would not be privatized until the 1980s, ushering in an era of alliances and mergers.

7.2.2 United States

In the United States, the first practical demonstration of air freight transportation took place in 1910, when a department store shipped a bolt of silk by air from Dayton to Columbus, Ohio. (2) The first dedicated air postal service operated by the US Army began in July 1918 with service between Washington, DC, Philadelphia, and New York City. In 1924, the US Postal Service inaugurated the first transcontinental postal service, connecting New York City to San Francis- co. The trip took 34 hours and 45 minutes in one direction, and 32 hours and 21 minutes in the other (by comparison, the fastest train serving the same cities took 91 hours). Similar to the experience in Europe, postal service was the foundation of air freight in those early years. The rapid growth in air mail service is evident in the number of letters carried by airplane; in 1918, 713,240 mail pieces were transported; by 1927, the number had skyrocketed to more than 22 million. Between 1926 and 1934 the aviation network in the United States changed dramatically. From a service almost exclusively used for the transport of mail, the air network system evolved into the largest passenger and cargo network in the world, served by a few airline companies. The Air Commerce Act of 1926 is often considered the foundation for a continental air cargo system. This act established regulations concerning the licensure of pilots, standardized the rules for air traffic control, and specified the varying roles of airports in a national system. By the start of World War II, the US air transport system was the largest in the world, handling more than half of all global passenger trips and just over one-third of mail traffic. On December 23, 1940, United Airlines inaugurated what many historians consider the first all-cargo service in US history. United used a Douglas DC-4 aircraft to deliver mail between New York and Chicago for five months before canceling the route. Freight went back to being a sideline operation until March 14, 1941, when Air Cargo, Inc., was formed by the “big four” airlines—United, American, TWA, and Eastern. By the end of the war, many airlines (including United and TWA) had begun their own commercial air freight services. Realizing the likely importance of global aviation after World War II, President Roosevelt hosted in 1944 an international conference on civil aviation, the result being an internationally agreed upon set of principles and 212 | Intermodal Transportation: Moving Freight in a Global Economy

rights for civil aviation in the post-war environment. This agreement, often referred to as the Chicago Convention, created the International Civil Avia- tion Organization (ICAO), defined standard approaches to international air navigation, and affirmed the rights of countries to protect their own interests in granting landing rights. By the late 1940s, the air freight market was dominated by established passenger carriers. The airlines that formed Air Cargo were particularly worried that small-time operators such as Slick Airways and Flying Tiger Line would destabilize the commercial aviation sector by offering irregular services at low rates. Through the late 1940s, the smaller operators, the established carriers, and the government’s Civil Aeronautics Board (CAB) debated how to award contracts and set proper rates for freight transport. In August 1949, CAB gave permission for four all-freight airlines to operate: Slick, Flying Tiger, US Air- lines, and Airnews. (2) US Airlines quickly folded after a series of accidents and the threat of bankruptcy. Similar circumstances caused Airnews to go under in June 1951. Slick Airways sustained moderate growth for a time before shutting down due to the airline’s inability to compete with big passenger airlines that had introduced all-freight services. Slick Airways cited the government’s lack of support for all-freight airlines as a contributor to the company’s downfall. Flying Tiger fared incredibly well compared with its competitors; by the mid-1960s Flying Tiger was earning a $20 million annual profit. Flying Tiger’s success was attributed to its business model, which had diversified its market share, and to favorable CAB judgments. (2) In the 1970s, a new airline revolutionized the air freight business. Fred Smith, now the chairman, CEO, and president of FedEx, had the vision of an overnight delivery service. He was the first to recognize the opportunity pre- sented by an all-in-one cargo transportation service that would eliminate the need to combine freight with passenger traffic, which in his opinion slowed down cargo delivery. Smith set up his headquarters in Memphis, Tennessee, and the Memphis International Airport became the hub for his exclusive freight air delivery service. One of the most important selling points was his guaranteed next-day delivery. FedEx reported revenues of $1 billion in 1983, an unheard of amount for a company that had existed for only 10 years. It is now the largest overnight express delivery company in the United States. (2) Figure 7-1 summarizes the historical trend of scheduled air freight activity in freight ton-miles since 1954 in the United States. In 2002, air cargo accounted for 7.4% of the value, 0.1% of the weight, and 0.3% of the ton-miles of commercial freight activity in the United States. (3) Although this percentage is relatively low, air freight plays a particularly important role in moving freight quickly over long distances. In fact, the majority of freight tons moved by air is transported 750 miles or more. Table 7-1 summarizes the value, tons, and ton- miles of air cargo moved by distance. The AIR CARGO Industry | 213

➤ Figure 7-1 trend in domestic scheduled air freight activity in the United States (ton-miles), 1954–2004

35,000,000

30,000,000

25,000,000

20,000,000

15,000,000

10,000,000 eight ton-miles (000s) Fr 5,000,000

0 1954 1960 1966 1972 1978 1984 1990 1996 2002 2004 Year

SOURCE: www.bts.gov/programs/airline_information/air_carrier_traffic_statistics

Due to the globalization of trade, the rise of e-commerce (transactions con- ducted over the internet), and the increasing use of advanced logistics techniques, the air transportation of freight has become part of our day-to-day activities. Different business models have arisen to better address the growing demand for air cargo services, as will be discussed in the next section.

7.3 Major Players with Different Business Models

The major players in the freight value chain are shown in Figure 7-2, which includes the integrated carriers and nonintegrated services (forwarders and airlines). Goods transport starts with the shipper. When the shipper contracts with a freight forwarder, the forwarder arranges the entire transportation chain, from door-to-door (shipper to consignee). The freight forwarding company is responsible for arranging all transportation segments (air, road, sea, or rail), processing and preparing the necessary documents to ensure compliance with all legal and customs requirements, and advising shippers on, or arranging, the packaging of transported goods. Freight forwarders are typically non- asset-based and therefore rely on carriers for the physical movement of goods. They may contract with trucking companies for road feeder services (RFS) to move the freight between the shipper and the airport. At the airport, the airline’s handling provider (in-house or outsourced) re- ceives the goods and documentation. After inspecting the freight and verifying that it is ready for air carriage, the handling company loads the containers and builds pallets (i.e., consolidates items onto pallets), delivers the containers and 214 | Intermodal Transportation: Moving Freight in a Global Economy

➤ Table 7-1 Shipment characteristics by distance shipped for the United States (2007)

Value Tons Ton-miles Number (million Number Number dollars) Percent (thousands) Percent (millions) Percent Air Total (includes truck and air) 252,276 100.0 3,611 100.0 4,510 100.0 Less than 50 miles 23,608 9.4 150 4.2 70 1.6 50 to 99 miles 4,233 1.7 40 1.1 26 0.6 100 to 249 miles 19,394 7.7 589 16.3 208 4.6 250 to 499 miles 40,548 16.1 857 23.7 540 12.0 500 to 749 miles 24,797 9.8 259 7.2 217 4.8 750 to 999 miles 29,328 11.6 230 6.4 239 5.3 1000 to 1499 miles 40,178 15.9 443 12.3 687 15.2 1500 to 1999 miles 40,050 15.9 369 10.2 706 15.7 2000 miles or more 30,149 12.0 673 18.6 1,819 40.3 SOURCE: US Department of Transportation, Research and Innovative Technology Administration, Bureau of Transporta- tion Statistics and US Census Bureau, 2007 Commodity Flow Survey. Sector 00: CF0700A11: Geographic Area Series: Shipment Characteristics by Commodity by Mode by Distance Shipped for the Untied States: 2007. factfinder.census.gov/ servlet/IBQTable?_bm=y&-fds_name=EC0700A1&-geo_id=&-_skip=100&-ds_name=CF0700A11&-_lang=en. Accessed December 20, 2010.

pallets to the airplane, and loads them into the airplane. The air cargo carrier is responsible for the airport-to-airport transportation. Carriers may act as all- cargo operators (e.g., Cargolux) or may carry both passengers and cargo (e.g., Delta Airlines, KLM). At the destination, the carrier makes the air freight available to the forwarder’s representative for road feeder service to the consignee, the ultimate re- cipient of the goods. Once the package is successfully delivered to the consignee, the supply chain process is complete. The role of intermediaries is very important in the air cargo supply chain since each step in the process depends on the successful completion of the previous step.

7.3.1 Cargo-Only Carriers

Cargo-only carriers often fly freighters, which are passenger aircraft that have been altered for cargo operations. Freighters have no seats or windows in the main cabin. They have larger doors than aircraft configured for passenger service and reinforced floors. Many are fitted with rollers to facilitate the loading of heavy items. Many modern freighters also have hinged tails or noses that allow for straight-in loading of large items. Cargo-only carriers generally operate widebody airplanes from one major airport to another. Approximately 10% to 15% of world air cargo traffic is moved by cargo-only carriers, primarily on long-haul international or transcontinental routes. The AIR CARGO Industry | 215

➤ Figure 7-2 door-to-door air freight value chain

Customer- Airport- Airport- airport to-airport customer Origin interface (A-T-A) interface Destination

Integrated Integrated Integrated carrier carrier carrier

Shipper Consignee

Forwarder Airline Forwarder

Airport to airport value chain

Origin Aircraft Airport- Aircraft Destination terminal Cargo prep and to-airport prep and Cargo terminal admin load maintenance ﬂying maintenance unload admin

ACMI provider

Source: MergeGlobal Value Creation Initiative. End of an Era? American Shipper, Aug. 2008: 33-47. Reprinted with permission of MergeGlobal.

7.3.2 Combination Carriers

Domestic US carriers (e.g., United or Delta) focus primarily on passenger transportation, but they use the spare space in the hold (belly) of their planes to transport cargo; hence, they are called combination carriers. The industry estimates that more than 50% of international air cargo is moved in the bellies of passenger aircraft, whereas only 10% to 30% of US domestic air cargo is carried on passenger planes. Many of the domestic combination carriers use a traditional airline business model, where the airline extends its operations with side services, such as engineering, cargo, or in-flight catering. Such airlines usually treat the cargo business as a byproduct of their main operation and thus management may pay only scant attention to it. In contrast to US carriers, for the past 30 years, European carriers have con- centrated significantly on incorporating air freight into their overall business models. They have established elaborate hubs and have seriously examined 216 | Intermodal Transportation: Moving Freight in a Global Economy

balancing the needs for passenger and cargo services. As national carriers, Luf- thansa, British Airways, Air France, and KLM have greatly contributed to the growth of their national economies by providing air cargo services. To that end, they built logistics centers at their major airport hubs—Frankfurt, Lon- don–Heathrow, Paris–Charles de Gaulle, and Amsterdam–Schiphol. Conse- quently, cargo accounts for a significantly larger share of operating revenues for European carriers compared with US carriers, as shown in Table 7-2. To support the above mentioned business model, European carriers maintain a dedicated fleet of widebody cargo aircrafts. For instance, Lufthansa Car- go operates 19 Boeing MD11 freighters while Air France–KLM Cargo operates 13 Boeing 747-400 and 777-200 freighters. US carriers do not have dedicated widebody cargo aircraft. (Northwest Airlines did own and operate a dedicated fleet of 10 Boeing 747 freighters, but the service was shut down in 2009.)

7.3.3 Integrators

As mentioned earlier, airlines typically market their freight transportation services—the airport-to-airport link—to freight forwarders. Integrators, in contrast, market their logistics solutions directly to shippers, offering an integrated transportation chain with door-to-door service. Integrators thus act both as forwarders and as carriers. They often have their own trucking and aircraft fleet and provide all the handling services themselves. There are four major air freight integrators in the world today—FedEx, UPS, TNT, and DHL. The integrators specialize in carrying express freight. During the past few years, integrators have moved towards carrying heavier freight as well. The four big integrators dominate the carriage of express freight by land, as well as the international air express market. They often operate their own fleet of aircraft through their intensive hub-and-spoke networks worldwide (except

➤ Table 7-2 operating revenue share for selected combination carriers

Cargo Revenue Share of Total Airline Total Revenue Cargo Revenue Revenue Year Reported Lufthansa €15.9 billion €2.7 billion 17% 2007 Air France–KLM €24.1 billion €2.9 billion 12% 2007 British Airways £7.54 billion £616 million 8% 2007 Delta $17.5 billion $498 million 3% 2006 United $19.3 billion $750 million 4% 2006 Northwest* $12.6 billion $946 million 8% 2006 US Airways $11.7 billion $138 million 1% 2007 SOURCE: Airline annual reports. * Northwest merged with Delta in 2008; in 2010, the two airlines received approval to operate under a single operating certificate (Delta). The AIR CARGO Industry | 217

TNT and other smaller express operators, who mainly use the worldwide cargo capacity available from other carriers) Integrators carry the majority of the market share of US freight, with DHL, FedEx, and UPS accounting for 62% of enplaned revenue-tons of freight. (4) FedEx, one of the four major integrators, is undoubtedly the largest cargo carrier in the world. However, although each cargo business model has its own strengths and weaknesses, it is apparent that cargo-only carriers, integrators, and combination carriers all hold a significant portion of the market share. Fig- ure 7-3 provides the percentages of the market share that particular airlines hold based on the scheduled ton-kilograms flown. Figure 7-4 shows similar information for US carriers. Table 7-3, which is based on data collected by Air- ports Council International, illustrates the market force of the integrator traffic. FedEx’s Memphis hub leads all airports in the world, and UPS’s Louisville hub ranks seventh in the world. It is striking to note the different growth rates

➤ Figure 7-3 Market share of cargo (2003)

35 30 25 20 15 10 Market share (%) 5 0 a y A A BA dEx KAL UPS SIA EV JAL rance KLM NW Fe Catha China airlines Lufthans Airlines Cargolux Emirates Rest of the Air F Airline SOURCE: Air Cargo World, Sept. 2010: 20-27.

➤ Figure 7-4 market share of major US carriers

5,000,000 4,500,000 4,000,000 -tons) 3,500,000 3,000,000 enue 2,500,000 2,000,000 1,500,000 1,000,000 eight (rev 500,000 Fr 0 a e ess West DHL west Alask Delta World Parcel USAir TransAir United American Continental NorthwestSouth Trans America ederal Expr United American Eagl F American Carrier

SOURCE: Summary of Aircraft Departures and Enplaned Passengers, Freight, and Mail by Carrier Group, Air Carrier, and Type of Service. Washington, DC: Bureau of Transportation Statistics, 2000. 218 | Intermodal Transportation: Moving Freight in a Global Economy

between North America and Asia. Where most major US airports have seen a decline in cargo traffic, China has seen increased growth in air cargo volumes, led by the Guangzhou and Beijing airports.

7.4 Network/Service Characteristics

Most freight is transported in lower level cargo holds of widebody passenger aircraft (i.e., aircraft with two or more aisles running from the front to the back of the aircraft). The holds are typically accessible through one or more outside

➤ Table 7-3 cargo traffic for top 30 airports (2009)

Rank City (Airport) Total Cargo % Change 1 Memphis TN, US (MEM) 3 697 054 0.0 2 Hong Kong, HK (HKG) 3 385 313 (7.5) 3 Shanghai, CN (PVG) 2 543 394 (2.3) 4 Incheon, KR (ICN) 2 313 001 (4.6) 5 Paris, FR (CDG) 2 054 515 (9.9) 6 Anchorage AK, US (ANC)* 1 994 629 (15.0) 7 Louisville KY, US (SDF) 1 949 528 (1.3) 8 Dubai, AE (DXB) 1 927 520 5.6 9 Frankfurt, DE (FRA) 1 887 686 (10.6) 10 Tokyo, JP (NRT) 1 851 972 (11.8) 11 Singapore, SG (SIN) 1 660 724 (11.9) 12 Miami FL, US (MIA) 1 557 401 (13.8) 13 Los Angeles CA, US (LAX) 1 509 236 (7.4) 14 Beijing, CN (PEK) 1 475 649 8.1 15 Taipei, TW (TPE) 1 358 304 (9.0) 16 London, GB (LHR) 1 349 571 (9.2) 17 Amsterdam, NL (AMS) 1 317 120 (17.8) 18 New York NY, US (JFK) 1 144 894 (21.2) 19 Chicago IL, US (ORD) 1 047 917 (17.1) 20 Bangkok, TH (BKK) 1 045 194 (10.9) 21 Guangzhou, CN (CAN) 955 270 39.3 22 Indianapolis IN, US (IND) 944 805 (9.2) 23 Newark NJ, US (EWR) 779 642 (12.1) 24 Tokyo, JP (HND) 779 118 (8.3) 25 Luxembourg, LU (LUX) 628 667 (20.2) 26 Osaka, JP (KIX) 608 876 (28.0) 27 ShenZhen, CN (SZX) 605 469 1.2 28 Kuala Lumpur, MY (KUL) 601 620 (9.9) 29 Dallas/Fort Worth TX, US (DFW) 578 906 (11.3) 30 Mumbai, IN (BOM) 566 368 1.3 Airports participating in the ACI Annual Traffic Statistics Collection. Total Cargo: loaded and unloaded freight and mail in metric tonnes. *ANC data includes transit freight. SOURCE: Airports Council International. World Airport Traffic Report 2009. www.aci.aero/cda/aci_common/display/main/ aci_content07_c.jsp?zn=aci&cp=1-5-54-4819_666_2__. Accessed Aug. 8, 2010. Reprinted with permission. The AIR CARGO Industry | 219 doors. Aircraft such as the Boeing 747, Boeing 767, Boeing 777, Airbus A300/ A310, Airbus A330, Airbus A340, and Airbus A380 are used for international flights and offer significant cargo space. The growth in the size of the widebody fleet has mirrored the growth of air cargo. To reduce ground times, it is common practice to load all suitable freight on or in unit load devices (ULDs), which are typically either pallets or containers. Pallets are aluminum sheets with rims that allow nets to be affixed to hold loose packages in place. Containers are fully enclosed, portable aluminum compartments of various shapes and sizes. To fully utilize the capacity of the airplane, containers are shaped to fit the contours of an aircraft’s doors and frame. For some shipments, highly specialized containers are used to maintain a specific temperature or absorb shock. Specialized cargo carriers own and operate their own fleets of dedicated cargo aircraft. Some of these airplanes are passenger aircraft that have been permanently converted for cargo usage (as described in Section 7.3.1). The Boeing 747, in its various configurations, is the aircraft most commonly used as a cargo plane. In the past, operational suitability and ease of maintenance were the major factors in deciding which aircraft would be added to a cargo fleet. Today, however, fuel economy, noise, and environmental concerns are also factors in an operator’s decision.

7.5 Economic Importance of Global Trade

Boeing reported that air cargo tonnage grew a robust 12% in 2004, but that was followed by three very weak years (1.7% in 2005, 3.2% in 2006, and 5.1% in 2007) attributed to the high cost of jet fuel. Boeing projects that air cargo traffic will triple over the next 20 years (5), primarily due to an increase in world trade in the increasingly globalized economy. The share of nondomestic trade grew by nearly 14% between 2003 and 2009, as shown in Table 7-4.

➤ Table 7-4 cargo revenue tons (tons of revenue traffic) enplaned by region (in thousands)

Region Share of Latin Other Non-Domestic Year Domestic Atlantic America Pacific International Total Trade (%) 2003 12,723 1,429 756 2,327 5,455 22,691 43.9 2004 13,260 1,687 850 2,785 6,206 24,790 43.9 2005 12,923 1,717 924 2,671 6,800 25,035 46.5 2006 12,612 1,732 953 2,833 7,108 25,238 48.4 2007 12,415 1,700 1,111 2,777 7,178 25,182 50.0 2008 11,046 1,691 1,050 2,457 6,846 23,085 52.2 2009 10,357 1,693 878 1,986 5,809 20,723 50.0 SOURCE: Bureau of Transportation Statistics. Air Freight Summary Data (All US). www.transtats.bts.gov/freight.asp?pn=0&display=data2. Accessed June 12, 2010. 220 | Intermodal Transportation: Moving Freight in a Global Economy

Air cargo growth is also fueled in part by the rapidly expanding and newly emerging economies in Asia. The economic boom in India and China is expected to result in intra-Asian traffic having the largest share of the air cargo market. Figure 7-5 illustrates the projected international air freight shares in 2011. Figure 7-6 shows the primary intercontinental air freight flows in 2007. Despite the financial crisis of 2009, the general midterm outlook for the air cargo industry appears strong. Nonetheless, there are growing concerns about factors that could hinder its growth. Rising oil prices, unrest in financial markets, and political uncertainty in many areas of the world have slowed the overall development of the market. Many consumers in Europe and North America are also concerned about the environmental impact of plane trips. Air freight accounted for 0.4% of the ton-miles of domestic freight in 2001, but was responsible for 23.2% of the fuel used in the domestic freight sector. (6) Global companies may try to limit their carbon foot- print by looking for alternatives to shipping goods from one end of the world to another. In addition, technological advancements that improve the speed of goods movement by ship may make sea transport a viable solution for express shipments.

➤ Figure 7-5 Projected 2011 international air freight shares

Within Latin America 1% Asia Paciﬁc - North America Others 13% 17%

Within Middle East 2% North America - Latin America 5% Within North America Within Asia Paciﬁc 1% 26% Europe - North America 12%

Within Europe 6% Europe - Asia Paciﬁc 18% SOURCE: International Air Transport Association Economic Briefing: Passenger and Freight Forecasts 2007 to 2011, October 2007. The AIR CARGO Industry | 221

➤ Figure 7-6 International air freight flows in 2007

SOURCE: MergeGlobal Value Creation Initiative. End of an Era? American Shipper, August 2008: 33-47. Reprinted with permission of MergeGlobal. FEU-Kilometer—a 40-foot container transported one kilometer.

7.6 Managing Air Cargo Successfully

Even in a growing market, success does not come easy in the air freight industry. Most airlines in the United States and Europe have shown poor returns on the investment for their shareholders. Several major carriers in the United States have been in bankruptcy proceedings at least once in the past several years. Former market leaders, such as Pan Am and Eastern Airlines, have gone out of business. Rising fuel expenses and the cost of meeting new security requirements have placed increased pressures on air cargo operators. At the same time, an abundance of capacity and strengthening buying power fueled by consolidation in the forwarder markets have put pressure on the revenue side. Airline executives need skills in a variety of business disciplines in order to achieve positive results for their shareholders.

7.6.1 Fleet Management and Network Planning

Managing a profitable freighter airline begins with the selection of a fleet that matches the airline’s business model. Successful airlines invest in aircraft that meet their operational needs while minimizing operating and maintenance costs. Constrained resources in the market, such as the limited number of aircraft available and the shortage of qualified pilots, in conjunction with the massive financial resource commitments that have to be made up front, con- tribute to the challenging task of fleet management. When selecting routes, a carrier must decide if it wants to be a network carrier with a published schedule or if it wants to be a charter carrier with a flexible schedule. Charter carriers market their air cargo capacity in conjunction 222 | Intermodal Transportation: Moving Freight in a Global Economy

with their operational capabilities and make routing and other operational decisions after securing business. Network carriers publish a reliable schedule and look for business for the routes in their network. The network can consist of many point-to-point routes, although most carriers operate with a hub-and- spoke network. In a hub-and-spoke network, freight is transported first to the hub, where it is reloaded on another aircraft that will bring it to its final destination. There are two advantages of the hub-and-spoke system. First, the con- centration of the fleet in one place allows a company to make appropriate operation decisions, such as which aircraft to use for which destination. Second, the hub-and-spoke system provides the possibility of consolidating freight on one flight. The disadvantages of hub-and-spoke are that most freight will not take the most direct route to its destination and that the operational challenges of managing all freight at one hub can be considerable. Regardless of the network structure, trade imbalances often make it difficult for airlines to fill available cargo space. For example, the demand for cargo capacity from China to the United States greatly exceeds the demand for capacity from the United States to China—and this trend is expected to accelerate over the next few years. (7) Some flights will, as a result, travel relatively empty in one direction. Airlines need to obtain traffic rights (called “freedoms of the air”) from foreign governments to operate internationally. There are a total of nine freedoms that describe the right of one nation’s carrier to operate in another country. The first freedom, for example, is the right to fly across the territory of a foreign country without landing; the second freedom is the right to land in a foreign country to refuel or for other purposes. These freedoms are typically ex- changed between countries, and a carrier must apply for the traffic right referred to in these international agreements. (8) In 2007, the United States and China signed an agreement that vastly ex- panded a carrier’s right to fly to the destinations in the other country. (9) The EU-US Open Skies Agreement of 2007 went even further by allowing carriers to fly between any two cities within the two areas of jurisdiction. In addition to traffic rights, airlines need to negotiate with airport operators to obtain landing rights. Often landing rights become part of the “intergovernmental traffic right” discussions, as limited gate capacity at airports can constitute a trade barrier. As part of the negotiations between the United States and the Euro- pean Union, London-Heathrow Airport has been opened to more US carriers; previously, only United Airlines and American Airlines had the privilege of operating in and out of this lucrative gateway. (10) All-cargo carriers may have different routing needs than passenger carriers and thus require different sets of air traffic rights from those needed by passenger carriers. But separating air cargo and passenger rights will be fraught with difficulty in Asia because of the distinctive characteristics of its air cargo market, where most passenger carriers have substantial cargo business and operate combination fleets. (11) The AIR CARGO Industry | 223

7.6.2 Operations Management

An important part of air cargo service quality occurs on the ground. Managing the export acceptance, the import delivery, and timely transfer of millions of single shipments each year is an operational challenge. Cargo handling and aircraft handling are ways for airlines to differentiate their services. For example, after a period of outsourcing, Delta Airlines announced in 2008 that it would once again begin to manage its own handling processes as part of a stra- tegic push to grow its cargo revenue share. (12) Aircraft handling or ramp handling is the process of loading and unloading the aircraft. Skilled loading requires fast but safe operations so that neither freight nor aircraft are damaged. Training of operators and the use of appropriate loading equipment is required. Because the investment in such loading and unloading equipment can only be amortized through frequent use, the airport entity or dedicated companies typically provide this service to airlines that must load/unload outside of their hub. Cargo handling or warehouse handling refers to the processes in the warehouse where shipments on the export side are accepted from customers, weighed and measured, and loaded into containers or onto pallets. Optimizing these processes is a major operational challenge. Total quality management and continuous process management techniques are often employed by airlines (or their selected subcontractors) to reduce the incident rate (loss of freight due to damage or pilferage), optimize throughput in the warehouse, and limit costs. Security screening has recently added complexity. Warehous- ing technologies such as electronic transfer vehicles and automated stacker systems are often employed to optimize the workflow. Shippers and forwarders select air transport over more economical means of transportation only in cases of necessity. The customer expectation is that air cargo services will usually be a flawless operation as any damage, loss, or delay can have a major impact on the shipper’s business. Thus, ground quality is a key factor for successful air cargo management. As an example of the type of analysis that can examine such operations, Yan et al. combine two workforce supply principles, two flexible management strategies, and the related operating constraints to assist an air cargo terminal to more efficiently manage its workforce supply and set its shift schedule under stochastic demand. (13)

7.6.3 E-commerce

E-commerce has also brought new challenges and opportunities to the air cargo industry. An important component is a third-party e-commerce community network. Leung et al. present a framework for such a network, which extends the traditional business-to-business e-commerce exchanges to a more broadly based e-commerce approach at the industry level. (14) The 224 | Intermodal Transportation: Moving Freight in a Global Economy

proposed infrastructure differs from traditional portals in that it features the online integration of business transactions. It provides a virtual market for agents of the air cargo industry, enabling them to develop and engage in logistics integration. It also facilitates tracking and tracing, and minimizes un- necessary travel and inventory costs, thus achieving supply chain management at the industry level. Planning and cooperation among industry agents using e-commerce as an enabler could transform the air cargo industry into one that can provide customized services to individual shippers at the cost level of mass production.

7.6.4 Marketing, Product Management, and Pricing

While integrators such as FedEx and UPS provide complete door-to-door service, traditional cargo carriers provide service to only a segment of the transportation chain. Airport-to-airport transportation is almost always preceded and followed by other means of transportation, such as by road, rail, or water. Most shippers that rely on the services of a nonintegrated air cargo carrier thus find that they are in need of the services of an international air freight forwarding agent, that is, a freight forwarder. These companies are also often referred to as third-party logistics providers (3PLs). The forwarder is an agent that arranges, on behalf of the shipper, the entire transportation chain and provides ancillary services related to the transport of goods. Forwarders can apply to Cargo Network Services, a subsidiary of the International Air Transport Association, for accreditation as a cargo agent. Cargo airlines find most of their business is generated by freight forwarders, making them the customer base for all airlines. The top 10 freight forwarders are listed in Table 7-5. Techniques to win customers encompass all typical business-to-business sales and marketing practices. Cargo airlines employ sales representatives that

➤ Table 7-5 top 10 freight forwarders, 2006

Freight Annual Revenue (billions) Employees Warehouses/Offices 1 DHL Logistics $ 31.0 125,000 1,600 2 Kuehne & Nagel International $ 14.9 46,000 400 3 Schenker/Bax Global $ 14.0 53,700 1,500 4 UPS Supply Chain Solutions $ 8.0 37,000 936 5 Panalpina World Transport $ 6.33 14,300 240 6 C. H. Robinson Worldwide $ 6.6 5,700 100 7 Agility Logistics $ 4.9 20,000 n/a 8 Ceva Logistics $ 4.6 38,000 567 9 Expeditors International $ 4.6 10,600 110 10 NYK Logistics $ 4.2 17,000 260 SOURCE: Armstrong, Richard, and Thomas Foster. Moveable Feast of Top 25 Global Third Party Logistics Providers. Global Logistics & Supply Chain Strategies Magazine, May 2007: 28-53. glscs.texterity.com/glscs/200705. Accessed June 12, 2010. The AIR CARGO Industry | 225 call on customers. Trade fairs and business associations play an important role in bringing customers and suppliers together. Building relationships is crucial as airlines and freight forwarders engage in hundreds or thousands of individual transactions every year. Cargo airlines sell aircraft space that is constrained by both weight and volume. A load of dense freight (e.g., boxes filled with lead) could exceed the aircraft’s take-off weight limit long before the space in the aircraft is exhausted. Alternatively, low-density freight (e.g., boxes filled with feathers) would use up all the space in the aircraft before the aircraft’s weight limit is reached. Airlines thus charge the higher of either the actual weight (measured by a scale) or the volume weight (calculated assuming an average density). A load master’s task is to create the aerodynamically optimal load mix out of the total shipments booked onto a flight. The volume weight in periods calculated by dividing the volume of the shipment (in cubic inches) by 165. Airlines charge their customers separately for additional services; the rate is assessed by pound, with a minimum charge for small shipments. In the past few years, airlines have struggled to increase their rates. Despite strong demand for air transportation, capacity exceeds demand on most routes, making it a buyer’s market except for a few routes and during peak periods. To optimize revenues, cargo airlines differentiate their services and prod- ucts. Almost all cargo carriers offer an express shipment service that comes with special features. One of the most noteworthy features allows the customer to tender express shipments right up until the departure time, and the express freight is the first to be available for pick-up at the destination. Express services often come with a performance guarantee, possibly including a refund in case of a controllable delay. Other special services are often designed and marketed for special handling needs, i.e., goods requiring refrigeration, live animals, dangerous goods, and high-value items.

7.6.5 Margin Steering and Revenue Management

Generally, airlines offer cargo space in two stages. In the first stage, a few months prior to a season, freight forwarders bid for cargo space over the next season; the cargo capacity committed during this bidding process is called allotted capacity. Out of the remaining cargo space, airlines allocate specific amounts to contracts, which reserve space for large customers at a fixed price. In the second state, the remaining space—the capacity available for free sale— is then available for booking within four weeks of the flight departure. Airlines typically do not know how much allotted capacity will be unused in advance of the flight departure. In addition, on planes carrying both cargo and passengers (combination carriers), the cargo space contains passengers’ baggage, cargo, and mail (which always gets high priority). The amount of fuel that is loaded onboard the aircraft varies with weather and other factors, and the weight of 226 | Intermodal Transportation: Moving Freight in a Global Economy

the fuel influences how much cargo capacity is available for free sale. Airlines do not know how much capacity they will have available for free sale until close to the departure date. Freight forwarders often intentionally book more capacity than they actually need to ensure space on constrained flights, since most airlines do not charge a penalty for returned capacity. The airlines add the released space to the pool of capacity available for free sale. To hedge against the variability in the amount of cargo actually handed in at departure (cargo tendered) and customers’ cancellations, airlines commonly overbook their capacity—that is, they sell more capacity than physically available in order to compensate for cargo that does not show up prior to departure. Two considerations important in overbooking are spoilage (demand turned away because the overbooking level was too low, leaving excess capacity at departure) and off-loads (booked demand that the airline cannot accommodate at departure because the overbooking level was too high). Spoilage tends to be more costly for the airlines, as off-loads can usually be rerouted at no extra cost. In the passenger sector, the common practice is to formulate the overbooking problem (inventory) as a newsvendor problem (15), with the overbooking level selected to minimize the total expected costs of spoilage and off-loads. New approaches designed specifically for cargo overbooking are described by Luo and Cakanyildirim. (16) The allocation of the capacity available for free sale to the demand that arrives over time constitutes an important problem in the airline industry. This problem is very similar to the seat inventory control problem in the passenger revenue management literature (17)—namely, how to allocate a finite seat inventory to demand that occurs over time, such that at departure the plane is filled with the most profitable mix of passengers. The fundamental decision in revenue management is whether to sell capacity when a request comes in, or to save it for a potential later sale at a higher price. For example, a seat on an airplane can be sold at different prices, depending on the capacity already sold and the time remaining until the departure of the aircraft. While revenue management practices have been widely used in the passenger segment of the airline industry, they have only recently received increased attention in the cargo segment. Cargo capacity has all the features for revenue management techniques to be successful: it is lost after the plane takes off, it is limited, and it can be offered at different rates depending on the service offered (e.g., critical and specialty cargo, expedited, standard). The decision of whether to accept or to reject an incoming booking request (for a seat on the plane or for cargo capacity) can be based on different strategies. The most important types of control in the passenger segment are booking limits, protection levels, and bid prices. (18) Book- ing limits allocate a fixed amount of capacity to each fare class. Protection levels specify an amount of capacity to be reserved for a fare class or a set of fare classes. Bid prices are threshold values used to accept/deny incoming booking The AIR CARGO Industry | 227 requests—that is, the decision maker accepts the request if the sum of the bid prices along the itinerary is lower than the proposed fare. There are two commonly used mathematical programming models in the passenger revenue management literature for computing bid prices on a flight network. The first, the deterministic linear programming (DLP) model, makes the assumption that the demand is deterministic and equal to its mean. The second, the probabilistic nonlinear programming (PNLP) model, maximizes the expected revenue assuming a randomly distributed demand. The deterministic solutions have been observed in several studies to give better bid prices than the probabilistic solution. (19) However, the studies usually assumed Poisson distributed demands, which ignore bookings with more than one passenger (which occurs very commonly in practice); as a conse- quence, the resulting variation in demand used in the studies was much lower than that observed in actual practice. When applied to the air cargo industry, the bid prices derived from the DLP model have proven to be almost nonrestrictive (20)—they reflect a first-come, first-served (FCFS) capacity allocation policy. Clearly, allocating the capacity in a FCFS basis is, in general, not very profitable and goes against the fundamental premise of revenue management, in which some capacity is reserved for high-margin customers. The research on developing efficient solutions for the PNLP model has been very limited. Besides the specialized algorithm proposed by Ciancimino et al. (21) for the railway yield management problem and the algorithm proposed by Rao (22) to solve a slightly different formulation, there is an approach with application for air cargo that has been developed by Popescu et al. (23) While the capacity allocation problems from the passenger and cargo segments have similarities, there are also some significant differences:

• For passengers, the unit capacity is defined by a single dimension (seat); for cargo, capacity has two dimensions (weight and volume). • Cargo capacity is often uncertain due to allotments, no-shows, and passenger luggage on combination carriers. • Most passengers demand a specific itinerary, whereas for cargo shipments customers often specify an origin and destination and accept any itinerary as long as the shipment arrives at the destination by the requested delivery time (itinerary-specific versus origin-destination-specific demand); hence, in cargo there is flexibility in routing. • Most passengers demand one unit of capacity (seat) whereas customers request multiple units of capacity for a cargo shipment (specified by weight and volume). Hence, cargo demand has a wide range of quantities and can be lumpy, which complicates matching demand to capacity. • The traffic is imbalanced. The greatest part of air cargo flies only in one direction; passengers, in contrast, mainly make round trips. On major freight 228 | Intermodal Transportation: Moving Freight in a Global Economy

routes it is common to find that the traffic in the densest direction is twice or almost three times as great as in the reverse direction, as in the case on the Hong Kong to Frankfurt route. All these differences make the already existing techniques from the passenger’s business model unsuitable for the cargo operation model. Several new techniques that address specific differences have been developed in recent years. Xiao and Yang (24) and Pak and Dekker (20) address theoretical aspects of revenue management under multidimensional capacity. Xiao and Yang model the problem as a continuous time stochastic control model, and derive structural properties for the case where the remaining capacities in two dimensions are equal or differ. When they are equal, they show that the optimal policy is not characterized by a nested price structure (if a fare class is open, then all classes with higher fares should also be open) as in the one-dimensional case. Pak and Dekker model the problem as a multidimensional online knapsack problem and propose a heuristic to determine the bid prices based on a greedy algorithm proposed by Rinnooy et al. (25) A test case shows that the bid prices perform better than the traditional deterministic model used in the passenger business model. Demand lumpiness has been addressed by Popescu et al. (23), who proposed splitting the cargo bookings into two categories, small and big cargo, and treating each category differently. The large bookings tend to be made close to the departure date of the airplane, and usually only a few bookings fill up the capacity dedicated to big cargo, whereas the small bookings are made throughout the booking period. Another problem studied in the air cargo literature concerns the optimal ordering policies for freight forwarders when acquiring cargo capacity from airlines to satisfy demand from shippers. The freight forwarders have to con- firm (out of the allotted capacity) the capacity needed a few days before the aircraft departs; however, shippers’ demands materialize between when the order is placed and the actual departure time. That is, freight forwarders have to place their order such that they minimize the cost of ordering too much capacity and not using it versus the cost of ordering too little capacity and back- ordering demand for next flights. Generally, there has been very limited research done in capacity planning models for air cargo, despite its importance in the air cargo supply chain. Chew et al. (26) analyze the capacity management problem for air cargo; however, the analysis is restricted to a six-period horizon and there are no results re- garding the structure of the optimal policy. The problem is solved by recur- sively calculating the space to order for each of the six periods of the planning model. Popescu (27) formulates the capacity management problem as a perishable inventory problem, with the perishable commodity being the aircraft’s capacity, which is lost after departure. She defines the time between capacity confirmation and flight departure as lead time. Although there is vast research on perishable inventory management, when there is lead time most of the re- The AIR CARGO Industry | 229 searchers propose either myopic heuristics or numerical solution approaches for a short planning horizon. (28) Popescu finds the optimal policy under vari- able ordering cost, backorder, and linear perishing cost, and shows that the optimal expected cost function is a convex function with respect to the available and future capacity ordered L periods in advance, for L being one or two periods. Furthermore, she shows that the optimal policy is a stationary policy when far enough from the end of the horizon.

7.7 Global Events Shaping the Industry

Several recent events have had significant effects on the air cargo industry. It remains to be seen if these events will have a long-term effect on the profitability of the industry.

7.7.1 Safety and Security in the Post 9/11 Era

Following the terrorist attacks on September 11, 2001, the entire aviation industry had to undergo major changes. In the United States, the Department of Homeland Security was established on November 25, 2002, by the Homeland Security Act of 2002 (Public Law 107-296). The Transportation Security Ad- ministration (TSA), formed in 2002 and initially part of the Department of Transportation, is responsible for all aviation security measures; in March 2003, TSA become a part of the Department of Homeland Security. The Implementing Recommendations of the 9/11 Commission Act of 2007 (Public Law 11-053) require 100% screening of cargo transported on passenger aircraft within three years of the law’s passage—i.e., August 2010. The Euro- pean Union and other government entities have imposed similar security di- rectives to improve aviation security. (29) These security demands have brought additional operational costs for international air carriers. Investments in security personnel, video surveillance systems, and screening devices have strained the resources of most carriers. In response, most airlines have introduced a security surcharge to recoup some of their investment and operational costs. For example, in August 2008, SAS Car- go reported on its website that it would impose a security surcharge of €0.15 per kilogram. Such security mandates not only add costs, but also slow down the handling process, which leads to an increase in total transportation times.

7.7.2 Oil Prices and Currency Volatility

The increase in oil prices over the past five years has brought many airlines to the brink of bankruptcy. Oil prices and consequently kerosene prices have increased sevenfold since 2002, as illustrated in Figure 7-7. 230 | Intermodal Transportation: Moving Freight in a Global Economy

Airlines have responded by fuel hedging—locking in the rate of fuel some- times years in advance. However, in times of price increases that exceeded most expectations, many carriers have found themselves very vulnerable to cost increases. As their ability to raise rates has been limited, airlines have introduced a different method to generate revenue to offset these escalating costs—namely, surcharges. Though each carrier employs its own model of surcharge calcula- tion, the basic model is similar. The carrier monitors the development of fuel costs and imposes a specific surcharge amount per kilogram of cargo, which is tied to the fuel price level. Whenever the fuel price increases above or decreases below a certain threshold, the surcharge is adjusted upward or downward. Carriers argue that the surcharge model allows full transparency. In times of volatility, surcharges reduce transaction costs as base rates do not need to be adjusted. Base rates are often set in contracts and are valid for several months or a year. Having a steady component in the rate and a fluctuating piece in the surcharge allows carriers and forwarders to negotiate long-term rates without fear of locking themselves into an unfavorable situation should fuel costs change. Critics argue that fuel costs are a cost of doing business and the airlines should build these costs into their regular rates. Making their surcharges public information (by, for example, posting them on their websites) led competitors to match surcharge levels rather than compete for business by, for example, investing into a more fuel efficient fleet. Some critics consider this illegal and anticompetitive price signaling.

➤ Figure 7-7 Oil prices between 2002 and 2008

Crude Oil Prices 160

140

120

100

80 rice in US Dollars

P 60

0 2002- 2002- 2003- 2003- 2004- 2004- 2005- 2005- 2006- 2006- 2007- 2007- 2008- 2008- Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Month

SOURCE: US Energy Information Administration. tonto.eia.doe.gov/dnav/pet/pet_pri_wco_k_w.htm. Accessed June 12, 2010. The AIR CARGO Industry | 231

7.7.3 Alliances and Antitrust Challenges

In February 2006, several news outlets reported that European and American authorities had begun to investigate an alleged price-fixing conspiracy related to the imposing of fuel surcharges. (30) The European Commission and the US Department of Justice initiated searches at the offices of many major international airlines. (31) The investigations apparently were not limited to cargo pricing practices, but also extended to passenger ticket surcharges. Since then many international carriers have announced that they have been fined by the authorities. In August 2007, British Airways confirmed that it had received a fine of $550 million from Britain’s Office of Fair Trading and the US Department of Justice. Korean Air Lines Co. Ltd. was fined $300 million by the Department of Justice after pleading guilty to colluding with competitors to fix fuel surcharges on cargo and fixing passenger fares between the United States and Korea. In January 2008, Qantas Airways pleaded guilty and agreed to pay a $61 million criminal fine for conspiring to fix cargo rates in the United States and elsewhere. In May 2008, Japan Airlines was sentenced to pay a $110 million penalty for price fixing on international cargo shipments. (32) In June 2008, further fines were made public. Air France-KLM, Cathay Pa- cific, Martinair Holland, and SAS Cargo pleaded guilty to conspiracy charges to fix air cargo rates. The Department of Justice announced that Air France- KLM was fined $350 million. Cathay agreed to pay a fine of $60 million, Mar- tinair $42 million, and SAS $52 million. The fines levied against the air cargo carriers to date far exceed $1 billion. Furthermore, high-ranking cargo executives from Qantas and SAS Cargo were sentenced to jail time. Alleged damages to shippers are still subject to civil lawsuits. The scandal shook the industry to its core. Even though surcharges for fuel and security costs continue to be imposed, airlines have made changes to the way they communicate internally and externally. The scandal also affected the collaboration between air cargo carriers. Cargo carriers seem to have scaled back their alliance activities in response to the antitrust investigations. At this time, there is only one large cargo alliance operating—SkyTeam Cargo. Air cargo alliances have been subject to academic research as well. Zhang et al. (33) developed an oligopoly model to investigate the effect of an air cargo alliance on competition in passenger markets. They consider a model in which the partners, while continuing to offer their respective passenger services, jointly offer a new integrated cargo service by utilizing their passenger aircraft and routes. Their findings show that such an alliance will likely increase the partners’ own outputs, while simultaneously decreasing their rivals’ outputs, not only in the cargo market but also in the secondary passenger market. Furthermore, the alliance is likely to reduce passenger prices and increase total surplus. 232 | Intermodal Transportation: Moving Freight in a Global Economy

Houghtalen et al. (34) address the operational issues that arise when cargo carriers form an alliance, taking into account the technical and legal challenges associated with integrating information systems of autonomous carriers and how to best manage alliances to ensure sustainability. In summary, operational and legal obstacles have limited the development and importance of air cargo alliances.

7.7.4 Emerging Markets and Players in India, China, and the Middle East

China has attracted a variety of foreign direct investment by offering cheap and skilled labor coupled with the world’s largest domestic market. As more corpo- rations shift their manufacturing capacity toward Asia, air cargo carriers have become very aggressive in obtaining air service rights and developing infrastructure to prepare for the expected large increase in air freight demand. According to Air Cargo World, China’s domestic air cargo market grew 20% every year since 1990, and revenues were expected to total $3.35 billion in 2010. Airports in China were expected to process 11.8 million metric tons in 2010, with an average annual growth rate of almost 14%. To address this rapid growth pace, China will need 130 new freighters over the next two decades, according to Airbus, which predicts that China’s domestic market will grow an average of 10.5% annually, while its international market will grow 8.5% per year. According to Boeing, China’s domestic air cargo sector will grow 10.8% a year over the next two decades. (35) As also reported in Air Cargo World, India has long served as a useful stop- over for cargo carriers operating between Europe and Asia, and it now serves as a refueling stop for freighters on their way to China and other parts of Asia. Future growth and diversification of India’s economy will trigger continued growth of the air cargo industry. New aviation trade deals have spurred increased passenger traffic on Middle Eastern airlines operating in India. (36) Registering nearly 20% growth in the past three years (both domestic and international) and notably 34% growth in domestic cargo in one year, India could become a key growth market for air cargo. Despite the economic and political instability in the Middle East, the region has been growing rapidly. As the United Arab Emirates vies to diversify its economy, it is making massive investments to shift traffic hubs for cargo and passengers away from Europe to the Middle East. Making use of liberated markets, it is gaining market share from the European carriers. Countries such as United Arab Emirates and Qatar are investing billions of dollars in major infrastructure developments. Among the ambitious projects currently underway is Dubai World Central, which is expected to become the biggest air freight hub in the world, capable of handling a massive 12 million tons of cargo annually. According to the International Air Transport Association’s (IATA) chief econ- omist, Brian Pearce, the Middle East’s growth trend is significantly higher than The AIR CARGO Industry | 233 projected, with the robust oil-based economies contributing to an increase in both passenger and cargo transport. (37) These market changes will probably cause cargo traffic to lean toward those emerging markets. New cargo hubs and a stronger fleet will position the new carriers to take advantage of a strong regional and international cargo market.

7.7.5 Open Sky Agreements and Free Trade Zones

China has agreed to substantially reduce trade barriers that have plagued US exports for decades. The Bilateral World Trade Agreement of 1999 led to Chi- na’s entry into the World Trade Organization (WTO), which is an important and positive step in expanding freight trade. The EU-US Open Skies Agree- ment allows any airline of the European Union and any airline of the United States to fly between any point in the European Union and any point in the United States. These agreements will spur growth, but they will also fuel further competition in a market that is already oversaturated with capacity. However, IATA reported the EU-US Open Skies Agreement increased transatlantic capacity by 10% in April 2008, which might mean that more capacity and flexibility com- ing from more competition can yield positive development. (38) One industry analyst has identified the following three major trends in the industry:

• Air cargo will grow at a faster rate than passenger side of the business. • Continuing consolidation among freight forwarders will trigger more glob- ally integrated solutions from the airlines. • The business of carrying freight will increasingly move toward dedicated carriers as opposed to a combination passengers and cargo. (39)

7.8 Air Cargo Research Areas

There are considerable challenges facing the industry, which provide up a variety of research opportunities:

Air cargo operations at airports • More efficient material, information flows in air freight terminals.

• More efficient warehouse and ground handling systems: many stations are reporting insufficient capacities to accompany the growth in the volume of air cargo. An example is Los Angeles International Airport, where storage facilities to temporarily store cargo have had to be located off-site.

• Appropriate performance metrics to evaluate air cargo hubs. 234 | Intermodal Transportation: Moving Freight in a Global Economy

Pricing and revenue management • Better pricing methodology: in general, contract pricing is often static. To adjust rates in response to daily changing supply and demand, forwarders and airlines depend on call centers to negotiate ad hoc pricing. However, technological advancements have made pricing more dynamic in the air freight industry. With market segmentation, pricing is an extremely compli- cated and highly-dimensional problem. This problem is of extreme importance and needs to be studied in greater detail.

• Revenue management: the air cargo revenue management problem is a very complex problem. There are several areas of open research in this direction, such as addressing the multidimensionality of cargo, forecasting the capacity available for free sale, and embedding origin-destination demand into the revenue management systems.

• More research is needed for guiding the freight forwarders when confirming their ordered capacity with the airlines. A better capacity management on the freight forwarders’ side will translate into a better service level to the shippers and a more reliable relationship between the airlines and the freight forwarders. It will also impact the accuracy of the available capacity at departure for the airlines.

Air cargo flight network While alliances can help expand individual flight networks, air cargo has an important feature that is not present to this extent in the passenger business— namely, traffic imbalance. A more thorough understanding of the impact of the traffic imbalance on network design is needed.

Security As a result of the events of 9/11, security procedures for cargo shipments have significantly increased. However, as Petersen points out in a white paper on the air freight industry (40), it is not realistic to expect 100% of cargo to be inspect- ed, as it would slow down its movement beyond acceptable margins. The opportunity in this sector is to develop models to address the trade-off between shipping cargo securely and efficiently.

Acknowledgments

The authors would like to acknowledge Brittany Luken, a graduate student in civil engineering at Georgia Tech, for her contributions to this chapter. The AIR CARGO Industry | 235

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