Thursday, July 19, 2018 | ISSN 0719-241X

The myth of the magic behind economies of scale

Paper analyzes impact in liner shipping industry
Edition of July 25, 2017

When it comes to economies of scale, the motto is “the bigger, the better”. In an industry where bigger ports and larger ships are the trend, economies of scale have become the most used strategy for saving the business from drowning in a sea of unstable freight rates, oversupply and low demand. 

Increase in “vessel size is frequently argued to be one of the main strategies of shipping lines to reduce costs and maintain competitiveness, at the same time the argument of size is one of the main reasons for the ocean carriers’ concentration process: “The economic rationality for mergers and acquisitions is rooted in the objective to size, growth, economies of scale, market share and market power. Co-operation between carriers serves as a means to secure economies of scale, to achieve critical mass in the scale of operation and to spread the high level of risk associated with investments in ships,” reads the analysis paper PORT MANAGEMENT IMPLICATIONS FROM ECONOMIES OF SCALE IN THE LINER SHIPPING INDUSTRY, by Ricardo J. SANCHEZ, UN-ECLAC; Universidad Católica, Buenos Aires, Argentina; and Gordon WILMSMEIER, Universidad de los Andes, Bogotá, Colombia; Hochschule Bremen, Bremen, Germany. 

However, the document argues that the global economy’s constant changes are shifting market conditions, therefore the question arises whether or not “the simple principle of economies of scale is still a valid argument, or if current tendencies need a broader and more complex discussion to understand the continued increase of vessels even in stagnating and sometimes declining markets.” 

Mergers, acquisitions, alliances and myths 

The search for economies of scale has driven the merger/acquisition/alliance trend, which has consequently created elevated entry barriers for newcomers and forged an oligopoly market ruled by mega-ships and over-tonnage in the world's major liner routes. However, the document reveals that operators have not reaped the benefits of savings caused by these economies of scale, because most freight rates have dropped more than the cost reductions. 

But, since 2008 the shipping industry has battled against a financial crisis that has had many casualties, despite the so-called benefits economies of scale promised. Other myths revolving around the benefits of implementing economies of scale are 1) “the bigger the ship, the better”; 2) all containers can be considered the same business; 3) supply follows demand and 4) individual vessel size generates economies of scale, independently from efficiency of networks or average operational speed, among others. 

Nevertheless, liners’ financial results are rarely above water, creating a vicious cycle of necessary mergers and alliances just to survive. 

An “incomplete” strategy  

The paper points out the four adjustment measures the shipping industry applied for survival: “1) changing the effective supply, 2) reducing operating costs, 3) realigning financial commitments, and 4) reorienting market strategies,” but highlights that there are other measures that can and should be applied in addition due to the decline in demand: “1) stop ordering new tonnage, 2) scrap (old) vessels, 3) terminate or postpone existing orders at shipyards, 4) implement slow-steaming, thus effectively limiting the available capacity, counterbalancing the increase of the nominal capacity of the fleet; and 5) temporarily laying up vessels from service.” It seems as if the strategy is incomplete, missing a crucial part to be 100% successful and break the cyclical pattern. 

So, the document proposes a rhetorical question: should the industry continue to accept what has been believed, or should it critically reflect on the tendencies of the liner shipping industry in order to create an understanding of what can be learnt from shipping development principles and tendencies? 

By MundoMaritimo

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