Due to recent developments including increasing labor costs in China, customer demands for shorter lead times and the rising cost of fuel, the alternative option of manufacturing the engines in northern Mexico is also on our table. We need to have a look at what the best inbound logistics options for our new supply.
Moreover, as Cuttengrass Inc. has recently been awarded a significant contract with a European big box store with 50 stores located all over Europe and we already have planned for the development of environmentally friendly re-chargeable products that cater to a more affluent clientele, we need to make an updated outbound logistics plan for our new market and new clients as well.
Our Supply Chain Team has made a careful study on customer needs, market situation and government initiatives for feasible and competitive solutions.
This report shall discuss the economic impacts of manufacturing the engines in Mexico versus China, specific to the following aspects:
- Supply and demand of air, road, rail and ocean and the resulting changes in rates. Make sure you address the positive and negative implications on supply and demand of the alternative modes for each manufacturing option.
- Government’s role in facilitating the increased trade
- How trade agreements with Europe and Canada will affect transportation pricing and lead times
- The economies of scale that will be achieved by the transportation firms servicing Cuttengrass.
- How environmental initiatives within the transportation industry may affect the firm’s decision.
This report then shall provide a recommendation based on above analysis.
- Supply and demand of Air mode, impact to rate and our feasible choice
- Supply and Demand of air mode transportation
Air transport provides an efficient solution for low inventory, short lead time and high value items. Due to the nature of air shipment, it always require high fixed cost investment and strict entry controls, therefore there are less competition in the market and only a few giant air carriers are providing the air cargo delivery services.
Since “A competitive industry is characterized by a uniform product being produced by many firms for many consumers with all parties operating with near-perfect information and no barriers to entry and exit being in place” , the airline industry does not have a typical supply function as under full market conditions, we can hardly use traditional supply and demand curve to describe the mechanism in rate and quantity relationship, as they are not “marked by competition in the way an economist would strictly classify it.” (CITT, 2016).
Actually the supply and demand transaction is always one-to-one and case by case, and it is not rare that for the same quantity or volume delivered, price is totally different.
- Impact to freight rate and our feasible choice
Because of the non-perfect market characteristics and some special features in operation, the air transport mode has some unique rate-setting mechanisms, most of which are used to maximize the long term profit for airline carriers and forwarders. We would like to discuss 3 special phenomena in air transport supply and demand area: S-curve effects, passenger pushing and price discrimination and their implication to our case:
What will be the S-effect implications for our freight rate?
Since we are comparing the options of delivering engines from Mexico and China, we then need to ask, which option would offer us better opportunity in using dominant carriers for the cargo delivery, if air mode is used?
The answer is there are no big differences if we use dominant airlines in either Mexico or China, as both of them would have host advantages due to S-curve effects, the air delivery service we get would be more efficient, less delay and with better cost options. After arrival to destination, services in Vancouver however, might be a little bit different. Since Vancouver air-port is a trade corridor for import and export between North-America and China and the import volume over Vancouver airport is higher than that of Mexico (statistics Canada, 2014), the negative impact under S-curve to China airlines could be less serve. But the impact to supply chain would not be huge, maybe just a few hours longer transit time.
In general, from S-curve point of view, there is no significant gap for the air cargo delivered from Mexico and China, if local dominant air lines are selected.
Needless to say, if air Canada is used for such delivery, the difference would be even smaller.
Passenger push effect on freight rate
As the passenger planes offers more spaces for air delivery and the excess supply would reduce the price level for the cargo service.
According to Tourism Vancouver, the number of visitors from China to Vancouver has outstripped those from the U.K. for the first time and China is now the biggest overseas market for the city — with domestic tourism and visitors from the U.S. coming in first and second overall.While the passenger airlines with Mexico are growing however the speed is less than that with China so far. Due to this passenger push effect, the rate for air mode delivery from China is under pressure of higher passenger demand, thus become competitive as that from Mexico. In fact, for a quick estimation, for a 60kg delivery, the freight rate we got from both origins is nearly same-around USD1300 per shipment.
This finding means if we use air mode, the China option would not be less competitive in terms of cost.
Both secondary and third degree price discrimination are widely used in air transport industry.
The secondary price discrimination is easy to operate and is in use all the time. The principle is very simple, the larger volume you are delivering, the higher discount. This rule has nothing to do with supply but more focus on demand management. If the customer can leverage its demand, aggregate its shipment volume, more competitive rate would be available.
For our case, as for both Mexico and China option, the volume of delivery would be same, so there is no difference if only the engines are put into consideration. All volume aggregation opportunities under service provider should be taken into consideration, if the supplier delivers more cargoes using the same air service provider, the rate could be even better. Then the China option might have a better chance as China exports more to Canada than Mexico does.
The third degree price discrimination needs more and deep segmentation of customer’s needs. For customer with urgent, special needs, premium would be charged and consumer surplus transferred into supplier’s profit.
This price discrimination has same impact to our two options. For stable supply chain, we would see same goods under same urgency for delivery either from Mexico or China. It’s all about supply chain planning and shipment arrangement. However, if the air mode is just a backup solution, most likely the air delivery needs are showed up under urgency, and then we have to pay more and offer our premium under service provider’s third degree price discrimination.
In general, considering the special feature of the supply and demand for air mode transport, we do not see many differences on rate and lead time between Mexico and China options even the distances to China is much farther away.
We believe if we decide to phase out China option gradually, it should not happen overnight. We might need to keep this air mode option from China as a backup solution for Cuttengrass should there be any problems in Mexico new source of supply.
- Supply and demand of ocean mode, impact to freight rate and our choice
- Supply and demand of ocean mode
Ocean shipping is one of best option for regular and large volume shipment due to its cost competitiveness. With regard to supply and demand, unfortunately they are not functioning along standard curves showing in perfect market situation either.
In a perfect market situation like the case for bulk shipping, the increase of demand would move the demand curve right and increase the rate, the short term rate increase would attract more supply into the market. For long run, due to external intensified competition and internal economics of scale, there will be a new equilibrium between supply and demand for a stable and balanced freight rate.
However, container shipment industry is not a perfect market due to historic reasons. Due to the needs for global operation, the shipping market is dominated by a few big ocean carriers after rounds of merging and acquisition. Instead of making price wars among each shipping lines, the carriers have formed Cartels under the name of shipping conferences.
The tools used by the shipping conferences are published minimum shipping rates and volume allocations (quota) to each carrier. This would resist the member’s temptation to increase its volume of supply so the supply curve would not be able to move towards right and the equilibrium prices are artificially kept at a high level.
As long as there is no cheating, this is good for all industry as carriers can get a premium charge from shippers. In fact, few carriers want to let their vessel sleep somewhere as there will be cost as well, in order to realize the goal, the carriers are normally move slowly to save fuel, call more ports.
That’s why the financial crisis and global economic slowdown did not put ocean shipping into jeopardized situation, as it did to bulk vessel delivery which we can judge from the BDI collapse.
- Impact to freight rate and our feasible choice
As the ocean shipping is most cost competitive choices for both Mexico and China options. Theoretically, the Mexico option should be more competitive given it has much less geographic distance to Vancouver. However, the reality is the supply of ocean shipping service for Mexico option (short sea shipping) is still not yet widely available and reliable than the China option.
Let us have a look at the real situation for both options.
- For China option
As Vancouver is gateway in Canada’s trade corridor with China, and meanwhile the transport is just a derived demand of trade, the growth of ocean shipment is mainly contributed to the trade growth between Canada and China.
In spite of global economic recession, the demand for trade between Canada and China is growing continuously. For instance, between 2008 and 2013, Canada’s bilateral merchandise trade with China has increased faster than any other country in the world. More impressive, is that China’s annual bilateral merchandise trade with Canada is worth $41.1 billion more than Canada’s third most important merchandise trading partner, and second fastest growing partner – Mexico.
Obviously, the high demand of trade has increased the derived demand for transportation especially for ocean shipping, and makes the China-Vancouver lane busiest ocean shipping lane in Canada. Therefore, the operation efficiency and economy of scale is already there and ready to use any time.
For the ocean shipment from Mexico to Vancouver, we have to face the fact that it is still quite challenging to operate the ocean shipment from Mexico to Vancouver through the coast of Pacific Ocean which are normally called short sea shipping among people in the industry.
Everyone understands that, theoretically, Short Sea Shipping could be a smart and cost effective solution for the cargo delivery between Mexico and Canada, and for our case, from Mexico pacific ports to Vancouver. Comparing with ocean shipment from China, It would shorten the transit time from 35 days to 7 days, and reduce cost by ⅔.
By Charles Yang, CITT, Copyrights Reserved.