Temporary disruptor, or catalyst for supply chain revolution?
An effortless downswing launches a ball up into the sky where it bisects an incoming China Southern 747 freighter making its final approach toward the nearby airport’s eastern runway. Unbeknownst to the golfer, a footwear executive in town for an urgent supply chain meeting, she has more in common with the aircraft than their link to Tan Son Nhat – the name shared by the golf course and adjacent airport in Ho Chi Minh City. Both have been deployed in hopes of landing an ace of different sorts as part of a broader mission to Vietnam.
Although well outside the crosshairs of an escalating trade war between the United States and China, Vietnam’s potential to play a larger role in global supply chains is being rigorously tested as an indirect result. When souring trade relations between the world’s two largest economies led to a tit-for-tat tariff showdown in July 2018 when both countries began following through with punitive 25% tariffs on a first series of products, neither airfreight stakeholders nor the apparel industry were immediately concerned. Apparel was excluded from the first lists and so were most commodities that move by airfreight.
Just as a gust of wind can alter the trajectory of an in-flight golf ball, the latest squall from the U.S. Trade Representative (USR) now threatens to impose tariffs on virtually all commodities imported into the U.S. from China. Companies in virtually every industrial sector with exposure to China are suddenly finding it necessary to reevaluate their global supply chains in an attempt to mitigate the impact of tariffs. The China Southern freighter happens to be carrying pieces of factory machinery previously used by an apparel manufacturer in Guangzhou – the machines will soon be put to use as fuel for Vietnam’s growing industrial machine. Just over the fence from the tarmac, the footwear executive is departing Tan Son Nat Golf Course and is on her way to deliver a massive purchase order to a local supplier.
One popular option is to source product from elsewhere. “Partial relocation of manufacturing bases in China to neighboring countries,” and increased procurement from factories outside of China, “indeed that is what is happening right now,” said Toshiya Tamada, EVP global marketing, ANA Cargo. “A question you have to ask yourself is so what? Do we expect more air cargo volume is coming up from, for example, Vietnam or Thailand?” Perhaps just as important, what does this mean long-term for volumes ex-China and Hong Kong?
From the onset of the first tranche of tariffs in 2018, airfreight demand remained robust well into the year, until October 2018, when air cargo traffic began to lose momentum. By December, total market growth measured in freight tonne kilometers (FTKs) turned negative, dropping 0.5% year-over-year, according to IATA. By April, International FTKs were down 5.4% compared to April 2018, and 3.4% year-to-date. Only this year have trans-Pacific volumes ex-China and Hong Kong begun to react to the increased trade friction.
As for volumes out of Vietnam and other gateways in Southeast Asia, although tonnage continues to climb, growth alone will not suffice. “If you look at it, the growth in airfreight out of Thailand and Vietnam, Cambodia, Malaysia, it’s been double-digit for years,” said Neel Jones Shah, SVP and Global head of air, Flexport.
To counterbalance softening volumes out of China and Hong Kong, Vietnam’s air cargo market needs an albatross to outperform already high expectations. Despite industrial momentum driving exports, many carriers and forwarders Air Cargo World spoke with have been thus far underwhelmed with air cargo uptake out of Vietnam. “Volumes out of Hanoi (HAN) destined for the U.S. were not up significantly – and volumes ex-Bangkok (BKK) meanwhile, were actually down,” said ANA’s Tamada. Trinity Logistics, a U.S.-based, fashion-focused forwarder which has chartered scheduled freighter flights between Southeast Asia and the U.S. since well before the trade war began reported some of the lowest load factors to date on flights ex-Hanoi this past May.
But it may not time to call a bogey on trans-Pacific airfreight for the remainder of the year just yet. While the latest round of tariffs has put a damper on some optimist sentiments, says Wilson Kwong, CEO of Hactl, “A pickup is still possible.” In an industry known for its ability to navigate volatility, leading carriers and freight forwarders are reordering their networks and service offerings in order to remain one step ahead of the supply chain shift.
Supply chain shift, or shudder?
Even prior to the trade war, Vietnam and other rapidly industrializing economies have long been a beacon to labor-intensive manufacturing that was once the backbone of China’s exports in industries such as footwear and apparel. “China is over the peak in terms of footwear production for the U.S. market from a high of 90% to 69% today, and dropping,” said Matt Priest, President & CEO of the Footwear Distributors and Retailers of America (FDRA). The trade war can be seen as a catalyst for a quicker shift. Even companies that rely on China to manufacture the bulk of their products “are now looking” for alternatives, said Priest.
Initially, many manufacturers with flexibility in their supply chains held on to hopes of a quick resolution and avoided a wholesale exodus out of China. Additionally, many companies, “couldn’t change and move production elsewhere,” because they were “locked into contracts,” said Bob Imbriani, VP, Team Worldwide. As concern grows that a trans-Pacific truce may not be on the table and as purchasing contracts expire, additional supply chain shift is occurring. “We’ve been working with many customers looking at alternate landed cost scenarios if they did start sourcing in Vietnam, Taiwan or other places,” added Imbriani, whose Trade Services helps shippers navigate customs and regulatory issues.”
The boom in the number of purchase orders being issued to factories outside of mainland China has had consequences for export volumes from the country but highlights the speed at which carriers can retool their networks. Transit hubs such as Taiwan, South Korea and Japan have long catered to trans-Pacific cargo flows, says Tamada, whose carrier ANA saw a 24% drop in traffic on the China-Japan lane during 1Q19. Softer volumes out of China have made ANA Cargo and many other carriers to trace supply chains back to alternate sources of volume.
“We reallocate the space unfilled by our China stations to the stations in Asia and Japan to minimize negative impact on the business to the U.S.,” said Tamada. “Airlines in greater Asia in general are now struggling to maintain load factors on the flights to U.S.” Taiwan-based China Airlines noted air exports from Vietnam to the U.S. had increased by 26% in 1Q19.
Shah confirmed the trend, saying, “Carriers in North Asia are giving markets in Southeast Asia a bigger allocation for transpacific freighters than their home markets.” While this might have the effect of making airfreight capacity a buyer’s market, for carriers looking to make up lost ground outside of China, “One-stop carriers are in fact trashing yields out of Vietnam” said Shah.
Given the bi-lateral nature of the tariffs, flights returning to Asia from the U.S. are also seeing a drop-off in demand for perishable items like lobsters and fresh fruits. Importers are “shifting the orders to Canada,” which further weakens demand from the U.S., added Andrew Lin, GM of cargo marketing & planning, China Airlines.
Retooling for nothing?
For now, increasing industrial activity in other markets has so far been insufficient to make up for sagging volumes out of China and Hong Kong. Many indicators suggest a greater pickup, still to come, may have been delayed as a result of previous forward-stocking. “Specifically, in the U.S., what has happened is that [shippers] tried to front-load prior to the various tariffs coming through, and inventories are at an all-time high, but volumes now are down,” said Mike Short, president of global forwarding, C.H. Robinson.
Forwarders are reporting higher LCL volumes out of major ports in Southeast Asia, but there is some debate as to whether these volumes foreshadow a boost in demand, or indicate faltering speed requirements stemming from saturated inventories. “Inventories are down from 2018-2019, the U.S. economy is robust, and companies are finally starting to replenish inventories,” said Shah, noting Flexport’s uptick in ocean volumes.
Robinson’s Short, meanwhile, sees the use of oceanfreight as a reflection of bloated inventories. “They have high inventories, so they don’t need it as fast,” said Short.
Regardless of whether another round of tariffs goes into effect, many manufacturers are operating according to contingency plans that will lean on airfreight as a mitigator of supply chain disruptions. Supply chain forecasts from at least two major footwear and apparel brands have called for increased use of airfreight for the remainder of the year. “We are going to reasonably increase the use of airfreight from Q2” said Harm Ohlmeyer, CFO, Adidas, during a first-quarter earnings call. Ohlmeyer added that Adidas suffered from supply chain shortages in Q1.
Anticipating a global rush to get product across the Pacific ahead of Tariffs, Lululemon is also working with forwarders to reserve capacity. “We are committing to higher airfreight usage as a hedge against disruption in ocean shipping lanes as we approach the key dates related to tariff increases,” said PJ Guido, CFO, Lululemon.
As port capacity is tested, airfreight may still find an ally in the inability of some ports to process an uptick in volumes. “Only so many containers can move through a port, at some point investment will be needed,” said Shah. Unlike the Chinese government which could match industrial growth with massive investments in logistics infrastructure, Southeast Asian governments do not currently have the resources to do so. Unfortunately, airports too will see their capacity limits tested without further investment.
Major brands are taking a lesson in contingency planning from the first rounds of tariffs, says FDRA’s Priest. While it is impossible to predict if and when additional commodities will be subject to tariffs, and what commodities will ultimately end up on the list, previous rounds of tariff implementation provide a few clues. On May 10, importers of certain commodities into the U.S. were told that if they could get product out of China by June 1, the consolidations would be subject only to the existing 10% and not the full 25% according to FDRA’s Priest.
“For shipments that couldn’t be brought into the U.S. ahead of the deadline by sea, airfreight was used,” said Priest. With the threat of tariffs on potentially any export from China, even commodities that typically wouldn’t travel by ocean could find their way onto an aircraft as part of a front-loading strategy.
Long-term, if an accord isn’t reached soon, industry elsewhere may pick up as well. “Southeast Asia has directly benefited from the first stage of the trade war,” said China Airlines’ Lin, referring to how quickly supply chains for consumer goods were able to gravitate towards the region. The threat of tariffs on high-tech goods such as mobile phones and laptops is now driving some production back to North Asian countries, like Taiwan. So far these types of shifts have been limited to increasing utilization of existing industrial capacity outside of China.
Shifting production, after all, is not quite a hole-in-one for mitigating the costs of the trade war. “Moving a supply chain is an incredibly complicated decision,” and for many high-value verticals, “the investment required for a new factory does not justify the costs of avoiding tariffs,” said Shah. China for the foreseeable future will remain a major force in industrial production.
Even if a G20 summit held in late June in Osaka produces a Sino-American trade accord, the export output from China is unlikely to pick up as quickly as it has dropped off. “There’s going to be a waiting period even when the dispute is over, said Imbriani. “People are going to be skeptical, could this come back, could it happen again?”