In this series of articles disruption is the keyword, and we look at various areas in which the traditional airfreight industry needs to be streamlined and simplified, so as not to be swept away by something completely new and innovative, as is happening in other areas, where new mobile internet technology is making traditional business models obsolete.
Last week, our author Mark Grinsted, started the series with an introductory piece, complemented by a critical look at the bewildering rate structure. In today’s issue of CargoForwarder Global,
he focuses on the unfathomable surcharge regime in airfreight.
Readers are cordially invited to send their inputs and post comments or make suggestions for additional cargo themes worth to be elaborated in depth by Mark and published on our CFG portal.
Fuel and Security
Today’s subject is rate surcharges for fuel and security. With the introduction of all-inclusive rates by various airlines in the last two or three years this subject has lost some of its actuality, but many airlines still apply surcharges, and a general revival can be expected as soon as oil prices increase again or additional security measures become necessary.
In most walks of life, if the price of oil, or other commodities, goes up (or down) so do the prices. We pay more, or less, for petrol, heating oil, but also for electricity, rail and bus fares, and so on. Similarly, the prices for chocolate, coffee or butter vary depending on the price fluctuations of the raw materials. None of these suppliers impose surcharges; they just adjust their prices accordingly.
Why is airfreight different?
Adjusting prices is a cumbersome process: New rate sheets must be prepared and distributed, special rate agreements must be renegotiated individually, and regular clients may be tempted to look for better offers if prices change. The same applies to freight forwarders and their exporters. Better to just adjust a “one-size-fits-all” fuel surcharge. Even for exporters this makes life easier. The exporter does not need to re-negotiate rate agreements, and if the export manager exceeds his budget for airfreight charges he has a simple excuse: It was not his negotiating power, it was the fuel surcharge, that is “force majeure,” he can do nothing about it, and everyone must pay it.
But we know that the industries which are most threatened by disruption are the ones where over decades a set of rules has developed which protects the interests of all the insiders in the industry, a sort of cocoon which lets them live a comfortable life inside – until some unexpected innovation sweeps it away and replaces it with something completely new: Disruption.
While surcharges made life easier for everyone, they also had some disastrous effects. Let’s look more closely at this phenomenon.
Since the beginning of airfreight up to the mid-70’s surcharges did not exist and the published TACT rates were applicable. In those days, these TACT rates were legally binding and applicable to all airlines operating on a certain route. Under the umbrella of IATA these rates were agreed between all the airlines operating within the respective IATA Traffic Conference Area (“TC”), called TC1, TC2 and TC3, and some additional sub-areas.
In the 70’s the price of oil increased dramatically. At least the price increases looked dramatic in those days, even if, in retrospect, they were quite moderate compared with today. Older readers will remember the oil boycott by the Arabian OPEC countries and the ban on Sunday driving in 1973. 1979 saw a further round of oil price increases after the Islamic Revolution in Iran and the subsequent war between Iraq and Iran. Airlines, faced with higher fuel costs, felt the need to take some action to compensate. In line with the mentality of those days, this was arranged within the framework of the IATA Traffic Conference Areas, and a simple surcharge of – if I remember correctly - 7% was applied on the applicable TACT rates. Later, as oil prices continued to rise, a further surcharge of 8% was imposed on top of the old surcharge. These surcharges were shown officially on the AWB as additional lines in the rate calculation and were applicable to all airlines.
When the oil prices dropped again, this cumbersome surcharge calculation was discontinued, and by this time net rates (or “Split charter rates”) had made the IATA surcharges irrelevant anyway. But the mentality was still there and reappeared when, two decades later, the political situation again awakened the need for surcharges.
9/11 sent shockwaves through the airline industry. Insurance premiums increased dramatically, additional security measures were required, and airlines imposed a security surcharge of $0.15 (or the equivalent in local currency, in the Euro zone €0.15 per kg), applicable to all airlines and all routes, irrespective of the actual costs faced by the airlines in various countries or of the fact that some countries required more security measures than others. After a short period of uncertainty as to whether the surcharge was applicable to actual or chargeable weight, the general opinion was that it would be very difficult to justify applying it to the chargeable weight, so actual weight became the basis. An odd side-effect of this was that volumetric shipments effectively paid a lower surcharge per kilogramme, even though most carriers prefer dense cargo.
In the general shock after 9/11 no-one really asked what actual costs were being covered by this surcharge – security is something you don’t ask too many questions about - and so this surcharge remained with us to this day. As a matter of fact, it was not so much the airlines but the cargo handling agents who faced additional security costs. When the handling agents themselves imposed a very small surcharge of €0.015 on their charges to the airlines, several airlines immediately increased their security surcharge from €0.15 to €0.17accordingly.
Following 9/11, oil prices increased, and airlines again felt the need for compensation. By this time the TACT rates were effectively obsolete, so another mechanism had to be found. But the memory of the old IATA fuel surcharges still lived on, and this is when the fuel surcharges, as we know them, were introduced; first just a very small amount, just €0.05/kg, but, as fuel prices increased, so did the fuel surcharges.
Many airfreight managers will have certainly regretted their decision to start on this slippery path. As oil prices increased, so did the fuel surcharges, until they reached the point where they were higher than the market all-inclusive rates to China and other Far East destinations. For such destinations fuel (and security) surcharges had to be dropped and be replaced by all-inclusive rates. This reduced the fuel surcharge policy ad absurdum. How possibly could one justify fuel surcharges at a higher level than the all-inclusive rate for a long-haul flight! And to some destinations and not to others! And on top of this, the same fuel surcharge was charged irrespective of whether the cargo moved on freighters or passenger aircraft, whether on short-haul or long-haul flights. A “one-size-fits-all” surcharge. There was no correlation between the actual fuel charge imposed for a certain shipment and the actual additional fuel costs to move this same shipment.
But the fuel surcharge policy had another far-reaching and even more severe effect: In line with the surcharge mentality of the 70’s, airlines had now again just followed each other by all applying the same surcharge levels and all increasing or reducing these at the same time. The U.S. Government, who had always been suspicious of IATA’s price-fixing activities, saw this methodology as being a proof of illicit behind-the-scenes price-rigging and started anti-trust investigations against the airlines, and later also forwarders. Airlines did then start to set up their own individual rules and fuel price indices, but it was too late. Many airlines were found guilty of colluding to fix rates, primarily surcharges, huge fines were imposed and some airline managers even spent some time in jail. And it was not only the USA. Other countries jumped on the bandwagon when they saw the opportunity of increasing state revenues by collecting fines, and all over the world anti-trust investigations were launched. In some cases, paradoxically, states collected huge fines from the same state-owned airlines whose losses they were subsidising.
This all led to a widespread fear within the industry of talking about rates – or about anything else, for that matter. Airline staff refused to meet with other airlines for fear that someone might mention the word “rate”. Some airlines did not even publicly announce their own surcharges for fear that they may be accused of inducing others to follow. And thus, any interchange of ideas about how to work together to improve the cargo industry was effectively blocked.
What is the lesson to be learned from all this today? It is a prime example of the danger of doing things in a certain way just because “we always did it this way.” What may have been right in the 70’s was no longer right in the new millennium.