Economists: Don’t leave home without one

As business leaders seek to stay ahead of the curve, they should ensure that somewhere in their range of view are the ideas of economists. Not forecasts or models or the dry parade of graphs and equations found in the typical introductory textbook, but rather economists’ insights and ideas, which sometimes have an enormous impact on the evolution of industries and also have been put to use in very practical and profitable ways by real companies. I am an economist, so this assertion may seem a bit self-serving. But I wouldn’t make it if there weren’t powerful evidence in its corner.

In this article, I’ll focus on one example: the Internet economy we know today would not have been possible, in scale or in speed of adoption, without an extremely important policy development of the 1970s and 1980s—the deregulation of transportation—in which economists played an important role. Nor would the business model of two of the Internet’s well-known players have been possible without the embrace of an idea—auctions—that has its roots deep in economics. I don’t think the Internet is an isolated case. I’ll close with an example of how a big economic idea could, in the future, have major implications for another major industry: pharmaceuticals.

Transportation deregulation
Had the transportation industry not been deregulated in the 1970s and early 1980s, and had the much more efficient and flexible systems built by companies such as UPS not emerged in response to competition, it is difficult to see how Internet retailers like Amazon, which came along roughly two decades later, would have been able to get started or succeed. Amazon would have had to begin with its own fleet of trucks or even planes to escape the strictures of the pre-1980 regulatory regime, a barrier to entry that almost certainly would have been impossible for new retailers to overcome.

The deregulation of prices and of entry into the transportation industry—especially interstate cargo air traffic and trucking in the mid to late 1970s—is an exciting story in retrospect, but its importance would have been easy to miss at the time. As such, it is a useful reminder for business leaders of the value of keeping their ears to the ground when big economic ideas are playing out in policy arenas. That this particular dismantling of economic regulation happened at all is an amazing fact that contradicts one widely held notion of political economy: a policy benefiting large numbers of people and businesses in a small way is unlikely to be adopted if it imposes large harm on a small, concentrated number of other individuals and businesses.

Air cargo and trucking fit this description to a T. Economic regulation artificially suppressed competition and kept prices of freight (and passenger) traffic too high. But since freight costs represent only a small fraction of the costs of any retail operation and are not separately broken out, consumers paid only a little bit more than they otherwise might. Moreover, even if consumers knew this, they were too diffuse to oppose the concentrated lobbying efforts of the firms in the transportation industry (and its workforce), which would have been hurt greatly by additional competition. That was true even if the price for keeping it at bay had to be price regulation.

How then did things change in the United States? The starting point was congressional hearings organized by the late Senator Edward Kennedy and his chief staffer on these issues, Stephen Breyer (currently a Supreme Court Justice). The hearings featured economic research that made clear the large price cuts to be expected from dismantling price and entry controls in the airline industry. When Jimmy Carter was elected president, he joined forces with Kennedy (and senators whom Kennedy recruited to the cause) to push deregulation. Carter started with the appointment of two prominent economists, the late Alfred Kahn (as chairman) and Elizabeth Bailey, to the Civil Aeronautics Board, which oversaw the airline industry.

Airline deregulation passed Congress in 1978. Once the deregulation ball was rolling, it next went to the trucking industry, whose prices and routes were just as strictly controlled, even though there were thousands of firms in the industry. Trucking deregulation came in 1980, with the help of some heavy pushing along the way by the Interstate Commerce Commission, headed by another highly regarded economist whom Carter had appointed as chairman (on Kahn’s recommendation): Darius Gaskins. The bottom line is that neither deregulation success would have been possible without many years of prior economic research and, most likely, without articulate economists such as Kahn, Bailey, Gaskins, and the economists they appointed to key regulatory positions. When the stars align in this way, it’s worth paying attention.

Auctions

Economists and their ideas also have had an important impact on the evolution of the Internet directly, not mediated by policy changes, through their championing and theorizing about auctions. In the early 1900s, the whole notion of how prices are set in a market economy was analogized to an auctioneer, since frequently referred to as a “Walrasian auctioneer” in the academic literature. The auctioneer conducts continuous auctions for all kinds of commodities, not just those in scarce supply, to which it was once commonly thought that auctions would be limited.

Auctions played a role in the rise of mobile telephony, which has become deeply intertwined, through smartphones, with the Internet itself. (Economist Ronald Coase proposed auctioning off segments of the electromagnetic spectrum in the late 1950s, an idea that was not adopted until the 1990s.) And auctions also played a direct role in the growth of two well-known Internet companies.

One example is Priceline, launched by Jay Walker, who studied economics at Cornell as an undergraduate and learned his lessons well, especially the lectures and reading materials relating to demand curves, which are constructs in economic textbooks but not directly observable in the real world. Shortly after the Internet’s commercial possibilities became evident, Walker and his colleagues came up with the idea of “name your own price travel”—essentially reversing the typical process, in which firms set prices and then hope that consumers pay them. But Walker’s idea was not just to have consumers offer to pay their own prices: if it had only been that, travelers would have bid a dollar or two, and the airlines and hotels he was seeking to participate (TWA and America West became the first) would have refused. No, Walker’s clever innovation was to require consumers to pay the price they bid if the airlines and hotels on Priceline decided to accept it. That condition made travelers think hard about their bids and induced them to make serious offers.

Priceline is an example of a company founded by an innovator with a background in economics. Another company where economic principles later proved to have importance is Google. The search-engine pioneer generates most of its revenue through an auction-based system of selling ads. The system was developed by two engineers but validated by Google’s chief economist, Hal Varian, who was also the first dean of the School of Information at the University of California at Berkeley.

It’s worth mentioning as a side note that Varian has since overseen the hiring of a large corps of statisticians (mostly) and economists who developed other innovations for the company. Google Trends, for example, tracks search-term volumes, which can be helpful in predicting various real-world events, such as the progress of the flu or forthcoming official unemployment statistics. Indeed, the big data revolution ushered in by the ease of capturing, storing, and analyzing large bodies of data has generated new demand for economists and statisticians. High-tech companies like Amazon, Google, and Yahoo! now employ economists to sift through all kinds of data—retail transactions, browsing patterns, mobile-phone usage—to fine-tune their product offerings, pricing, and other business strategies. While teasing out relationships from masses of data can be helpful, correlations found in them often speak to the past and have limited forward-looking utility. Data mining is likely to be more useful if guided by underlying theories, which is what economists can do.

Looking forward

What do these stories of economic ideas have to do with business leaders today? I’d suggest that, every now and then, economic concepts are likely to make their way forward in surprising places, creating real opportunities for watchful executives and threats for unsuspecting ones. Here’s an idea, developed by economists at MIT, that I believe has promise: the securitization of research and development for pharmaceuticals or medical devices.1

The notion here is to pool the R&D expenses of many different research endeavors, most likely ones that have passed some preliminary vetting (for example, Phase 1 clinical trials mandated by the US Food and Drug Administration). I know that the mere word “securitization” has a bad name in the wake of the financial crisis. But the notion itself is not bad; it’s what’s inside the pools of securities and the completeness of disclosure for investors that matter. Structured the right way, pharma R&D bonds could be not only attractive for investors but also a potentially important way to bring more capital to support research for drug therapies and medical devices that both extend and improve the quality of life for millions of people.

When and how this kind of securitization will happen I don’t know. But I do believe that pharmaceutical researchers and leaders should keep an eye on the potential for it, and I will be surprised if, at some point, economic and financial value don’t shift in surprising ways as a result. Business leaders are unlikely to catch signals like these, though, if they limit their focus on economics to one-off situations—listening periodically to the forecasts of economists, hiring them as experts in lawsuits, or seeking their assistance in very specific projects, such as how best to bid in upcoming federal auctions for the electromagnetic spectrum.

I believe economists have a broader and more ongoing usefulness for business. John Maynard Keynes, one of the most famous economists of them all, surely was right when he observed that “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” The one qualification I would add is that the originators of the ideas need not be defunct; economics is a living field whose generation of ideas with business relevance bears watching all the time.

Source: http://www.mckinsey.com/insights/economic_studies/economists_dont_leave_home_without_one

UPS buys TNT Express: Strong deliverer

THE “conveyor belt” for global commerce is how Scott Davis, the boss of UPS, describes his company, the world’s biggest express-parcel shipper. On March 19th UPS announced that it would buy TNT Express, a Dutch competitor, for €5.16 billion ($6.8 billion). The deal adds TNT’s hefty regional network to UPS’s vast global one. The merged firm will be much larger than FedEx or DHL, its main rivals (though DHL is part of a larger group).

It is a good time to strike a deal. TNT Express, which split from TNT’s mail-delivery firm last year, has wobbled as the world economy has faltered. Its share price is depressed, but its prospects are not bad. As the world economy revives, package-toters with global networks should thrive.

The big three have the field to themselves. The huge capital costs of building a worldwide network of planes and trucks to ensure swift deliveries of parcels, documents and freight keeps smaller rivals at bay. And the more complete the network, the better customers are served. TNT Express’s business fills a gap in Europe, where UPS lacks a road-freight operation. It also has a struggling business in fast-growing Brazil that UPS reckons it can fix.

Strong growth looks set to resume. Express delivery is enabling smaller firms to run the long global supply chains favoured by big companies, helping everyone to save cash. UPS reckons technology and demography offer plenty more scope for shifting parcels.

First, technology. E-mail may have killed the letter, but online shopping is great for parcel-deliverers. Shifting things bought on the internet is 30% of UPS’s business in America. That jumps to 50% at Christmas and other peak times. And as people everywhere discover the joy of shopping from the sofa, the business has excellent growth prospects. Online shoppers don’t care whether goods come from a few streets away or must be shipped, more profitably, from another continent.

Second, demography. Greying populations seem an unlikely source of profits. Yet to contain spiralling health-care costs, older folk are increasingly receiving treatment at home rather than in hospital. UPS already has a good business ensuring that organs and skin grafts get to hospitals in good time. (Transplant patients prefer not to wait.) The next bonanza, it reckons, will be delivering drugs and medical devices to patients’ doors.

Source: http://www.economist.com/node/21551086

Maersk Bets on Better Shipping Forecast

Container ships and hurricanes don't mix, as all captains know. But AP Moeller-Maersk is weathering economic squalls well. Despite weak global trade and high fuel prices, shares in the world's largest shipping company are up 25% this year, buoyed by cuts to industry capacity. Now Maersk is merging some of its Asia to Europe services with rival CMA CGM, further reducing capacity. If that enables Maersk to raise freight prices this year, the shares could rise further.

Still, it won't be plain sailing. The industry's order book for new ships—placed in healthier economic climes—is around 30% of the current fleet. Capacity is currently outstripping demand for shipping of finished goods by around 4% annually, forcing shipping groups to cut prices last year. Even after a recovery this year, spot shipping rates from Asia to Europe—the world's busiest route—are around $710 per container box, below the cost of the fuel needed to transport them.

The wind is now changing. The main carriers are aiming to raise prices between Asia and Europe by $600-$900 per container in coming months, an unprecedented hike, notes data specialist Alphaliner. To regain pricing power, Maersk, CMA CGM and MSC are keeping ships in port or cutting routes. Around 7% of market capacity is sitting idle, double the level of a few months ago, already enabling the industry to push through the first rate rises in two years.

Even so, Maersk still trades at around book value. That's in line with Asian rivals China Cosco Holdings and Evergreen Marine, which lack Maersk's oil-rig operating business and stake in oil producer DUC, which act as a partial hedge against rising fuel prices. Yet even a small freight-price increase could buoy its prospects. Each extra 1% rise would add approximately 5% to its 2012 earnings, notes Deutsche Bank. That's something investors might like to take on board.

Source: http://online.wsj.com/article/SB10001424052970204131004577235363815010118.html?mod=WSJ_Heard_LEFTTopNews

Freighter Oversupply Weighs on Shipowners and Banks

SINGAPORE — The skyscrapers and immaculate beaches of this seaport look out on one of the world’s largest parking lots: mile after mile of empty cargo ships, as far as the eye can see.

Similar fleets bob at anchor, with empty cargo holds, off the coasts of southeast Malaysia and Hong Kong. And dozens of newly built ships float empty near the giant shipyards of South Korea and China, their owners from all over the world reluctant to accept delivery during one of the worst markets ever for the global shipping industry.

As recently as six weeks ago large freighters that can carry bulk commodities like iron ore or grain were fetching charter rates of $15,000 a day. Now, brokers and owners say, the going rate is $6,000 a day. If any customers can even be found.

Although the fault lies partly with doldrums in the global economy, the bigger factor is a glut of new freighters. The oversupply is putting financial pressure on the shipowners that bought them and the already struggling European banks that financed many of the purchases.

Shipping industry leaders hold little hope of a quick recovery.

“If the tunnel is 2012, I can’t see any light at the end of it,” said Tim Huxley, the chief executive of Wah Kwong Maritime Transport Holdings, a Hong Kong-based shipping line with 29 bulk freighters and tankers.

Back during the global commodity boom, which continued through the spring of 2008, the world’s shipowners could hardly place orders for freighters fast enough. But because of the long lead times in shipbuilding, those vessels only now are being delivered by the hundreds — into a very different, much less robust international economy than when they were ordered.

For the shipping industry, the glut means not only lower charter fares, but also steep declines in the value of their vessels. The bigger losers, though, could eventually be some big European banks, many of which are already struggling with big losses on their holdings of government bonds from Greece, Italy and other heavily indebted European nations.

Basil Karatzas, the chief executive of Karatzas Marine Advisors, a ship brokerage and finance advisory firm in Manhattan, estimated that European banks hold about $500 billion in shipping loans on their books and face nearly $100 billion in losses to restructure them.

Just as American banks have grappled with huge loan losses for houses that are worth less than their mortgages, European banks face tens of billions of dollars in potential losses on shipping loans.

The banks’ “biggest concern is what is the write-off, and how do you treat it from an accounting point of view,” Mr. Karatzas said. “They do not know how to deal with these losses.”

Banks in Europe have long been the world leaders in ship financing because many of the biggest fleet owners are based there. But many have abruptly stopped lending money to shipowners. Some, as they scramble to muster capital to meet tougher reserve requirements demanded by European banking regulators, have even tried to raise money by asking some shipowners to prepay loans in exchange for a discount.

There is a scant secondary market for ship loans right now, except at deep discounts that banks are loath to agree to, according to shipping finance experts. Even for loans on which the vessel is still worth more than the mortgage, these experts say, the discount demanded is about 20 percent.

Commerzbank in Germany and the Lloyds Banking Group in Britain are among European institutions that have publicly said they were reducing their exposure to shipping loans.

Société Générale in France also has been looking for ways to reduce its holdings of shipping loans and instead focus on providing financial advice to shipping companies, according to two people with knowledge of the bank’s moves.

The bank declined to provide a comment on its shipping exposure ahead of the release of its annual financial report next month.

Shipowners, meantime, are nervously monitoring an industry benchmark, the Baltic Dry Index of bulk freighter charter rates, which has lost more than half its value since the start of the year. The index is now at its lowest level since January 2009, during the depths of the economic downturn after the bankruptcy of Lehman Brothers.

And as charter rates plummet, so do prices of the vessels themselves. A large tanker that sold for $137 million in early 2008, the Samho Dream, was repossessed by bankers late last year and sold last week in Hong Kong for just $28.3 million.

The world’s tonnage of large freighters is climbing by more than 10 percent a year, with 1,650 large freighters for bulk commodities expected to emerge from shipyards this year alone.

As long as the shipped tonnage of world trade is creeping up at an annual rate of only 2 to 3 percent a year, the oversupply can only grow more burdensome for the seaborne freight industry.

Making the glut especially acute right now is the fact that shipyards have delivered a large number of vessels to owners since the beginning of the year. Just as some car buyers wait to buy a car at the start of a model year — because it will hold its resale value longer — shipowners have traditionally taken delivery of as many vessels as possible in January, so as to have a full calendar year’s use before a vessel celebrates its first birthday, said Natasha Boyden, an analyst at Cantor Fitzgerald in New York.

Buyers who might be tempted to refuse delivery of vessels can lose their deposits, which are typically up to 40 percent of the contract price of the ship. But it is getting harder to borrow money from struggling banks to pay for the remaining 60 percent — particularly with resale values now much lower than the prices at which contracts were signed four or five years ago.

Freight rates are now close to operating costs for many bulk freighters, leaving almost nothing to pay the mortgage, so more old vessels may be scrapped in the coming years, which would eventually reduce oversupply.

Worldwide lending for ships totaled about $100 billion last year, down only slightly from previous years, according to industry estimates. But as much as three-quarters of last year’s loans were to refinance or restructure previous loans that the borrowers were struggling to repay, shipping finance executives said.

One big question is whether the plunge in freight rates might also signal further trouble in the global economy. World oil demand has been fairly flat lately because of weak economic growth, so there has been limited need for more tankers to haul oil.

The biggest market for bulk carriers lies in carrying iron ore to China’s voracious steel mills. But with a real estate slowdown in China undermining demand for steel, the annual growth rate of Chinese iron ore imports has abruptly slowed since October.

Harley Seyedin, the president of the American Chamber of Commerce in South China, said that many construction projects had slowed to a crawl, with barely enough work being done for developers to persuade their bankers to continue financing projects already under way.

Yet the growing glut of vessels, combined with seasonal factors, could skew the reliability of shipping as a global economic indicator. Bad weather lately off Australia and Brazil, the two countries where bulk freighters are most likely to take on iron ore and other cargo, has made companies leery of chartering vessels and risk waiting for days for ports to reopen after storms.

Further confusing the picture is that the cost to ship a container from China to the United States or Europe actually jumped in the first two weeks of this year, as factories rushed to fill orders before shutting down for up to a month for the Chinese New Year, which began Monday. But that could be a misleading metric, because container rates temporarily surge every year for the last sailings before the Chinese New Year.

Even if world trade does not slow in the coming months, the shipping industry still has a long way to go before cargo demand can possibly catch up to capacity. Meantime, bulk freighters, container ships, tankers and refrigerator ships by the hundreds may continue to bob idly in the waves here, their hulls showing wide bands of paint that would be submerged if the vessels were fully laden.

Source: http://www.nytimes.com/2012/01/26/business/global/the-global-downturn-weighs-on-shipowners-and-european-banks.html?pagewanted=1&_r=1&ref=global

Shipping: Economies of scale made steel

ABOARD one of the world’s largest container ships, moving almost imperceptibly through the seas off Vietnam, it’s easy to appreciate the economies of scale that allow a T-shirt made in China to be sent to the Netherlands for just 2.5 cents.

The Eleonora Maersk and the other seven ships in her class are among the biggest ever built: almost 400m long, or the length of four football pitches, and another half-pitch across. The ship can carry 7,500 or so 40-foot containers, each of which can hold 70,000 T-shirts. On the voyage your correspondent took, the Eleonora was carrying Europe’s New Year celebrations: 1,850 tonnes of fireworks, including 30 tonnes of gunpowder.

To move all this cargo from China to Europe in just over three weeks, the Eleonora boasts the largest internal-combustion engine ever built, as powerful as 1,000 family cars. This engine turns the longest propeller shaft (130m) ever made, at the end of which is the largest propeller, at 130 tonnes. Yet the ship is so automated that it requires a mere 13 people to crew it. Reassuringly, most captains prefer to take a few more.

Maersk Lines, the world’s biggest container-shipping company and owner of the Eleonora, is betting that, given the current economics of world trade, the only way to go is yet bigger. In February it announced an order for 20 even larger ships with a capacity of 18,000 twenty-foot-equivalent units (TEUs), the standard measure of container size. (The Eleonora can carry a mere 15,000.) The new ships will cost $200m each. And judging by this year’s order books, Maersk’s example will be followed by others. Singapore’s Neptune Orient Lines has ordered ten vessels of 14,000 TEUs; Orient Overseas Container Line has ordered ten of 13,000 TEUs. This is excellent news for South Korean shipyards (see article).

Most of these vessels will be designed for the Europe-Asia run—now the world’s busiest trade route. Given the rising price of fuel, many shippers think they need huge ships to turn a profit. Fears of a renewed slowdown in global trade accelerate the rush to find economies of scale.

Freight rates have plummeted in recent months, thanks to weakening demand and an oversupply of container ships, many of them ordered in the optimistic years before 2008. Freight rates on the Europe-Asia run are now below $700 per TEU, less than half the peak a year ago. At this price, says Janet Lewis, an analyst at Macquarie, a bank, “It’s hard for any container company to be making any cash.”

Recent financial results bear this out. On November 9th Maersk said its container business had lost $297m in the latest quarter. Neptune posted a third-quarter loss of $91m, having made a profit of $282m a year earlier. Japan’s “K” Line reported a loss of $239m on its container-shipping unit in the fiscal first half. And things could get a lot worse.

Companies are searching for new strategies to differentiate themselves from rivals, or merely to survive. Maersk has launched what it calls the “Daily Maersk” service on the China-Europe run, deploying 70 vessels to promise daily deliveries to Felixstowe, Bremerhaven and Rotterdam, the three main European container ports. The firm is hoping to deliver 95% of these containers on time, up from 80% for its own service on that route. This would be far higher than the industry average of about 65%. If a container arrives more than a day late, Maersk pledges to compensate the customer. Orient Overseas, by contrast, is focusing on the quality of its cargo-handling. It charges more, for example, to ship perishable items, such as blood plasma.

Given the stormy waters that may well be ahead, it seems likely that shippers will seek economies of scale not only from bigger ships but also from mergers. The industry is too crowded, many analysts believe. Smaller firms may soon be swallowed like containers vanishing into the hold of the Eleonora Maersk.

Source: http://www.economist.com/node/21538156