1. Overview Meli Marine is a leading player in the container shipping industry on intra-Asia routes and has built a strong presence in the market and demonstrated very high operating margins and operating ROA from 2002 – 2007 compared to its main competitors. As Meli Marine’s CEO, David Tian seeks to steer the company towards expansion in 2008, with an option to acquire 16 vessels from Teeh-Sah Holdings. With these ships, he plans to expand to the trans-Pacific market.
However, we believe this deal will not be in Meli Marine’s best interest at the moment, and the company will be better off without the acquisition. 2. Prelude to Acquisition Consideration 2. 1 Market Attractiveness: Trans-Pacific route appears attractive as number of shipping lanes has grown by 48. 9% between 2002 and 2007, and projected to grow by 42. 9% from 2007 to 2012. Loyal customers have also approached David expressing interest in staying with Meli should they provide trans-Pacific operations.
Therefore, this market can potentially be a big revenue driver if Meli’s assets are properly aligned to capitalize it. 2. 2 Benefits of Diversification: Trans Pacific route, particularly outgoing flows to North America, could offer diversification of income source to Meli Marine in periods when Intra-Asia’s demand is weak. Moreover, in most cases of macroeconomic downturns, countries such as Asia in 1990s will resort to export-push policies to stimulate the economy and a race to affordable transport options; these could enlarge the volume of outgoing freight flows. 2.
3 Tit-for-Tat Strategy against Competitors’ Cascading: On a macro level, an expansion move to Asia-NA route will be a strong hit on their competitors “on their profit pool”, and also serve as a possible strategic tool to thwart competitors’ threat of cascading. 2. 4 Improve Churn Rate of “Feeder Only” and “Both Services” Customers: Offering addition services of shipping to the Asia-North America market may reduce churn rate through benefiting the customers by creating greater convenience and increased speed of delivery (from reduced number of transfers and changeovers, and uniformed tracking).
3. Problems with Expansion into Asia-North America Market 3. 1 Internal Factors 3. 1. 1 Cost Incompatibility: The acquisition of Teeh-Sah’s vessel assets does not look favourable from a cost standpoint. In the industry where container carriers are largely price-takers, profitability depends heavily on reducing cost and gaining cost efficiencies. Arguably, much of Meli Marine’s turnaround under David Tian was also due to its cost restructuring.
Meli Marine thrived under David because it gained cost flexibility, with it owning just 30% of total fleet capacity. The decision to own less fleets gives Meli a cushion in the face of industry cycles. It reduces downside risk and gives Meli more ease in adjusting capacity to meet changing demands because of the medium term nature of the contracts. Acquiring the fleets may undo the cost-saving strategy that Meli has benefited from since 1990s. In conclusion, currently, Meli is not yet in the best position to enter this route.
3. 1. 2 Niche Incompatibility: Meli Marine’s niche is the delivery of a narrow set of commodities which include perishables, chemical commodities and halal products heading to Muslim customers in Malaysia, Indonesia, and India. In the NA market, demand for halal products is traditionally known to be smaller than in Asia, and perishables may not be suitable for long distance shipping. Thus, not only would Meli be venturing beyond its niche expertise, they would also indirectly face demand uncertainty for their services. 3. 1.
3 Unfavourable Economies of Scale: The demand for shipment to Asia from North America is much lower than the supply due to global trade imbalances as seen in Exhibit 1, where 70% of the Asia-North America trade comes from Asia compared to 30% from North America. Meli Marine’s vessels could thus potentially return from North America half empty. Furthermore, the price they get from this capacity is also less optimal as seen in exhibit 7, where North America to Asia rates are only about 70% of rates charged for Asia to North America.
Given the significant risk of drops in volume and price, Meli Marine may not be able to achieve economies of scale nor break-even should such a scenario occur. 3. 1. 4 Less than Optimal Ship Size: The vessels that Meli Marine planned to purchase were on average 4,500 TEU in size. This is smaller than the ideal size of 10,000 TEU for Asia-North America route. The supersize ships were better able to achieve economies of scale through spreading the fixed cost over a larger shipping capacity. In this manner, due to a lower cost, competitors may be able to successfully undercut Meli through lower pricing.
Thus should Meli Marine enter this market, they would begin with a cost disadvantage compared to their competitors. As further elaborated in Appendix B2, the long-distance of Trans-Pacific route also makes it unfeasible for Meli to replicate its successful operational strategy that it has implemented in Intra-Asia. 3. 1. 5 Backlash from Competitors – Feeders Line Mainline Operators: Expanding Meli’s service to cover the Asia-NA line will likely strain its relationship with existing ‘feeder line’ channel partners (MLOs). The MLOs may stop partnering with Meli for other routes.
Further, going head-to-head against established MLOs may intensify the threat of cascades. Also, if the influence of MLOs on current customers is larger Meli’s, the MLOs may coax Meli’s customers to switch to other Liner service providers. Such customer exodus will put at stake two customer segments with combined 28% size and overall higher contribution margin that Meli’s ‘Liner Only’ segment. Ultimately, this move could undermine Meli’s profitability if Meli’s branding and persuasion over customers are weaker than its channel partners.
3. 2 External Factors 3. 2. 1 Uncertain Demand: It would be hard to predict the demand for Meli Marine in the Asia-NA market. With little branding, little experience in operating over longer distances and a fierce competition against bigger vessels, Meli Marine may find it hard to gain market share and to recruit new customer pool in the Asia-North America market. 3. 2. 2 Lack of Diversification Value: Moreover, the case for diversification does not seem compelling if one accounts for the sources of demand variance.
In this regard, it may be useful to separate the Asia-NA route to its 2 components: flow from Asia > NA, and NA > Asia. Diversification of route may provide cushion against a weak demand within Asia (intra-Asia) However, weak demand within Asia (due to weak economies) would theoretically reduce demand of goods from NA > Asia, thus put into question the assumption that diversification of route can protect against downside risk from macroeconomic conditions. 3. 2. 2 Poor Macro-Economic Climate: the macro-economic factors of 2008 were not ideal.
With the global financial crisis looming in the horizon, the container shipping industry will inevitably suffer from a significant drop in global demand, as it swings in the past. Coupled with the existing excess of supply, this drop in demand will expose Meli Marine to unnecessary bottom line issues, should they decide to purchase the additional vessels. 4. Recommendations Trans-Pacific market is undoubtedly a huge source of potential revenue, but the time is not right for Meli Marine to enter, even just for strategic reasons.
Instead, they could use their excess cash to try expanding vertically into other services with higher margins, like terminal operations and inland delivery, building around their current strategy (see Appendix B2). Such a move can further boost their operating margin and absorb up to 30% of total cost. By extending its service to terminal operations and inland services in spoke cities, Meli also stand to gain from monopolies of the terminals and from gaining a lucrative 25% and 34% ROCE in these parts of value chain.
During this time, they can strengthen their branding and loyal relationship with customer base on the feeder services, thereby reducing the threat of MLOs backlash. Also, they can keep their eyes on the market and look for cheaper vessel deals from smaller players going out of the business, and expand at the first sign of economic recovery. Appendix Appendix A. Industry Analysis A1. Threat of Entry: The container shipping industry is a challenge one for both new and existing businesses. Threat of entry is relatively low, given that the industry is one typified by high capital requirements.
As an asset-intensive and network-based business, new entrants face challenges in getting financing, in achieving maintenance cost saving (through standardization and economy of scale), in building network and acquiring trust from customers. Operation and capital costs are high, with nearly 50% investment strapped in fixed costs. 20%-40% of costs come from fuel costs, which are prone to fluctuations and not fully transferable to customers. However, in vessel operations as is seen in Meli’s case, the huge capital requirements can be slightly reduced through leasing agreements.
Further, entry by established container carriers are less restricted, and “dumping of capacity” or “cascading” can be a big threat to industry’s profitability. A2. Power of Customer: Since container carriers offer generally similar services, customers in this industry have a lot more negotiation power. Container carriers are dependent on key customers – freight forwarders and major retailers – to make most of their shipment. Indeed, these customers contribute 60% of shipping volumes in 2007. A3.
Bargaining Power of Supplier: Suppliers of vessels carry somewhat less bargaining power in the value chain, given the widespread market for second hand and leased containers. This can be seen by the somewhat low ROCE of 9% for container delivery players. On the other hand, supplier of terminal services look more powerful, given the dependence of ships on each port. For instance, although one vessel can dock at another harbour, switching harbours will be expensive for ships due to added fuel cost, transhipment re-arrangement and administrative cost.
As such, suppliers of terminal services have bargaining power over the prices they charge. A4. Threat of Substitutes: Substitutes could include future advances in air cargo that lowers its cost and thus increases economic viable for mass transportation. Presently however, the threat of this substitute is low as air cargo’s current value proposition is to offer quick transportation at a higher cost, which is different from container shipping’s proposition of a cost-efficient mass transportation medium. A5. Rivalry among Existing Competitors: While the threats from substitutes are not major, competition within the industry is intense.
High customer power has fueled a price war between players, while global trade imbalance with manufacturing concentration in Asia brings inefficiencies in shipping capacity – ships can potentially return from a destination (US to Asia) only half full. Increasing trends like tightened regulation, shift to bigger ships, and excess supply have made competition more intense. Appendix B. Meli Marine’s Competitive Position B1. Value Proposition and Niche Market: In this fiercely competitive industry, Meli Marine has been able to come out on top for the past 5 years due to its unique strategy.
By shifting from large and old vessels to smaller ones, and from a 100% to a 30% ownership of its own ships, Meli Marine has secured more flexibility in its cost structure. Furthermore, through adding liner services on top of their current feeder function, Meli Marine has improved its coverage from hub-to-spoke routes to also a spoke-to-spoke one. Forward integration into its own freight forwarder arm and management of inland transfers was key to establishing a high quality, on time, and door-to-door delivery process that became one of the features for which Meli Marine could charge a premium price.
One of the main strategic moves that worked for Meli was its decision to concentrate on niche markets and goods, particularly on perishable (including halal food) and intermediate (chemical and textile) products which are time-sensitive. The investment in specialized containers such as refrigerated and insulated ones, enables customer-centric services to be provided to a narrow but very loyal set of clients. By increasing its service quality and investment to each customer (specialized sales force and scheduling flexibility), Meli gained more protection from price erosions and price-based competition.
B2. Operational Strategy: Meli’s other differentiating strategy is to own smaller vessels with an average of 1,200 TEUs per vessel, which are apt for use from spoke-to-spoke as they allow for more frequent trips to cities. Albeit carrying lower volume of goods, smaller vessels stand to gain transporting more goods with more frequent trips from one small ‘spoke’ city to another. The stability and frequency of trade within Asia also promise a more stable capacity utilization of outgoing and incoming voyages.
By investing further in this strategy, Meli can build sustainable competitive advantage in ‘spoke-to-spoke’ branding and efficiency in each harbour. As trades among Asian countries are expected to increase to 143 billion FEU-Km, Meli can strive to be the dominant force in Asia by transporting goods to many smaller harbours that others hardly notice. More frequent trips and smaller vessels carry the benefit of lower bunker cost and lower vessel cost. However, it carries the downside of having to pay more terminal and port charges when travelling from spoke-to-spoke.
Overall, Meli’s strategy of offering more frequent trips from spoke-to-spoke will function if it can offset the loss of economies of scale and more frequent terminal and port charges. To drive down cost and improve customer retention, there is an opportunity for Meli to vertically integrate and build their terminal operations branch and/or inland delivery services. This move can not only boost their operating margin, but also absorb the cost of terminal charges, a cost that Meli has traditionally paid to other companies.
Firstly, by vertically integrating their services, they are able to absorb up to 30% of total cost. By extending to terminal operations in spoke cities, Meli also stand to gain from monopolies of the terminals and from gaining a lucrative 25% ROCE in this part of value chain. Secondly, forward integration to terminal and inland delivery operation can also theoretically improve customer retention. For instance, an integrated end-to-end offering benefits customers through greater convenience and increased speed of delivery, through reduced number of ownership changeovers and a more uniformed tracking.
B3. Operating Margin: The niche-premium strategy and cost flexibility strategy worked, as can be seen from Meli’s operating margin that consistently hovered above 8% from 2002 onward (an average of 9% and ranges between 10. 1-12. 2%). In comparison, Meli’s competitors achieved a much less stable and lower average operating margin from 2002. Yang Ming Marine’s average operating margin is 7. 15% and fluctuates between 1. 3-13. 8%. Wan Hai Lines’ margin average is 3. 5% and ranges from -1. 0 to 9%. Evergreen Marine’s margin average is 5%, and ranges from -2. 4 to 9. 4%.
