DISECONOMIES OF SCALE IN CONTAINER SHIPPING

Economic theory and practice tells us that economies of scale have the potential to increase welfare of both consumer and manufacturer. However, there are limits to the advantages that they can bring.

It is important to be aware of some of these. Changes in market demand, linked to large units of capital equipment have the potential to produce high levels of output – but if demand is at a low level, capital will be under-utilised leading to excess capacity and rising average total costs.

Some large units of capital may not be transferable to other uses if there is a switch in consumer demand due either to sufficient lack of demand in other areas or operational restrictions. This is clearly applicable to the container shipping market and the potential for  shifting fortunes in the market.

Diseconomies of scale may appear when the units of production, the very large containerships, grow beyond the scale of production that minimises long-run average cost. The rise in the long run average cost is caused by diseconomies of scale. It is often difficult to pinpoint exactly the causes of diseconomies of scale, however management theorists often point to issues related to control of the productive units and the coordination along a large supply chain that needs to fill a ship of 12,000 teu every week.

Let us consider an example of the 10,000 teu-12,000 teu ships, all coming on stream during a period of unprecedented trade growth, we need to consider the above economic theories. Let’s consider the Europe-Asia trade where the demand and volumes are sufficiently large to sustain these ships.

A string of eight ships sailing at around 24.5 knots with a minimal number of port calls, however the same string travelling at  21.5 knots would require around 40%- 50% less bunkers. Alternatively, more ports of call would need an additional vessel, at a cost of $165m, around $50,000 per day,plus the extra fuel costs.

The question is, at what point does the equilibrium between additional fuel costs and asset cost break, causing a shift in the slope of economies of scale. Have we reached this point of diminishing returns?

Let us look at the bigger picture – a more holistic view

Like other forms of transportation, container shipping benefits from economies of scale in maritime shipping, transshipment and inland transportation. The rationale of maritime container shipping companies to have larger ships becomes obvious when the benefits, in terms of lower costs per TEU, increase with the capacity of ships. There is thus a powerful trend to increase the size of ships, but this may lead to diseconomies to other components of container shipping.

For port terminals the growth in ship capacity comes with increasing problems to cope with large amounts of containers to be transshipped over short periods of time as shipping companies want to reduce their port time as much as possible (improved ship asset utilization and keeping up with schedule integrity). Larger cranes and larger quantities of land for container operations, namely temporary warehousing on container yards, may become prohibitive, triggering diseconomies of scale to be assumed by port authorities and terminal operators.

For inland transportation congestion growing capacity, such as more trucks converging towards terminal gates, leads to diseconomies. Because of technical innovations and functional changes in inland transportation, such as using rail instead of trucking to move containers from or to terminals, it is unclear what is the effective capacity beyond which diseconomies of scale are achieved.

The fundamental point is that diseconomies are a challenge that impacts several segments of the transport chain.

Source: Hostra Edu