Surviving the Slump

Finding the Balance

The figure below shows the boundaries for operations and helps illustrate the balance of priorities between production/performance and protection and the consequence of getting it wrong.  

 

It is important to recognise that there are boundaries to cost cutting and boundaries to the protection you can put in place.  The safest company in the worlds doesn’t make the seas any safer if it is bankrupted.  Equally the cheapest company in the world does not make money without a ‘licence to operate’.  In this visualisation I view reliability as included in the protection axis.

The positioning of an organisation in the matrix will vary over time, as indeed will the boundaries.  In a high freight market costs will be less important than in a low freight market and the gap between operating costs and low profitability and ultimately  bankruptcy will be high.

Focus will be on ensuring access to the high day rates and investment will be made in reliability and quality (to ensure no vetting failures).  The mindset of the organisation will focus on keeping the ship running and not managing cost.   The investment equation will be different as the value of investments will be increased by the high day rate.

In a low freight rate market the boundary will move towards the middle causing profitability and bankruptcy concerns and the drive for action.

Before considering the various strategies its worth pointing out that in general that operating cost efficiency will not save a company with a weak balance sheet and overpriced assets.   Just as some governments believed the ‘boom and bust ‘cycle was gone forever in the noughties so some shipping companies believed that low freight rates were gone forever.    A number of companies are already in trouble and will over a period of time fail leaving some expensive assets at low prices.  The nature of things is that those vessels will remain in the market for as long as possible as laying up a new asset is a sure indicator to a bank that all is not well. 

The ‘global village’ effect is also important.  In the 80’s, even without the Internet, the herd mentality prevailed in looking for cheaper manning sources, cheaper flags, etc.

 The company that survives will have a clear strategy and a clear view of what market it serves.

The cost versus quality discussion and the drift to failure

In the final analysis it’s the decisions that are made at the most senior level of management that sets the tone for how the company copes with the slump.

The problem is that of knowing the ‘cost of everything and the value of nothing’.   When costs are reduced it is easy to see the effect of that cost on the bottom line immediately.   It is not easy to assess the value of what is lost especially from the point of view of the risk to safety and reliability.  This is because an operation after a period of high sustained rates may have many different barriers for each risk, not least the quality and competence of the officers and crew aboard ship.  Removing one barrier or a part of a barrier may increase the risk but does not create a certainty of a catastrophe.   Provided no incidents happen the next cost cutting cycle will take place removing further barriers until over a period of time ( even after the slump is over!!) the system fails and catastrophe occurs.

The irony is that the debate will be at the most intense the first turn of the cycle as the organisation changes direction and when there are the most barriers are in place.   Subsequent turns of the cost reduction cycle will be more easily accepted as ‘nothing happened the last time’.  The ‘drift to failure, will have started.  Equally it should be stressed that there will be many easy wins in the early days of cutting back that will not create risk provided the right  decisions are made.  The issue will be in differentiating between the two.

The technical name for this is ’asymmetric feedback’.  A simpler analogy is the block tower game Jenga where each player takes away blocks until the tower collapses.    Cost reduction without understanding the value of what is being taken away is like playing Jenga with a blindfold.   At the early stages of the game, by feel alone, you can remove the blocks from a stable structure.  As the game progresses and it becomes more unstable it is difficult by feel to identify where blocks can be taken from without the structure collapsing.

This becomes more of an issue the more complex the organisation is.  

Fat Dumb and Happy

One reaction to a slump is the ‘fat dumb and happy’ approach.   In this approach the company will to some extent ignore the signs of impending slump and believe that the money made in the good times will tide them through the bad times.  They will probably not have taken any action on cancelling or deferring newbuilds and will have new assets joining the fleet.  They may believe that they have enough power in the market to be able to turn the rates around and will concentrate on attacks on charterers who are not paying enough for quality.  This approach will have a finite life until a ‘tipping point ’where free cash flow falls off.  The reaction to this may be accompanied by ‘slash and burn’ action.

Slash and Burn

This approach emphasises cutting costs rapidly and on a broad front.  It may mean reductions in office staff, replacing the existing manning, outsourcing, cheaper sources of fuel and cheaper dry docking.   The changes will be forcefully made and feedback on risks will be suppressed by ‘macho management’.   Over a period of time quality will suffer and the tradability of the fleet will suffer.

The Resilient Shipping Company

The best placed company will be the thoughtful one capable of acting quickly and thoughtfully.  They will have not overbuilt in the boom times and will have a sustainable balance sheet.  They will be positioned to take advantage of lower asset prices.  They may have cancelled or deferred new builds early in the slump when the opportunity was available.

They will be looking at their cost base and the ability of their company to change in the slump and to access opportunities.   They will have a good reputation with charterers.

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