Special Interest Group on Maritime Transport and Ports
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INTERNATIONAL WORKSHOP
Genoa - June 8-10, 2000

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STRATEGIC CHOICES FOR SMALL BULK SHIPPING COMPANIES
IN THE POST ISM CODE PERIOD

Ioannis N. Theotokas Department of Shipping Trade and Transport University of the Aegean 2a Korai Str., 82100 Greece Email: gtheotokas@stt.aegean.gr

Eleftherios D. Katarelos Department of Shipping Trade and Transport University of the Aegean 2a Korai Str., 82100 Greece Email: e.katarelos@stt.aegean.gr

1. INTRODUCTION

The new regulatory framework that has been imposed mainly by IMO in world shipping in the last few years has created a new environment for shipping companies. The complete implementation of these regulations will further differentiate companies' external environment. Shipping companies wishing to remain competitive in the market must be prone to adapting to this change. For a certain number of companies adaptation will be easily achieved either because they have already moved towards this, applying safety & quality systems or because their structural characteristics allow this. This does not apply, however, to a large proportion of shipping companies, whose structural characteristics might impose hindrances to the adaptation process. This article is aimed at defining the influence of the new environment to the latter group that is for small sized companies.

The trend towards consolidation also apparent in bulk shipping over recent years (Chorinou, 1999), did not differentiate proportionately the structure of all markets or segments of the industry. This is especially true for dry bulk shipping markets, as liquid and other specialized markets like chemicals, have already lived the consolidation effects. However, this is an ongoing process whose termination cannot be predicted. Nowadays, small sized companies operate a great proportion of bulk shipping fleet. This is especially true for Greek-owned shipping. According to the latest figures, 45% of companies operate one or two ships (Naftemporiki, 4/5/200). Having this in mind, it is logical to suppose that Greek-owned shipping will be affected by this change, unless companies succeed in adapting to the requirements of the new shipping environment. In other words, as environment defines strategy, a large proportion of Greek-owned shipping companies might find themselves in a dilemma regarding their strategy.

The second aim of this paper is to produce a methodology, which will help shipowners/decision makers to analyze and evaluate the external and internal environment of their companies and to select and implement the proper strategy. The basis of this methodology is the combination of Minimum Standards and the Reliability Curves System and the Cost/Reliability and Investment Choices/Reliability Matrices.

2. THE PRE ISM CODE ERA

In the pre-ISM Code era, companies based their competitiveness on their ability to produce low cost services. Sletmo and Holste identified three generic strategies for shipping companies, that are absolute competitive advantage, differentiation and specific adaptation to customer needs. (G. Sletmo-S.Holste, 1993) If a company covers with its ships the major trade routes, it could implement either the strategy of absolute cost advantage or that of differentiation. If its market coverage are in special niches of the market, the strategy of specific adaptation to customer needs would be more appropriate. The driving forces in the shipping industry have been historically minimal charter hire and minimal operating cost (Thorstensen-Shield, 1996). This is more apparent in case of bulk shipping, which is built around minimizing unit cost (Stopford 1997). Furthermore, other structural characteristics of bulk shipping eliminate the strategy selection. For a bulk shipping company that covers with its ships the major trade routes, the only viable strategy is that of absolute cost advantage. (Theotokas, 1997). Quality, although present in these days, was rarely perceived as the main source of competitive advantage, but instead as a factor that contributed to the strengthening of the low cost advantage. Differentiation based on the quality of the service did not allow companies to differentiate its freight rates.

Social responsiveness was a matter of choice for the companies of the self-regulated bulk shipping. For a certain number of companies, quality and safety were values as elastic as the achieved cost level(Theotokas-Alexopoulos, 1998). Since there was a lack of market mechanism for the definition of the lowest acceptable cost level, numerous shipping companies strove to preserve their competitiveness through lowering their costs and consequently their safety and quality standards. However, there were also companies that strove for competitiveness being simultaneously socially responsible, that is, applying to self imposed minimum safety and quality standards. In this environment they were allowed to base their competitiveness on their core competencies applying governance and operational systems that served their aim, being simultaneously part of what we could call quality shipping. Here, in our opinion, the basic environmental change arrives. What was voluntarily applied will be strictly enforced, depriving companies from the flexibility which was the core of their competency.

3. THE NEW SHIPPING ENVIRONMENT

A key factor for the analysis of competitive position of every company is the environment in which it operates. Determination of a suitable strategy for a company begins in identifying the opportunities and risks in its environment (Andrew, 1998). At the same time a critical task is the internal analysis of the company, which will allow the assessment of its strengths and weaknesses in order to maximize the former and minimize the latter. In other words internal analysis is the task of identifying its resources and capabilities that contribute to the creation of its core competencies, i.e. the critical bundle of skills that an organization can draw on to distinguish itself from its competitors (Miller, 1998).

The external and internal analysis is extremely useful for shipping companies especially in nowadays, as several changes have evolved differentiating basic structural characteristics of bulk shipping markets. These changes are mainly related to the imposition of a series of regulations that intend to improve the whole performance of the industry regarding safety and quality. The 90's were the decade of regulation for shipping. OPA' 90, ISM Code, STWC, are just a few of the new regulations that have been imposed during those years. However regulations imposed either by governments or by international organizations such is IMO can be an important factor affecting who can hold a competitive advantage.,Also changes in this arena can alter competitive standing of the industry (Miller, 1988). Considering this side effect of regulations it is expected that competitive standing in shipping will also be altered, as we will explain shortly.

3.1 THE POST ISM CODE ERA

The changes that ISM and other regulations will bring to bulk shipping markets are expected to be substantial. The complete application of these regulations is expected to create a more formal approach to what is called social responsiveness of shipping companies. Safety and quality will be central values and their application pre-requisition for every shipping company in the new environment. This is of-course a very positive evolution for the shipping industry, although it is not without repercussions. The new environment is expected to create opportunities for a certain number of companies whereas it will be a threat to others. What would be the effects for a shipping company is not necessarily related to its attitude towards social responsiveness. Certainly for those companies that had already embarked on the development of quality management systems the new environment will be considered as an opportunity. For them, new regulations are simply a way of meeting the challenge. However, there exists a certain number of shipping companies, mainly of small and medium sizes, with the same attitude towards social responsiveness whose ability to respond to it, will unavoidably affect their competitiveness. In other words, they will be obliged to operate following specific procedures in order not to just comply to the values of safety and quality but to also certify their compliance and to stay in the business. For these companies the new environment can be considered as a threat, since no compliance could gradually lead them out of the market while imperfect compliance could lead to decreased competitiveness. This is, in our opinion, the change that will differentiate the shipping environment and the factor that will alter the competitiveness in the shipping industry.

In the post-ISM Code era the implementation of minimum safety and quality standards will define the way the shipping companies operate and manage their business. A particular way of organization and management will simultaneously affect the minimum operating cost level of companies that apply to them. In other words, the minimum standards will redefine the conditions of competitiveness for all companies. For companies that were already familiar with quality management systems the effect will not only be minimal but it will also create conditions for further expansion. For those companies that without applying formalized and structured quality systems, produced quality services, the competitive standing will change. They will be enforced to abandon cost effective practices that helped them to be competitive, without necessarily being substandard. (Theotokas-Alexopoulos, 1998).

3.2 THE FORTHCOMING FORMAL SAFETY ASSESSMENT

The expected introduction of Formal Safety Assessment (FSA) (Kuo,1998) for the evaluation of safety standards will complete the framework through the imposition of Reliability Standards. FSA may be seen as consisting of the identification of hazards; the assessment of risks associated with these hazards; ways of managing the risks identified; a cost-benefit assessment of the options identified in managing risks; and decisions on which options to select. All marine transportation systems comprise of three interacting components (Ronald - Moriati, 1990):

• the ship and her equipment (the hardware - HWR)
• the rules and regulations, codes of practice, operating procedures and casualty records and statistics (software SWR)
• and the personnel involved, both afloat and ashore (humanware - HR).

In a previous paper of one of the co-authors (Angelis-Katarelos, 2000) a System Reliability (Spiegel, 1975)assessment method has been developed, which is based on Reliability Curves. Reliability is expressed as a function of three factors and hence its graph is 3-dimensional. But, to simplify things we combined the first two factors into one, namely HSR, expressing the reliability of both Hardware and Software (Figure 1).

Figure 1

The Reliability Curves and the Company's Options Square

All attainable reliability levels lie on Reliability Curves restricted by a square O'O''EZ. The square contains minimum and maximum levels. The latter of course, although realistic seen from a cost-benefit analysis view, cannot be easily identified. Every point in a given Reliability Curve expresses the same reliability although resulting from different combinations of the factors.

A shipowner may choose for his vessel any point within the Options Square. In doing so, he decides on the level of Reliability (and hence Safety) he wants for his ships. Also he decides on the combination of HSR and HR he will use in order to achieve this level, subject of course to the constraints that minimum acceptable standards are satisfied. Therefore shipping companies are able to define their own particular Reliability Curve (RC). The System Of Minimum Reliability Standards means that for a company to remain competitive in the market, its Reliability Curve must be at least above the minimum level, namely in Company' Options Square.

4. THE RELIABILITY MATRIX AS DECISION MAKING TOOL

One of the uses of the developed decision making model is to determine the control options of FSA method. In other words, to help the decision maker in preparing his strategic plan by taking into account the market in terms of supply- demand (Mitropoulos, 1998), and the company's market positioning (Karlof-Ostoblom, 1993) on one hand and safety on the other. The decision maker is able, to know in advance the minimum/maximum standards and therefore is able to decide where to place his ship according to his corporate and marketing strategy, while of course always satisfying minimum standards.

Supposing that the market compensates for quality, then it is the company that will decide in which quarter of the matrix of Figure 2 it will place itself. Company's decision is of course influenced by the vulnerable character of the freight markets. This placement helps the company to evaluate the various alternatives of its own position against those of its competitors. Therefore the use of that matrix allows the placement of the company's alternatives in terms of strategy and helps in decision making.

Figure 2
Safety and Quality Matrix based on Reliability curves

The higher the achieved standards of any of these three factors, the higher the RC of the company will be. At the same time, the higher the RC, the higher the cost for the company will be. At this point, however, economies of scale emerge as the increase in reliability and cost are not proportionate. For example, a company that operates sufficient number of ships has the ability to employ a pool of seamen and recruit them onboard the same ship. Furthermore, it can afford the cost of internal training procedures thus upgrading its seamen qualifications. This ability allows the company to achieve the highest level of "Humanware" compared to a smaller company which operates two ships and cannot follow the same policy. Furthermore, this difference allows the former company to be in a higher position in the RC than the latter, despite both facing the same manning costs. Since higher RC leads to increased competitiveness, it is evident that competitiveness for every shipping company will be based on its ability to achieve a higher RC with minimum cost.

This approach is dictated by of the market, according to which the charterers are only willing to pay for the minimum standards. The increased quality does not provide to shipowners increased freight rates (Goulielmos-Giziakis). Charterers are indifferent about higher standards when they cost more so choose the ships that combine the lowest costs while simultaneously offering standards above the minimum. Especially in the case of dry bulk market, the almost perfect competitive character of the market does not seem to perceive quality as crucial for the fixing of freights. As Thanopoulou and Tamvakis state "any indications towards freight rate differentiation depending on quality are still too sporadic to revolutionize our current perception of the dry bulk carrier market". The Erica case and the dispute that arose has also indicated that charterers in liquid bulk shiping are not always interested in quality vessels if they cost more (Efoplistis).

Under these circumstances smaller companies are expected to become less competitive, especially in periods of low demand. In those periods charterers choose vessels that offer minimum cost combining it with higher quality, that is companies which are able to be positioned on the upper level of the safety matrix. Smaller companies are not able to meet these criteria because of their inability to exploit economies of scale in achieving high RC. This inability becomes more intense because of the structural characteristics of these companies related to their fleet age, that is their hardware. Of 376 small Greek-owned shipping companies with one or two ships, 302 of them (80,3%), operate ships whose age is above 20 years old (Neftemporiki). They could increase their reliability by achieving higher RC through humanware and software. These two factors, however, are definitely dependent on the companies' size. Their present status imposes hindrances to that aim. Certainly, even during the pre-ISM period size was a factor that defined competitiveness for small companies and gave to shipmanagement companies a considerable boost (Spruyt p.43-44). In that period however, small companies were able to apply cost effective solutions based on their flexibility. The post-ISM period deprives them from this ability and affects their competitiveness especially during periods of low demand.

However, they could remain competitive in the market no matter what the level of supply and demand will be, only if they adapt to the requirements that the new shipping environment imposes on the shipping companies, that is only if they succeed in achieving improved reliability at minimum cost levels. This can be better achieved if they move towards strategic decisions that will allow them to exploit economies of scale and to overpass their structural characteristics that reduce their competitiveness, thus simultaneously preserving those that are related to their capabilities.

5. STRATEGIC CHOICES FOR SMALL SIZE COMPANIES

The strategic choices that are available to small shipping companies wishing to increase their reliability and to remain competitive in the market no matter what the level of demand would be, except of course to remain in the same position, that is independent, are the following:

• To assign technical management of their fleet to a shipmanagement company
• To move toward strategic alliances with other, preferably bigger companies
• To merge with other small companies

Decision makers must arrive at one of the above choices after having successfully completed the analysis of the external environment and the internal analysis of their firms. Each choice offers numerous advantages and disadvantages to companies, which could not be examined or mentioned in this analysis.

Independence does not help them to overpass the difficulties of the new shipping environment unless internal development is pursued as a method to obtain the critical mass. However, as we shall shortly see, independence as a selection either of stability or of internal development, might offer a few advantages to the companies if it is properly combined with their investment strategy.

Assignment of technical management of ships to shipmanagement companies is a choice free of any cultural implications and at the same time it secures for the companies the achievement of higher reliability, through the increase of the HWR and SWR. Furthermore, it allows companies to retain their flexibility in the sale and purchase market. However, this choice will not drastically reduce their cost level as it will be achieved by paying fees to shipmanagers. These fees will not necessarily be less than their present technical management cost. In addition, it will force them to assign an element that is related to one of their core competence, that is their cost effective technical management.

The third choice is to look for a strategic alliance with a preferably bigger company. By forming an alliance, companies will have the ability to coordinate their activities in order to improve their competitiveness. This choice will allow small companies to obtain access to the value chain of the bigger company and to have their cost reduced. Furthermore it will ensure that the company accesses wider information channels. On the other hand alliance presupposes also mutual leadership and decision making (Papadakis, 1999), a fact that could eliminate small shipowners' ability to retain the commercial management of their ships and to deliberately apply the strategy of buying and selling ships. Moreover, it can not be considered certain that the alliance will lead to the increase of the reliability of the company, which is the other target of this selection. Factors that might cause obstacles to this aim are the non-permanent character of the alliance, the level of integration between the companies and also the compatible cultures or managerial styles.

The last choice concerns the merger with other small and medium size companies in order to obtain the critical mass. This is a choice of long run commitment, whose benefits will be also gained in advance. Following this choice they will form a corporate structure based on the equality of the partners and will benefit from the synergy effects. Forming mergers, they will be able to combine their core competencies, that is their cost effective technical management and at the same time exploit the economies of scale in order to improve their humanware and software and to increase their reliability. One critical factor for the success of this choice is the entrepreneurial philosophy of shipowners and the prevailing organizational culture of the companies which might create disagreement regarding power and control. However, as the merger will be based on the basis of equality, these obstacles can be eliminated.

Based on the level of reliability that is desirable for each company and on the cost level that is pursued to be achieved we can draw the matrix 2 (Figure 3) whichshows that each choice gives certain combinations of cost and reliability. However as the choice of each company will be strongly affected by its investment strategy, it is necessary to include this parameter in the analysis. The investment strategy is critical for the survival and development of a shipping company due to the vulnerability of the markets. Timing is the factor that defines the potential of investments. There are two types of strategy that allow the exploitation of timing. The first is that of "beat the market" buying and selling ships in the short run and the second, that of long run selling of transport services. In the first strategy profits are mainly derived from sales and purchases of ships while in the second from the trading of ships.(Hope & Boe) It is evident then that the choice of a company is strongly related to its investment strategy. For a company whose profits mainly come from the sales & purchases, either cost level or reliability are factors of secondary importance. As it has been stated, in this case companies' reserves allows both the finance of the vessels' operation and the exploitation of the chances in the s&p market during periods of low freight rates (Goulielmos, 1999). On the contrary, for a company that is more interested in trading its ships, cost level and reliability are of primary importance. Matrix 3 (Figure 4) embodies this additional factor trying to combine the desired reliability level with the investment strategy that the company intends to apply. As it can seen in the Matrix 3, the strategy of "beating the market" is more compatible with choices of independence and assignment to third party management, as both give to the shipowner flexibility. On the contrary, choices of high commitment are more suitable for the strategy of long run selling of the ships services.

Figure 3

Reliability/ Cost Matrix

Figure 4

Reliability/ Investment Strategy

Combining the two matrices a shipowner can decide which strategic option is more suitable to his aims. For the shipowner who is short-term oriented and interested in applying the strategy of beating the market, buying and selling ships, the choice would be either to assign the technical management of his ships to a shipmanagement company, or remain independent. In the first case he will succeed in increasing the reliability of his services, while in the second he will face both low reliability and high operational cost. On the contrary, the shipowner who is more dedicated to the long run selling of his ships' services, preferable choices are to merge or to form an alliance. However, only merging leads to both low cost and increased reliability which is the optimum.

Therefore the above strategies may be defined as follows:

• Merger (M)
  • High Reliability HR
  • Low Cost Level LC
  • Long Run Selling LRS
• Ship Management (SM)
  • High Reliability HR
  • High Cost HC
  • Beat the Market BM
• Strategic Alliance (SA)
  • Low Reliability LR
  • Low Cost Level LC
  • Long Run Selling LRS
• Independent (I)
  • Low Reliability LR
  • High Cost Level HC
  • Beat the Market BM

The consolidation of Matrices 2 and 3 give us the Combined Matrix where the decision maker can place company's Reliability, Cost Level and Investment Strategy. The new consolidated Matrix appears in Figure 5.

Figure 5

Consolidated Matrix presenting Reliability and Cost Level/Investment Strategy

Combining the above analyzed matrices we can draw a flow chart that a shipowner could follow in order to identify both what is the present situation of his company and also what the desired situation would be, according to his intention. Following the chart and replying to the questions the shipowner completes the external and internal analysis. A shipowner for example may find, following the chart, that his company faces high reliability and high cost while following the strategy of the long run selling the services of his ships. However this is not an efficient placement because his investment strategy is not backed by company performance. Using Porter's analysis, he is "stuck in the middle" lacking any competitive advantage (Porter, 1990). In order to decide on the optimum choice, he will follow the chart again, selecting the points that will support this choice. For example, if he prefers the strategy of long run selling, he is interested in facing low cost and high reliability. Then the choice for him is to merge.

Figure 6

Maritime Decision making flow chart based on Reliability, Cost Level and Investment Strategy

CONCLUSIONS

The new environment that the regulations create for shipping companies seems to alert the competitive standing of the industry. This environment creates opportunities for a certain number of companies and threats others. In the new environment critical factors for the survival of the companies is not only their cost level but also their reliability. In the reliability/cost relation however, the significance of scale is evident. Here the disadvantage of small companies emerges. Being unable to exploit economies of scale, they face a higher operating cost and their ability to achieve increased reliability levels is constrained. In order to overcome this disadvantage and to remain competitive in the market it is necessary to move towards strategic decisions that will allow the effective adaptation to the new environmental requirements.

The choices for the small companies are to remain independent, to assign the technical management of their fleet to third party management, to form strategic alliance or to merge with other small companies on the basis of equality. The final choice however, must be take into consideration the implemented investment strategy of the company. In order to analyze and evaluate the present situation of their companies and also to decide what the ideal placement could be, a methodology that combines decision matrices and flow charts has developed. This methodology constitutes a decision making tool that leads to strategic choices compatible to external environment requirements and to companies internal environment.

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