This economically illogical system could not last. Ship lines had no reason to care what was inside the containers they carried, and with rampant excess capacity they were willing to accept any payment that exceeded their cost to carry the container. By early 1967, Waterman Steamship, Malcom McLean’s former company, switched to a flat rate for shipments from the United States to southern Europe: $400 for a shipper-owned 20-foot container, $800 for a 40-foot container, regardless of the contents. Waterman did not yet have any containerships and its rate structure had no imitators, but its move reveals the pressure on prices. Carriers began threatening to leave their conferences unless rates came down. The conferences struggled vainly to keep the rate structure intact. In the summer of 1969, the transatlantic conference system blew apart. Eight lines formed a new conference with the aim of leaving commodity-based rates behind and establishing rates that made sense in the world of containers.25
As the artificially high rate structure collapsed, ship lines faced profit squeeze. Restructuring was the only way out. In July 1969, barely three years after container shipping had become an international business, West Germany’s two biggest shipping companies agreed to merge as Hapag-Lloyd, a huge new player in the North Atlantic. Three months later, Malcom McLean responded in kind. McLean had always preferred consolidation to competition; had the U.S. government not blocked him, he would have acquired Sea-Land’s sole East Coast competitor, Seatrain Lines, in 1959, and its main competitor to Puerto Rico, Bull Line, in 1962. Now, on Sea-Land’s behalf, he committed $1.2 billion of R.J. Reynolds’s money to an audacious deal with United States Lines. U.S. Lines was in the midst of building 16 containerships, all able to carry more than 1,000 containers and to steam faster than 20 knots. It would soon have the greatest containership capacity of any line. Sea-Land proposed to lease that entire fleet, all 16 vessels, for 20 years. U.S. Lines would surrender its status as a subsidized carrier, which would allow Sea-Land to deploy the ships wherever it wanted, without government approval. A major competitor would be out of the game, and Sea-Land would become by far the largest ship line on both the Atlantic and the Pacific.26
Competitors cried foul—but they reacted promptly. In early 1970, Grace Line was merged into Prudential Lines. Matson surrendered its international ambitions, selling its ships in 1970 and giving up its efforts to turn Honolulu into a hub for commerce across the Pacific. Moore-McCormack Lines sold its four newest freighters and exited the North Atlantic. Two British carriers, Ben Line and Ellerman Line, joined forces on the UK-Far East route, and three Scandinavian companies combined their ships to create a single international carrier called Scanservice.
Those shifts were far from enough to stabilize the industry. In the Australia trade, Overseas Containers Ltd. lost $36 million between 1969 and 1971. Hapag-Lloyd suffered losses in 1969, 1970, and again in 1971. On the North Atlantic, where one-third of containership capacity was unutilized, American Export Isbrandtsen Line lost so much money in 1970 and 1971 that its parent company’s shares were suspended from trading on the New York Stock Exchange and its president was forced out. U.S. Lines, operating in both the Atlantic and the Pacific, lost $14 million in 1970 and as much again the following year. Even Sea-Land had a difficult passage after the U.S. government blocked its efforts to combine with U.S. Lines, its profit falling from $39 million in 1969 to $21 million in 1970 and barely $12 million in 1971. R.J. Reynolds, like the other conglomerates that had invested in ship lines, was learning that container shipping was not the gold mine it had imagined.27
In desperation, the leading carriers on important routes tried an old-fashioned solution: reducing competition. Five competitors in the Europe-Far East trade, two British, two Japanese, and the German Hapag-Lloyd, combined their Pacific interests in an alliance called TRIO. Among them, the companies agreed to build nineteen large ships, with each company allocated a number of container slots on each ship. A second Europe-Pacific consortium soon followed, with the Swedish carriers and the Dutch company Nedlloyd merging their Asian operations into a company called ScanDutch. Those two alliances drastically cut the number of competitors between Europe and Japan, helping stabilize rates. An even more powerful cartel, the North Atlantic Pool Agreement, was born in June 1971. The pool agreement, strongly backed by six European governments, combined the efforts of what had been fifteen separate ship lines from six countries. It spelled out exactly what percentage of the total cargo each company would carry. All of the members agreed to charge identical rates, and revenues from North America-Europe service were to be shared. The cartel managed finally to put a floor under rates. “Without the pool, a lot of us would go under,” one executive admitted in 1972.28
Economic growth around the world picked up in 1972, and with it the flow of trade. Container tonnage nearly doubled from 1971 to 1973, and as carriers finally found enough cargo to fill their ships, they earned profits once more. But the shipping industry that survived the carnage of containerization’s first rate cycle was quite different from the one that had existed in 1967. Far fewer independent companies were left, and they had no illusions about the future. Rate wars would obviously be a permanent feature of the container shipping industry, recurring every time the world economy turned down or ship lines expanded their fleets. Shippers would pay according to the distance their containers traveled, regardless of the weight or the nature of the contents, and in difficult times rates would dip so low that carriers would barely cover their operating costs. Ship lines would be under constant pressure to build bigger ships and faster cranes to reduce the cost of handling each container, because at some point overcapacity would return, and when rates collapsed the carrier with the lowest cost would have the best chance of survival.29
The next collapse was not long in coming.
The years 1972 and 1973, as it turned out, represented a peaceful interlude in an economically turbulent decade. Industrial production rose 18 percent in the United States, 19 percent in Canada, 22 percent in Japan, 12 percent in Europe. International trade grew strongly enough to transform the glut of container shipping into a shortage, despite the launch of 143 containerships in just two years. The sharp rise in oil prices that began in 1973 proved initially to be an unexpected blessing for the maritime industry, giving containerships, which transported more cargo per barrel of oil, a further cost advantage over the remaining breakbulk ships. The amount of containerized ocean cargo around the world rose 40 percent in 1973 alone. Companies ordered their ships to reduce speed in order to conserve fuel, cutting the number of voyages they could make over the course of a year, which further tightened the market. Freight rates soared, as conferences pushed through hundreds of rate increases and added surcharges to cover exchange-rate movements, higher fuel costs, and port delays. “Many shippers, faced with rate increases of over 15 per cent plus surcharges, must have found their freight bills increased by as much as 25 to 30 percent,” a United Nations report declared.30
The boom lasted into 1974, when a weaker dollar drove exports from U.S. factories up 42 percent in a single year. Rate increases, along with the various agreements around the world to limit capacity, pool revenues, or join forces, finally worked magic on the shipping industry’s bottom line. Sea-Land reported a healthy $142 million profit, up from $16 million in 1973. Even U.S. Lines, which had seen little besides red ink out of its sixteen new containerships, posted a $16 million profit for 1974. Judged the head of Atlantic Container Line, “If an operator can’t make it on the North Atlantic now, he will never make it.”31
The oil crisis, though, ended up devastating the shipping industry. The world economy tumbled into recession in the second half of 1974 as central banks tightened monetary policy to counteract the inflationary consequences of dearer oil. Industrial production collapsed, and with it the flow of trade. World exports of manufactured goods fell in 1975 for the first time since the war, and the amount of seaborne trade dropped 6 percent. Even as trade flows diminished, shipyards kept delivering new containershi
ps—and every new ship weakened the ship lines’ ability to hold rates up. Containerships from the Soviet Union joined the competition in both the Atlantic and the Pacific outside the conference structure, pressuring rates further. The shipping conferences were forced to roll back or eliminate surcharges six hundred times between 1974 and 1976.32
The second crisis of container shipping was made worse by the carriers’ own choices. The hundreds of containerships built in the first half of the 1970s had been designed for the world of the late 1960s. High speed was important because of the closure of the Suez Canal in the 1967 Arab-Israeli war, which forced ship traffic between Europe and Asia and Australia to take a much longer route around the tip of Africa. High fuel consumption—the inevitable result of high speed—did not much matter, because oil was cheap. The world of the mid-1970s was totally different. The price of fuel quadrupled. On the North Atlantic, fuel went from one-fourth of operating costs in 1972 to half in 1975. On the Europe-Far East route, the unexpectedly fast reopening of the Suez Canal in June 1975 eliminated the reason for having fuel-guzzling high-speed ships to sail around Africa. Many carriers were stuck with the wrong vessels for the times.33
Prominent among them was the Sea-Land division of R. J. Reynolds Industries. Malcom McLean, acting, per usual, on intuition rather than cautious analysis, had overridden objections from Sea-Land’s board to move ahead with the SL-7 in 1968, and Reynolds had agreed to build eight of the ships when it bought the ship line in 1969. The costliest merchant ships ever built were also the thirstiest, each burning five hundred tons of fuel per day. At full speed, they consumed three times as much fuel per container as competitors’ vessels. When the price of bunker fuel jumped from $22 per ton to $70 within a matter of months, the SL-7s became a crushing burden. Although R. J. Reynolds boasted to its shareholders that the SL-7s “provide the fastest container shipping service in the world,” the ships consistently missed their ambitious schedules and could not make money.34
A settling of scores was inevitable. McLean, unhappy with Reynolds’s bureaucratic ways, began selling his stock in 1975 and left the board in 1977. Reynolds, frustrated with its inability to control the extraordinary volatility of the steamship business, reorganized Sea-Land to put the ship line under tighter corporate control. The changes did not help. In 1980, Reynolds finally took a $150 million loss on the SL-7s, which had been in service for less than eight years, and dumped them on the U.S. navy for rebuilding as fast supply ships. Four years later, it got out of the shipping business altogether and spun off Sea-Land as an independent company. As R. J. Reynolds’s new management explained to investment analysts, “investors who might be interested in owning RJR stock were not the type who ordinarily would be interested in a capital-intensive, cyclical transportation company.”35
Quite so. For R. J. Reynolds, and for the other corporations that had chased fast growth by buying into container shipping in the late 1960s, their investments brought little but disappointment. Sea-Land and its competitors were not at all like Polaroid or Xerox, companies whose proprietary technology and constant stream of innovations provided inordinately high profits for decades. Ship lines’ end product was basically a commodity. Just like farmers and steelmakers, they would always be hostage to external forces, their prices and profit margins depending mainly on economic growth and on their competitors’ decisions to build new ships. The go-go years were over. By 1976, less than a decade after container shipping became an international business, the Financial Times could declare that “the revolutionary impact of containerization, the biggest advance in freight movement for generations, has largely worked itself out.”36
Except that the Financial Times got it wrong. The revolutionary impact of containerization, as it turned out, was yet to come.
* The quantity of breakbulk shipping was measured either by weight or by “measurement tons,” a standard method for converting volume into tonnage, and these conventions were initially applied to container cargo. The capacity of containerships and cranes, however, was determined by the quantity of containers rather than their weight, and by the mid-1960s ports and ship lines began to emphasize the number of containers they handled. Raw numbers proved problematic, because they failed to distinguish between empty containers and full ones, and between large containers and small ones. In 1968, the Maritime Administration began to report container traffic in standardized 20-foot equivalent units, or TEUs. A 40-foot container represents 2 TEUs, and one of Matson’s 24-foot boxes registered as 1.2 TEUs.
Chapter 12
The Bigness Complex
Malcom McLean sold his stock and quietly left the board of R. J. Reynolds Industries in February 1977. By all accounts, the marriage had not been a happy one. McLean was frustrated by the tobacco giant’s bureaucracy and bewildered by its repeated changes of strategy. Most of all, though, he was restless. “I am a builder, and they are runners,” McLean explained. “You cannot put a builder in with a bunch of runners. You just throw them out of kilter.”1
After giving up day-to-day responsibility for Sea-Land Service in 1970, he had spent $9 million to buy Pinehurst, the famed golf resort in central North Carolina, not far from his birthplace in Maxton. He acquired a small life insurance company, an estate in Alabama, a trading company. Then, in 1973, he started First Colony Farms on 440,000 acres in the swamps of eastern North Carolina. Modeled after his friend Daniel Ludwig’s plantation in the Amazon, First Colony was probably the largest agricultural development in U.S. history. McLean spent millions draining wetlands to start a massive peat-harvesting operation, then built a plant to turn the peat into methanol. Nearby he planned the world’s largest hog farm, where the hogs would be raised mechanically to slaughter weight and then shipped to a slaughterhouse he would build on-site. The peat scheme, though, was blocked by one of the earliest environmentalist campaigns, and the hog farm, able to raise 100,000 animals a year, never made money. When he got an offer for the hog farm in 1977, McLean sold—for $12 million plus 40 percent of the profits for twenty years—and looked around for something new.2
In October 1977, he found it. To the surprise of almost everyone, he arranged to buy United States Lines.
U.S. Lines was not exactly a prize. It had long since been supplanted by Sea-Land as the largest American-flag ship line, and its owner, the conglomerate Walter Kidde & Co., had been trying to unload it almost since the day it purchased the company in 1969. Its famous flagship, the luxury liner United States, had been sold off to the U.S. government. U.S. Lines had lost money through most of the 1970s. Nonetheless, McLean spotted value. For an investment of $160 million, of which $50 million went to pay off debts, he got thirty ships; $50 million in cash; a huge new terminal on Staten Island, in New York Harbor; and an important network of routes to Europe and Asia. U.S. Lines, unlike Sea-Land, was entitled to operating subsidies from the U.S. government on its international routes. The subsidies were a curse as well as a blessing: the ship line was assured a source of revenue, but the Maritime Administration got to dictate where and how often its ships sailed.
In 1978, as his new ship line was eking out a very modest profit, McLean hatched an audacious plan. U.S. Lines would build a series of enormous containerships, half again as large as anything else on the sea, and send them around the world. The timing was right, because shipbuilders’ order books were shrinking after the headlong expansion of the 1970s and construction prices were falling. A round-the-world route, McLean thought, would solve one of the industry’s inherent problems, the imbalanced flow of freight that left some ships sailing full in one direction and half-empty in the other. The new vessels would have the lowest construction cost per container slot of any vessel in the world and the lowest operating costs per container as well. U.S. Lines would achieve what it took to succeed in container shipping: scale.
Scale was the holy grail of the maritime industry by the late 1970s. Bigger ships lowered the cost of carrying each container. Bigger ports with bigger cranes lowered the cost of
handling each ship. Bigger containers—the 20-foot box, shippers’ favorite in the early 1970s, was yielding to the 40-footer—cut down on crane movements and reduced the time needed to turn a vessel around in port, making more efficient use of capital. A virtuous circle had developed: lower costs per container permitted lower rates, which drew more freight, which supported yet more investments in order to lower unit costs even more. If ever there was a business in which economies of scale mattered, container shipping was it.
Ship lines responded to the imperative of scale by extending their reach. The old breakbulk companies had often been content to serve a single route. In 1960, no fewer than twenty-eight carriers had sailed the North Atlantic, from the mighty Cunard Line to such one-ship minnows as American Independence Line and Irish Shipping Limited. In the container age, minnows could not survive, and the truly big fish, companies such as Sea-Land, U.S. Lines, and Hapag-Lloyd, wanted to be in every major trade, either with their own ships or with an arrangement that allowed them to book space on someone else’s. The more ships they had, the more ports they served, the more widely they could spread the fixed costs of their operations. The more far-flung their services, the easier it would be to find loads to fill their containers and containers to fill their ships. The broader their networks, the more effectively they could cultivate relationships with multinational manufacturers whose needs for freight transportation were worldwide.3
The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger Page 27