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Oil Tankers Case

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Industry Structure: Fragmented
Product Differentiation: Generic
Technological Change: Slow (Long Product Life Cycle)
Product/ Service Technology: High Switching Costs
Location: Global
Product Life cycle: Maturity stage.
The maturity stage is identifies in the mass distribution of crude oil, less product differentiation, overcapacity, lower labor skills in developed countries, & the increasing stability of manufacturing process.
General information related to Value Chain * A firm is profitable if the value it commands exceeds the costs involved in creating the product. Creating value for buyers that exceeds the cost of doing so is the goal of any generic strategy. * Value activities can be divided into two broad types; primary and support activities. * Primary – activities involved in the physical creation of the product and its sale and transfer to the buyer as well as after sale assistance. In relation to this case the primary value activity would be the vessel. (Inbound logistics, Operations, Outbound logistics, Marketing & Sales, Service) * Support – activities support the primary activities and each other by providing purchased inputs, technology, human resources and various firm-wide functions. (Human Resources Management, Technology development, Procurement)
Porter's 5 Forces Analysis 1. Threat of New Entrants.
Economies of Scale/ Government Policy
The threat of new entrants is high. New Entrants like Brazil, South Korea, Yugoslavia, and Poland were growing two to three times as fast as the rest of the industry due to low labor cost, centralized planning and new capacity. Also the government offered tax incentives for the development of shipbuilding such as tax allowance programs, depreciation tax deferment, rebates and credit assistance. * On a per ton basis building a 200,000 DWT tanker would be cheaper than the cost of a 20,000 DWT tanker. Meaning entry for new competitors could be relatively cheaper and they could enter a larger part of the market. * Larger tankers do not require larger crews * The trend toward the use of larger tankers had resulted in a decrease in the average cost of tanker transportation; however, tankers over 500,000 DWT required larger engines, lower fuel economy, and create the risk of massive accidents which raised insurance cost. * Industry demand had been closely related to economic growth * Cost related to the operation of the vessel does not increase as the size of vessel increases. * Variable costs fluctuate based upon the size of the vessel. * Ecos of scale – In the oil tanker industry shipping sectors are volatile and unpredictable so that is why ecos of scale in this industry are not simple. In the bulk and dry goods sector is where the room competitive advantage is in this industry. An alternative employment opportunity, when there is a slower demand for oil, is in the large increase in the number of large ore carriers needed for the long-haul transport of ore from Brazil to China. * Capital requirements - The need for large financial resources creates a barrier to entry in the oil tanker shipping industry. Many of the oil tankers often sold second-hand because of the high investments. In addition to the purchasing of a vessel, there are also large tanker operating costs which include wages, repair, maintenance, fuel and insurance (which can go up substantially depending on the age of the vessel). Due to the threat of inflation, operating expenses will also begin to increase. * Government policies - Government policies can be a source of high barrier entry because of the need for environmental protection, especially since the BP Oil Spill in 2010. There has been increased amount of government policies have put in place to prevent another disaster since the BP Oil Spill. Governments Policies can also affect the amount of investment in a vessel as the case introduces the Norwegian Government allowed owners to write off up to 25% of the cost of a new vessel in the year the building contract of the vessel was signed. There is threat from countries wanting to exploit their own natural resources, rather than companies from other countries. * In general one would say that high barriers to entry is good for the incumbents and contribute to high profitability. The barriers to entry are very low in tanker shipping as practically anyone could become a tanker owner overnight by simply buying a vessel and then purchasing both technical and commercial management of that vessel with one of the many international service providers.

Other items to consider related to the entry into the industry * Time required to produce the vessels * Safety and Environmental aspects

Proprietary Product Differences * Spot Market and Period Market * Spot agreed to carry a single cargo between 2 specified parts in the near future (World Scale Rates) * Time charter, Bareboat, Contract of Affreightment, Consecutive Voyages * Different types of tanker trips * Oil companies – major purchaser of oil tanker services bought and operated vessels to minimize cost of transportation, also controlled the skill of the crew and the maintenance of the ship, * Independent Ship owners – could obtain a long term charter before deciding to build a ship, less about numbers, a way of life, playing the hunches, having a feel for the business. * Different Sources of supply

Brand Identity
Breaking into the oil tanking industry would require building a strong brand identity in the market. This may prove difficult because of the long standing history of the major players already in the industry.

Major players include: * World’s wealthiest * Major multi-national oil companies * International banks * Shipyards

* Scandinavians –highly respected in shipping business, most technologically sophisticated owners in the industry. * Scandinavians (Norway and Sweden) are known as the second large ship builder in the world with innovative production. * Greeks – close kit families buying secondhand ships who could run with cheaper labor * The Greek is known as seller and buyer of used and small ships. * Hong Kong Chinese – owned and operated 9% of the world’s merchant fleet * Japan is known as the largest shipbuilder in the world with the most productive ship worker in the world.

Capital Requirements * Ship Financing, Capital to finance a ship, crew (technically know how), ability to dock at a shipyard, cost of fuel, insurance, maintenance, and repairs. * Fixed cost (highest cost): Tanker started from 16 million us dollars * Variable cost: Insurance, Fuel, crew cost, Stores, Repair, Maintenance

Note: inflation plays significant role in all cost
Access to Distribution * Ability to trade with Arabian Gulf, Mexico, Alaska, & China. * Having the connections to do business with oil distributors * These distributors may tend to be conservative when choosing new business partners * Oil tanker shipping industry is global. All players in the industry are closely connected through brokers. Any transaction occurs, in short amount of time other players will know. Therefore, I would say that new player only need to know brokers in order to find buyer.

Absolute Cost Advantage * Learning curve of a skilled crew and technical knowhow (maintenance & repairs)

Government Policy * Knowing and following laws of foreign governments. Especially important in international trading. Must be aware of the rules and regulations of each country in which you are involved in trading with. * Government play significant role in this industry. Government policy can directly and indirectly affects the industry. For example, taxes for ship owner or shipyard. * Government policies influence investment decisions in tanker industry. Ex. Norwegian owners were permitted to write off up to 25% of the costs of a new vessel in the year in which a building contract was signed.

Expected Retaliation * In this industry of long history and dominant players I would say that any retaliation by competitors would be harsh and swift. Those already established in the industry would want to relate in order to preserve their profits. In addition, larger players in this industry have the capital to make and commit to a certain type of relation.

2. Power of Suppliers.
In 1978 the power of suppliers was diminished as the supply exceeded the demand by 30%. In addition, the customer base is limited. The ability to obtain a new buyer after the implementation would be difficult.
Differentiation of inputs * Cost of product to the supplier * Cost of transporting the product to the buyer * Cost of vessel upkeep * The inputs in the industry are tankers. The shipyards are the sellers of the tankers. Therefore, the reputations of shipyards are the key differentiation of inputs. For example, Japan is known as the most productive and skillful worker and Scandinavians are known as innovative shipbuilders. The quality, cost, and punctuality are also key differentiation of inputs.

Presence of Substitutes inputs * Other suppliers, other vessels * Different countries ability to supply oil

Supplier Concentration * How many firms in the market? * How many large players in the industry?

Importance of volume to supplier * In the industry there is a need for large amounts of volume * Who can supply the most volume at the best rates

Importance of volume to supplier * There is no difference for size of volume to suppliers.

Cost relative to total purchases in the industry * If this is a major player in the industry such as the Hong Kong Chinese, they would have more of a say at the price in which they purchase. * Depending on how much is bought by a certain firm would determine their ability for barging on price.

Cost relative to total purchases in the industry * It really depends on the power and size of volume. If the buyers are big players or have a big volume of order, they would definitely have upper hand in bargaining about the price since there are more supply of tankers than demand.

Impact of inputs on cost or differentiation * If the price of oil or fuel increases or decreases that will affect the cost to the buyers * Also if internationally trading, the current events of that country will also have an effect of the cost of oil

Impact of inputs on cost or differentiation * Since this is international trading, the money currency plays significant impact on cost of buyers. For example, if buyer’s currency is stronger than seller’s currency, buyer will purchase the tanker in cheaper price.

3. Power of Buyers.
Bargaining Leverages
Buyer Concentration vs. Firm Concentration * More buyer than suppliers * Buyers have other options when choosing to buy but suppliers have many more customers to sell to; therefore they may not want to meet the demands of a particular buyer, if they can sell elsewhere.

Buyer Volume * Oil Industry growth is directly related to economic growth. * The larger the economic growth the more like the oil industry is to expand * However due to energy conservation the oil industry may decline due to less buyer volume

Buyer switching costs relative to firms switching cost * Buyers are negotiating between different firms pricing * Suppliers are negotiating between different types of cargo transportations along with crew, fuel, and tanker maintenance costs.

Ability to Backward Integrate * Firms need the capital required in order to backward integrate. * It would save on transportation cost and allow companies to increase profits * There is a high possibility that buyers that mostly are oil companies will do backward integrate. In fact, most of oil companies have their own tankers so that they can reduce cost shipping.

Price Sensitivity Price/Total Purchases * Buyers purchasing large amounts have more bargaining power over suppliers. If the supplier does not comply with the buyers demand they risk losing that customer to the competition * Since the industry is an international trade, there is a flow of information in real time. Buyers are able to make decision though distance phones call in 5 minutes for a deal. Therefore, buyers have so many options to pick based on the best deal they get.

Product Difference * In this industry the product is relatively similar but different suppliers are able to meet different time schedules and haul different amounts of cargo. * They buyers needs will determine which supplier they choose * Most of tankers are not significantly different in term of function and capacity. What really make them different are the companies that provide service or ship owners’ reputation. Those reputations come from years of experience in business and integrity.

Brand Identity and Impact on quality and Performance * Buyers will choose a brand based on the quality and performance. * If the supplier has a good track record in delivery, timing, and price, a buyer is more likely to use this supplier * Brand identity is important in business. For example, buyers hire Scandinavians company because their reputation of experience and innovative skill.

Decision Making Incentives * Are there price incentives offered by suppliers? * What other reasons would the buyer choose that supplier? * Timing, cost incentives, country of origin?

4. Availability of Substitutes.

High Switching Costs
Doing further research outside of the case substitutes for the oil industry in general include alternative fuels such as coal, gas, solar power, wind power, hydroelectricity and even nuclear energy. Substituting Crude oil would involve high switching costs. Although there are many sources for oil it is still considered to be one of the most cheapest and reliable sources on the planet because combustibility, density, and efficiency.

Retrieved from: (http://ocw.mit.edu/courses/political-science/17-906-reading-seminar-in-social-science-the-geopolitics-and-geoeconomics-of-global-energy-spring-2007/lecture-notes/lec02_02152007.pdf)

Relative Price Performance of Substitutes * Price differentiations between those in the industry i.e. oil companies, independent ship owners, Scandinavians, Hong Kong Chinese, and Greeks. * Scandinavians better Technology * Hong Kong Chinese larger market share * Greek cheaper rates due to old tankers * Are the prices the same in relation to services provided?

Switching Costs * What is the desired reason to switch? * Are they sacrificing anything if they switch to the substitute? * Will their buyers be affected if they switch? * Switching costs really depends on type and detail in contract that ship owner sign with suppliers. Mostly the cancellation penalty charges from 20% - 40%. * Switching cost hinges on type and length of contract buyers sign with ship owner. The cost is probably low if it’s a short-term contract. * Switch to different shippers could increase the cost due to paying highly skilled workers with the Scandinavians and the Hong Kong Chinese and newer tankers. * Whereas Greek uses secondhand tanks

Buyer Propensity to Substitute * What are the buyer’s feelings toward the substitute? * Is there brand loyalty in the oil industry? * What are the reasons for brand loyalty in the oil industry – timing, price, etc.? * Buyers have the ability to use substitute distributors but they also have the option to opt to buy less oil in order to reduce energy consumption

Substitute product is a matter of searching for other products that can perform the same function as the product of the industry (CS, P.23). By this definition, therefore, I think there is no substitute product for oil tanker shipping industry yet. Different kinds of tank or cargo are not substitute product. 5. Competitive Rivalry.
Industry Growth/ Diversity of competitors

Competition was very high in the oil industry as shown in the Overcapacity of tankers which was estimated to be 50% in 1978. Also diversity of Competitors increased competition by different techniques used to gain market share. The Japanese used computerized scheduling, purchasing and industry control while companies such as Sweden tried to gain a competitive advantage through large investments in innovative production methods for constructing increasingly large bulk carriers and tankers.
The fewer the competitors, the higher the potential of exploiting market power and normally the higher the attractiveness of the industry (particularly for the incumbents). The analysis clearly shows that the number of competitors is very high in all segments of the industry.
Industry Growth

* From Exhibit 9, the oil tanker outlook grew in demand but the surplus also grew, in part due to cancellations of orders. Moving forward, many were concerned with energy conservation which could negatively affect the oil tanker industry. This could make the already matured industry less attractive to new entrants

* Oil tanker shipping industry growth is heavily relied on world economy. If world economy is in a good shape, there is more oil consumption leading to more frequent times shipping. If the world economy is in downturn, on the other hand, there is less oil consumption leading to less time frequents shipping. * However, the industry is predictable in the long term due to world population is getting higher especially in developing country that do not concern about energy conservation leading to more oil consumption. Therefore, there will be higher demand for oil tanker shipping.
Demand growth * High demand growth is clearly associated with high attractiveness of the industry. In this respect, the cruise industry scores highly. The transport work in crude oil shipping has grown on average 4% p.a. for the 45 years from 1962-2007. The current growth trend is around 2.5%, so the industry is not a fast growing one.

* The primary drivers of global oil demand—population trends, supply availability, economic activity, consumption patterns, and efficiencies in use—provide insight to increasing and declining oil demand in the world’s nations. In aggregate, however, as the emerging economies mature, oil demand is forecast to increase past current supply capacity. * Fundamentally, oil exploration is driven by the economics of global supply and demand. Global oil demand is on an upward path, mainly due to increasing demand from emerging economies such as China.

Macro of the oil tanker industry: (system as a whole) * Schedule to deliver everything on time * Size of the vessels * Shipping distance * Demand for oil * The environment * The political

Fixed or Storage Cost/Value Added * Fixed costs are operating the vessel, wages, repairs, maintenance, fuel, and insurance. * Slow steaming a vessel could save on fuel but it would increase the duration of the trip. * Holding costs would be associated with shipments if the tankers had to hold the oil until it could be unloaded.

Low fixed costs are normally associated with high industry attractiveness. Tanker shipping is relatively capital intensive in the sense that the cost of acquiring the asset is high relative to the operations costs. In that context, the fixed costs may be regarded as high. Unlike liner shipping operations, however, an owner can lay up his vessel if the market is too unattractive, so very little of the total operation is truly fixed costs.
Intermittent Overcapacity * In the late 1970’s the industry was facing over capacity paired with depressing rates. If this were to continue into the future it would warn off new entrants into the oil tanking industry.

Product Difference * Different methods of shipping, spot or period, slow steaming. * Different suppliers, meaning different distances to travel which could increase or decrease the cost

Informational Complexity * Entering this industry requires past experience with technical knowhow of operations of daily routines. This is a complex industry and requires expertise of the shipping, sailing, and oil industries.

Corporate Stakes * This is a multi-billion dollar industry, meaning the stakes of every investment and decisions are very high. This requires in depth knowledge of the companies market and industry.

Exit Barriers * Large capital costs of tankers * Contracts with suppliers and buyers * Potential upturn in the market * Exit barriers are high as the commitment to the banks for financing are extremely high. Banks have forced shippers to accept disadvantaged charter agreements in order to meet their financial obligations. Exit is difficult and there is not an opportunity to walk away due to the large financial commitment. * Reputational risks * Exit barrier in this industry is very high due to highly required initial investment such as tankers and ships. Those fixed cost are millions of dollars. Also if we want to sell them, the price is substantially dropped. Moreover, we have to concern about contracts with both buyers and sellers. The damage that we have to pay in order to cancel those contracts in case that we want to go out of the industry.

Low barriers to exit normally favors profitability. It is easy to get out of the tanker shipping business. Just a phone call to a broker will normally be sufficient to set in motion the necessary steps to get out of the business or the vessel. There are always some new investors that are looking to buy.
Part II

Capital intensity – In order to share cake in the industry, I need to sink a lot of money in fixed cost such as tankers and stores. Also many variable costs such as maintenance, crew cost, and so on. There are high entry barrier and high exit barrier as well. It’s a hard-to-get-in-and-hard-to-get-out business. Matured Industry – There are already so many competitors in the market. The buyers in the industry are all experienced, which means they are sensitive to price and quality of service. Being a new player in the game with little experience will make it harder to complete with others that are highly experience and full of cash reserve. Moreover, there is little margin in this industry since there are so many players in the game. Small firm will definitely be dominated by both powerful buyers and suppliers. With those two big reasons, therefore, I will not complete in this business.
Choosing a Vessel
When choosing a vessel we have to distinguish between Tankers, Bulk carriers and Cargo Vessels. I would eliminate liners (cargo vessels) because Tankers and Bulk carriers were larger, required fewer crew members and could Load and Unload in less time than cargo vessels. The distinction between Tankers and bulk carriers could be that bulk carriers could carry 7 types of commodities while tankers could only carry one type. (Note: We all have to agree on the type of vessel we would use). I would focus on one commodity Crude Oil so I would utilize a Tanker. * Tankers – are larger required fewer crew members. They carry single cargo and hired to carry this cargo between port of call designated by hire. Can be loaded and unloaded in less time than general cargo vessels. * Bulk carriers – are larger required fewer crew members. Can be loaded and unloaded in less time than general cargo vessels. Can transport several different types of commodities but cannot carry oil. * Liners – carried many different types of cargo and maintain fixed schedules. * *Combination carriers – could carry cargo on the return or ballast leg of the voyage. Can be converted from oil to dry bulk cargo use in three days.

We would purchase a 150,000 DWT Tanker. On a per ton basis it can be produced cheaper than a smaller tanker but it can carry a larger amount of cargo without being too large that it would cost more money for loading and unloading tools or that it would need a specialized shipyard for it to dock.
We would obtain our vessels through Japan because of the cheap cost of materials used to make the boats. Due to worldwide overcapacity we would think we would be able to obtain more affordable tankers as when there is overcapacity in supply we will be able to compete on price, taking advantage of a price war.
Size of Vessel
Since we have to choose a size of a vessel I would chose a size of a maximum 150,000 dead weight tons. My rationale behind choosing this size is due to the fact that U.S. port facilities could only accommodate tankers of up to 150,000 DWT tons. Other port facilities around the world could accommodate tankers of up to 500,000 DWT but I’m going on the assumption that the U.S. was one of the biggest importers of foreign crude oil in the 1970’s. (We can research this). Also 1 Dead Weight Ton =7.3 barrels of Crude Oil
150,000 x 7.3 barrels= 1,095,000 (This is our maximum carrying capacity)
What makes it attractive?
The opportunity of profitability lies in the closing of the Suez Canal in 1967 which increased tanker demand by approximately 25 %. Renovations were being made on Suez Canal which was projected to be completed in 1984. The renovations would shorten the distance between the Arabian Gulf and Western Europe. Since the article stated that the Useful life of a Tanker is 20 years along with the world energy consumption growing at a rate of 5.5% annually it makes this energy a lucrative opportunity. Under what flag would you fly it? Although the Scandinavian were technologically sophisticated owners in the industry. I would rather operate under the flag of the Greeks because of their less expensive labor and the ability to utilize second hand vessels at a lower cost. One of the drawbacks of doing business under the Scandinavian flag could be the fact that they were becoming more unionized , laws made it harder to make money by paying higher wages as well as being subjected to taxation. The Greeks also had large cash reserves which could enable enter the market in the buying and selling of ships. I would suggest we sail on long term basis while utilizing one or more of the four contractual arrangements. This allows us to open into a larger market. We can lease the vessel or we can take set arrangements of cargo. This way we can capitalize on all aspects of the business, instead of waiting for customers to come to us, like in a spot market.
How will you sell this vessel in caring crude?
I would utilize our personal vessel on the Spot market where we obtain contracts immediately. I would also utilize a Time charter by taking advantages of Forward oil contracts in the near future. Once we establish a contract in the future for a specified period of time we could then lease a time charter at a set rate during a specified period of time. In doing so we avoid the expense of crews, maintenance and repairs while focusing on the cost of the voyage itself such a fuel, port charges, canal charges and extra insurance.

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