Of Markets and Middlemen
Technology transforms industries. When we think about how products are made and sold, we see its influence throughout the process: sourcing happens in online marketplaces such as Alibaba; factories are automated; sales channels have been virtualized to the point where Amazon – which has no storefronts – is one of the world’s largest retailers.
But logistics, that multi-trillion dollar system that makes trade possible by transporting those products, has largely resisted the technology revolution. In particular, the market for ocean freight—which is responsible for carrying 90% of the world’s goods—remains stuck in the past.
The adoption of an exchange model – a framework for simultaneously connecting many buyers with many sellers – has led to efficiencies in the forms of better price discovery, faster clearing, and decreased risk in many industries. It’s time for the logistics industry to embrace trade technology; when transportation logistics modernizes, the world will find it much cheaper and easier to conduct commerce globally.
From Hand-to-hand Commerce to the Exchange
Up until a few centuries ago, almost all trade was conducted through individual barter. Buyers and sellers had to physically find each other in order to transact. The financial industry gradually emerged, as people began to trade debt, commodities, and eventually equities. Brokers appeared – men who knew both buyers and sellers, and kept track of what prices people were paying. They served as middleman connectors.
As trading activity increased, ad-hoc markets grew too complex. The realization that trade was more efficient when it was centralized led to the designation of specific houses where brokers and people who wanted to trade congregated…and eventually, to the first stock exchange. The London Stock Exchange opened in 1801, bringing all trading activity to one place and pioneering a series of market innovations, including systems designed to detect fraud and using auctions to determine fair prices.
The financial exchange brought many benefits. A centralized platform permitted greater numbers of people to participate in the market, and lowered the cost of transactions. Exchanges provided regulatory oversight (e.g. by de-listing dubious companies), helped to manage risk, and disseminated pricing data. They provided transparency and a unified price—bids and offers are now communicated to all members simultaneously, so that traders can be sure that they’re acting on the best information possible.
A Need to Modernize
The market for ocean freight hasn’t yet adopted the structural innovations of the 19th century. This is somewhat ironic, since the shipping industry was a pioneer of financial innovation. The first limited liability companies were formed around ocean voyages; the Dutch East Indies company was the first to have an “IPO” and to issue stock.
But the industry’s now a laggard. Aside from a few basic software elements, shippers are stuck with 20th century technology, relying on phone calls, emails, and fax machines to find providers who can transport their products. Since quotes are created via emails and phone calls, price discovery is slow; it takes hours, days or even a whole week to get a freight quote from a service provider. And on the provider side, this system of sporadic outreach and outbound sales means that demand management and forecasting remain poor; some routes are overbooked, while others have ships with excess capacity. Ocean freight carriage is still largely negotiated as long-term contracts via time-consuming processes.
Freight hasn’t yet evolved. Most shippers still rely on brokers—called “freight forwarders”—to obtain quotes for their shipments. They can’t see the entire market, so they don’t really know if the price is fair. The lack of a centralized exchange means that pricing will remain opaque, especially for small and mid-sized shippers. The result is that this trillion-dollar industry is largely run by Rolodexes.
The shipping industry should look to finance for solutions to these problems. Financial firms have long been on the forefront of leveraging technology to increase efficiency. For example, human participants have largely been removed from the execution of trades. Couriers have been replaced by electronic quotation systems. Exchange market makers have morphed from humans on the trading floor to computers routing orders to other computers. Most crucially, brokers have largely disappeared. Their value had been tied largely to their superior knowledge of market dynamics, so the technology that made price dissemination instantaneous also eliminated the need for brokerage services.
Transforming Logistics Transforms Trade
Global logistics deserves its exchange moment. Evolving to an exchange-based model reduces operational costs, which results in better margins and more efficient trading. And that matters: making transportation logistics more efficient means that it’s easier to move the goods we use and the food we eat. There’s always an imperative to reduce its frictions so that people can buy more affordable products.
Technology can help get us there. Matching engines and predictive pricing have already enabled finance, air travel, taxis, and many more industries to eliminate human brokers. It can also do the same for the freight market. There will be great things to come when the industry abandons the Rolodex and embraces the information age.