Commentary: When Is A Carrier Price Gouging?

The views expressed here are solely those of the author and do not necessarily represent the views of FreightWaves or its affiliates.  

There is a lot of talk about the recently soaring spot rates in trans-Pacific container trade. Year-over-year increases of 70% and higher are hard to ignore, especially in the middle of a pandemic – a time when many are working desperately to keep supply chains intact. Shipper associations may become even more concerned given the degree of consolidation among container carriers. But is this a group of carriers that are price gouging their shipper customers?

A container ship is anchored in port and taking on cargo containers.
(Photo: Jim Allen/FreightWaves)

Only three container alliances (i.e., 2M, Ocean Alliance, and THE Alliance) account for 80% of the market share between Asia and North America. Container alliances (excluding Jones Act carriers) are even granted antitrust immunity in the United States. Of course, this immunity is limited to agreements among alliance members and these are filed with the Federal Maritime Commission (FMC). This is not out-and-out price-fixing as was practiced in the bygone days of liner shipping conferences. In addition to discussing availability and sharing capacity, alliance members can discuss pricing guidelines (i.e., methods) but not actual prices. These guidelines are taken by the membership to be voluntary when they set their individual freight rates. Anything more than that would be akin to cartel-like behavior.

It is also important to note that shippers and carriers can negotiate year-long contracts instead of dealing in the spot market. Each side must make decisions regarding locking-in some certainly instead of playing for some flexibility. This trade-off always involves taking calculated risks. Shippers in the spot market right now are likely feeling a sense of risk. But, then again, carriers face risk too.

What is price gouging? One answer might be – it is whatever the FMC says it is. More objectively, price gouging means a seller is taking advantage of a captive buyer by extracting a price that the latter would not pay if other options were available. But they are not – and that is what separates price gouging from charging whatever the market will bear. The operative word here is "market" because price gouging occurs in a situation where markets are either non-existent or under severe stress.  

A container ship near a U.S. port.
(Photo: Jim Allen/FreightWaves)

A supplier able to charge a price above all economic costs is a signal of lack of competition for the good or service in question. It should be noted that these economic costs include a payment to the owner/entrepreneur (called a "normal profit") and a return on investment (ROI) as compensation for the opportunity cost of tied-up financial capital. In other words, a price that covers all of these economic costs per unit of a good or service produced compensates everyone on the supply side.

Any extra revenue earned through a price set above all economic costs is unnecessary to promote production. Also, any supplier would find it hard to charge such a price unless, of course, the business had monopoly power. Economists have demonstrated that earning monopoly profits – barring the extreme case of perfect price discrimination – is less efficient across the market than competitive situations. One alternative to monopoly power is for the government to break up the monopoly and encourage competition among the now smaller firms. The other is to regulate the monopoly by mandating a lower price per unit approximating one expected in a competitive market.

Of course, emergencies can thrust suppliers into monopoly-like situations. Think of a lone store selling groceries or hardware in a small town that is cut-off from the rest of civilization after the connecting infrastructure is impacted by a flood, forest fire, etc. The store, pricing at what the market would now bear, could earn a lot of extra profit per bottle of water, case of dried food, a package of batteries, portable generator, etc. Is this price gouging even though some people would be willing to pay multiple times more than the day before? Yes, it is. The reason is two-fold.

Inventory was virtually depleted in the early days and weeks of the pandemic.
(Photo: Jim Allen/FreightWaves)

First, the normal marketplace is no longer functioning because of the emergency. Customers cannot shop elsewhere to search for lower prices like they could before; and the store's vendors cannot replenish dwindling supplies. Second, the emergency can lead to hoarding by those with the money and the timing to get to the store before others. This is not indicative of a truly free market made up of normal economic activity. When it is a matter of survival, normal economic activity shuts down and government regulation must take over and ration goods and services in order to prevent any further strain on the socio-political fabric. In this context, markets are luxuries propped up by stable societies willing and able to accept the law of supply and demand. Markets that offer trade between buyers and sellers separated by considerable distance are also luxuries made possible by functioning logistical networks.

Logistical networks allow markets to operate to a degree necessary to prevent some of the problems outlined above. For example, suppose the emergency in the small town had left customers stranded yet the store was able to arrange a steady supply from vendors. Perhaps some of the infrastructure is still functioning and the authorities prioritized it for relief efforts. In this case, raising prices on necessities is not price gouging. Why not? Charging a higher price for items flying off the shelves incentivizes the store to ask the vendor for more than otherwise. By paying the vendor more – earned out of the store's excess profits – the incentive to produce more travels upstream along the supply chain. Basically, a normal functioning market alleviates shortages only when suppliers have the prospect of earning more profit. Certainly, the store could institute purchase limits per customer to prevent shortages if it felt that would enhance fulfillment across its customer base. This is supply chain management in action.

Bottled water was a key target for shoppers in the early days of the pandemic panic-buying.
(Photo: Jim Allen/FreightWaves)

What about the COVID-19 pandemic? Well, the same reasoning applies. Rising prices are not evidence of price gouging if alternative supplies are available and if the rise in price is due to upstream cost increases that the supplier is passing along to the customer base. In other words, there are no gratuitous actions designed to burden captive customers. 

In this context what can be made of rising spot rates in the ocean vessel sector? Is this industry taking advantage of captive customers who would not dream of taking on the expense of moving trans-oceanic bulk cargo by its only other modal substitute, air cargo? Should rises in spot rates at a time like this deem suspicion of price gouging? Well, only if monopoly power can be demonstrated. If such market power exists then excess profits must be the norm. But are they?

If ocean carriers end up making profits this year it will not be the first time. Then again, they may end up with losses and that will not be the first time either. Basically, the industry was volatile before COVID-19 struck and it will remain so as U.S.-China tensions intensify and trade activity adjusts between U.S. East Coast and West Coast ports. Blank sailings to control capacity in combination with supply chains moving more safety stock are a recipe for spot rates to increase. Demand by consignors is returning, yet merchandise sales this fall are subject to the risk of further spikes in COVID-19. Basically, excess carrier capacity was held down by blank sailings; but now that demand is up, supply will bounce back to some degree. Soaring spot rates at this time simply show the law of supply and demand in action.

Thousands of containers are stacked at a U.S. port.
(Photo: Jim Allen/FreightWaves)

Of course, if price gouging is suspected, then certainly the FMC can use its oversight function to look into it. After all, they are the body that agreed to the formation of the container alliances in the first place.

Click here to see other commentaries by Darren Prokop on American Shipper and FreightWaves.