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Canada's overnight wonder: can cargojet's Canada post express contract be a win for all parties?

Normally, when two companies bid for a competitive contract worth nearly a billion U.S. dollars, the story becomes one of winners and losers. This month, however, when Canada-based Cargojet officially takes over the seven-year contract to deliver express mail for Canada Post's Purolator Express, Cargojet may not be the only winner.

The previous holder of the Purolator contract, all-cargo carrier Kelowna Flightcraft, is also undergoing a trans formation. After holding the contract since 1987, Kelowna is reinventing itself as a general freight carrier and expanding its horizons beyond the Canadian border.

Not to be forgotten, the freight forwarders across Canada may also be winners, as Cargojet and the reborn Kelowna are both adding capacity for general cargo. Where there was once a dedicated, one-customer express carrier and a general cargo airline with an aging fleet, there are now more and newer aircraft available, added intra-Canada and international routes, and improved flexibility in the nation's express delivery market to better handle the rapid increase in e-commerce.

"In mid-March we will begin the main part of the transition that will go until April 1," said Cargojet's executive vice president Jamie Porteous. "We've already started to transition a small portion earlier this year and will be slowly ramping up deliveries until the start date."

"Canada is simply not big enough for two express cargo carriers," conceded Grant Stevens, spokesman for Kelowna Flightcraft. The Great White North, however, with its affluent populace and booming oil and gas trade, clearly has room for more general cargo services to flourish.

Untangling the express market

For all its majestic size, Canada, the second largest country in the world by landmass, is mostly empty. About 75 percent of Canada's 35 million-resident population lives near the border with the United States, which stretches from the eastern Maritime Provinces to Vancouver at the extreme southwest corner of the country. These demographics create a mail delivery corridor that is roughly 3,000 miles long and about 100 miles wide, with only a few detours to northern cities like Calgary and Edmonton.

"It's difficult to serve the whole market on a traditional basis; there are no hubs," Porteous said.

In such a linear arrangement, the cost to deliver mail to remote areas keeps rising at a time when mail volumes are plummeting. As a result, Canada Post has been seeking ways to cut costs. The problem is that there are few carriers large enough to compete with Kelowna's two DC-10-30 freighters and thirteen 727Fs.

Because Canada Post is a government-owned service, it could not partner with a foreign carrier. That pretty much left Cargojet as the only potential rival.

But Mississauga-based Cargojet was not seen as much of a threat for many years, mostly because of the long history between Kelowna and Purolator. Back in 1977, Kelowna first began providing air services for the express carrier, a relationship that continued in 1993, after Canada Post purchased a majority stake in Purolator. Today, Purolator is 91 percent owned by the postal service, and Kelowna's founder, Barry Lapointe, sits on Purolator's board.

Behind the winning bid

The seeming lock that Kelowna had on the coveted Canada Post contract, however, did not intimidate Cargojet. The executive team, Porteous said, knew they had the right business model already in place. They had also learned from the last time they bid for the overnight business--and failed.

"We had tried to bid for the contract seven years ago and lost out to Kelowna," Porteous said. At that time, Canada Post was happy to continue the fixed "cost-per-package" model that Kelowna had always offered. But that was well before e-commerce had begun to dominate the express delivery market and when the steep declines in mail volume became most alarming.

"By the time this new contract came back up for bid, [Canada Post was] clearly looking for a way to save costs, so they went with our cost-per-pound route," Porteous said. "The RFP came out of our business model. It almost describes our business to a T, and gave us a real competitive advantage."

The RFP was sent out in December 2012, letting the interested carriers know the size and scope of the business. From December 2012 to the spring of 2013, Cargojet worked on documentation and formalizing its offer, which it submitted it by the end of that year.

Cargojet had some experience with express mail, flying routes for UPS, DHL and Canada-based Loomis Express, but at nowhere near this scale. Purolator estimates it handles about 750,000 to 1 million pounds of express mail for Canada Post every night. To handle this increase, Cargojet would have to effectively double its fleet capacity with new aircraft in less than a year.

Last February, Canada Post officially awarded its Domestic Air Cargo Network Services contract to Cargojet, which signed a Master Services Agreement for an initial seven-year term, with three 36-month renewal options. Projected revenues are estimated to be C$1 billion (US$782 million) for the first seven-years.

The one element of the RFP that Porteous said may have sealed the deal for Cargojet was its willingness to provide comprehensive airfreight services and assuming all the risk for aircraft and pilots. "It was all done at our expense," he said.

While some in the industry were surprised by Cargojet's win, Porteous said he was not. "From a reliability standpoint, ours was just a better mousetrap," he added. "We were very pleased to be awarded, of course. It's a very competitive business, and we recognize how big this is."

Change in the air

Almost immediately after the contract was finalized, Cargojet began its 13-month scramble to boost its airfreight capacity to meet the expected increase in e-commerce volumes. In an interview with the Financial Post last year, Cargojet's CEO Ajay Virmani said that e-commerce and the small-parcel business was rising so fast in Canada that, in the next three to five years, it would at least catch up to the U.S. in the percentage of users making online purchases.

At the time the contract was awarded, Cargojet had just 12 freighter aircraft--mostly 727s that were more than 40 years old. By the end of this year, the carrier will add 12 more freighters, including newer 757s and widebody 767s, bringing the total aircraft to 24. And by the end of 2016, the fleet will be exclusively 757s and 767s as the aging 727s get phased out. The balance of the fleet has been purchased, Porteous added, at a cost of roughly C$300 million.

"This timeline puts us in a unique position," Porteous said. "We've effectively doubled the size of our business in one year. That's probably unprecedented, that we doubled in size based on a competitive contract rather than through acquisition."

What's perhaps more remarkable than the fleet expansion was Cargojet's ability to retain so much of its previous business. The addition of so much widebody space with the 767s has allowed it to add on the Canada Post business without disrupting any of its already established charter services and general cargo operations.

"We still have 20 percent of ad hoc open space for sale," Porteous said.

"We always had this network designed in the past. We contract out 80 percent of our capacity on any heavy-demand leg."

From a freight forwarding perspective, this can only be positive news. "This new contract with Cargojet means there will be more capacity, newer aircraft and a larger schedule, which is always a good thing," said Debbie Hanlon, manager, Alberta region, for logistics firm Agility.

Hanlon said she often uses Cargojet for large domestic moves, including "all types of goods related to oil and gas." The added capacity with the new fleet will only give her more options from which to choose. "We prefer to use local airlines as much as possible." In addition to the Canada Post contract, Cargojet now holds 10 to 12 other cargo contracts and operates a scheduled cargo network serving 400 to 500 customers in 13 locations. A significant portion of the linehaul traffic will fly on the Vancouver-to-Hamilton, Ontario, freighter route, but some of it will also be carried in the bellies of planes operated by Air Canada, which Cargojet had partnered with just before the Canada Post contract was inked.

"We've been able to achieve our business model, where our customers have some flexibility with variable costs," Porteous said. "Canada Post was on more of a fixed-cost model, but they've switched to ours. We've given them a larger scale and more capabilities."

Besides the costs to upgrade the fleet, Cargojet spent another C$6 million (US$4.8 million) on new ground-support equipment as it seeks to expand its facilities in Hamilton. "Purolator had its own ground handling equipment, and we're buying that," Porteous said. The carrier is also adding about 200 new employees to handle the increase in cargo, introducing new scanning equipment, and purchasing a new main-deck loader at its Halifax facility to accommodate the larger 767-300 aircraft.

Looking east

Back in British Columbia, the mood at Kelowna Aircraft's corporate headquarters last year was gloomier, of course, due to the loss of its main source of cargo revenues, but the activity level was no less hectic than it was at Cargojet. As the company prepared to wind down its Purolator business, it began searching for new business to fill the void.

"Last year, given our fleet composition, we decided to look for a combination of domestic and international business," said Kelowna's Stevens. As part of its rebranding efforts, the carrier created a new "KF Cargo" division and focused its attention on trans-Atlantic routes. In February, the new KF Cargo decided it was time to move to where the opportunities were ripest and announced that it was shifting its main operations about 60 kilometers northeast from Hamilton to the nation's largest city, Toronto. The shift to Toronto will provide much better access to trans-Atlantic routes, but the corporate offices will remain in the small city of Kelowna in British Columba.

"Most of the forwarders are based in Toronto, and most of the freight comes in there in belly space," Stevens explained. "The move seemed better than moving the cargo by truck from Hamilton to Toronto."

While it plans to keep its 727s in domestic service, KF Cargo will begin operating DC-10 service from Toronto to Brussels, Belgium, starting this coming May. "We have our own airplanes, and we're trying to break into a marketplace," Stevens said. "Since a 767 is about C$30 million (US$24 million), we want to see what we can do with the planes we already have."

Some of the key commodities it plans to ship to points in Europe and beyond will be live lobsters and other perishables. Other markets it will pursue include pharmaceuticals and oil-and-gas-related equipment. "We noticed that there were no good Europe-to-Canada routes for these products," he added. "We are also looking at flying to Anchorage to give us possible access to Asia."

Growing pains

The change in the Purolator contract did not come without difficulties for both carriers, of course. Kelowna had to go through an initial round of layoffs at the end of last year, some of whom were later retained. "We had 75 pilots based in Hamilton, and we will now move about 65 of them to Toronto," Stevens said. "So there will unfortunately be some reduction in staff."

But the company will continue with its well-established aircraft maintenance facility in Hamilton, where it has 600 employees. In December 2014, this lucrative maintenance arm of Kelowna Flightcraft secured a contract with WestJet to upgrade the interiors of all 100 of the carrier's aircraft.

Cargojet's journey also endured a few hardships, too. The preparation "was by far the most intense review of our business," Porteous said. "[Purolator] really did their homework. But I think they made the right decision."

The carrier also struggled mightily with the bureaucracy of Transport Canada, the nation's transporation department, as it tried to add aircraft to the fleet. Under the contract, Cargojet had to have committed agreements on its new aircraft by Nov. 1, 2014, or it would have been subject to timeliness penalties.

"It was easy to find aircraft. The hard part was the sitting around," Porteous said. "We had converted, freshly painted, C-checked aircraft waiting for weeks and weeks to be approved. With Transport Canada, if a process was designed for days, they would do it in months."

Aside from a few white-knuckle days before Cargojet made its Nov. 1 deadline, most other surprises during the transition period have been good, including the unexpectedly strong peak season, allowing Cargojet to operate at full volume at yearend and testing its ability to handle holiday surges.

Proving themselves

Now that the start date of the new contract has arrived, it's time for both carriers to show their mettle--for Cargojet to demonstrate that it can handle the daily demands of the express market while still retaining its general cargo business and for KF Cargo to find new international customers. Because the overnight Purolator contract only requires daily flights Monday through Thursday each week, with limited service on Friday, this leaves a lot of availability for weekend and evening flights, Porteous said. "We expect to get even more global charter business," he said. "We're can add some new destinations to smaller cities, such as Saskatoon and Regina. Our charter business has doubled every year since 2008 and we plan to continue that."

Cargojet will extend the 12-year contract it has held with UPS as an exclusive supplier for the integrator, along with some flights for Canadian DHL and Loomis. Service will also continue on a few other ad hoc and charter routes, such as Newark to Bermuda, Montreal to Cincinnati, Toronto to Havana, New York to Warsaw, and Halifax to Cologne. The 727s should be in rotation for at least another 18 months until they run into their next C-check.

"Right now, the big focus will be to ensure the transition to the new customer goes smoothly, internally and externally," Porteous stressed. "We don't want to forget the importance of the customer."

Meanwhile, as KF Cargo reinvents itself as a general cargo carrier, it will still retain a bit of its old express business. Last October, it was awarded the contract to operate the BC Feeder Service for Purolator at Vancouver International. While Cargojet will handle the main-line flights, KF will provide the ground handling and air movement services at YVR for a minimum five-year term.

But mostly, KF Cargo is looking toward its new future--specifically May 17, which is the target date to begin its DC-10 service to Brussels. By mid-July, Stevens said the carriers will begin Vancouver-to-Anchorage service with the other DC-10. Down the road, the company may consider using Brussels and Anchorage as jumping-off points to reach into other international markets, such as Africa and Asia. Currently, he added, the company is going through some avionics upgrades with the aircraft, conducting crew training and working with various forwarders along these routes, but could not provide more details as this issue went to press.

Stevens did say that KF will plan to go after general cargo business first before seeking more specialized cargo, such as perishables and pharmaceuticals. "We're putting together a number of deals with forwarders to get access through the pipeline," he said.

45 Years and still flying

For nearly half a century, Barry Lapointe, founder of Kelowna Flightcraft, has been an aviation legend in Western Canada, amassing an empire of 50 aircraft and 1.000 employees, as well as a series of maintenance facilities capable of servicing 80 types of aircraft. His fleet of 727s, Convair 580s and DC10s ruled the night skies, carrying 500.000 pounds of express freight every day to 17 locations across Canada. Here are a few of the milestones of the company he built.

1970      Commercial pilot and aircraft engineer
          Barry Lapointe, along with Jim Rogers,
          co-found Kelowna Flightcraft, an aircraft
          maintenance operation for small aircraft
          in Canada's Okanagan Valley.

1974      Kelowna Flightcraft begins charter
          flight operations.

1977      First began negotiations to carry
          parcels for Purolator.

1995      Partnered with the short-lived Greyhound
          Air, where the company first began flying
          surplus 727s.

2005      Awarded a 22-year, C$1.8 billion contract
          as the prime contractor in a team of
          companies providing maintenance for the
          Canadian Forces Air Command.

2005-     KF expands rapidly, adding new
2009      hangars, plus engine and landing-gear
          shop facilities.

2008      With Purolator, KF begins support operations
          for Canada Post with the purchase of two
          DC-10-30s, the largest dedicated freighters
          in Canada.

2009      Awarded a contract to maintain and modify
          the Buffalo and Twin Otter Search & Rescue
          aircraft based in Western Canada.

2014      Awarded a contract to upgrade the interiors
          of the entire WestJet fleet of more than a
          hundred 737-600/700/800 aircraft.
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Comment:Canada's overnight wonder: can cargojet's Canada post express contract be a win for all parties?
Author:Woods, Randy
Publication:Air Cargo World, International ed.
Geographic Code:1CONT
Date:Apr 1, 2015
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