‘Committed’ ocean carrier contracts are key to surviving supply chain challenges

Retailers need to take a different approach to negotiating contracts

It’s an understatement to say the supply chain has been a critical issue for retailers the past two years. Shutdowns of factories and shortages of capacity and equipment to move merchandise coupled with soaring demand for goods over services have led to strained inventories and record inflation. U.S. retailers imported a record 25.8 million Twenty-Foot Equivalent Units —  one 20-foot container or its equivalent — in 2021, up 17 percent from 2020.

One key concern throughout the pandemic has been the skyrocketing price of shipping a container and the ability of ocean carriers and terminal operators to deliver on promises made in contracts they sign with retailers. The price of sending a 40-foot container from Asia to the West Coast soared from a little over $2,000 in June 2020 to more than $5,000 by the middle of last summer, while the price to the East Coast rose from under $3,000 to nearly $7,000.

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Even at those inflated prices, 100 ships have sometimes sat at anchor waiting days to dock after arriving at key entry points like the Ports of Los Angeles and Long Beach. And containers have been left in terminal yards for weeks because of lack of trucks, truck chassis, truck drivers and rail capacity to haul them away.

Given that background, it was my pleasure to host a session, “The Future of Ocean Contracting,” at NRF 2022: Retail’s Big Show last month in New York. I was joined by Gordon Downes, CEO of NYSHEX, a New York company that uses technology and expertise to help retailers and ocean carriers develop and execute “committed” contracts intended to guarantee that each party receives what it expects. Downes is a former Maersk executive with two decades of global experience in supply chain specialties ranging from marketing to intermodal strategy.

“It’s not just that demand is increasing,” Downes said. “All of these bottlenecks are essentially sucking the supply out of the system. You’ve got increasing demand and decreasing supply, which is part of why we see these extremely high prices (for shipping) and constraints around service. The issue is very real.”

During the pandemic, retailers have found ocean carriers sometimes don’t have enough space on their ships to handle their cargo even though they have a signed contract in hand. Carriers sometimes demand a bonus payment to take a container aboard, or at least give preference to their largest customers. And even if there’s room on the ship, there’s no guarantee the container will arrive on time.

Downes said these challenges mean retailers need to take a different approach to negotiating contracts with carriers in the future.

In the past, contracts have been “very much a gentlemen’s agreement with no real firm levels of performance” guaranteed and retailers’ approach has been to “form a good relationship with your suppliers and hope that those relationships pay off,” he said. Those ways of doing business “haven’t always worked in the past and I don’t think are going to result in a great outcome at this point.”

By contrast, the trend today is toward far more business-like contracts where carriers commit to detailed, specific levels of capacity and service and retailers commit to ship guaranteed volumes of cargo on certain routes at agreed-upon times. Clear standards are set to measure performance, either party can face financial penalties for non-performance, and unilateral rate increases are not allowed. Contracts are also growing in length, from a typical 12 months to two and more often three years — providing retailers with predictable costs and carriers with predictable revenue.

“That’s a fundamental shift, and we’re seeing the whole industry move in that direction,” Downes said. “When we talk about building a more resilient supply chain, being able to make these longer-term contracts with true commitments really does de-risk the supply chain.”

In contrast to pre-pandemic days when demand was weak, prices were low and carriers sacrificed service to try to remain profitable, retailers today are willing to pay higher prices — but only if they get the service they expect and on-time delivery of cargo in return.

Better data sharing and transparency is “absolutely fundamental” under current supply chain conditions and should be addressed in contracts, Downes said. Retailers, carriers and intermediaries need to know how shipping capacity is being allocated and discover problems fast enough to be able to “course-correct in-flight.” Increased use of digital technology is making that sort of data more available, which is particularly helping small shippers that have not had as much access to data as large shippers in the past.

The move to long-term contracts is a key to supply chain success, according to Downes. Prices that carriers are agreeing to for the next 12-18 months are far lower than current prices. And while prices could fall even further, the guarantee of getting goods delivered by locking in price and service agreements now has value. Without a commitment, a retailer could pay higher prices on the spot market, be forced to turn to expensive air freight or — in the ultimate supply chain failure — suffer the cost of lost sales if in-demand merchandise doesn’t show up in time.

“It's not just a question of how much ocean freight you’re paying,” he said. “It’s also a question of, if you don’t have that commitment what is the consequence?”

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