Indexed Gains

Indexed Gains

I am having a hard time understanding why freight rate indices should not be incorporated into each and every ocean carrier service contract out there. If shippers and carriers want to get serious about getting away from price as the overbearing, domineering element in shipper-carrier relationships, sabotaging any meaningful conversation about service, they need to take price out of the equation, or at least control it as such contracts would do.

I applaud Rodolphe Saade, executive officer of CMA CGM, who told last week’s Journal of Commerce TPM Asia conference in Shenzhen that contracts need to contain this element. That this amounted to a major proposal shows how far the industry still needs to come, but it was an encouraging start.

The fact is, for shippers and carriers alike, the industry is getting killed by out-of-control freight rate volatility and needs to do something. Getting carriers to order fewer ships isn’t the answer. There is no chance whatsoever of ship deliveries ever being smoothly timed to demand.

Shipping has always been a boom-and-bust industry for the precise reason that it’s impossible, if not illegal, for shipowners as a group to coordinate their ordering. Even if they could, it would be impossible to do so according to a reasonably accurate forecast. One carrier orders huge ships, and other lines will follow suit. When the inevitable occurs — too many ships chasing too little cargo — rates plummet.

Shippers may benefit in the short term, but any experienced logistics director knows there is no long-term gain associated with this. They would much prefer that rates remain stable because they know that freight rates can’t and don’t remain at rock-bottom levels forever. They also know that unprofitable rates and a dialogue that is solely about rates means pressing service issues fail to get the attention they deserve.

Richard Iozzo, general manager of logistics and compliance at Fellowes, a maker of paper shredders and other office products, told a revealing story at the JOC’s TPM Asia conference. “Thirty different carriers came to see us about signing a contract for 2011. We ended up signing with three of them. Of the 27 we didn’t use, all of them said the exact same thing when they came in to see us. ‘How much will it take to get your business?’ and, ‘How much volume can you give me?’ ” he said. “Not one of them asked, ‘How is your business?’ or ‘What keeps you up at night?’ That question, they never asked.”

The reason is an obsessive focus on price, price, price. That is where the industry is today.

“The industry has focused far too much on price,” Richard Smith, vice president for transportation at Sears Holdings, told the Shenzhen audience.

Price simply must be removed as a central element of the relationship, and service should replace rate discussions. That has never been able to happen before. Now it can. Indices are the way to do it.

The concept is not complicated. The rates in a service contract aren’t fixed, but rather are pegged to a third-party index. They can and will fluctuate based on open market conditions. There can be upper and lower bands within which a shipper’s rate doesn’t change, but above or below and it does.

Until a few years ago, rate indices didn’t exist in the container industry. But within a very short space of time, they have become well established. The Shanghai Shipping Exchange led the way with the Shanghai Container Freight Index, or SCFI, but others have quickly followed. Some, such as the SCFI, are based on spot rates, while others such as the index published by Container Trade Statistics includes both spot and contract rates.

Regardless, they generally all move in basically the same direction, reflecting the ups and downs of rate levels as operators respond to the constant change in supply and demand.

Container freight derivative brokers are trying to encourage the use of indices in contracts, because that is a first step to shippers, carriers and 3PLs using derivatives to hedge against adverse movement in rates within their contracts. Reducing price volatility is a first step, but what becomes really interesting is that it opens up the conversation to the real issues and drivers behind shipping. Thus, it’s an idea that can, and should be embraced by both shippers and carriers as a way to contain, sideline, and marginalize price as an element within contracting.

There are signs the industry may be picking up on the opportunity. Many shippers present in Shenzhen said they are negotiating at least a few long-term contracts, and many of them say indices of one kind or another are elements of the multiyear deals. According to the Container Freight Derivatives Association, more than 50 contracts on file at the Federal Maritime Commission contain a reference to a freight rate index. It’s a good start.

Peter Tirschwell is senior vice president for strategy at UBM Global Trade. Contact him at ptirschwell@joc.com, and follow him at twitter.com/PeterTirschwell.