With the drop in global consumer demand, well publicized glut of capacity in ocean freight and cost cutting objectives in many companies, we’ve been fielding a lot of questions about ocean freight contracts and securing lower long-term fixed rates lately. The market is at an low time low and now is the time to act, since the rates that you would get in a negotiation today cannot go much lower. But before taking action, you need to decide on your goal - short-term costs savings, predictable prices (when oil prices fluctuate), or sharing risk and improving supplier relationships - since strategies are different for each.

Before approaching shippers, it’s important to understand their perspective on the current marketplace. The ocean freight market is in precarious situation that it hasn’t encountered in over five years. New vessel orders that were placed several years were finally delivered right as the global demand look a drastic spike downwards adding capacity on top of excess existing capacity. But despite interest from shippers, carriers are reluctant to sign any type of contract longer than twelve months since they hope the global economy will improve in the near future.

With that in mind, what are smart shippers doing to seize the current opportunity and meet their goals?

• Short-Term Cost Reduction: Some shippers are implementing benchmark clauses that allow them to “test the market” at any time and if they find lower prices, their incumbent must meet those rates or the contract is terminated. There are disadvantages since this approach doesn’t create a “partnership” relationship and instead becomes very transactional. So when the economy turns back up the shipper’s freight may be the first one left at shore.
• Predictable Costs: We are encouraging shippers to explore ways to ride the market besides trying to get the lowest rate from a carrier. For example, you can have a fluctuating bunker factor instead of a fixed rate and capture the low prices of oil. Bunker fuel changes with the price of oil. Over the past few years some shippers have signed contracts with a “fixed” bunker to protect themselves from rising oil prices. They felt it was better over the length of the contract to be charged $550/MT than to ride the wave of fluctuating prices. This was fine until oil went above $100/barrel and carriers imposed an EBAF (emergency bunker adjustment factor). This was a second charge on top of their bunker price to cover rising prices and this was a price dictated by the carriers. Shippers had very little control of it and essentially they paid it or freight didn’t move.
• Sharing Risk & Improving Supplier Relationships: A few shippers are taking the indexed pricing model further by pegging against a specific port, which gives them true market pricing at the time of their shipment. Some choose to use origin port, some choose to use destination port. Luckily technology now enables you to follow different prices at major ports. When a shipper chooses to peg, they show the carrier they are willing to take some of the risk on. They share the lows and experience the highs with their carrier in a partnership that can benefit both sides.

Carriers are already getting extremely creative in order to secure freight. I’ve even seen some carriers charge $0 for the freight portion and simply bill the accessorial charges that were incurred on a shipment. So if you are interested in any or all of the goals above, now is the time to act.

Rachel Rutkoski is a Category Manager for Transportation and Logistics in Ariba’s Global Services Organization. Rachel is recognized by the Institute for Supply Management as a Certified Professional in Supply Management (C.P.S.M.) and has several years experience as a supply chain and transportation analyst in Fortune 500 companies.