An offer they couldn?t refuse

An offer they couldnÆt refuse European Sony executive explains the highs and lows of carrier rate negotiations.

By Eric Johnson

      Rate volatility for ocean freight shippers is often discussed but rarely quantified.
      In mid-April Adam Rashid, head of supply chain solutions in Europe for Sony, gave an insight into just how volatile rate swings can be, even for a major, well-established, international manufacturer.
      Sony, which negotiates annual rates with its carriers for service between Asia and Europe, saw rates rise 45 percent in March 2008 from March 2007. In March 2009, rates dropped 75 percent from March 2008 levels. Then in March 2010, rates rose 200 percent from March 2009 levels.
      The rollercoaster ride does neither side any good, Rashid explained at Containerisation International's Global Liner Shipping conference in London.
      'There's a three-year lead time for carriers to order vessels?' he said. 'I don't fancy going to my bank manager' with those swings in revenue.
      Rashid said in February 2009, Sony received several bids from carriers to move containers from China to Rotterdam that were 75 percent lower than the previous year, reductions that were not specifically solicited by the company. The low rates led to internal discussions at the Japanese company.
      'We asked, 'what if a carrier goes out of business offering these rates?' ' he said. 'What will happen to service levels? In the end, we said, 'our sales are down and there's no way we can refuse these rates.' '
      Rashid offered a pragmatic view of liner-shipper relations during his discussion, often sympathizing with carriers in spite of the wild swings in service and rates his company has endured in recent years.
      'We're in this together,' Rashid said. 'We need stability, we need to set prices in advance, and we need a dependable supply of goods. Carriers need stability to maintain services, predictable volumes and profit to reinvest. Please be profitable, but do it within reason and avoid huge rates swings.'
      Yet he firmly opined that carriers contributed to their own troubles in early 2009.
      'Carriers did contribute to the crisis by offering annual, not spot, rates way below breakeven,' he said.
      Whether the rates were offered because certain carriers had deep pockets to weather losses and gain market share, or whether some knew they had state backing, Rashid said he didn't know.
      'Why would all of the top lines assume everybody would do the same thing (drop rates)?' he asked.
      Rashid said he can only surmise that it's the way the shipping industry endemically operates.
      Yet a Maersk Line executive who spoke at the conference said 2009 could not be pinned merely on the typical cycles that have come to define the industry.
      'This is an industry that has been used to growth year after year,' said Morten Engelstoft, chief operating officer of Maersk. 'The downturn was entirely historic and very unexpected. Freight rates decreased sharply in a very short period of time.'
      Maersk's container business losses topped $2 billion in 2009, and Engelstoft said that's after the line had taken out millions of dollars of costs and laid off thousands of employees.
      He admitted the changes affected service.
      'We made 200 network changes last year,' he said. 'We didn't want to, we had to. And we didn't give customers as much notice about the changes as we'd like.'
      Echoing similar comments by Maersk Line Chief Executive Eivind Kolding in March, Engelstoft said carriers and shippers should be prepared to jointly reduce rate volatility.
      'High volatility is still being accepted,' Englestoft said. 'Less volatility will stabilize supply chains and make them more safe.'
      Maersk projects that 95 percent schedule reliability would allow its customers to reduce their inventory buffers by 60 percent.
      'There won't be one model that fits all customers,' Englestoft said. 'Some will look to long-term contracts with benefits and some will prefer shorter arrangements.'

Quarterly View. Sony has typically operated via annual contracts on the Asia/Europe lane ' where quarterly contracts are more typical given the more prominent role of forwarders in this trade.
      'Sony is a cautious company,' Rashid said. 'Until 2009, we always had fixed annual rates. But for 2010, we have changed to having annual rates with a quarterly review. It may not sound like a drastic change, but it's a significant change for us. I think it will help us monitor service levels and establish a closer relationship with carriers on a strategic level.'
      Rashid said the move was not made purely on the basis of the recent economic crisis, but rather 'because of the volatility over the past five years.'
      'I don't think a quarterly review implies a shorter contract,' he added. 'What a quarterly review gives us is a snapshot. We could even go to a two-year contract with a review.'
      Yet before shippers can even consider moving to longer-term agreements, they have to be convinced lines will honor 12-month deals.

'Carriers need stability to maintain services, predictable volumes and profit to reinvest. Please be profitable, but do it within reason and avoid huge rates swings.'

Adam Rashid Head of supply chain solutions Europe, Sony

      In August 2009, Rashid said Sony's carriers began leaning on the company to increase rates from the low levels agreed upon in the annual contracts cemented only months before.
      'The lines told us we can't maintain these rates and we can't maintain the service,' Rashid said. During the negotiations in February 2009, 'we were in Tokyo looking at the bids, saying 'wow, these are the rates for the year?' But we didn't ask for these rates.'
      Rashid then lamented how far the pendulum has swung the other way this year, saying slower vessel speeds should not translate into higher rates.
      'No one asked us if we would be willing to pay less to go slower,' Rashid said. 'They said, you can pay more and your goods will move more slowly.'
      An executive from Hellmann Worldwide Logistics said the schedule disruptions and service slowdowns have forced logistics providers to make up the gap for their customers.
      'We worked harder than ever before to keep track of daily changes, at a time when our resources were stretched,' said Marcus Leaver, head of global ocean freight at Hellmann. 'Despite being asset light, forwarders were not the winners. Our shipping line partners didn't keep their promises. Shipping supply has been deliberately kept below demand. He who pays well gets service is the mantra.'
      Rashid said shippers absolutely would be interested in faster transit times, despite the talk that slow steaming might continue even after demand recovers.
      'There is definitely a market to go faster,' he said. 'For sure there is a market if we could get this to three weeks door-to-door (from Asia to Europe). I think there is an opportunity port-to-port, with a mid-size vessel. I really think you could fill it up.'

Uncertainty Reigns. Now whether demand rebounds is another matter altogether.
      Englestoft pointed to an oft-repeated line early in 2010 that's keeping the liner carrier industry cautious: 'Growth in demand to the U.S. and EU has been much stronger than retail sales. In order for the volume surge to be sustained, we need retail sales and consumer demand to grow. So far we haven't seen evidence that consumers are spending. Until we see that, there is uncertainty and we will remain cautious.'
      The implication, as Kolding said in early March, is that the volume increases are being driven by restocking, not necessarily consumer demand.
      However, U.S. sales figures from March showed consumer spending may be trending upward after all. It surpassed a November 2007 peak, while incomes also appear to be rising.
      Still, carriers stung by 2009 are taking the conservative approach. Englestoft said he expects the supply/demand balance to remain in the short term, but that 'the reality is there's so much uncertainty, it's difficult to predict. We do see a demand recovery, but in the second half of the year. Rate levels remain at a fragile level. They're around the break-even level, which is a great improvement from last year, but not sustainable.'
      Rashid, however, said shippers have a difficult time understanding what constitutes breakeven.
      'I think rates are already high,' he said. 'What is a break-even rate? Is it $900 between China and northern Europe? Is it that kind of number, because frankly I don't know. It would be interesting to work for a shipping line. Then I'd know the cost to go from China to Europe.'
      Englestoft said he could envision a scenario where distressed assets come up for sale in 2010. He said there's a 'reduced likelihood of consolidation' given that carriers made it through the worst of the downturn.
      Meanwhile, an executive with Maersk Line sister company APM Terminals said 2009 inexorably changed the flow of container volumes.
      'This is the new normal,' said Richard Mitchell, chief commercial officer for APM Terminals. 'There is significant free capacity in large gateways and slower growth with a better balance between head-haul and backhaul. There will be opportunities, but they will be different. The good old days aren't returning anytime soon.'
      APM Terminals projects that container volume won't fully rebound until mid-2012 in Europe and mid-2013 for North America.
      'Emerging markets will clearly offer opportunities,' he said.
      Mitchell said APM Terminals is eschewing greenfield sites for terminals and looking at existing facilities where there's chance for profitability.
      'Rather than build a terminal and wonder 'where are all the customers?' now we're going to the customers,' he said.
      He also said the growing list of new carrier partnerships and alliances, and network changes, is as hard for terminals to deal with as it is for shippers.
      'Who is not sharing with whom?' Mitchell said in reference to the phalanx of new carrier partnerships that have emerged in recent years. 'For terminal operators, it makes our business more complex, and it also makes it harder to win new business. It's not fantastic when all your customers are losing money.'