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A SMART service contracting solution?

A SMART service contracting solution?

   Your recent cover story,    'Attention to details' (January American Shipper, pages 6-13), on problems and opportunities related to container shipping service contracts and the shipper-carrier relationship addressed practical, important issues and problems faced by shippers.

   I would like to offer Drewry's opinions of some of the comments and contents in this article.

   First, I completely agree that shippers and carriers will need to concentrate on 'specifics' of their service contracts in 2011 to avoid a repeat of some of the problems experienced in 2010.

   It is also necessary to point out that the No. 1 focus of these 'specifics,' in Drewry's view, is to have tight, clearly defined service contract clauses that give contracts real teeth in case of non-performance and service failure by carriers. Shipper-carrier relationships in 2010 were strained because of this. In the field of service contracts, this is the key area in which Drewry has been asked by our shipper customers to provide expert advice during 2010.

   Second, the article suggested that the problems of 2010 could have been avoided if shippers and carriers had paid more attention to the details of their service contracts. This is not the whole story. While I agree that there were loopholes in some service contracts (which carriers took advantage of in 2010), some problems of non-performance and cargo rollovers had more to do with carriers walking away from the contracts they had agreed to, no matter what the contract said. Therefore, shippers will need to reconsider in their vendor selection which of the ocean carriers and non-vessel-operating common carriers are more reliable and trustworthy.

   Third, you correctly reported that 2010 was 'the year of the carrier' and that Drewry has advocated longer (18 to 24-month) contracts to provide more stability and predictability in the shipper-carrier contractual relationship, rather than the typical 12-month contract validity. In logistics activities other than container shipping, contracts of two years or longer are common practice.

   You also reported that the worry of many carriers and shippers is, in effect, that it may seem artificial to 'fix' freight rates for a period of two years and that the contract rates may become out of sync with the market. There is also the worry that one party (shipper or carrier) would force the other party to renegotiate half-way through the contract if the market changes (which would defeat the purpose of a longer contract). Drewry would counter these arguments by saying there are practical solutions which can reconcile the need for stability and the need for some pricing flexibility.

   One solution merits consideration by many shippers in 2011. This solution is supported by Drewry and a similar mechanism was already outlined in 2009 by the Swedish appliance maker Electrolux at an industry conference. The three components of this solution are:

   ' The shipper and the carrier agree that the freight rate during the life of the contract will be subject to a minimum price and a maximum price (say, plus or minus 30 percent from a base price).

   ' The shipper and the carrier also agree that the freight rate during the life of the contract will be indexed on an independent price benchmark and therefore will be revised if market prices change significantly.

   ' The shipper and the carrier also agree that the price revisions would be triggered only if the market price rises or falls by a pre-determined threshold level to reduce the need for numerous price revisions (and invoicing complexity).

   Provided the contract is backed by mutual obligations (volume commitments, service guarantees, etc.) and by tight contractual language, the pricing mechanism above has the benefits of providing stability to both parties (up to a point), of avoiding unacceptable big surprises during the period of the contract and of reducing the opportunistic temptation of either party to walk away from the contract.

   I urge shippers and carriers to consider including this type of 'stable, market-adjusted rate term' (SMART) pricing mechanism in their 2011 service contracts. It may well represent a workable solution to one of the shipping industry's long-term problems.

   I would also like to hear the views of other American Shipper readers about this service contract idea.

Philip Damas

division director,

Drewry Supply Chain Advisors, London

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