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Commentary: Playing the spot market

Service contracts should have teeth to encourage good behavior

Importers adjust to downstream order cancellations while carriers adjust schedules to fill capacity. (Photo: Jim Allen/FreightWaves)

The views expressed here are solely those of the author and do not necessarily represent the views of FreightWaves or its affiliates.

Relational or transactional. One of those words describes the interactions between supply chain partners. Relational applies to a steady, long-term interaction typically codified in a well-defined service contract. Transactional deals with one sale at a time, meaning short-term interactions subject to change at the pleasure of either party. An automobile manufacturer likely thinks in a relational way when it seeks steel and glass vendors for its assembly line. It more likely thinks in a transactional way when it seeks to fill a shortage of paper clips and bags of coffee in the back office.

Consignors and for-hire carriers may interact in relational or transactional ways. Using the spot market to facilitate a one-off shipment is certainly transactional. Establishing a contract for a stream of services over time is relational. Dedicated transportation and beneficial cargo owners (BCOs) are good examples of this because they necessarily involve more negotiation between consignors and carriers. However, whether the two parties envision a stream of shipments over time or just one, a bill of lading is required by law. Of course, the terms within the bill of lading and the freight rate are open to negotiation if both parties care to do so.

Motor carriers may hire independent owner-operators to top-up their services. These interactions could be relational or transactional as well. The flexibility that owner-operators provide to the motor carrier sector is one of the reasons why it is so competitive. Of course, some modes are less flexible than others. Consignors and carriers may, for different reasons, seek spot market flexibility when freight rates and capacity are perceived to be moving in a favorable direction. Alternatively, they may seek the certainty of longer-term service contracts when rates and capacity changes are perceived to be unfavorable. Naturally, consignors (as buyers) and for-hire carriers (as sellers) take opposite views as to what directions are favorable. This sets up a perennial tug of war. And the degree of market power in the tug of war is never the same over different networks, routes, etc. Consignors want routes that service their customers. Those providing e-commerce want to do this evermore quickly. Carriers want to move their capacity to where the demand is growing. In other words, each is looking for profit.

The ocean carrier mode has its own unique challenges. Whether relational or transactional, this mode makes a practice out of container no-shows and blank sailings as means to adjust. Importers adjust to downstream order cancellations while carriers adjust schedules to fill capacity. Importer and carrier actions may also affect spot rates. They rise or fall depending on which of the two parties has more power to disrupt. No-shows and blank sailings represent one party’s adjustment without giving much notice to the other. Furthermore, importers not providing scheduled containers leaves carriers with excess capacity. On the other hand, blank sailings make it harder for importers and ports of call to allocate their time and resources to plan out their operations. Containers are moved to other vessels with different travel schedules, which can disrupt supply chains. Containers waiting to be loaded onto vessels or moved inland after unloading exacerbate demurrage charges. These account for the costs borne by a port when a container languishes in the terminal yard. This terminal space is valuable and yet the port is tied up providing extra security and dealing with the congestion.

The coordination problem goes even deeper and can lead to cascades. No-shows may result from blank sailings and vice versa. An importer, mitigating against the risk of running up against a blank sailing, could always book container capacity on two or more vessels. Such overbooking means at least one vessel is going to face a no-show. Carriers, experiencing (or simply expecting) enough no-shows, can do a blank sailing that delays the delivery of the other containers that were duly tendered. These containers will be delayed and become, in effect, a no-show downstream along the supply chain.

Volatility could, of course, be stopped by such things as rate regulation and territorial licenses. By and large, deregulation of transportation has served the economy well, spurred globalization, etc. The churn of consignors and carriers deciding between being relational or transactional is better than a regulator deciding for them. On the other hand, each side trying to wiggle out of contracts because it does not have nonperformance penalties is rational only in a narrow sense. It is not an example of the sort of good-faith behavior that engenders trust. To end the incentives to wiggle, each side needs to put teeth into its service contracts. Coming to terms with volume and capacity commitments, rate fixity, fuel surcharges, demurrage and detention, and dispute resolution procedures is necessary.

Many industry-watchers have wondered why the ocean vessel sector plays games that would not be tolerated in, for example, the airlines. It is true that a plethora of oversold fights and traveler no-shows without penalties to either side would lead to chaos on the ground — though not in the skies since a lot of planes would simply not be flying. Passengers are “freight that complain.” Containers, on the other hand, are easier to tolerate as they languish. Of course, this is no excuse to avoid improved contracting procedures. However, just like each mode of transport is different, apparently so are the levels of tolerance.

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Darren Prokop

Darren Prokop is a Professor of Logistics in the College of Business and Public Policy at the University of Alaska Anchorage. He received his Ph.D. in economics from the University of Manitoba in 1999. Prior to his academic career Darren Prokop worked in government as an economist and in the private sector in inventory planning.