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6 Ways To Incorporate Committed Contracts Into Your Annual Agreement

March 18, 2021

Over the last few weeks, we have seen an enormous increase in shippers and carriers looking for new approaches to service contracting and utilizing two-way committed contracts to create diversification and flexibility in their 2021 ocean strategy:

  1. During day one of the #TPM21 conference Mary McNelly, the Director of Logistics from Crocs, said two-way committed contracts are going to be “incredibly important to watch and think about how you play that in your network."
  2. Maersk Ocean and Logistics Chief Executive Vincent Clerc expects “that in five years close to 100% of our business will be based on two-way commitments.”
  3. And lastly, Lars Jensen from SeaIntelligence Consulting and a leading expert in the container shipping industry recently posted on LinkedIn saying  “In the midst of the disruption in the container market we should take note of a different trend: Diversification.” He cited how NYSHEX only had 1% of containers not moved in accordance with their contract as compared to container rollovers in the 20 largest ports reaching 37% in December.

So, the question remains, if you are a shipper entering the 2021 ocean contract cycle and want to incorporate this new approach of two way committed agreements into your tender process, what should you consider?

In this article, I'll explain the value of two-way committed ocean contracts and how you can incorporate them into your annual agreements.

The value of two-way committed ocean contracts

Two-way commitments are exactly what they claim to be. You as a shipper need to be willing to commit regular volumes in exchange for guaranteed space, equipment, and pricing for the duration of the agreement.

While the terms of the agreement can be customizable between the shipper and carrier, the expectations are specific and crystal clear to both parties. This detailed framework allows performance to be easily measured and exceptions are managed through a mutual accountability process.

Ultimately, committed agreements enable reliability by ensuring contract terms are clear, and therefore, the expectations of both the shipper and carrier are aligned on mutual performance goals.

How to incorporate two-way commitments into your annual agreement

Now that you have decided to incorporate two way committed contracts, the final decision is how to implement this solution. There will be different needs for each individual shipper, but I will share some common approaches being implemented in today’s committed contracts.

Diversification

One approach is to look at your carrier ecosystem as an investment portfolio.

You could have a group of carriers considered high risk, in other words, traditional contracts with no guarantees. These are risky because there is a good chance your capacity could be restricted at the times you need it most or be forced to pay for premium services.

Another option to reduce risk would be to try and work directly with a carrier on committed contractual terms, if they offer this to customers. Unfortunately, not all carriers offer this contracting alternative. The lack of standardization across carriers may also create administrative challenges for the shipper.

Finally, you could partner with a neutral 3rd party to assist in supporting these committed agreements with an approved group of participating carriers. This option would also reduce risk with the advantages of a standardized approach, visibility to performance and mechanics for fair and efficient resolution of exceptions.

Redundancy

This is where you can be very strategic in how you award business to your partner carriers.

For your critical lanes that move the majority of your cargo, you should consider a primary option with several back up alternatives. Especially if these lanes have carriers with traditional contracts with no service or capacity guarantees. These lanes are a great opportunity to minimize risk and allocate a portion of this business to committed contracts.

You as the shipper have confidence in stable regular volume and if one of your high-risk carriers does not perform, you still have the security of knowing a guaranteed percentage of that cargo will move as planned to the final destination.

Seasonality

Traditional contracts typically set weekly volume expectations by taking the annual contract MQC (minimum quantity commitment) and dividing by 52 weeks. The challenge for many shippers is that their volume can fluctuate based on seasonal flow initiatives and customer buying patterns.

However, many of these seasonal flow initiatives are planned well in advance and can be forecasted with a high degree of accuracy.

A committed agreement could allow you as a shipper to outline future seasonal capacity needs when the contract is created. This gives carriers the advanced notice required to reserve this space and make any other necessary network adjustments.

Overflow

As previously noted, most traditional contracts restrict the shipper to a weekly allocation of the MQC divided by 52 weeks. Committed agreements could allow for the shipper to pre-negotiate access to additional space flexibility at a guaranteed price.

A practical example would be the shipper has an agreed weekly allocation of 100 TEUs but can “flex up” an additional 25 TEUs for a $500 premium. This option could simplify the administrative burden that often comes with overflow cargo going to a backup carrier or NVOCC.

Performance

Committed agreements are a great way to drive performance improvement because of their clear contract terms and aligned expectations. This goes back to the Peter Drucker quote of “what gets measured gets managed.”

If you have overall performance challenges with a particular carrier or multiple carriers in a particular lane, committed agreements allow for regular meaningful performance reviews. This is where the focus becomes understanding the root cause analysis to exceptions and developing counter measures to minimize future disruptions.

Optimization

Procurement teams and logistics managers negotiating ocean contracts will certainly be put to the test this year. Many tenders have several rounds of negotiations where rates, service and value-added terms are adjusted to eventually create a finalized carrier award.

This painstaking, but necessary, scenario management process happens across thousands of lanes to result in the best overall optimized result. This optimized plan becomes the playbook or operating instructions for supply chain managers to execute plans against.

Unfortunately, if the ocean contracts are not constructed with the clarity and expectations to perform accurately, then the result will be far from the perfectly optimized solution.

A diversified approach is the key to success

There is no doubt that one of the most important strategic questions facing shippers today is how should I adjust my 2021 ocean contracting process to accommodate this dynamic marketplace?

Based on the options available, it might be worth considering a diversified approach that results in a mix of early committed contract protection, traditional May agreements and shorter-term alternatives to address seasonal demands later in the year.

This approach will allow you to strategically test and learn with new contracting vehicles, knowing this is where the industry is moving in the future. It also creates a phased approach to implementing change, which in many large organizations happens over several contract cycles.

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