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The Cost of Non-Performance in Ocean Contracting

April 14, 2021

Well, it’s hard to believe but April is here and if you are responsible for moving cargo in the Transpacific Eastbound trade lane, then you know annual contract season is coming to a close! While it has been noted that some shippers started and concluded their discussions earlier than normal this year, there are still many contracts to be finalized with just a few weeks before the end of the month.

The question everyone usually wants to know is what happened with rates this year? Unfortunately, much of that drama has been removed with the majority of shippers accepting that annual contract rates will increase this year. The question now becomes how much did the rates increase and what will you get in return for paying more to move the same cargo?

Price will always be an important part of any supply chain decision, but is it the most important priority?  This is a question that only the shipper can determine based on their company’s strategic objectives and customer promise.  However, many importers are taking a more holistic look at their total supply chain landed cost, and some interesting findings have been revealed. 

In this blog post, I will share some real examples that highlight the cost of contract non-performance and the downstream impacts it can have with compounding effects. 

In my role at NYSHEX, I have the opportunity to review and offer guidance to shippers on their ocean freight strategy.  This gives me unique access to aggregated information for the past year on how supply chains performed. 

Without breeching any confidentiality, I am going to share several examples for benchmarking purposes.

The cost of non-performance

This example will look far too familiar to many shippers over this past year. 

This is a shipper who contracted directly with a carrier in a traditional annual contract with a 25,000 TEU MQC.  Like many shippers, the actual volume for the first half of 2020 was less than projected due to COVID impacts.  In other words, they shipped less each week than their annual MQC/52.  However, as volumes rebounded in the second half of the year their volume exceeded their annual MQC/52 weekly commitment. 

Because of the challenging capacity situation, the carrier very closely managed their capacity commitments and rarely exceeded the weekly minimum capacity.  The overall result was a traditional annual contract that performed at 60% of the annual MQC and lead to the use of premium services, additional carriers and NVOs at significant cost increases to move all cargo. 

In fact the total cost of non-performance in this example was $20,500,000.  

Example 1: Annual contract expense at 60% performance & 40% premium

ServiceVolume (TEUs)Base RateRate PremiumTotal RateCost
2020 annual MQC (60% performance)15,000$1,500$0$1,500$22,500,000
2020 premium service space commitment 5,000$1,500$1,250$2,750$13,750,000
New direct carrier added via RFP Q31,500$1,500$1,500$3,000$4,500,000
New direct carrier added via RFP Q41,500$1,500$2,000$3,500$5,250,000
2020 multiple NVOCCs2,000$1,500$4,500$6,000$12,000,000
Total25,000$1,500$58,000,000

Example 2: Annual MQC expense assuming 100% performance

ServiceVolume (TEUs)Base RateRate PremiumTotal RateCost
2020 Annual MQC (100% Performance)25,000$1,500$0$1,500$37,500,000
Cost of Non-Performance  ($20,500,000)

Insights

In this example the cost of non-performance is measured only by ocean freight charges.  However, upon further discussion with this shipper, while the $20.5 million dollars is a large sum of money it was actually minor compared to the added knock on impacts of unpredictability. 

When cost impacts were estimated for the additional inventory carrying costs, inefficiency in domestic logistics (trucking, warehousing), increased administrative burden and lost sales opportunities. The total cost impact quickly began to multiply.  This again will be no surprise if you have been reading the latest headlines from major retailers financial results

For shippers who experienced something similar to this example, I would challenge you to approach your discussions with carriers differently this year. 

Not just negotiating a higher price with the same old results but looking at your price increase as an investment in service reliability.  Instead of the traditional positional bargaining approach which tends to be an adversarial, zero-sum exercise focused on claiming rather than creating value, be very clear about service expectations and get a firm commitment in writing. 

This approach may cost you a few hundred extra bucks per container in ocean freight premium but could save you millions in overall supply chain expenses.

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