Executive Briefings

The Impact of Bad Contracting Practices in the Logistics Industry

Contract terms being demanded by shippers and consignees in their agreements with logistics providers have become unacceptably onerous and one-sided, says Philip M. Coughlin of Expeditors International. Coughlin details common requirements, such as shifting all risk to providers, which he considers unfair, as well as discussing ideas on how to move forward.

The overall tone and tenor of logistics contracts has changed dramatically, and not for the better, says Coughlin, president of global geographies and operations at Expeditors International. "It's a perfect storm," he says. "On the purchasing side, there is a total drive toward commoditization of pricing; at the same time, global shippers and consignees are requiring higher and higher levels of service; and procurement folks are starting to outsource more and more supply-chain risk on to service providers. So we are winding up with contracts that are lop-sided and onerous in their terms and conditions."

Driving this trend is the constant pressure from the customers of global shippers and consignees to lower costs. “This constant pressure, coupled with their own pricing constraints, are forcing them to take costs out of the supply chain, and they do that by lowering rates and shifting inherent risks,” Coughlin says.

The industry as a whole is not dealing well with this issue, he says. “We are sort of just on our heels, signing terrible agreements or trying to negotiate our way out of them.”

The transfer of risk is one of the most serious aspects of this trend, Coughlin says. “Think about an airline losing your luggage. If you say your Rolex watch was in your bag, they are not going to pay you the full cost of a Rolex. This is called limited liability and makes it possible for the airlines to offer fares people can afford. In logistics contracts, many customers are demanding full-value, all-risk insurance at no cost.” When service providers protest, customers tell them to build the cost into the rate, he says, “but when you have to go through a commodity-based purchasing program, it is impossible to build in the cost of free, all-risk cargo insurance.”

When something happens that triggers one of these onerous provisions, service providers are reluctant to honor them, Coughlin says. “As a result, what we now see are customers demanding that contracts include the right to offset any claim against what they owe the provider, in effect paying themselves their own claim. This is a very dangerous situation.”

Going forward, the industry as a whole needs to change the way contracts are perceived, says Coughlin. “Instead of the blood sport it has become, we need to move toward collaborative, results-oriented negotiations. Contracts need to be about creating value between partners rather than extracting value from one partner. They need to be based on outcomes and desired results and shared risks―and both parties need to share risk in a way that is proportional to the commercial benefit of the agreement. If we can get to a more collaborative environment, we will have healthier, more long-term contracts that breed innovation and create long-term value. That will improve the industry as a whole.”

To view the video in its entirety, click here

The overall tone and tenor of logistics contracts has changed dramatically, and not for the better, says Coughlin, president of global geographies and operations at Expeditors International. "It's a perfect storm," he says. "On the purchasing side, there is a total drive toward commoditization of pricing; at the same time, global shippers and consignees are requiring higher and higher levels of service; and procurement folks are starting to outsource more and more supply-chain risk on to service providers. So we are winding up with contracts that are lop-sided and onerous in their terms and conditions."

Driving this trend is the constant pressure from the customers of global shippers and consignees to lower costs. “This constant pressure, coupled with their own pricing constraints, are forcing them to take costs out of the supply chain, and they do that by lowering rates and shifting inherent risks,” Coughlin says.

The industry as a whole is not dealing well with this issue, he says. “We are sort of just on our heels, signing terrible agreements or trying to negotiate our way out of them.”

The transfer of risk is one of the most serious aspects of this trend, Coughlin says. “Think about an airline losing your luggage. If you say your Rolex watch was in your bag, they are not going to pay you the full cost of a Rolex. This is called limited liability and makes it possible for the airlines to offer fares people can afford. In logistics contracts, many customers are demanding full-value, all-risk insurance at no cost.” When service providers protest, customers tell them to build the cost into the rate, he says, “but when you have to go through a commodity-based purchasing program, it is impossible to build in the cost of free, all-risk cargo insurance.”

When something happens that triggers one of these onerous provisions, service providers are reluctant to honor them, Coughlin says. “As a result, what we now see are customers demanding that contracts include the right to offset any claim against what they owe the provider, in effect paying themselves their own claim. This is a very dangerous situation.”

Going forward, the industry as a whole needs to change the way contracts are perceived, says Coughlin. “Instead of the blood sport it has become, we need to move toward collaborative, results-oriented negotiations. Contracts need to be about creating value between partners rather than extracting value from one partner. They need to be based on outcomes and desired results and shared risks―and both parties need to share risk in a way that is proportional to the commercial benefit of the agreement. If we can get to a more collaborative environment, we will have healthier, more long-term contracts that breed innovation and create long-term value. That will improve the industry as a whole.”

To view the video in its entirety, click here