As global supply chains lengthen and increasingly rely on tight schedules and precise execution, ocean service contracts have become a vital part of most large shippers' logistics strategies. And as ocean capacity has become tighter and the market advantage has shifted to the ocean carriers, global shippers are finding out how critical good negotiating practices have become to achieve advantageous service contracts.
For example, E.I. DuPont de Nemours & Co., based in Wilmington, Del., carefully negotiates its marine service contracts so they become an integral part of the supply chains they support. According to William A. McCurdy Jr., DuPont's logistics and commerce counsel, who is responsible for overseeing the negotiation, drafting and legal enforcement of these contracts, they are an important tool wherever the company's global supply chains demand customization, stringent service levels, high reliability, cost certainty and risk avoidance.
"We use marine contracts to create competitive advantage for our businesses around the world," says McCurdy.
Among the service elements that a large shipper like DuPont might include in its marine contracts that are not included in the tariff offering are:
• Additional, enhanced or different land-based services
• Distribution and information management services
• Different or extended payment terms and means of payment
• Guaranteed space and equipment availability
• Specialized equipment
• Guaranteed just-in-time or expedited delivery
• Expanded storage or use of equipment
• Re-routing services
• Specialized tracking and tracing of product
• Specialized packaging or packaging services
• Enhanced security
• Enhanced liability protection
• Customer directed or focused services
Such enhanced services afforded by marine contracts have increased in importance for all major ocean shippers since the enactment of the Shipping Act of 1984. After decades of lobbying Congress, carriers and shippers were finally able to enter into contracts with confidential terms and rates. In exchange for rates and services that were not part of the carrier's tariffs filed with the Federal Maritime Commission (FMC), the shipper had to define the amount of the cargo to be carried under the service contract in absolute numerical terms, usually expressed in 20-foot or 40-foot equivalent units (TEUs or FEUs) but sometimes as tons, pounds, packages, pallets, etc.
To meet the demands of even greater global competition, shippers and ocean carriers successfully lobbied Congress to pass the Ocean Reform Act of 1998. Known as OSRA, the act allowed the shipper's volume commitment to be expressed in terms of a percent of a shipper's freight requirements on a specific trade lane. Service contracts could now provide a range of requirements based on the minimum amount of cargo to be tendered by the shipper and the maximum amount that the carrier is required to accept.
"The use of a requirements-based contract allows the shipper and carrier to deal with the uncertainty and market fluctuations that make accurate volume forecasts impossible to predict months or years in advance," says McCurdy. He adds that this approach can benefit the carrier trying to grow its business within a market in a predictable and orderly manner while building a long-term, service-oriented alliance with the parties in a specific supply chain.
Gauging Service Needs
With operations all over the globe, planning and negotiating DuPont's service requirements for these contracts has become quite complex. Many of its contracts with specific carriers are global, covering many different trade lanes and many different strategic business units (SBUs) within DuPont. According to McCurdy, the most time consuming phase involves information gathering within the company before any carrier is contacted.
"We have to find out the specific needs of each of our SBUs and make sure we cover all of those requirements in the global contracts," he says, adding that the service requirements in these corporate-wide contracts reflect the needs of many businesses and products.
"Our contracts are a form of mass customization," says McCurdy. "When you look at all the service requirements in the contract they are very broad, but each term meets the specific needs of each unique business."
By including as much volume as possible into its contracts, DuPont is able to leverage the volume of all the SBUs, but that does not mean that carriers have to provide service for every trade lane of business segment. Carriers choose to bid on the business and lanes that they want to serve.
"We give the carrier the opportunity to determine where their business is most profitable, and just bid on that part," says McCurdy. "We want carriers to make money on our business. We also always want to have multiple carriers participate on each lane, so we develop healthy competition."
For its global contracts, DuPont almost always prefers to express its volume commitment to the carrier as a percentage of its requirements. According to McCurdy, competition on a trade lane can be enhanced by committing a minimum percent to more than one carrier in a particular trade, and then have each carrier offer to accept a much larger percentage.
"Whoever provides the best service gets the most business," says McCurdy. "You just have to keep the volume commitment low and the carrier acceptance limit fairly high."
An extreme example would be to commit 10 percent of volume on a route as a minimum to two or more carriers, each of which would agree to carry up to 60 percent of our total volume. As long as the shipper gives 10 percent to each carrier, it has fulfilled its commitment, but the carriers are obligated to take up to 60 percent. That differential can go to whichever carrier is providing the best service.
OSRA allows shippers to calculate volume minimums in terms of number of TEUs or actual revenue, but McCurdy says these commitments can work against the shipper if its business has a sudden spike or dip.
"If your business suddenly grows, you may find yourself unable to find a carrier to take the traffic," says McCurdy. "If sales drop for your product to the point where they are under your fixed commitment with the carrier, you're stuck paying for capacity that you will never use."
Most Favored Nation
The giant chemical and life sciences company ships more than 130,000 TEUs each year on virtually every shipping lane in the world, so DuPont almost always has the best rate on a route. Occasionally another large shipper on a route may be able to negotiate a lower rate, so DuPont always includes in its contracts a so-called "most-favored-nation" clause.
The clause requires a carrier to give DuPont a price equivalent to or better than any other shipper that is similarly situated. To make sure carriers are complying, DuPont uses third-party auditors who, even under confidentiality provisions of the carrier's contracts, has access to the carrier prices.
"We don't get to see the pricing of both our contracts and the other shipper in question, and the auditor does not tell us," says McCurdy. "He will just tell us if the carrier is in compliance with the most-favored-nation clause. If they are not, we will inform the carrier of the non-compliance and give the carrier an opportunity to fix it. The auditor will go back and check to see if they have made the correct adjustment. If they are still not in compliance, then we have direct discussions with the carrier."
If a carrier offers DuPont a lower rate after it has signed a contract with another carrier, that carrier has to match these lower rates or terminate that portion of the service from the contract so DuPont can make other arrangements.
"This term becomes important if transportation costs are a critical factor in the sales price of our product in a particular market," says McCurdy. "If rates make a sudden change in that market and our competitors are not to be exposed to that same shift in transportation pricing, we could suddenly be non-competitive. Not only would we be out of the market, but because we would have no sales the carrier would lose our business as well. We are just doing what we can to keep the carrier and ourselves competitive in this market."
Incentives and Penalties
According to McCurdy, DuPont would much rather build in incentives for excellent performance than impose penalties for service failures. Even if a carrier is performing poorly, DuPont merely has to meet its minimum volume commitment. Then, it can just not give the carrier any more business. If there are service failures that are caused by circumstances beyond the carrier's control, DuPont may terminate for cause, but it usually does not impose penalties. There are situations where penalties are enforced.
"We will penalize carriers if they do not take the cargo they committed to," says McCurdy.
Where penalties can become a major issue is with contracts requiring just-in-time performance to meet supply-chain schedules of DuPont or its customers.
"We pay a higher price for this service commitment, and we are relying on the carrier to get the cargo to a specific place at a specific time," he says. "If the carrier service fails, there is going to be a significant consequence because other processes were dependent on the timely delivery."
McCurdy says that penalties are built into contracts to protect DuPont against such consequences. He is quick to add that DuPont often builds in performance incentives where the carrier helps DuPont be more profitable by improving service times or helping to cut costs.
"If a carrier keeps its billing errors below a certain level, we might provide for a bonus because that saves us money," says McCurdy. "We put in the carrot and the stick in the contracts to encourage the carriers to live up to the terms of the contract, and hopefully improve upon the required performance."
Service requirement descriptions in DuPont's contracts are sufficiently flexible to permit changes that may become necessary to meet evolving market conditions and customer demands. The service descriptions are usually provided as an attachment to the main contract. This appendix is detailed enough so operations personnel without further instruction can easily understand it if the need arises.
Rates, volumes and specific service descriptions are also in an appendix. "We spell out these terms in great detail by trade land and by business," says McCurdy.
The requirements appendices are often built before the bidding process and distributed to the carriers who are invited to enhance the requirements if they choose to. McCurdy says that if the enhancements appear important to DuPont, the company will pay more for them. If not, DuPont will reject them and go back to the requirements originally issued. Enhancements would include such things as container availability, maintaining a container pool near a DuPont facility and land-based services to take responsibility for customer delivery.
"Our willingness to pay for these enhanced services is mainly a function of whether our customer considers them a competitive element," says McCurdy.
As a practical contract construction practice, DuPont avoids referencing tariffs, rules tariffs and bills of lading in their service contract. If references to tariffs are necessary, they are limited in scope and include a provision that prohibits alternation except with the written consent of both parties and in accordance with standard amendment provisions of the contract.
Information systems are a critical part of DuPont's supply-chain management, and its ocean contracts. The availability, and compatibility of information systems for all parties-including any transportation intermediary, supplier or customers-are essential to meeting the performance requirements of the contract. McCurdy negotiates with the carriers on their information system's capabilities and how it meets DuPont's requirements. These terms are spelled out in the service contract, usually as an exhibit, along with terms covering confidentiality, licensing parameters, data and systems ownership and other intellectual property matters.
Among the most important capabilities for carrier information systems are compatibility across the supply chain and the ability to comply with online reporting requirements for Customs, dangerous goods, security and other cross-border government regulations. From an operational standpoint, the carrier's information system must be able to adequately track product and provide data necessary to measure adherence to service and operational performance levels. All services, including information services, must be subject to measurement and audit.
"Ocean carriers are getting better at providing information in the form we need it," says McCurdy, adding that carrier portals have become especially useful. A few years ago, these portals were not well developed. Each had a very different interface that made communicating across supply chains difficult. "That lack of an easy, uniform interface is disruptive to a large company, but information systems are improving rapidly."
In the post-9/11 era with, advanced notification, inspections, tracking technology and other security issues becoming more important, the division of the tasks for each party to the contract are negotiated and spelled out as precisely as possible. For example, more and more carriers want shippers to place very specific types of seals on the container, and confusion over such requirements can slow down the movement of the containers.
"We are starting to see supply chains slow down as a result of a great increase in security measures," says McCurdy. "There are more advance notice procedures, more controls over who loads and unloads the ships and containers, more checkpoints for truckers and more customs requirements."
Shippers are not usually in the best position to deal with these operational matters, but they are the ones that have to live with the delays.
"Security issues in ocean contracts will command as much attention in the future as service requirements do now," says McCurdy.
Confidential, Or Not
Much has been heralded about the new confidentiality afforded shippers and carriers under OSRA because government and carrier conferences are constrained from sharing the contents of service contracts except under extraordinary circumstances. However, McCurdy points out that no similar restriction is placed on the parties to the contract itself. Carrier and shipper parties to a contract may, if not constrained by contract terms or business pressure, publish any and all of the contract's contents to the general public. McCurdy believes shippers-and carriers-should include a strong confidentiality clause in the contract if they do not want their competitors and the general public to know their business.
"Competitive advantage gained through the group efforts of those who make up the shipper's supply chain could easily be lost if confidentiality is not maintained by the terms of the contract," he says.
The liability limits of most ocean common carriers are found in the Carriage of Goods by Sea Act (COGSA), its equivalent outside of the U.S., in the carrier's standard bill of lading, or in the carrier's tariff rules. All of these limits strongly favor the carrier. They offer far less protection for the shipper than the full-liability usually provided for by trucking and rail. In fact, COGSA allows carriers to avoid or limit its liability based on 17 defenses that include almost every likely situation that would cause loss or damage to cargo. However, under COGSA carriers can agree to assume greater liability than is provided in the Act, the rules tariff or the bill of lading.
"Shippers should consider negotiating a different and more balanced liability scheme," says McCurdy. For example, common law supports the concept of each party assuming responsibility for the results of its negligence and willful misconduct and that of its employees, officers and agents. Such a liability scheme creates economic incentive for those who perform work or exercise control over potential liability causing events to exercise due care to prevent the occurrence of such events.
"The net result would be fewer liability-causing events, a more efficient supply-chain network and overall lower costs for the parties to the contract and the ultimate consumer," says McCurdy.
DuPont tracks a number of performance metrics for its ocean contracts. Perhaps the most important one is how much and often carriers turn down an offering of DuPont's cargo.
"Carriers can turn down some cargo now and again and still meet their minimum requirement, but if they turn down cargo frequently, they are not reliable," says McCurdy.
Other metrics that DuPont tracks include meeting promised delivery dates, cargo meeting sailing schedules, claims for loss and damage, and billing accuracy for freight and for such charges as demurrage.
"If we find we have to constantly review a carrier's bills for accuracy, that becomes an unnecessary cost to us," says McCurdy.
In fact, every services description in DuPont's contracts is defined by performance metrics, so adherence to required standards is quantitative. "We also include metrics for our own performance, so the carrier can measure how well we are performing," says McCurdy.
Period of Agreement
McCurdy says that he usually tries to negotiate a three- to five- year term for ocean contracts if only to limit the amount of time taken up with renegotiating boilerplate terms. Other terms in the contract will allow price to be re-examined if market conditions change, or perhaps terminated if no agreement can be reached, but the basic terms and the service requirements should not require complete restructuring.
"If we have up to five years to live with the basis contract and only have to make minor tweaks, that saves everyone a lot of time and costly renegotiations," says McCurdy.
Each trade lane has its own market characteristics, however, and the length of the contractual term depends on the outlook for that trade. If the market is not favorable, and its looks like rates are going to climb and service will tighten, DuPont will try to extend the contract as far out as reasonably possible. If the market looks like it might soften or be subject to abrupt shifts, DuPont will keep the term fairly short.
Occasional disputes over contractual terms with ocean carriers are bound to happen, but DuPont tries to control how these disputes are resolved. McCurdy says that he always tries to avoid arbitration and litigation if possible. He prefers mediation where the parties themselves get in a room together and work out problems.
"We have found that almost everything we do in mediation results in greater satisfaction of both parties," says McCurdy. "If I were going to have to work with a carrier long term, I would rather not have to litigate or have an adversarial arbitration. If we can resolve things through mediation, that is a better atmosphere."
Forums for determining liability should also be considered. DuPont tries to select New York as the appropriate U.S. based jurisdiction to litigate a marine dispute because of its expertise and experience. The business and contract laws of New York are well developed, stable and sophisticated. In the U.S., New York is a good compromise selection for both shippers and carriers. According to McCurdy, the only carriers that do not want to be in New York are those that have no significant presence in the U.S. For example, a carrier that only operates between Australia and Hong Kong and never comes to the U.S. will probably not agree on New York or anywhere else in the U.S. as a forum.
Safety Audits and Insurance
As a global company extremely aware of safety issues, DuPont audits its carriers for their safety and operational procedures. The auditors will check to make sure that carriers are using proper safety equipment and practices and that the ships are properly maintained and manned. For large carriers, DuPont will do a system-wide audit to look at the carrier's procedures. For smaller carriers, DuPont will look at the actual ships.
"These shipper safety audits have been common in the trucking industry for many years, and now they are beginning to be used in the marine community," says McCurdy.
DuPont uses both large and small carriers around the world, but it is especially concerned about risk exposure with the small carriers that have minimum financial strength. "We want small carriers to have the right type and amount of insurance, especially environmental insurance," says McCurdy. "If they spill our product in the ocean requiring a major cleanup, we want to make sure there is insurance available to deal with it, so we do not get stuck with the costs."
McCurdy says that for most large carriers, these concerns are rarely an issue. These carriers will have insurance, and in any case, they are financially strong enough to deal with any risk that would involve DuPont.
Operations and Communications
Underlying every ocean contract are the shipper and carrier operations that have to be coordinated to meet the terms agreed upon. To the degree possible, the operational needs of both parties have to be anticipated and included in the contract itself, along with a means for changing those operational needs if required.
For example, a shipper that only moves a few containers a year does not want a dozen containers on the plant site. Likewise, if a DuPont plant ships several containers each day, the operating people need to know there will be a steady equipment supply available.
"Our contracts require the carrier and our operating people to coordinate their activities and to communicate any problems," says McCurdy. "If one party is creating needless bottlenecks and costs to the other side, we need to be able to bring these issues to the forefront and find a solution. It is a continuous improvement process that we work into the contracts."
To avoid small problems becoming big ones, DuPont's ocean contracts include clear communications links for every type of issue between specific people on the shipper and carrier sides.
"If there is a legal issue, I know the exact name and contact information for the person whom I should be speaking with at the ocean carrier," says McCurdy. "We have similar links set up in advance for every type of issue, whether its operations, safety, legal, technology or environmental. The people specified are empowered to act to deal with the immediate problem whether it is something as simple as a missed sailing, or something as serious as a major accident."
By setting up these links in advance between managers with the authority to fix problems without having to go through a huge bureaucracy, small glitches do not get out of hand. The natural tendency for finger pointing when problems do occur is greatly diminished.
Last Words of Advice
McCurdy says that total supply chain cost-not rates-should be the focus of shippers when they are negotiating ocean service contracts.
"Companies love to compare rates, but what is important is minimizing the total cost and maximizing the value," says McCurdy. "A shipper should be willing to pay more if the service is valued by its customer. If the customer doesn't value it, we don't want to pay for it."
To the degree that the ocean carrier is able to have a favorable impact on inventory, handling and storage, equipment availability, and other costs across the supply chain, these benefits must be weighed against what the carrier is charging. On the negative side, if the carrier is difficult to do business with, requires hours on the phone to resolve problems and uses information systems that require modifying the shipper's systems, a low rate may be no bargain.
"The process of negotiating ocean contracts between your company's business units and the carrier should reveal where the real values lie," says McCurdy.
Of course, not every shipper has the volume and worldwide leverage that DuPont has, but McCurdy says any shipper can improve its negotiating position with a carrier by improving the carrier's profitability. Shippers can help carriers lower costs by improving equipment utilization with two-way movements, regularly scheduled shipments and rapid loading and unloading of equipment.
Even small shippers can create efficiencies for the carriers by combining their freight with other shippers, either through a shippers association or just with a joint consolidation agreement.
"Carriers are finally realizing that the most attractive shippers are not necessarily those with the greatest total volume," says McCurdy. "The shippers that can keep the carrier's containers full and moving at a profit are the ones that provide the best business."
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