An endurance race
Preparing for 2010 ocean carrier rate negotiations.
By John Isbell
Just as the old adage states: 'what goes down must come up,' ocean carriers are intent on getting much higher rates for their services in 2010 than in 2009.
Ocean carriers have apparently learned two lessons in 2009:
' You can't chase volume by lowering rates because your competitors will follow and, in the end, the volume will be about the same, but the rates will be too low to be sustainable. This approach was tried in the 1980s by a U.S. flag carrier, leading to those same exact results.
| John Isbell vice president, Starboard Alliance Co. LLC |
' If demand is falling dramatically, you must effectively manage capacity. Ocean carriers used the air freight carrier model and removed more than 12 percent of the available 20-foot equivalent units from the global supply in 2009. Though this was a sizable chunk that resulted in higher vessel space utilization and a platform from which carriers can begin to increase rates, some say that is still not enough of a reduction to match capacity with demand. Whatever the percentage should be, idling ships to create an artificial supply level is expensive and so that cost will be included in the carriers' cost recovery model.
In March 2009, Ron Widdows, chief executive officer of NOL, projected rates would decline, much to the dismay of his ocean carrier colleagues. However, to say anything else would have been seen as arranging the deck chairs on the Titanic.
'The world economy is undergoing a fundamental change during the current global crisis and won't emerge from the crisis for some time,' Widdows said at the Journal of Commerce Transpacific Conference. 'As a result, several container lines are likely to go out of business.'
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Thanks to extended credit lines and investors willing to invest in new stock and bond offerings, and the fear of being saddled with sub-par assets should carriers file for bankruptcy, all the large global ocean carriers are still in business, but drowning in a boatload (excuse the pun) of red ink projected to exceed $20 billion in 2009.
Are shippers prepared to throw the ocean carriers a lifeline by accepting higher rates in return for service stability? Some shippers, who have had their well-oiled supply chains pulled and tugged in different directions in 2009 due to service string reductions and realignments, appear ready to support rate increases.
'Carrier cutbacks are playing havoc with the supply chains of retailers,' Martin Bernstein, transportation excellence director at J.C. Penney, was quoted in a Nov. 17 JOC article. 'Twenty-five percent of Penney’s routings this year have been affected by changes in schedules and reduced sailings.' The same article quoted a Nike spokesperson as saying: 'carrier cutbacks had hurt the shipper’s (Nike) ability to diversify its gateways.'
Rates have been rising dramatically in trade lanes like Asia/Europe, which are dominated by non-vessel-operating common carriers contracts that are subject to periodic changes by the ocean carriers. But this is not sufficient to staunch the revenue losses from global operations. So the transpacific carrier consortium, operating under the Transpacific Stabilization Agreement, announced emergency rate increases for all shippers, effective Jan. 15.
As Widdows told American Shipper on Dec. 12, 'Taking this step now, as many shippers face the stress of an economy that is still a long way from recovery, is not what carriers would have preferred. But without some improvement in the economics of this trade in the very near future, they will be left with some very tough choices that involve either moving even more aggressively to individually consolidate or reduce the number of services now offered, or incur further losses that in the longer term are simply not sustainable.'
Beyond the Jan. 15 emergency rate increases, the TSA has announced an overall $800 increase per 40-foot container for shipments from Asia to the U.S. West Coast and $1,000 per 40-foot container for all-water and intermodal shipments.
As a former shipper, I know the TSA announcements are generally put aside during the face-to-face negotiations because not all carriers and shippers are alike and each relationship is unique. Actual negotiated rates are a product of the level of partnership between the shipper and carrier, shipper committed volume and service requirements, accessorial charges, claims policies and bunker fuel formula. That being said, in 2010, ocean carriers will likely approach contract negotiations with a more serious tone. At stake is the survival of the company and/or the negotiator's status as an ocean carrier employee.
With the inevitability that some rates may double — remember we are starting from very, very low rates — how are shippers preparing for their 2010 transpacific contacts negotiations, if they are preparing at all? One thing I learned from the dramatic rate swings in the transpacific trade from 2002 to 2003 is that the 50 percent decline in the 2002 rates was greeted by senior management with high-fives and words like 'great job in getting those carriers to drop rates.' Then in 2003, carriers succeeded in raising rates back to 2001 levels — a 100 percent increase in the rates! Executive reaction was certainly less enthusiastic to say the least. I spent my time reassuring senior managers that the company's rates were still competitive relative to other similarly situated shippers.
What I took away from that experience is it made sense to better manage year-to-year rate fluctuations so they would be less severe. That whipsaw event changed the framework for contract negotiation discussions between my former company and some of its more strategic carrier partners. Our team looked at the pros and cons of multiyear contracts and formulas that could make the natural market swings in ocean rates work better for the way the company priced its products. Both parties adopted a longer-term perspective rather than only considering what could be gained at the expense of the other in one year. Those more in-depth and out-of-the-box conversations with our strategic carriers achieved their objectives while giving the company quality service at competitive rates and the carriers more stability. Our negotiating team was able to add the word 'sustainable' in front of competitive rates. Over a four-year period, we definitely had less variability in our rates compared to the industry in general.
The process required ongoing adjustments, just like fine-tuning a race car. Achieving a positive outcome required a committed crew (our internal team) and the car owner (the ocean carrier). We, collectively, never lost sight of the overall objective of creating a win-win proposition for all parties. 'Trust' was the underlying principle that made the relationship work for both sides.
When a shipper and carrier adopt a long-term perspective in which each accepts the need for the other to survive and prosper, it means that each has to grip the handrails tight at some time or other and hope the cooperative process to minimize year-to-year variability in rates with consistent service expectations is better than fighting for supremacy and the ensuing rate volatility and service disruptions. Chasing low rates, bleeding money, reducing service, then watching the supply-demand curve flip the tables as rates rise dramatically may not be the best measure of success.
The 2010 ocean contract negotiations will be critical for both the carriers, who need to stem the tide of red ink and to the shippers, who are being held accountable by their companies for controlling costs. A possible way out of this conundrum is to think about the negotiation process from a far-sighted perspective.
It may be too early for ocean carriers to consider any type of long-term rate leveling course of action, given their financial condition and length of time it will take to regain their footing and a return to profitability to satisfy their investors and shareholders. But the essential ingredient in any longer-term agreement is trust. So maybe that is the starting line for shippers and their carriers during the 2010 negotiations. A less chaotic and more profitable future for all will be built on that foundation.
John Isbell can be contacted at john@starboardalliance.com, or by phone at (503) 329-2599.