The benefits of index-linked contracts for ocean shipping
When properly implemented index-linked contracts can ensure costs are optimized, productivity is increased, and supply chains are protected. This chapter explains how:
Cost optimization
Market volatility can render months of negotiations irrelevant in the traditional tender process. When rates are agreed in a falling market, logistics providers may end up signing contracts at a loss, benefiting shippers. However, when the market subsequently shifts and rates rise, logistics providers may choose to roll (not ship) cargo, forcing shippers to turn to the more expensive spot market or renegotiate at higher rates. This breakdown creates a lack of trust, damaging the relationship. In cases when demand exceeds offered capacity, shippers may need to switch to a more expensive mode like air freight.
In contrast, because index-linked contracts ensure rates remain aligned with market conditions, both shippers and logistics providers can be confident the rate is fair. Shippers remove the risk of paying excessively high rates compared to the market, which can often be the case when fixed-rate contracts are agreed in a rising market ahead of a dip. Logistics providers can protect their margins because adjustments move in line with the market, instead of having to lock in significantly low rates based on a dip in the market or arbitrary negotiations.
Increased productivity
Preparing and negotiating traditional fixed-rate contracts typically takes 4-6 months each year. While access to a trusted freight intelligence platform like Xeneta can save customers thousands of hours a year on market monitoring, reporting, and tendering, extensive negotiations and renegotiations that can take another 2-3 months are sometimes still required due to ever shifting market conditions.
Adopting an index-linked contract can save months of negotiation and renegotiation time and resources. Shippers don’t have to worry about cargo being rolled and scrambling to secure capacity and are freed up to focus on other strategic supply chain priorities.
Logistics providers can focus on strengthening customer relationships and attracting new business. Index-linked contracts are typically longer than fixed-rate contracts at 18-24 months and counting, rather than 12 months, saving all parties yet more time.
Supply chain resilience
In traditional tender processes, much of the time is spent on negotiating and then renegotiating prices when the market moves. This often means there are limited considerations given to the service elements of the contract despite on-time shipping being central to supply chain resilience. This cycle repeats itself every tender season with the ‘winners’ being whoever the current state of the market favors: shippers in a falling market and logistics service providers in a rising market.
In an index-linked contract, once the market position has been agreed based on the chosen index price, negotiation becomes less of a focus than in a traditional tender. This frees up both shippers and logistics service providers to focus on service quality and building long-term partnerships. The shipper can have confidence in the resilience of their supply chain and the logistics provider can be confident in their margins and long-term profitability. As mentioned in the above section, reducing the risk of cargo being rolled further protects the supply chain: if your rates are reflective of the market, your containers are more likely to get shipped / be attractive to ship.
