News / Contract-shy BCOs eye a shift to index-linked pricing

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Shippers have been reluctant to sign new contracts with ocean carriers, citing uncertainty about the market outlook and volatility – and some argue it’s time to move to index-linked pricing.

“Long-term fixed-price contracts no longer serve shippers or carriers,” said Ian Arroyo, chief strategy officer of Freightos.

The pricing and booking platform surveyed some 60 beneficial cargo owners (BCOs) late last year to gauge the impact of the volatility in ocean container rates.

Rates for 40ft containers soared from about $1,500 pre-pandemic, to $20,000 in late 2021 and, subsequently, dropped to less than $1,000 in early 2023, creating extreme levels of discrepancy between spot and contract rates, pointed out Freightos head of research Judah Levine.

In such extreme fluctuations, the pricing stability contract rates are supposed to guarantee went out of the window, he said. When spot rates climbed in 2021, BCOs started to see their shipments rolled by carriers unless they agreed to pay surcharges, as fixed contract rates were no longer aligned with market conditions, he added.

Freightos found 34% of shipments were rolled in 2020 if BCOs did not agree to pay a premium, up from 20% two years earlier.

Likewise, when rates plummeted in 2022, no-shows surged and BCOs shifted to the spot market or tried to re-negotiate rates, Mr Levine pointed out.

The percentage of BCOs that had their contracts revised jumped, from 28% in 2018 to 48% in 2020. Three years later, 83% of BCOs re-negotiated their contracts, Freightos found.

Mr Levine added that recently some reports of rolled containers and premium charges emerged as rates escalated in response to the disruptions in the Red Sea.

Freightos said it had seen a shift among BCOs to go for short-term contracts with a larger number of providers. Inevitably, this meant more work for them to manage their transport spending, added Mr Levine.

The Freightos team regard index-linked long-term contracts as a better option to manage pricing volatility. This would remove the incentive for carriers to roll cargo or add charges when pricing indices go up, while shippers would not be likely to opt for no-shows when they decline.

Critics may argue that this undermines the idea of long-term contracts to hedge against rising charges, but the experience of recent years has shown that this model is broken when pricing volatility is extreme, said Mr Levine. BCOs ended up paying more to ensure their cargo still moved when rates surged.

In essence, BCOs gain reliability through exposure to price fluctuations, he added.

Further benefits would be less-complex negotiations and the ability to signs contracts for longer terms – multiple years – as the parties would not have to revisit price negotiations every time, he added.

Interest in new tendering approaches is widespread among BCOs, Freightos found. Mr Arroyo noted that some forwarders had also begun to embrace index-linked pricing.

Still, there is a considerable gap between interest in, and actual pursuit of, the concept. In its 2023 shipper survey, DAT Freight & Analytics found 43% of respondents used or considered index-based contracts for their trucking needs. However, among this group, less than 20% implemented them, which shows that the concept has aroused interest, but it is not widely adopted.

Historically, technology may have been an obstacle, but issues like high data resolution and data leniency were no longer hurdles, Mr Arroyo noted.

Ram Menen, the retired head of Emirates SkyCargo, reckons awareness and understanding of index-based pricing is still lacking in the BCO community. In addition, there are worries about job security, as this would diminish the role of procurement professionals.

He regards attitudes and concerns as the main obstacles to adoption in the air cargo sector. Concerns about potential manipulation of data and access for unauthorised people have held back adoption, although both issues could be addressed, through use of blockchain against manipulation and by limiting access to authorised users, he noted.

Index-based contracts would be feasible between forwarders and shippers as well as forwarders and airlines, he said, and added: “It would take all the negotiations, all the aggravation out.”

On the other hand, this went against the prevailing practice in air cargo of people making a dollar out of each other, instead of simply billing for a service based on an index, he reflected.

“The other big problem the industry has is cash flow – mostly between forwarder and shipper,” he added.