This is part 8 of the Xeneta 11-part FAQ series where we focused on key questions related to freight rate benchmarking and procurement. The series provides answers to the most frequently asked questions revolving around the complex world of ocean freight rate benchmarking and procurement. It provides you some tips and tricks to make the process a little less painful.
Shipping is a dynamic industry, and shipping volumes are always fluctuating based on the movement of global trade and business performance.
When there are stability and continuity of business, Beneficial Cargo Owners (BCO) may opt for a service contract. But then, of course, perceptions of stability and business continuity are relative as these could disappear in a flash as we have seen over the years.
Service Contracts Factoring In
A service contract is a contract between a BCO and an ocean carrier. In a service contract, the BCO gives the carrier an MQC (Minimum Quantity Commitment) to ship a minimum volume over a fixed period of time. In return, the ocean carrier commits to set rates and a defined level of service.
In principle, a service contract may contain specific terms regarding the fulfillment of the MQC and penalties thereof in case of non-fulfillment. However, whether the penalties mentioned in the contracts can be enforced is one of the conundrums facing container shipping, and the jury is still out on this.
If there is a decrease in volumes from the MQC, the shipping line is well within their rights to apply a higher rate or charge the BCO the differential in the freight levels. But this largely depends on how good the relationship is between the two sides.
For example, if there is an MQC (Minimum Quantity Commitment) of 2000 TEUs per year to secure a specific rate and the volume achieved is 1950 TEUs, the line may take a favorable view and not charge any penalties. Carriers may offer a tolerance level on the MQC of around 20% depending on the reliability and credibility of the BCO.
Other than with companies that have high and quick growth possibilities (like Amazon for example) increase in MQC volumes are quite rare.
But if it happens, shipping lines may choose to create a new service contract with different terms for the remainder of the period. But this again depends on the terms negotiated at the time of the service contract and the relationship with the line
In short, if volumes increase or decrease during the contract period, the BCO or NVOCC could be at the mercy of the carrier, and eventually, it could all boil down to the relationship with the carrier and how much the carrier needs you at that stage in their business - or whether the customer have provided substantial volumes and delivered on commitments in previous contracts.
Further reading: How to Efficiently Plan and Execute Supplier Negotiations