Freight contracts can be a daily source of headaches for shippers and carriers alike, but they don't have to be, according to two new startups proposing to fix one of the industry's deepest problems: shipper no-shows and cargo rollovers.
The problem is a game of chicken and the egg, rooted in a flawed economic system that has sown deep distrust between shippers and carriers. Shippers in need of spot market shipments may book slots on several carriers to secure the lowest rate for their cargo. Meanwhile, carriers looking to fill up capacity per trip turn to the spot market and sometimes overbook in anticipation of shipper no-shows.
The behavior guarantees near-term success for shippers and carriers, but at the industry's expense in the long-term. Broken contracts encourage an unhealthy competition, where carriers consistently undercut each other on the spot market for short-term gains. Companies sometimes try to enforce penalties for breaking a contract, but it isn’t done consistently and it hasn’t changed either side’s practices.
The solution lies in finding a way to enforce contracts between shippers through economic incentives and technology, according to 300cubits and New York Shipping Exchange (NYSHEX), two of the startups trying to find novel ways to enforce contracts bilaterally.
“Penalties have been used as a way to drive changes and behaviors. That hasn’t worked. It’s caused a lot of angst and distrust in the industry,” said Gordon Downes, CEO of NYSHEX.
A new market for forward contracts
Instead of pitting one company against another, NYSHEX aims to drive industry change by providing a new option: the forward contract.
Service contracts, which cover volume business generally over a period of three to 12 months, make up about 60% of the shipping market, said Downes, and they don’t offer guarantees. The remainder is the spot market, where carriers give rate quotes that also aren’t guaranteed; prices are determined when a shipper asks for a booking contract. Downes said that NYSHEX created a forward contract — something new — in between the spot market and service contract market. These forward contracts lock in rates and provide guarantees typically one week to six months in advance.
Penalties have been used as a way to drive changes and behaviors. That hasn’t worked.
CEO, New York Shipping Exchange
Downes says that his exchange is similar to how the airline industry works. In the past, if a passenger didn’t show for a flight, the airlines rebooked the passenger or refunded the ticket at no cost. Airline seats were underutilized, until the carriers started offering several types of tickets. Passengers could decide what they valued most, flexibility or price. Passengers who value price can buy a nonrefundable ticket, allowing them to commit to the airline: show up for the flight or lose the ticket. Customers wanting flexibility pay a premium for that ticket.
Using the shipping exchange, both sides have skin in the game, said Downes. In the current spot market, no money changes hands until the cargo is in the water, at the earliest. At any point before that, either party can cancel without an enforceable penalty. With both startup models, the parties offer collateral at the time of contract.
So far, the NYSHEX model is working well. Downes said that the exchange’s goal is to avoid penalties, and they’ve been infrequent. “We’re proud of the fact that we’ve had less than 1% of penalties paid,” he said. That’s because of the bilateral incentive to meet the contract. For example, if a carrier has space for 100 containers and there are 120 on the dock, the carriers are incentivized to load ones with potential penalties first.
How the new models work
Shippers and carriers contracting through NYSHEX put up collateral worth 35-40% of the contract (the percentage depends on trade and shipping direction) when agreeing to a forward contract. If either side breaks the contract, that side loses their deposit.
Hong Kong-based startup, 300cubits, is trying a similar approach but with some major differences. They introduced a cryptocurrency called TEU tokens — yes, the same as the industry acronym for the twenty-foot equivalent unit for shipping containers — as the deposit. On the Ethereum platform, carriers and shippers will negotiate contracts, determining the amount of cryptocurrency both sides will use for deposit. Like NYSHEX, if either side breaks the contract, they forfeit the TEU deposit.
With both startups, the carrier must guarantee that the cargo will arrive at its destination at the agreed time, and shippers guarantee that the contracted amount of cargo will dock-side by the appointed time. This allows the carrier to better plan vessel space and the shipper knows that their cargo will arrive at its destination on time.
|Negotiations on the platform?||No||Yes|
|Deposit?||Cash, insurance bond or bank credit||Cryptocurrency|
|Company status?||Active||Selling cryptocurrency; contracting to be available in 2018|
|Penalty?||35-40%, varies per trade and shipping direction||Negotiable|
|Who pays for the service?||Carriers||TEU tokens distributed free, but customers pay to use the service|
There is no cost to the shipper to use the NYSHEX exchange; the carrier pays the cost. NYSHEX accredits shippers before they get access, and carriers opt in to work with specific shippers. Shippers see listings from those carriers, including lanes, dates, number of containers available and prices. Whatever quotes the shippers choose are binding and enforceable on both sides, and that cargo space is removed from the exchange.
After entering a shipping contract on NYSHEX, the shipper has 24 hours to determine how to provide their guarantee. Both parties can provide collateral several ways:
- Money is placed in an interest-bearing account until the cargo is delivered
- They offer a performance bond
- They get bank credit
For 300cubits, verified shippers and carriers will receive cryptocurrency and use contracting and booking modules on the site. Customers create a unique contract and both must agree on the TEU token deposit amount. “The carrier has to match, or the booking confirmation has no meaning,” and the shipper can look for another carrier, said Johnson Leung, 300cubits founder.
One obvious difference between NYSHEX and 300cubits is that the latter uses cryptocurrency, given at no cost to qualified companies based on industry market share. The idea is that traditional deposits (cash, bond or bank credit) can be costly for carriers and shippers. They either tie up working capital, or the companies must pay for credit or a bond.
Downes counters that their cash deposits earn interest in escrow, and that bonds are inexpensive, especially for reputable shippers with strong balance sheets. Credit lines depend on a company’s balance sheet and credit terms. NYSHEX works with banks to provide customers with options.
Where are they now?
NYSHEX was formed in March, 2017, and is already working with multiple carriers and shippers. NYSHEX has a lot of capacity on the exchange, with 600,000 TEU currently, and a healthy volume, Downes said. Shippers using NYSHEX currently use the exchange for around 15% of their total volume.
They’re testing their ability to fill the contracts and want to make sure they can deliver the freight on time. “We’ve been clear with shippers,” said Downes. “Even if you see a super offer on the exchange, don’t lock in your volumes unless you’re absolutely confident you’ll deliver. We’re measured on your defaults.”
We’re proud of the fact that we’ve had less than 1% of penalties paid.
CEO, New York Shipping Exchange
While NYSHEX is operational, 300cubits is still building. They haven’t yet distributed tokens to the industry, but Leong said there’s interest. By late August, they sold about $60,000 US in token presales during their trial run (mid-August to mid-September). This presale is offering 2% of total available tokens to non-industry users, and another 18% will be offered in November to the same market. 300cubits will issue 100 million total tokens, with 40% sold to the public and 15% given to the industry at no cost. By November, 300cubits should have their smart contracting and booking system in place, so customers can write their contracts in the system.
One challenge for 300cubits is that using cryptocurrency is a novel idea. “For a lot of parties, the first reaction is curiosity,” he said. Still, he said many think the new model is a good idea. After all, it’s a lower cost solution for the penalty problem.