Index Linked Contracts (ILCC) are increasing in popularity. What are the trends and why are suppliers and customers interested in such contracts?
Back in 2012 I wrote a blog on how Index Linked Contracts are a way of dealing with the rate volatility seen in many container sea freight trade lanes.
I am not aware of any comprehensive and up-to-date study on the use and development of Index Linked Container Contracts (ILCC’s); in any case, my impression is definitely that their popularity is increasing. However, the development is very different from market to market and trade lane to trade lane.
I see a higher acceptance in countries with high salaries and less in low-salary countries. For instance, in Denmark there is basically not a forwarder who is not ready to offer an ILCC whereas forwarders in Czech Republic are more hesitant. This is a naturally cause as the time saved on negotiations has a higher impact in high-salary countries. Similarly it is more used on Asia to Europe than on Transatlantic trades.
The historic benefits remain applicable. However, it does not mean that an ILCC should be made without focus and good planning. Without thought, there are several pitfalls you can fall into.
Before concluding that an ILCC is the right thing for you, as a cargo owner, you have to identify what the process will cost you i.e. how much time you spend on negotiating freight terms, how often you experience delays en route or if your bookings are denied? It does not need to be an exact study but having rough figures is a good idea.
If you decide to obtain quotations for index linked contracts, you need to ensure you compare with your existing set up in a proper manner. Do not just take your last spot price and compare with the ILCC offer in a specific week. It would basically be like comparing apples and pears and the result can vary greatly from one week to the next (in case the market index changes significantly over a few weeks).
It takes time but find out how your spot prices have varied from the market index over the course of 6-12 months. Then compare this average spread with the spread you are offered.
If you get multiple offers for ILCC, make sure that you compare similar products, i.e. that you are talking about the same index, about which week is the basis for the offer and how adjustments will be made in the future, regarding both what triggers an adjustment in the price, which index prices go into calculating your price for the coming period, if there are any floor/ceilings in the offer, what charges are included in being adjusted according to the index and which is offered on fixed basis, etc.
While this comparison might take longer than asking for new rates valid for the next month/quarter then the ILCC will give you an agreement where you do not need to spend time on negotiations for a longer time and thus overall reduce your time spend on negotiations.
As a last point, make sure that, as in all negotiations, you negotiate on equal terms. The suppliers are quickly gaining experience in negotiating ILCC’s so you need to ensure you also have a deep insight or that you partner with someone who has this experience. If not, you might miss out on important elements of the contract.