Many companies think long-term vendor contracts are the best approach for their organizations, and a number of arguments exist that support this position. However, and especially as it relates to small parcel shipping, a long-term contract isn’t always the best option.
Recently, a company expressed interest in small parcel benchmarking and rate negotiation services. They are a $40MM/year shipper and they provided all the information needed to perform an initial analysis. In reviewing their carrier agreement and their rates, it became clear that they had best-in-class rates for one of their services. And when I say best-in-class, I mean really fantastic. The problems were (among other things) that the other services had mediocre rates, their accessorial rates were sub-par, and their rebate was lukewarm at best.
The initial thought was, “OK, so there is great room for improvement in nearly all areas of the contract, annual savings opportunities are in the millions, and I look forward to sharing this information with the client to discuss the best road forward.”
Then we realized something — and initially thought our eyes must be deceiving us: The aforementioned organization had just renegotiated the contract for a period of five years with an early termination clause spanning the entire length of the contract ranging from $1,300,000 to over $2,000,000, depending on the year in which the agreement was ended prior to the expiration of the five-year period. Frankly, I was shocked. The sheer magnitude of the early termination clause was outrageously high relative to typical penalties.
Notwithstanding the great rates on one service, the rest of the contract was merely “meh” and the company, by signing this long-term agreement, did a very good job at weakening their bargaining position with the carrier in the event they would like to make changes to the other portions of their contract. In my opinion, the carrier won, and won big.
Why Do Companies Choose Long-Term Contracts?
On the buy side, a long-term contract may be desirable for a number of reasons including, but not limited to: forecasting, ongoing partnership with a vendor that really knows your operation, or, presumably in this case, locking in great rates on a service that is very important to an organization’s operating model. But on the other hand, and especially as it relates to small parcel shipping, long-term contracts can quickly equate to substantially over-paying for small parcel shipping over the duration of the contract as well as being (to a degree) handcuffed in a world changing faster than burning paper.
The transportation industry is changing rapidly, and the threat of an additional option as a viable small parcel carrier is becoming more of a reality. Other viable carrier options will likely place downward price pressures on some organizations that could make exploring their services and pricing a prudent inquiry. And in the case of the above organization, they have added additional layers of material complexity by agreeing to a five-year carrier agreement with an onerous early termination clause. If they were to consider jumping for better rates, they would have to factor in the impact of the early termination clause, and even if they failed to do so, I’m certain the carrier would remind them.
Additionally, while the above organization and many others have rate caps in place that are below the standard annual general rate increases, their protection does not extend to accessorial charges. As we mentioned earlier, the above shipper had poor accessorial charges that made up millions of dollars in their annual small parcel spend. I can assure you that the accessorials will continue to rise over the next five years. I can also confidently say that new accessorials will be introduced and current accessorials changed as it relates to how they are calculated.
A good example is what we saw from 2019 into 2020 with the large package fee. This accessorial was redefined at great monetary expense to shippers, and the standard language in the carrier agreements allows the carriers to do so unfettered. In short, over a five-year period, accessorial charges can go from bad to worse on an annual basis. To quantify, from 2019 to 2020, the average accessorial increase for the most common accessorials for both UPS and FedEx were in excess of ~6.6% and ~14%, respectively.
In our view, there is nothing wrong with locking in a competitive carrier agreement for a reasonable time period, but companies should do so with their eyes wide open. For starters, before signing a new agreement, they should do all they can to ensure that the rates that they consider accepting are, in fact, best-in-class rates. The best (and perhaps only) way to do this is to get the input of a qualified and objective third party.
Identifying good small parcel pricing is vastly different than determining the appropriate price to pay for an appliance, an automobile, or any other widely consumed product because the carriers work hard to make sure the small parcel pricing information is not easily available. This lack of information leads to a severe imbalance of power at the negotiation table, and a third party with access to this information can help level the playing field.
The next step is to give serious consideration to going through a bid process where you can compare multiple competitive offers. Not only does this help increase an organization’s bargaining position, it will help to ensure that either one or more carriers comes forward with a very strong offer relative to their competitors. The strength of the offers received can (and should) also be determined by an objective third party with the expertise to quantify the financial impact of the offers.
In summary, while long-term vendor contracts are at times considered the best approach for organizations, they often work against organizations in the world of small parcel shipping. If you are curious about the quality of your organization’s rates or are considering trying to attain better rates, we recommend getting the assistance of a qualified and objective small parcel expert . . . not the carrier presenting the pricing.
Michael J. Kelley is Commercial VP & Executive Director, ParcelLogix.