Contract vs Spot Rates
There are few battles in the world of freight more heavily debated than
contract vs spot pricing. In a complex marketplace, like transportation,
shippers are often left with more questions than answers. Does the benefit of
fixed costs and consistent partners outweigh the freedom and potential savings
a shipper could see by shopping the spot market? When assessing the risk vs
reward of contract vs spot rates, what factors need to be considered? And, more
urgently, which side comes out on top in a tough market like what we've seen so
far this year?
Fixed vs Flux
What is a spot rate? A spot rate is a one-time single-use rate quote that is valid for a short period of time and is issued to a shipper at or near the time of their shipment.
What is a contract rate? A contract rate is a fixed price that is valid for a predetermined period of time and is negotiated with a shipper in advance of any freight moves.
Trucking rates rise and fall at any given time in a market driven by a variety of variables but none more important than the load-to-truck ratio. The main factor in determining the cost of moving freight is capacity. Typically, when there's more loads than trucks rates go up and when there's more trucks than loads rates go down. Unlike the stock market, the freight market isn't nearly as tethered to the economy. Regardless of nearly any other factor, when the load-to-truck ratio is upside down, rates increase.
Shippers that strictly adhere to spot quotes are betting against a strong
freight market and believe that all factors indicate rates will decline for the
foreseeable future.
Shippers that lock into contract rates are hedging their bets against
escalating rates and limited capacity.
It should be noted that spot and contract rates aren't mutually exclusive from each other and most shippers under contract will still use spot rates on less traveled lanes, out of contract moves, and when the market presents savings opportunities. That is because a shipper under contract isn't obligated to move every single shipment under their contracted rate. It's entirely possible to benefit from a soft spot market while maintaining a good relationship with their contracted carrier as long as minimum freight volumes are being delivered. Conversely, it isn't unheard of for less reputable carriers to refuse contracted freight in periods of high capacity strain. Neither contract or spot rates are without their risks and rewards.
Risk vs Reward
As mentioned in our previous blog, shippers who have been playing the spot market have been paying more for freight than at anytime in 2017. In January, spot rates increased 4 weeks in a row and were up an astounding 22.9% from the previous year . Beyond ballooning costs, spot shippers are getting crushed by the capacity crunch as trailers, flat beds, and vans become increasingly more scarce. Nearly all of the fear factors that concern contract shippers are converging in a perfect storm while spot shippers are left out in the rain without an umbrella.
We've mentioned rates throughout this blog so far and cost is king but it doesn't tell the whole tale. You can't look at risk vs reward without looking at the overlooked. Spot market based relationships are inherently risky and rife with hidden costs. Service agreements are often not well managed and service levels can be wildly inconsistent. Carriers unfamiliar with a shipper's routing and customer needs may lead to chargebacks, late fees, and other activity that could be damaging to the carrier-customer relationship.
Spot shipping can siphon savings and guzzle time if you're not careful. The more freight you have the more work it takes to spot shop. Since each move is a transaction, every shipment must be sent out to any number of truckers for bid. The harder a shipper negotiates those bids the more money they may save but the more time it soaks up. This process is then repeated for every single shipment. Ultimately, these operational costs should be looked at as a part of the final number paid per transaction.
Strong carrier relationships mitigate risk. The rewards for working with a
contracted carrier are predictable costs, higher service levels, the
opportunity to negotiate fuel and accessorials, and access to capacity when
capacity is in short supply. Capable partners contractually obligated to help
you can keep you dry regardless of how many clouds there are in the sky.
Not sure when to go with a contract and when to stay in the spot market? Contact a trusted adviser at Aborn & Co. and celebrate our 30 th Anniversary with a complimentary freight audit and consultation.
Articles from Episode 18:
- 5 Reasons Why You Should Benchmark Your Carriers
- 3PL vs 4PL (available 10/04)
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