Contract vs. spot freight: Advantages, differences, and navigating opportunities
By Alex Riemersma, Ally Logistics Pricing Analyst
Navigating pricing options in logistics is crucial to reducing transportation costs for shippers, and equally important for carriers to keep drivers moving on the road. When we take a step back and evaluate the historical relationship between freight spot and contract rates, we can point out a few key differences between the two.
For those who may not be familiar, let’s start by defining spot freight and contract freight.
SPOT FREIGHT
Spot rates are a market-driven price quoted by a carrier or broker for immediate service. They are determined by the basic laws of supply and demand. An increase in the supply of trucks will lower prices if not accompanied by increased demand, and an increase in consumer demand will raise prices unless accompanied by an increased supply of trucks.
An equilibrium price is reached when the quantity of trucks demanded equals the quantity of trucks supplied within the market. When agreed upon between shipper and carrier, this spot quote represents the price of that carrier’s service in moving a shipment from point A to point B.
A spot quote covers a single shipment. Because there is no long-term arrangement between shipper and carrier, spot rates are dynamic, changing based on the laws of supply and demand.
CONTRACT FREIGHT
Contract rates are a type of long-term, stable pricing for truckload freight. Rates for service are agreed upon between shipper and carrier/broker throughout a bid process normally referred to as a Request for Proposal (RFP).
Throughout this process, shippers are evaluating their carrier networks on the merit of rates, service, and capacity among other things. At the end of the bid, a shipper will award specific lanes to the carriers and brokers who meet required price and service criteria. When a lane is awarded, price and volumes are locked in for a specified amount of time, usually a year.
Shippers tend to like contract rates because it allows for easier budget forecasting, stable capacity, and more accountability from their carrier networks. Carriers chase contract freight for dependable revenue streams and consistent driver scheduling.
If the dollars and cents make sense for a shipper-carrier/broker partnership, contract agreements are the optimal method of managing the bulk of a supply chain.
ADVANTAGES OF SPOT FREIGHT VS. CONTRACT FREIGHT
Both types of rates offer shippers different advantages.
Contracts provide security in the form of price and capacity. They also allow for the formation of relationships between shippers and their carrier networks.
Spot service is more dynamic, non-committal, and under ideal market conditions, can be cheaper in the short term.
Employing different rate structures at different times can save companies a lot of money in the long run, but knowing the right situations to lock in a contract rate versus sending a load out onto a spot board can be difficult.
From the shipper’s perspective, the ideal strategy for servicing an individual lane with substantial volume is to utilize both contract and spot rates. Locking in a contract rate that both a shipper and carrier are happy with is the first step in solidifying a supply chain. From there, adding alternate carriers and brokers for service on a spot basis can help assuage instances where the primary carrier cannot provide their agreed upon capacity. Organizing a network of spot carriers can lead to contract relationships on future RFPs and can also cover logistics needs on urgent or unexpected shipments or low volume lanes.
THE CONTRACT/SPOT RELATIONSHIP
Analyzing the relationship between spot and contract rates is another important aspect of cost management in logistics. The ideal plan for service outlaid above is not always the cheapest.
On a macro scale, contract rates usually favor shippers because carriers are likely to negotiate on price in exchange for guaranteed volume. However, because the truckload market is cyclical, the supply and demand relationship of capacity must be taken into consideration when searching for the cheapest option.
In a shipper’s market, capacity is easy to secure, and carriers must compete against each other on price to secure volume. Under these conditions, spot rates are generally lower than contract rates.
In a carrier’s market, capacity is tight, and shippers must pay a market premium to secure capacity as competition for drivers is intense. In this environment, spot market rates are generally higher than contract pricing.
Spot market activity in the previous quarter leading up to an RFP will heavily influence contract rate negotiations. If spot market rates are inflationary, it will push up contract rates in the next bid. If they are deflationary, rates will likely remain stable or begin to decrease.
The national spot rate is much more reactionary to the supply-demand relationship for capacity whereas contract rates change more slowly to reflect current market conditions.
NAVIGATING SPOT AND CONTRACT OPPORTUNITIES
Logistics decisions have an increasingly large impact on a company’s bottom line. Shippers must remain alert to changing market conditions while balancing service-oriented goals to navigate the nuances or spot versus contract pricing.
Carriers and brokers also must keep an eye on the truckload market for the purposes of aligning the right opportunities for the right prices. Being slightly ahead of market trends will pay dividends for carriers bidding on spot freight and negotiating rates on RFPs.
Navigating spot and contract opportunities is a deliberate process on both the shipper and carrier ends of the spectrum. Success in optimizing an efficient supply chain is largely dependent on toeing this line effectively.