Freight markets always are on the move. Freight capacity and, therefore, truckload rates are constantly shifting. Some market shifts are more extreme than others. This level of volatility can potentially leave shippers in a difficult position if they haven’t built a strategy that encompasses both spot and contract truckload rates.
Understanding contract versus spot rates can help companies make better decisions about how to move freight, saving both time and money, while keeping operations flowing smoothly. But what is the difference between the two, and should businesses be more focused one versus the other?
The Difference Between Spot and Contractual Rates
Freight rates are broken down into two different categories: contract and spot rates. Today, contract rates make up 70 to 80 percent of the freight market; that can change over time. They are long-term agreements, typically six to twelve months, agreed to in advance of freight execution via a procurement exercise between shippers and transportation providers.
Contract rates can offer peace of mind for both parties. Although these rates are non-binding agreements, they mitigate risk and exposure during normal seasonality and especially during market fluctuations. For capacity providers, this means consistent load volumes and predictable revenue. For shippers, more accurate budgeting, higher service levels, and accountability.
Spot rates [today] make up the remaining 20 to 30 percent of the overall market. They are short-term, transactional rates. They’re volatile and constantly changing since they’re based on the fluctuating truck-to-shipment ratio, which reflects supply and demand in the freight market. Spot rates are typically used when the primary providers fail on contractual obligations and cannot cover a shipment, or when the density of the lane does not justify contract pricing.
Shippers should take a balanced approach between spot and contract to mitigate exposure during different freight cycles.
When demand is high and capacity is constrained, spot rates will increase. Conversely, the opposite is true when volumes decrease and capacity increases. Shippers should take a balanced approach between spot and contract to mitigate exposure during different freight cycles.
Ideal Scenarios for Using Spot and Contractual Rates
In many instances, contractual rates are the best option. They offer security in both rates and capacity to shippers and providers alike. When contracts are well-executed, they can help shippers keep their transportation budget in check. Freight shipped regularly at steady volumes aligns well for contract rates because of its predictable nature.
There are situations where shippers should consider spot rates instead of contract.
There are situations where shippers should consider spot rates instead of contract. For inconsistent freight volumes, seasonal, or one-off shipments, shippers might not benefit from a contracted rate. When the market is particularly volatile, and rates are sky-high, shippers may consider shorter, quarterly bid cycles or even mini bids in some cases. Not being locked into a long contract in a volatile market offers flexibility as network and market dynamics change.
Value of Contractual Truckload Freight
Setting more freight contracts isn’t necessarily a full-proof solution, but neither is relying entirely on the spot market to ship freight. Different freight cycles call for different approaches. Contractual rates can be valuable and beneficial because they:
- Assure shippers can get their freight off the dock on budget
- Help insulate shippers and mitigate exposure when capacity is constrained
- Help shippers enforce KPIs and maintain a high level of service
- Help providers build a more predictable and sustainable network
- Protect providers from under-utilized equipment
- Help providers increase driver satisfaction and retention rates
The secret to mitigating risk and exposure comes through balancing contract actual and spot rates. However, the path to that balance isn’t always obvious and depends on freight networks and business needs. Setting fair and long-lasting contracts for both sides remain a challenge. Shippers and providers should remain flexible and use a relationship-based approach that doesn’t leave one side in a difficult position during any given freight cycle.