How Capacity, Contracts, and Spot Rates Work.
The price of freight continues to be extremely volatile. And when you’re focusing on getting goods out the door while meeting your transportation budget, you don’t really have time to wax philosophically about how it all works. Well your favorite supply chain technology company (hint: that’s us) is here to help.
So how does this all work? Let’s start with contract rates.
Contract rates are rates that carriers and brokers/3pls apply to to a shipper’s freight on a specified lane, for a specified kind of load, over a set period of time. Contract rates are typically locked in for a year so having contract rates usually gives shippers a cost advantage as well as some guarantee around service levels being met. The idea is that you have guaranteed capacity at a discount on your ‘milk run’ lanes. Sounds great, right?
Ok. What about the spot market?
Spot rates are a little less complicated. They reflect the market cost of shipping any item at a given time. Spot rates can fluctuate based on the lane, service level requirement, and – most importantly – the capacity available. For this reason, spot rates change more frequently then contract rates. That said, using the spot market provides a few advantages. One, you can often find capacity on lanes that are new for your business. Two, you can leverage the spot market when you have to meet particular service requirements not covered by your contract rates. Unfortunately, spot rates can cost quite a bit more than your contract rates.
Spot rates and contract rates combined create the market with the lowest cost on average being dubbed the market rate.
But why do rates fluctuate so much? Capacity!
When there’s a big demand for capacity and there isn’t enough to go around, contract rates get rejected. (Yep, even contract rates are beholden to the law of supply and demand.) When contract rates are rejected, shipper’s turn to the spot market to find trucks. This drives up the cost of spot rates. It also increases lead times and compliance checks for contract rates, making it especially difficult to secure contract capacity.
If the last 18 months have taught us anything, it’s that we’re entering a new era in shipping. Truthfully, we entered this new era years ago. But now it has become essential. The most important thing for shippers isn’t negotiating the best contract rates for the next year. Market’s change too rapidly for that.
The most important for shippers is to have access to the right rate at the right time.
In today’s volatile markets, it doesn’t really matter if it’s a spot rate or a contract rate. What matters is the right rate. The rate that will get your shipment out the door at the best service level and lowest cost.
Recent news of loosening capacity and lower spot market volume may have some of you excited about a return to normal when it comes to planning transportation budgets. And while we’re not here to burst your bubble, we do have some bad news. Even if rates return to normal you will likely overpay. Why? Because unless you use a dynamic rating technology, you won’t have access to the best option at the best time. You may book a load with a contract rate that is 15% higher than the spot market at that time. A month later, spot rate may shoot up 45% and your contract rates will make the most sense.
The familiar cycles of peak seasons and slow seasons are out the window until at least 2022. But dynamic rating technology can keep you competitive in a rapidly fluctuating market.