Determining When to Use Contract vs. Spot Freight Solutions
How to maximize spend, optimize shipping and mitigate risk
Spot and contract freight play essential roles in the movement of goods, and both options offer different value propositions for shippers. Recently, freight market volatility has challenged both shippers and carriers with fluctuating demand, natural disasters, economic shifts and more, making it difficult to forecast costs accurately.
Additionally, wide swings in trucking capacity have further complicated freight management, requiring shippers to monitor and strategically utilize both spot and contract options. Understanding when to utilize which solution can help shippers maximize freight spending, meet service levels, optimize shipping strategies and mitigate risks during uncertain market conditions.
Understanding Contract and Spot Rates
With contract rates, shippers commit freight to a carrier or logistics provider, and the carrier or logistics provider commits capacity for an agreed-upon rate. Contracts provide the security of price and capacity and make up the majority of freight moves. Contracts tend to last six months or longer.
A spot rate is the one-time, on-demand, transactional price a carrier or provider charges to move freight from point A to point B. Spot rates are based on the current market conditions and can change day to day or even hour by hour. The spot market can be highly volatile. Severe weather or unexpected disruptions can drive prices higher quickly.
Like most things, supply and demand factor into the prices of both contract and spot rates. When trucking capacity is tight, spot rates tend to increase and contract rates experience upward pressure. When capacity loosens, spot rates typically fall and future contract rates decrease. Spot rates, which are instantaneous, are a leading indicator for contract rates, with contract rates tending to lag behind spot rates by about four to six months.
There are times when the spot market provides more competitive pricing than contract rates. Some shippers “channel shift” and move to the spot market to take advantage of lower rates. However, disruptions experienced over the last few years have shown how critical long-term relationships are to the successful movement of goods during challenging times.
Determining the Best Option
Market uncertainty is expected to continue for the foreseeable future, and shippers will want as many channels as possible to move goods.
Contract freight offers guaranteed capacity at a predetermined, agreed-upon price, making it easier to forecast freight expenses. Contracts also provide opportunities to negotiate rates and fuel and accessorial charges, which are typically fixed in the spot market. Entering contracts also allows shippers and their logistics partners to develop strong, reliable relationships that can help ensure access to capacity during peak periods, improve service and uncover additional opportunities for savings. Overall, strong relationships can be critical to long-term success.
The spot market offers shippers flexibility and can provide valuable space when there is a planned or unplanned surge in demand, new shipping lanes develop faster than anticipated, or incumbent carriers reject loads. The spot market may also work best on some lanes, especially if they are inconsistent.
Volatile market conditions often drive freight into the spot market, and brokers can connect shippers with thousands of smaller carriers working primarily in the spot market. Because of the flexibility brokers offer, shippers don’t have to commit to more capacity than they need until they need it. Plus, utilizing all available carriers is critical to the functioning of the entire supply chain ecosystem.
Factors to consider include:
- The overall network
- The amount of freight to move
- The consistency of freight
- The level of service/specialization needed
- Seasonal surge demand
- Anticipated growth
- Contingency plan needs
Developing a Strategy
Penske Logistics can work with shippers to evaluate their overall network and identify opportunities to increase efficiency, such as consolidating multiple less-than-truckload shipments into one cross dock. From there, the Penske team can review capacity needs, individual lanes, planned surges, anticipated growth, and current market conditions to help shippers determine the right mix of contract and spot freight for their operations.