Transportation Contract Versus Spot Pricing: Which Wins?
Contracts Drive Greater Savings and are Safer, Says Industry Expert
A recent RFP assignment once again brought to focus the topic of spot rates versus contract rates and what it means to align with freight providers on a contractual basis for better pricing, service and less risk.
This is important for shippers to know, as we often find many believe that playing the spot rate market drives greater savings, which is just not the case over a calendar year. Playing the spot market has similar characteristics to gambling, with tremendous downside risk; the house (meaning the market) has the upper hand; everyone talks about the wins, yet very little is said on losses.
Risk vs reward in the spot freight market
So, if your business is a spot market believer, please hear us out. This is based on facts that came out of an annual bid just performed for a shipper that we recently on-boarded within our Managed TM Service group. For this particular shipper, double digit savings were attained within its line haul rates with total annualized dollar impact to the bottom line being over $1.0 million, plus from all accounts hours of phone calls, emails and service failures.
Why do spot rates not consistently produce the savings? To start, spot rates are based on how much buyers are willing to pay and how much sellers are willing to accept at that exact moment. Now there are times the buyer wins, but within these one-time spot bid relationships there is tremendous risks on both sides and the strongest carriers will inflate their standard margins on spot business to protect from the unknowns and potential downside of hitting docks the business typically do not touch.
So, even if there is a win, the added margin could be taken out of the equation in a contractual basis. We are not saying there are not wins in the spot market, but it takes a great deal of analysis and understanding of market conditions to identify trends for particular lanes that produce the wins and is why we publish the InTek Spot rate index blog every week and have a web page dedicated to weekly intermodal spot rates.
Think of spot rates in terms of weekly grocery purchases. A consumer can either pay full price at the time they are out of an item or they can save 25 percent to 40 percent on their entire grocery bill if the majority of purchases are made when on sale, while sprinkling in some of those immediate (spot) needs.
What sacrifices do buyers make when playing the spot market?
Over a twelve month period they pay a higher price than contracted rates in the same lane. They experience capacity constraints driven by lack of a long term service agreement. Many of the strongest freight companies shy away from the spot market because of the risks of hitting unknown docks. Hidden operational execution costs of time and money are incurred when having to spot a lane over three to five carriers for every shipment. They enter inherently risky relationships, as service agreements are typically not well managed on insurance, safety and financial fronts. Finance cannot plan based on the variability within the budgets. Unknown market conditions can bring the organization significant cost over-runs. Inconsistent service levels are often experienced. Spot relationships lack accountability, as the carriers used within lane are fluid. There is a lack of an ability to manage requirements and measure performance against KPI’s to drive improvement.
Fixed contract rates open up negotiations on fuel and accessorials that are otherwise fixed in the spot market.
Don’t get me wrong, there is a place for spot rates for price reasons. Also, shippers are not the only group using spot versus contract. Many brokers live on the spot market all day, every day, which is why many shippers find inconsistent service from some of the freight brokers they utilize to fulfill their capacity needs.
Win-Win Freight And Logistics Relationships
To sum it up, the hidden costs in time, money and risky relationships inherent to the spot rate process offset many opportunities for savings, so instead of gambling on the spot market, shippers should consider making an investment in managed TM solutions and contracted carriers, as the shipper InTek recently contracted with discovered.
Rick LaGore is CEO of InTek Freight and Logistics.
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