There is so much that goes into today’s freight rates. In addition to all the variables, there are contract and spot rates. This addresses spot rates.
The classic definition of a freight rate is a “price charged by a transportation carrier for moving an item or items from point A to point B. Actual amount charged varies based on weight, commodity, and distance traveled.”
Based on the above definition, one could easily surmise that freight rates would be consistent on a regular and year round basis, but that would be very wrong.
Most, if not all of us, have heard of Adam Smith, often touted as the world’s first free-market capitalist. He is largely credited with defining and creating the laissez-faire philosophy of an “invisible hand” economy, namely, the law of supply and demand. The law of supply and demand is an economic theory that prices are determined by the interaction of supply and demand: an increase in supply will lower prices if not accompanied by increased demand, and an increase in demand will raise prices unless accompanied by increased supply. In a competitive market, the unit price for particular goods or services, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in economic equilibrium for price and quantity transacted.
So how does this relate to rates and pricing in the transportation business?
For the last several years, I have been working on the trucking side of the intermodal industry—the drayage side. The drayage business is every bit as competitive as the 3PL side of the business with one notable difference: consistency of rates. For the most part, drayage rates have been fairly predictable and stable. It’s an extremely competitive market and as such, the law of supply and demand is strictly adhered to and one will very seldom see there are wild swings in the rates, either up or down.
This is due to the amount of drayage service providers in the marketplace and the competition for existing business. As a consequence, customers know what the rates are today and pretty much what the rates will be 90 days or so down the road. It offers and affords some sense of economic stability and the opportunity to realistically budget for their drayage spend, not to mention that the drayage carriers are also better positioned to plan and budget for their fiscal year. In this instance rates have settled at the point where the quantity demanded equals the supply which has resulted in economic equilibrium – true Nirvana!
Moving on to spot rates. Spot rates are defined as the price quoted for immediate settlement on a commodity, or in our case a service. The spot rate is based on the value of an asset—in this case, equipment—at the moment of the quote. This value is thus based on how much buyers—purchasers of transportation services—are willing to pay and how much the sellers—owners of the equipment—are willing to accept, which depends on factors such as current market value and expected market value.
As a result, spot rates change frequently and sometimes dramatically. The changing prices become a source of frustration in the full truckload and intermodal industry, as shippers feel very little control in their process as their budgetary prices and available capacity is thrown out the door.
As the intermodal marketing company in the middle of the transaction, I have had difficulty myself in getting my head around the fact that a rate I quoted from Point A to Point B today, may very well be a much different rate (sometimes dramatically) tomorrow. Fewer pieces of equipment with excess demand equals a higher rate and conversely excess equipment with lower demand equals a lower rate, and, as I have discovered, the fluctuation in equipment can happen within days or even hours of an initial rate quotation. A vexing situation indeed and seemingly out of our control.
So, with all the above in mind, is there a way to add some consistency and control regarding pricing and rates in the transportation and intermodal industry? Can we actually break the law of supply and demand in order to make our professional lives more uniform and steady? I submit to you that the answer to the first question is, “Yes, we can,” and that the answer to the second question is, “No, we can’t.”
Here is how we do it. We can’t necessarily break the law, but what we can do is to use it to our advantage. The supplier of equipment is subject to the same dynamics that we’re subject to, namely supply and demand. If we can offer the supplier a consistent demand and offer a fair market rate that can be agreed upon for a specific length of time, then we have come a long way towards regular and stable rates which makes it easier to budget for. It can become a near perfect situation—the supplier is happy as he knows what revenue his equipment is generating for a specified time frame, and the shipper is happy because they now have a known and consistent rate. Slowly but surely I am getting my head around the spot rate situation and I am certainly learning how to live with it. I sincerely hope that we all are, as it is a fact we all must deal with.
Vince Castagno is client solutions manager at Integrated Distribution Services.