A freight rate is a price at which freight is transported from Point A to Point B. This price depends on a variety of things, such as the type of commodity or freight, weight of the freight, travel miles (distance) from origin to destination, and, of course, the selected mode of transportation whether it be truck, ship, train (rail), or aircraft. There are typically two ways to deliver these rates – either as a long-term contractual rate or a short-term spot rate. Let’s talk more about these two categories.
Contract rates make up 80% of the trucking market and make sense for both carriers and shippers when freight is consistent and travels on regular lanes. Contract rates are nonbinding and negotiated in a bidding process based on an estimated shipping volume at an agreed upon per-mile rate. Contract rates are customized between a shipper and a carrier (or a broker) for a specific origin and destination. Contract rates are often referred to as “paper” rates and can be renegotiated, broken, or adjusted by either party. The level and direction of contract rates depends on the movement of spot rates, which are a leading indicator. Contract rates are usually good for a three- to six- month period, although the length of the agreement generally decreases as spot market volatility increases and spot rates move farther away from the contractual rate in place.
Characteristics of contract market rates:
Consistent lanes and freight
Protects from market volatility increases
More reliable capacity
A good example of freight that moves in the contract market would be from a beverage-manufacturing facility. For example, consider a craft brewery in Athens, Georgia, that has high demand from customers in Atlanta and all of the other major cities in Georgia. One example of a contract rate would be the price per mile that the brewery negotiates with its contractual carriers to move beer every week on the Athens to Atlanta lane. Given these are replenishment products that regularly move outbound to a dependable or mostly static customer list, having a contractual relationship with a contract carrier makes sense. A contract relationship makes sense for both the shipper and the carrier because the shipper secures adequate capacity to restock the shelves with its products at a known price while the carrier gets a reliable business partner that pays them fairly, keeps their trucks moving, and helps them leverage their fixed costs to generate cash flow.
If the beverage company wanted to move 100% of its products on the spot market to its grocery store and convenience store customers, in a market defined by tight capacity, it might not be able to secure adequate capacity to stock the shelves. Furthermore, the company might have to pay exorbitant prices to do so. Conversely, if the carrier only hauled spot market freight, in a down market for trucking it would likely go bankrupt quickly because spot rates tend to plunge alongside spot market load volumes.
Spot Market Rates
Spot rates make up the remaining 20% of the trucking market and are on-demand, transactional rates for a shipper to move freight right now or with a very short lead time from a specific origin and destination. They are one-time in nature and are the rates quoted to the shipper from the carrier or the broker. Usually the freight being moved in the spot market is from shippers with inconsistent shipping patterns or on inconsistent lanes. For example, A custom furniture manufacturer in North Carolina may move its loads on the spot market. This business’s ordering patterns might fluctuate depending on the volume of orders generated from its high-end, interior designer’s customer base. In other words, often the volumes are low, timing is inconsistent, and the destinations vary. When the furniture is finally finished and ready to be installed in an interior design project, the shipper will often want the furniture moved as soon as possible and so it makes sense to move that load in the spot market.
The spot market is highly volatile and much more volatile than the contract market. It is not unusual for spot rates to move 50% or more from high to low in any given year. Spot rates are determined by pure supply and demand in the trucking market.
Spot market rate characteristics include:
One-time transactional demand
Usually inconsistent shipping patterns
Highly volatile market
Rates are determined by supply and demand
When load volumes are high and truck capacity is tight, spot rates tend to rise and future contract rates tend to experience upward pressure. When load volumes are low and truck capacity is loose, spot rates tend to fall and future contract rates are likely to be pressured.
There are some other factors that influence both contract and spot rates, including the type of commodity being transported, freight value, the delivery time frame with faster being more expensive, the weight of the freight with heavier being more expensive, standard or oversize dimensions, accessorials, the specialization required by the carrier, and whether the freight is being delivered into a head haul or backhaul market. Many of the items are considerations when negotiating contracts and spot rates.
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Soshaul Logistics LLC and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. It is meant to serve as a guide and information only and Soshaul Logistics, LLC - Copyright 2023 - does not assume responsibility for any omissions, errors, or ambiguity contained herein. You should consult your own tax, legal and accounting advisors before engaging in any transaction or operation.