A Quick Guide of Contract Freight Vs. Spot Freight - Pros, Cons & How to Optimize

The world of logistics continues to evolve, and many organizations have clear preferences for contract over spot freight rates. However, the industry’s volatility gives rise to inevitable spot, or one-off, moves. Rather than getting bogged down and leaving your network at risk due to limited carriers for those one-off moves, it’s important to understand a simple reality. All freight is bought and paid for on spot, and while this may be confusing, a failure to understand spot freight will inevitably lead to losses in your contract moves too. Fortunately, this blog will seek to redefine your expectations and understanding of both contract and spot freight by covering a few core points, including:

  • The basics of spot versus contract rates. 
  • Spot rate factors affecting transportation spend. 
  • When spot rates are better than contract rates. 
  • The fundamentals of contract rates. 
  • The considerations to take and questions to ask when planning contracts. 
  • How to optimize your freight movements regardless of spot or contract status.

I.Defining Spot Versus Contract Rates

When it comes to freight transportation, both spot and contract rates provide shippers with a range of benefits. Contract provides security for rates and capacity availability for an entire year while spot helps fill in gaps and allows carriers to take advantage of short-term changes to rate and capacity demands. 

What Are Spot Freight Rates?

For shippers and carriers alike, spot freight rates can offer a versatile option when scalability and adaptability are of the utmost importance. According to FreightWaves, spot rate shipping is “Freight that moves under a single transactional agreement with no lasting implications beyond that movement.” It is a one-and-done approach that allows logistics managers to maximize rates and profits on a single shipment that falls outside the normal rates and capacity requirements or guidelines of contractual shipping agreements. 

What Are Contract Rates?

The other side of the shipping rate and agreement coin is what shippers and carriers refer to as contractual agreement rates. As also reported by FreightWaves, contract rate shipping is “Freight that moves under a predetermined rate over a set period of time between a shipper and a carrier.” These shipping agreements are made between shippers and carriers and are almost always set for the long-term duration of a year or at least six months and lock in rates and capacity markers to produce some stability in otherwise uncertain markets.

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II. Freight Spot Rate Basics

Freight and logistics work hand in hand and are impacted by various economic factors and can also impact market trends and consumer habits as well.  Spot freight market rates serve as an early guideline and indication of what a region’s economy is shaping up to be like. Spot rates are market driven by a fundamental concept that governs every economic trend- the law of supply and demand. As demand rises on the supply and transportation needs of the current market, the economic value of shipping services and transportation capacity increases.

Likewise, in times when the demand goes down, the opposite effect is seen and rate decreases as capacity becomes less valuable and not as highly sought after. The dynamics of any freight lane on any given day can cause the rates to swing dramatically. Depending on the market, transportation mode, commodity, carrier and shipper standing, and overall market stability, these shifts can occur hour-to-hour, day-to-day, week-to-week, and so on. This is why shippers and carriers alike need to closely monitor market trends in order to best prepare for spot rate opportunities as they arise.  

How Spot Rates Relate Back to Trucking Market Direction

Spot rates are most often defined by the price quoted for immediate settlement on a service- in this case transportation of goods.  The spot rate gets calculated based on the value of a product or commodity at the moment of settlement. If certain goods are selling for a higher price, then the rates may reflect that change. Likewise, if finding capacity becomes difficult it can cause rates to be at a premium for a short time due to backlogs or container tie-ups. Securing capacity at that moment for a particular shipment may command a premium price. Spot rate agreements make it easier to account for other aspects of the supply chain that can suddenly and at times dramatically shift and impact both availability and popularity. Shipping equipment, cargo containers, shipper fees, carrier networks, custom and duty penalties, and many other components of standard shipping services are prone to shifting at a moment’s notice and can drastically impact the transportation balance.

When Do Spot Rates Make More Sense to Use Over Contract Rates

No shipper operates their freight transportation services at committed rates all the time. The best shipping companies use a strategic blend of contract and spot. However, there are some distinct times when a one-off shipment at a custom rate may prove to be beneficial for all parties involved. Spot rates are short-term shipping agreements largely impacted by the overall demand in the truckload market. This is why they make sense over contracted rates when certain situations and conditions present themselves. 

Shippers use spot rates to maximize shipping density for three main reasons:

  • Their go-to carriers that they usually call on for transportation services cannot cover a shipment and it is too good of a deal to miss out on.
  • There is an urgent, extra-valuable, specialized, or unexpected shipment that needs a more tailored and customized rate than what is normally used.
  • There is inadequate freight density or consistency within that market or with that single client to justify contract pricing or a long-term arrangement.

The balance between contact freight vs sport freight can be a delicate one to manage as factors and influences can change quickly. Understanding the benefits of spot contract rates for shipping and freight management can make it easier for shippers and carriers alike to see when this option is the most profitable and logical.

III. Contract Freight Rate Basics

Contract freight comprises the dominant method of managing internal logistics and supply chain operations. It helps shippers secure the best price and service opportunities from carriers because it locks in freight transportation rates. It also carries with it the pretense of continued capacity and long-term shipping arrangement between truckload carriers and shippers.

The key phrase for logistics managers to remember is ‘continued capacity and long-term shipping arrangement.’ The point of contract freight arrangements is to take advantage of somewhat predictable and reliable capacity opportunities. Shippers and carriers both can stress a little less with a contract arrangement because it assures both parties there will be enough capacity and enough product to maintain a full shipment as often as agreed upon. 

If a company can guarantee the freight requirement and shipping load capacity agreed upon, then the idea of assured capacity at the contract rate becomes much easier. This will also strengthen the carrier and shipper relationship because this protects the interests and supports maximum profits for both parties, which is the primary benefit freight contract rates bring to the table.

Since a devoted opening is not the norm within the normal market thanks to supply chain, economic, and market instability, freight service providers need to take advantage of the opportunity for reliable capacity as much as possible.  Add not knowing exactly where freight will be coming from, and the ongoing concern about the ability to fill trucks and containers, it can make the spot market quite unpredictable and risky. Contract freight rates help lessen this concern and provide at the minimum a baseline that can be pretty much guaranteed and built upon with additional contracts or occasional spot freight loads.

The concept of a freight provider hedging its bets and not knowing if their freight network will stay in balance is a dominating reason for the appeal of contracts between shippers and carriers. Using spot freight opportunities to grab one time loads and take advantage of short-term capacity spikes reduces the risks involved. By relying primarily on the contractual freight loads and shipments, shippers and carriers alike know the minimum they are likely to earn and have to deal with less concern over rates getting to the point they are not practical or beneficial any longer.

With this general idea of hedging capacity loads and the concept of using contractual rates as a foundation to build from, it is generally recommended shippers increase their lead times where possible and partner with carriers of choice as often as possible. 

Doing one or both is extremely helpful because a company’s competition for freight capacity can get quite broad and anything that can provide a competitive advantage. This allows more custom services and options to be implemented and can provide that boost and upper hand that shippers and carriers alike are looking for.

IV. Steps to Improve and Optimize Both Contract and Spot Freight Rates

The critical point all transportation service providers, brokers, carriers, and shippers must remember is that both contract freight and spot freight are vital for the continued growth and success of the modern supply chain.  There are some key steps to take in order to improve and optimize these rates. And like most things in the shipping and transportation market today, it all starts with asking the right questions and reigning in expectations to align with company and market goals. Dealing with the freight capacity crunch is easier with the right balance of spot and contract rates.

Questions to Ask to Understand the Balance of Contract and Spot Rates

Contract and spot freight represent two sides to the same coin. Both are essential and impactful, but maintaining the balance is critical for ongoing success and growth, no matter how the market is trending. The following questions can help maintain that critical balance: 

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1. How are lanes affected by capacity? 

Capacity is the driving force behind supply chain optimization. The reason spot and contact arrangements exist is that some lanes are more profitable than others due to current available capacity. Checking to see where the best paying loads are can help managers secure the best loads. Long-term and regular capacity warrants contractual arrangements while the more one-and-done occasional capacity is better suited for spot arrangements. Capacity is king and it will always be among the most critical aspects of spot vs contract agreements that shippers and carriers alike need to contend with.

2. How is price inflation affecting total costs?

Another factor that can impact the balance between these two options is freight rates and inflation. As market stability changes so too can costs that impact shipping modes, lanes, and carriers. When expenses and rates increase, profit margins may shrink for certain arrangements. Contractual freight may need to be renegotiated and more spot freight options may need to be looked into for the short term. This balance is ongoing and will always need to be tweaked and adjusted depending on costs, which is why spot rates are so enticing and why even contract freight agreements get renegotiated at times.

3. What are fuel increases or changes doing to your shipping spend.

Monitoring expenses, including freight and shipping spend, remains a critical point that shippers and carriers need to stay focused on if they hope to continue to mitigate costs. As fuel costs go up and as more miles are driven to accommodate new customers, expenses naturally will also start to rise as well. The problem arises when these expenses increase more or at a faster rate than what was planned and budgeted for. Monitoring fuel usage and expenses can help point out routes, lanes, modes, and even customers that might be adding to overall expenses more than they are adding to overall profits.

4. Do you get a capacity guarantee with contract rates?

While this is the underlying reason for setting up contract freight agreements and rates, it is not always a given point and is worth double checking. When looking at carriers to partner with and when considering the terms of the contract, make sure it comes with a guarantee of some kind in regards to capacity and minimums. A contract should lock in an agreeable rate for an adequate capacity level at all times, within minimal changes or fluctuations. The point of contract freight arrangements is to provide stability and a solid foundation to work from and to branch out from with occasional spot freight loads as needed.

5. Do spot rates account for total landed costs, including accessorials?

Using spot freight opportunities makes it much easier to take advantage of short-term capacity opportunities without risking a long-term commitment to that freight, mode, source, or shipper. Shippers and carriers alike know they have the freedom to grab additional loads and branch out to other capacity options whenever they present themselves. This can greatly reduce concern over missing out on surprise spikes and one-time capacity openings that are too good to pass up. Spot rates are all about maximizing profits and shipping load opportunities and they are a great way to account for costs and accessorials.

6. What about GRIs, and do contacts protect against surcharges and GRIs?

Another reason for the popularity of contract freight over spot rate arrangements is the volatility of the shipping and transportation market in general. General rate increases occur all the time and can happen without warning. While an increase in handling surcharges of a few cents per mile will certainly add up, larger increases or small increases over multiple facets of the shipping chain can deal a devastating blow to budgets. Contract rates for freight should lock in rates for most price points and should significantly reduce the risk of multiple GRIs during the contractual time period.

7. Does your company have any policy on contract renegotiations?

While contract arrangements are long-term, they are not permanent. They are set up for a specific period of time- usually 6 months to a year- and then need to be renegotiated. Rates will change, services will change, and business goals and needs can also change in the course of a year. Renegotiation of contracts is good as it gives both shippers and carriers the opportunity to secure better rates and terms for the agreement. It is important to remember both parties depend on the other so presenting benefits and perks to the continued relationship can make renegotiations easier.

8. Are you following the practice of minibids in high-volatility markets?

Maximizing capacity and maintaining overall efficiency can be challenging during times of high market volatility. Employing the practice of sending out minibids and securing short one-time capacity opportunities can help carry shippers during times of capacity shortages. When markets are unstable it is difficult to get carriers to commit to long term agreements for rates and capacity. So smaller short-term bids and spot contracts can fill in the gaps and keep shippers and carriers afloat during highly volatile times and can hold them over until the market stabilizes once again.

9. Are all contract carriers being fully utilized to their max?

Having carriers and shippers of choice that can be trusted to handle loads and shipments is of course a primary goal for shippers across the board. Having a large network of carriers to pull from when and where needed can make maximizing capacity faster and easier. However, when it comes to contract freight agreements, it is vital that those carriers are being fully utilized and that they are performing at optimal efficiency. Paying carriers a flat rate and not getting enough capacity to make that investment worthwhile is the same as throwing money away.

10. Are you considering total costs, including accessorials and after-the-fact costs?

The final thing every shipper needs to consider when trying to balance spot freight and contact freight is the total costs involved with shipping via each carrier/mode. For long term large capacity contract agreements a lower cost or a particular fee range may be more logical and ultimately more profitable. For spot agreements a higher fee in one area and a lower fee in another may translate to a higher overall profit margin for that individual load, thus making it a worthwhile option.

How to Reduce Rising Freight Costs WIth a Better Contract/Spot Mix

Since rising freight costs continue to undermine efficiency in the supply chain, today’s shippers need to know a few things about how to optimize their existing contract and spot freight mix. That includes following these steps to improvement.

1. Pay Attention to Spot Rate Indexes

It is important to consider various spot rate indexes when looking at carrier selection and arrangements. Some indexes are provided earlier and offer insight into upcoming trends that need to be noted. Others can be set up in such a way as to position company RFP’s not as part of the budget cycle, but rather stemming from the current freight cycle.  This shift can offer new insight and make it easier for supply chain and logistics managers to better prepare for spot rate opportunities within the trucking network.

2. Moving Your RFP Cycle to Different Time Periods

To maximize both spot rate and contract rate opportunities, some adjustments to typical RFP submissions and practices may be needed. Consider moving RFPs to when the normal flat rate freight capacity hits the lowest levels every year. These are the times when bids are more likely to be noted and picked up. Shifting to a different cycle and timeline for bids can take some trial and error to hone in on the timing but it can be a great way to maximize efficiency of RFPs that are sent. 

3. Take Advantage of Data Analytics Services to Understand Your Cost Structure and Risk

In this digital day and age, proper data collection and analysis can significantly impact the way management views and interprets the overall cost structure of the supply chain. Proper data analysis can also help highlight key areas of risk and potential problem areas with financing, budgeting, and cost management. With strong data and statistical insight, cost management and fee reduction can be made easier and much more effective across the entire network.

4. Thoroughly Vet All Carriers

The carrier and shipper relationship is vital for both parties, whether the primary focus is on spot freight or contract freight. Ensuring you get the right carrier for your specific capacity needs is vital, which is why proper vetting must be done on all carriers during the transportation procurement process.

Core things to look for when vetting carriers include:

  • Proper licensure
  • Reputation
  • Financial stability and history
  • Insurance and certification for the type of freight moved
  • Offering multiple modes and service levels
  • Using technology to manage their trucks
  • Sustainable shipping processes

Of course, there are many other factors that may come into play, including how well you get along with the carrier. Regardless, using technology and streamlining operations is the end-goal, so all your carriers should keep their existing operations in top-notch shape. In turn, you should be able to see these records and know your carriers are on the up-and-up when considering a new partnership.

5. Diversify Your Carrier Base

Along with making sure the right carriers are selected, it is important that shippers pair the right carriers with the right capacity loads. Some carriers specialize in certain types of cargo or certain transportation modes. Depending on what spot and contact loads are available one carrier may be better suited than another for loads on hand. Having a diverse carrier base makes everything easier and it is vital that shippers be able to match carriers to loads quickly and easily to maintain the highest level of efficiency possible.

6. Take Advantage of Digital Freight Marketplaces to Secure Capacity in Volatile Markets

During times of instability and volatility, securing capacity can be difficult to say the least. Working alongside a freight aggregation platform can help shippers to find the best carriers offering competitive rates for spot capacity. It can also help improve carrier and shipper relationships in the long term with contract rate negotiations too. A capacity aggregator, working from a solid digital freight marketplace platform can help both parties secur capacity when unexpect shortages occur either due to delayed responses to bids and offers or due to sudden shifts to market trends and consumer demands. 

7. Use Analytics to Improve Performance and Get the Most From Your Carriers

Part of the challenge in managing transportation procurement in the realm of contract freight versus spot comes down to how well a carrier does with the actual transportation of the load. In other words, did the carrier deliver on time? Was any damage present? What other things went wrong or right?

These questions all allude to the need to improve performance and hold carriers accountable. By extension, they mean your company needs data analytics, and by another extension, such analytics can power improved routing management, blending both contract and spot loads across whole lanes to get the best deal. In some ways, this takes on a multimodal symbolism, carrying bits of the leg as a contract and others as spot to create a full haul move. 

Summary: Knowing the Nuances of Spot and Contract Freight Will Help Your Team Succeed

When dealing with the nuances of balancing freight transportation expenses and profits, both spot and contract rates offer a wide range of benefits for shippers and carriers alike. Contract freight arrangements offer much-needed security and stability in times of market volatility. Spot freight arrangements can help fill in capacity gaps and shortages to quickly respond to short-term changes to rate and capacity demands. Balancing the many modes for capacity procurement, including digital freight matching, traditional RFPs, and collaborative load dashboards can help shipping teams succeed in any market.

The critical point to remember is that both contract and spot agreements are vital for the continued growth and success of the modern supply chain. Carriers rely on shippers for load orders and shippers rely on carriers to provide that needed capacity to move goods as needed. It is an on-going balancing act that runs as a common thread throughout the entirety of the modern supply chain network. Spot freight and contract freight allows carriers and shippers to cooperatively keep the supply chain moving.

Partner With newtrul to Unlock More Value in Your Transportation Network and Find Ample Capacity Regardless of Whether Spot or Contract Is Best. 

Figuring out the best way to keep profitability in check is difficult for shippers and carriers alike. Regardless, it often comes down to how well each party can view the freight market and understand its use of spot versus contract movements and needs. That’s really what the whole industry is about in the age of disruption, knowing when to switch from one or the other and why a balance between spot and contract freight amounts to the size of your network, its diversity and the ease of finding coverage for your freight. 

Stop wasting time and get on the path toward success by leveraging a digital freight marketplace like newtrul today. Request a newtrul demo to learn more about how your company can embark on the next wave of digitization in logistics now.

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