Contracted Market vs. Spot Market - Striking a Balance
This insightful glimpse into the world of contract versus spot freight markets is contributed by Ruslan Shamanov, the Founder & CEO of Kavkaz Express, LLC.
The global supply chain is the engine that drives the world economy. As we painfully learned during the pandemic years, any sustained disruption to the supply chain can wreak havoc on both domestic and global commerce.
Three main components make up the supply chain - Purchasing(sourcing), Planning (Scheduling) and Logistics (delivery).
All are critically important, but the largest part is logistics and delivery estimated at $1274B in 2023 and expected to grow to $1619 Billion by 2029. That works out to a 4% Compounded growth rate.*
And, not surprisingly, the freight business in the United States is huge. Whether it’s moving raw materials to the factory or delivering an online order to a consumer in Iowa, the transportation industry touches everything. Domestic freight can be transported by air, train, and trucks.
However, Trucks are the workhorses by far, transporting over 12.5 billion tons of freight valued at more than $13.1 trillion in 2022. This represents approximately 65% and 73% of the total freight weight and value, respectively.**
If we dive a little deeper into the trucking industry in the continental 48 states, there are two primary ways a shipper can engage with a truck carrier. One is through establishing contracted lanes and the other is to buy truck capacity on what’s called the spot market. There are pros and cons of each and I’ll explain both in greater detail.
Contracted lanes represent 80% of the trucking market.
A Contract lane is when shippers such as Walmart or Costco sell a particular route to a trucking carrier. On any given week in America, approximately 230 million people shop at a Walmart. Therefore, the amount of inventory needed to keep their stores stocked is enormous. And how do they move the inventory from their warehouses and manufacturers to their stores? By these contracted lanes – the roads going back and forth from the warehouse to the stores. Over and over. Trip after trip.
And to ensure there is no disruption to this flow, Walmart will engage with several large carriers each designated to a particular lane. The science here is as sophisticated and precise as the original sourcing of products from China or a strawberry farmer in California.
Walmart won’t leave anything to chance, so they negotiate a “lane” and price with a particular trucking carrier to ensure day after day, week after week, the goods are delivered on time at a locked-in price.
And the same holds true for other major retail players. These companies want to lock up lanes, prices, and capacity from the best trucking carriers in the country. After all, their business depends on it.
The length of these contracted lanes vary – anywhere from a week, month, to over 12 months depending on certain factors. The fact remains, trucking capacity is a commodity. And commodity pricing moves up and down based on supply and demand.
But for the really big shippers, it makes sense to commit to these contracted lanes even if the pricing moves down. By committing to these lanes, they know they’ll have capacity, they can budget and plan freight costs more accurately, and tie up the best carriers – basically it provides peace of mind, even if it costs them a few extra dollars vs. current market pricing.
From a carrier’s perspective, there are many benefits as well. Planned revenue, tighter asset utilization, driver loyalty, more predictable expense management and scheduled maintenance, and even allows them greater leverage to negotiate fuel prices as they can promise volume to the fuel companies.
Once carriers begin to operate more efficiently, it allows them to move into a growth strategy. The margins in the trucking business are razor thin so volume is king. Trucks = revenue. The more a carrier can run a consistent, operationally efficient operation, the more trucks they can add, becoming more appealing to the big shippers like Walmart.
Contracted lanes are ideal for big shippers dealing with big carriers.
The remaining 20% of the trucking market is called the Spot Market.
The spot market is a completely different animal from the Contracted lane market.
Now, many of the players are the same, but the reasons the spot market is used is completely different. Let’s go back to Walmart to illustrate the point.
Given the massive volume and trucking needs Walmart has, you might think all their transportation would be locked up in contracted lanes. But that would be a wrong assumption. The fact is, there are some goods that Walmart sells that won’t justify a contracted lane given the volume it represents. Either because they don’t need a lot or maybe the supplier can’t produce a lot.
Let’s say for example, Walmart sells a particular fruit exclusively in its West Coast stores that has a limited production of only 100 loads per month. The fact is, a major carrier won’t want to commit to those lanes as they plot out their 12-24 month growth strategy. It doesn’t make sense from an asset utilization, pricing and driver standpoint.
So how will Walmart move those 100 loads per month? They’ll use the spot market. In the spot market, the loads are posted on a “load board” that any carrier has access to. The spot market is similar to the NY Stock Exchange. It’s about selling that load, that day, to a specific carrier that will do it for the price offered.
But even then, it’s not quite that easy. Because a shipper has to ensure their load will be handled properly, will be covered by insurance, the carrier is safety compliant, it will be picked up and delivered on time and many other factors.
This entire process is incredibly time sensitive and labor intensive. And because Walmart has hundreds, if not thousands of these “100 monthly loads'' across their system, the spot market is a critical part of their transportation strategy and execution.
But who helps manage all of this? Well, it’s the transportation’s middle man – better known as the Freight Broker.
The Freight Broker is a one stop shop for shippers to solve their needs and for carriers to find loads. In other words, Freight Brokers are a lot like matchmakers.
The great brokers will have a coalition of carriers that have been vetted, tested, researched, and used that will cover all the loads posted on the spot market. Their job is to connect shipper and carrier and make sure both are happy. Brokers and carriers use these marketplace load boards to post and search for loads.
They communicate with each other via phone, email and negotiate every single load. The spot market rates change depending on demand. The pricing can even change a few times each day.
For example if a particular area that you need coverage has a ratio of loads per truck less than available loads, it means it will be more expensive. But there are average rates so making a comparison and establishing a benchmark is very easy. But it also means there is constant rate negotiation going on.
And just think about the Freight Broker who has 10 - 12 loads every day. It takes some time to find the right carrier at the right price and that’s just the beginning. Once they have identified the carrier and agreed to a price, the broker must then set up the entire schedule between the shipper and carrier and ultimately make sure the delivery is flawless. It’s a lot of work and the price for this work? The average margin a broker makes on each load is approximately 15%.
As transportation costs continue to rise, the broker is usually the party in the crosshairs. Both shippers and carriers want to cut the middleman and either save or earn the 15%.
But in my opinion, I don’t think the spot market can operate without the brokers at this point. As detailed above, the brokers provide critical services to both the shippers and carriers.
In an ideal world, it would make sense for the shippers and carriers to work directly across all their loads. In this ideal world there would be enough carriers with enough equipment to handle even the smallest loads anywhere in an efficient manner. But the United States is a big, vast land with over 330 million people in urban, suburban, and rural areas.
Logistically, a shipper might be able to find a carrier that could make the trip from Idaho to Montana with five loads every month, but how could that be done efficiently? on time? And at a sustainable price? And how could the small carrier in Montana with 10 trucks guarantee he has the equipment in Montana on the day and hour the load needs to be picked up? How could he guarantee those loads would be five loads flawlessly delivered? How could he guarantee a price
that is sustainable to make a profit?
It’s not realistic at this point. The supply chain isn’t perfect, but it works. The transportation industry isn’t perfect but it works. It works because there are both contracted lanes for specific loads and the spot market for specific loads. It works because shippers and carriers can still make money. It works because the freight broker fills a specific need.
Founder and CEO of Kavkaz Express, LLC.