You have a lot on your mind every time a shipment needs to pick up. Mainly, you’re concerned with getting products where they need to go on time and damage free. Maintaining your transportation budget — and not overpaying — is a secondary thought, but just barely.
Not wanting to overpay for transportation services isn’t a unique desire; every company worth its salt vigilantly monitors its freight spend. And, since the transportation industry is so fragmented, and its barriers to entry are so low, you’ll always find a provider that’s willing to move your freight for cheaper.
Instead, developing ongoing partnerships with a group of core providers is a more stable practice. With these relationships in place, it’s easier to weather the transportation industry’s cycles — through the highest highs and the lowest lows.
Entering into contracts with your providers where they offer you a set rate in exchange for a volume commitment is a great way to manage your transportation supply chain — and build these relationships.
Contract rates help companies forecast their transportation expenses and secure reliable capacity from providers that (over time) intimately understand their business.
If you’ve ever contracted a lane or set of lanes, you’ve experienced the value of doing so firsthand.
Sometimes though, when the transportation marketplace is especially volatile — as it has been in recent history — pre-existing contract rates lose their efficacy (for one side or another) before they expire.
In these situations, a contract may require adjustment in order for the partnership to work for both sides. Whether a rate change is requested by a shipper or by a transportation company often depends on how rates have adjusted since the contract was signed.
Either way, having to change your contract rate can be inconvenient. That said, here at Anderson Trucking Service (ATS), more than six decades in this business have shown us just how quickly rates can change and why contract rates sometimes need to follow.
To help you understand why this process may occur in your supply chain, and when it makes sense to make a rate adjustment, this article will cover the following:
- What are contract freight rates?
- Why do companies lock in contracts with their providers?
- Two reasons your contract freight rates may change
- How frequently should you contract your freight rates?
What Are Contract Freight Rates?
Contract freight rates are pricing agreements where a transportation company agrees to supply a specific service to a business with freight to move at a fixed rate. In exchange, the shipper commits to tendering their provider a set number of shipments per period (day/week/month).
Though the length and breadth of these contracts can vary, usually, a shipper-provider agreement covers a specific lane (or set of lanes) for a set period of time. It’s not uncommon for contract rates to last three to 12 months — locking in freight pricing over their duration.
Why Do Companies Lock in Contracts With Their Providers?
The transportation industry is volatile — with spot freight rates rising and falling on a daily basis. While working with the spot market for one-off loads is effective, for higher-volume requirements, this tactic is less so; fielding spot quotes for every shipment takes exhaustive oversight.
This is where contract rates make their impact. You see, when a company has regular outbound/inbound transportation needs, entering a contract to cover them has several distinct advantages:
- You develop rapport and optimize with contract providers
- You can forecast and budget for your shipping expenses
1. You Develop Rapport and Optimize With Contract Providers
Today, there are more than one million registered, for-hire transportation companies in the U.S.
The vast majority of these companies — particularly the smaller ones — operate on the spot market, accepting one-off loads at current market prices. As a result, if you were to receive spot pricing for every load, you could (potentially) end up working with a different transportation company every time.
And, since your company and its processes are unique, having a foreign provider on each load may impact the level of service you realize.
By locking in a contract agreement with your provider, you’re guaranteeing them your business for the foreseeable future. In doing so, after a while, this company will learn your processes intimately. This includes understanding the protocols at your pickup/drop locations, your invoicing procedures and how communication will work every step of the way.
These are incredibly valuable for your business's long-term success and aren’t available if there isn’t consistency in your supply chain. Contract rates help you develop this consistency.
2. You Can Forecast and Budget for Your Shipping Expenses
Contract rates are as reliable as it gets; they don’t change unless it’s absolutely necessary. As a result, having them in place allows you to forecast your transportation expenses for months into the future. That way, how much you need to allocate for shipping is predictable and won’t change each day.
These understandings are impossible to garner when quoting on a spot basis; spot rates change daily in most locations.
Related Content: The Pros and Cons of Spot Rate Vs. Contract Rates
Two Reasons Your Contract Freight Rates May Change
Now that we’ve covered what contract rates are and a couple of reasons why they’re valuable to have in place (in the right situation), let’s talk about why they may need to change.
It would be awesome if you could agree to a contract rate with your provider(s) and have that rate held through the duration of your agreement. Usually, that’s exactly what happens.
At other times, though, it becomes unrealistic for one side or another to honor a contract rate. Most typically, contract rates need to be reconsidered when one of the following occurs:
1. Transportation Pricing Falls Dramatically: Shippers Need to Re-Evaluate
There are a number of factors that, together, dictate the going price of transportation services. In a healthy market, transportation pricing — across the dry van, open-deck, reefer and over-dimensional markets — usually doesn’t change that much month over month, at least not on a macro scale.
Things like area load-to-truck ratios and supply/demand adjust seasonally, but this can be predicted and accounted for during contract negotiations and in rate proposals.
However, sometimes major shifts in supply and demand (shifts that occur regardless of regular market forces) flip prices on their heads.
Freight rates fall whenever the supply of transportation services far outpaces demand — like what happened near the tail end of 2022. In these situations, contract rates that were enacted prior to this swing are often re-evaluated.
This is one reason a contract rate may change.
2. Transportation Pricing Rises Dramatically: Providers Need to Re-Evaluate
If there are far more trucks available in the U.S. than loads to move, rates bottom out, requiring shippers to adjust the rates they pay. On the flip side, when there’s a dramatic shortage of capacity and expenses rise, transportation companies are forced to re-evaluate.
This is what we experienced recently — starting in 2020 and fizzling off a little over mid-way through 2022.
Since trucking companies have finite amounts of capacity to provide, and a set of fixed expenses to attend to, they can’t ignore massive swings in transportation pricing.
For this reason, your provider may have to re-visit your contract rates whenever they start to worry about upholding the commitment they made due to tender rejections (as drivers make more money elsewhere) or heightened operating expenses.
Although this is unfortunate, it’s necessary for providing top-of-the-line service while adequately paying drivers and making overhead.
This is the second reason your contract rates may change.
How Frequently Should You Contract Your Freight Rates?
You should base the frequency of your request for proposals (RFPs) on your business cycles. Often, companies contract their freight lanes every 6-12 months. That said, sometimes it can make sense to hold more frequent RFPs, upping this cadence to quarterly. This is the case for peak seasons when you’re shipping far more frequently than normal. You may also consider hosting quarterly RFPs during periods of prolonged price instability.
It can be helpful to consult your trusted transportation providers and use tools like DAT Freight & Analytics to gauge market trends before setting a bid frequency.
Contract Rates Are a Great Tool: Here Are 4 More!
At the end of the day, the freight-rate pendulum can swing quickly in the transportation industry. And, while contract rates are a great way to forecast for the future and develop consistency with your provider(s), sometimes they need to be adjusted.
Namely, whenever your contract rate is far above going market prices, you should talk to your provider about making an adjustment — great partners will do so in a heartbeat (they may even suggest this change themselves). Also, if the rate they’ve agreed to ends up not being enough to reliably meet the service commitments they’ve made, a provider may want to re-evaluate.
The best thing you can do here is to communicate with your trusted carriers and clearly articulate your needs. Freight pricing is complicated and although contract rates are valuable, it’s important they work for all parties.
As you continue to refine your transportation supply chain, you may want to explore alternative methods for tendering your freight — contract rates are one of the many. To help you do so, here is an article that touches on the pros and cons of five freight-tendering methods (contract rates and four others).
If you have any questions after reading it, or would like some help incorporating a few of them into your business, we can be contacted here.