*NOTE* For this post, I am going to focus solely on these two markets as they pertain to freight brokers, not asset-based trucking companies.
Freight brokers often must decide whether they want to participate in a bid for a customer. These bids can happen quarterly, annually, or over other various durations. Bids can be time consuming, and often lead to a gain of no business for brokers if they are not effective in the bid process. Conversely, the spot market can be a gold mine for brokers if they are effective in sourcing carriers on live loads when time is crucial.
What is the difference?
A contracted rate is a rate offered by a broker that is good for a set period, usually for the year.
A spot rate is a rate offered for a specific lane at a specific time, usually with a short window of time before the load moves.
The Danger of Brokers’ Contract Rates
Freight brokers do not control carrier capacity, carrier rates, or anything that could potentially lead to the broker taking a loss on a contracted load. The strategy of contracting rates during a bid is to gain a larger volume of business, but typically at a lower margin overall. Looking further into it, the broker will likely lose money on a fair amount of the loads that they move at a contracted rate. This is offset by the hopeful gains made on the other loads.
Let’s look at an example. Let’s say a broker wins a bid for 100 loads at $2.00 per mile contracted throughout the year. We know that rates fluctuate throughout the year for a ton of reasons. When carriers are in abundance and a truck can be booked for $1.60 per mile, the broker is profiting $0.40 per mile (20% margin). On the other hand, when capacity is tight that same truck might cost $2.10 per mile, resulting in a loss of $0.10 per mile (-5%). There is a risk/reward relationship here, and brokers carry that risk more than a carrier that owns their own assets would. By winning a bid, you can move more freight overall as a broker, but you are relying on the market fluctuations to work in your favor to make it worth your while.
For the reasons listed above, it is crucial to have an experienced person working on a bid that has a good comfort level of market fluctuations. Further, you will want to use the best technology and rating tools available to you to compare past market conditions to future predictions.
Spot Rates Are Where Brokers Make Their Money
As mentioned previously, brokers do not control carrier capacity. As we have seen with the COVID-19 global pandemic that changed the supply and demand drastically, there are many unforeseen events that can change both shipping volumes and carrier capacity. We have seen this in the past with ELDs, natural disasters, produce seasons, fuel prices, peak shipping seasons at the end of the year, and the list goes on. What we will not know is exactly how much the market will change, but we do know that the market will change. This is where the spot market comes into play, and where brokers can capitalize.
The role of a freight broker is simply to be a value-add in connecting shippers to carriers. It’s a job that is done most efficiently by the broker, rather than a shipper or carrier taking this role on themselves in most cases. When the market changes, which can happen literally every hour, brokers can match their best available shipments with their best available partner carriers. If a broker does not have an available carrier, they can still source additional trucks by using load posting tools such as DAT and Truckstop.
By working in the spot market where you are not forced to take a load, a broker can choose which loads best match with their partner carriers, preventing a loss on certain loads. Then, the broker can add the appropriate amount of margin as they deem proper. For example, when a broker covers an easy load during a normal workday with 24 hours’ notice, they are competing with more brokers resulting in a better rate for the customer and a lower margin for themselves. Oppositely, when the same broker covers a load at 10pm on a Saturday night with 30 minutes notice, they have less time to price carriers likely resulting in a higher rate. A higher rate typically comes with a higher margin. Harder work deserves higher profit.
The purpose of the spot market is not to just make more money, it is just where most brokers perform at their best. They are in a position where they are competing which drives price down for shippers. They are adding value to both carriers and shippers with real live loads and actual available trucks. The spot market does have its downsides, though.
Some Points to Consider
What about long-term customer relationships? Customers tend to like lower rates obviously, so the long-term repeat shipping customer tends to lean towards the contract market if they can. The spot market is generally reserved for loads out of the ordinary in those cases.
The contract market offers simplicity for larger shippers and reduces costs of having to spot price out multiple lanes to multiple brokers and carriers every day. The spot market is a good way to prove your value as a broker before getting involved in a bid process.
If the spot market works well for your shipper, do not encourage the introduction of a bid. Often when a shipper does a bid their first time, they are focused on cost alone. This can be a danger to shippers. We all know that you get what you pay for, and the same goes for service and quality of both brokers and carriers. I have seen this happen far too many times, resulting in headaches that should have never happened.
All in all, there is a place for both contract rates and spot rates for brokers. I am personally a believer in the idea that good brokers can outperform their competition in the spot market with quick response times, quality carrier options, and fair rates. If you can master these, the profits will follow.