Logistic Strategies: Spot Market Freight vs. Contracts

Surcharge Pricing Announcement

Last week’s announcement of an Emergency Bunker Surcharge from several major ocean carriers should give shippers who put most of their freight business in the spot market enough reason to reflect on their pricing strategy. Usually, emergency surcharges are implemented with only 15 days notice and can be applied at any time. There have been many types of emergency surcharges over the past 20 years, which were fully applied to the spot market and not to shippers under contract, or in a worst case scenario applied at a discount after negotiation between the two parties.

Deregulation Drives Shippers To Spot Market Freight

Shippers want two things; freight cost certainty and service reliability. However, when shippers suspect their contracted rates are higher than the market level, they push more of their freight in the spot market. Indeed, deregulation and rate volatility has driven many shippers to play in the spot market far more than they should. Playing the spot market takes time. Comparison of services, origin charges and supplier relationships are only a few factors that make continuously negotiating rates a full time job. Most shippers are systems driven and are required to load new vendor pricing into their database.  A real pain if it is a monthly exercise. So what is the most effective strategy? How can a shipper have the benefit of market level pricing, service reliability and medium term cost certainty?

Successful Shipping Strategy

Depending on their volume, many successful shippers will contract a large portion (70-75%) of their freight once a year. The remainder will be made available to the spot market if and when it makes economic sense to the shipper. By committing a large part of their volume to one or two service providers, shippers get the benefit of more favorable pricing and services with economy of scale. Moreover, if there is a space crunch, the shipper with the service provider they have been supporting will have an advantage over the shipper who continuously moves business from one carrier to the next over price. Conversely, by keeping a portion of their freight in the spot market, shippers are able to keep an eye on the market. If freight rates soften, they can take advantage of the dip by pushing volume to their spot carriers. If price rise, they can try to get more freight booked with their contracted carriers.

Freight Rate Landscape

The world is adapting to the deregulated environment where freight rates are entirely driven by supply and demand. Global demand growth has been relatively steady at 5-6% per year. Volatility in pricing has been driven almost entirely on the supply side. Carriers can remove tonnage from a trade, thereby driving freight rates up, or they can add tonnage which of course lead to some dramatic price reductions. Emergency surcharges such as the bunker fuel surcharge announced last week are typically strategies used by carriers to recover costs without increasing freight levels. While the 75/25 contract/spot formula may not fit with all shippers, good freight partners can map out a strategy tailored to their business needs.

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