Primary Contract Rates vs. Spot Rates: What are the Differences?
The choice between whether you should pursue contract rates or spot rates for your business is not an easy one to make, especially following a year filled with so much uncertainty. We’ve just recently made it through 2020, one of the strangest and hardest to predict years for nearly every industry that exists.
The essential question to ask yourself when exploring your shipping rate options is: how much risk am I willing to take?
In this article, we are going to be taking a look at primary contract rates and spot rates in detail as we outline the benefits and downsides of each option.
Hopefully, by the end of this article, you’ll have a better understanding of the differences between these two rate options and can get a better idea of which option is the right choice for your business.
Primary Contract Rates
Primary contract rates refer to rates that are agreed upon for a defined period of time (usually a year or so). This price is agreed upon by all parties involved prior to any shipments being made. Generally, this is a more conservative approach to shipping.
A shipper who elects to pursue a contract rate agreement is essentially attempting to protect themselves against rapidly rising rates and decreased truck availability.
What are the Benefits of Using Primary Contract Rates
As previously stated, contract rates are above all else: safe. All parties know what is expected of them and are prepared with the necessary funds, trucks, and loads for the job at hand.
Additionally, when you utilize a contract rate agreement, you will develop relationships that can be maintained long-term. If you know your carrier and they know you, you’ll likely have an easier time weathering the storm when markets take an unanticipated turn. In fact, you may find that you actually have an advantage over your competitors when this happens but you have a solid rapport with your carrier.
What is the Downside of Using Primary Contract Rates
As any gambler can attest, a conservative approach may leave a shipper kicking themselves when rates decrease. To use a gambling analogy: choosing a primary contract rate is like putting a small bet on black every time in roulette: a safe bet that is unlikely to make you a ton of money quickly, but gives you a better chance of keeping your money in the long run.
Compared to contract rates, spot rates tend to be, on average, riskier decisions. A shipper who decides to pursue spot rates is assuming (or hoping) that rates will decrease steadily and that truck availability will increase. A market where rates are low and truck availability is high is the dream for a shipper using spot rates.
What is the Benefit of Using Spot Rates
As the saying goes: high risk leads to high reward. If you take a big chance, you stand to potentially gain a lot when it is time to ship. All monetary decisions involve some level of chance. The decision to use spot rates is certainly a risky one but could pay off big-time if shipping rates decline and truck availability soars.
What is the Downside of Using Spot Rates
On the other side of the coin, high risk could also lead to a devastating outcome. If you, as a shipper, are betting that shipping rates are going to drop and truck availability will skyrocket, but in fact, the opposite happens, you may be left out in the cold holding the bag so to speak.
While we drew a comparison between primary contract rates and spot rates as more conservative and more risky approaches to shipping respectively; there are some nuances to consider…
It’s Not Always an Issue of One or the Other
There are times when a shipper may use a spot rate while still maintaining a primary contract rate. This is actually a fairly common approach. Instances where a shipper who is under a contract rate but uses a spot rate when moves include out-of-contract jobs or simply when a soft spot market presents itself is a good example of why it is a good idea to keep your options open and play it by ear.
A shipper can still keep a good relationship with the carrier they have contracted while seizing opportunities as they appear.
The Ratio of Available Trucks to Load Size is Most Important
While rates can rise and fall for a multitude of reasons, the load-to-truck ratio is of paramount importance. This is one of the main factors you should consider when deciding on which type of rate option you will pursue. To put it in its most basic form: when there are more trucks available than there are loads to ship, rates will decrease; when there are fewer trucks than there are loads to ship, rates will increase.
While shippers should never make any decisions without thoroughly considering all of the available options, it’s important to keep the above points in mind. There is always the option to change. If rates are down one day, it’s very possible they could be up the next, and vice versa. Only you can decide what the right course of action for your business will be.
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