Spot Prices versus Contract Prices

Noël Perry is TIA’s Chief Economist

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717-673-2998 |transportfutures.net

Something is rotten in Denmark:  As the availability of data improves, people are talking more frequently about differences between spot and contract prices and also about the relative shares that each earn from the market.  As you consider that commentary, or perhaps, the data that you obtain, make certain you are making an apples-to-apples comparison.  This is important because contract data with or without fuel is always a door-to-door rate; what the shipper pays.  In contrast, the spot data is usually reported as what the broker pays the carrier, with or without fuel, and does not include the add-ons that the broker charges the shipper to cover his or her costs.  Such apples-to-oranges comparisons seriously understate the spot market rates, indicating an erroneous pricing advantage spot-over-contract as is commonly cited to describe current market conditions.  Spot prices have recently fallen, following softening market conditions.  Because such spot market swings generally precede contract price swings by six months or more, the spread between the two has changed in favor of spot prices.  Enough to shift volume from contract to spot?  Nope, read on.

Let’s turn the oranges into apples:  The accompanying chart illustrates the issue.  Most depictions of the comparison show only the blue and dashed lines, representing what some follower[1] of contract rates reports and what either Truckstop.com or DAT reports about spots prices.  Those two lines show the commonly-held view that spot rates move above and below contract rates depending on market conditions.  In this market they are below contract rates, suggesting a reason to put more volume on the spot market.  Here’s the point.  Truckstop.com confirms that its spot market data is the revenue brokers pay to their carriers.  The shipper pays that plus the 14-16% broker fee, the money that all the new digital brokers are lusting after.  So, the apples-to-apples comparison adds that margin to the dotted line data to get the orange line, what the shipper pays.  Using this proper perspective, we see that spot rates fall below contract rates only at the weakest point during this recovery and are currently seven percent higher than contract rates, even at the peak of the contract rate cycle.

[1] This contract data comes from Chainalytics

Low productivity equals high cost equals high price: As an economist with a deep interest in the productivity of trucking, I have long known this relationship.  That is because the random, chaotic nature of spot market gives it lower productivity than the far more orderly contract market.  It is easy to match equipment to demand if you know what the demand will be, not so with the volatile spot market.  People think it is a low-rate market because of that guy who ends up in Maine on Friday afternoon with no load home to Chicago.  He will take anything to be heading on I95 South.  But remember, the same thing goes for the shipper who needs an extra truck to get into Maine on Thursday.  What trucker would move that load knowing he would have to return empty.  The shipper has to cover that risk in the Thursday rate.  Over time then, the Maine spot market generates average spot rates that cover costs plus a margin to account for the additional risk of going in there.

Spot markets are expensive to manage:  There is also the business of administrating and operating in the spot market.  The two most obvious issues are transaction costs and unfamiliar operating patterns.  Unlike contract relationships, the broker and carrier have to separately and negotiate each load.  That takes time and people, hence money.  Moreover, the broker has to manage relationships with many carriers, while a contract holder deals mainly with a small number of core carriers – more money required for spot market users.  As to operations, the driver has to venture out of his comfort zone: unfamiliar roads, unfamiliar parking spots, non-standard fueling stations, even unfamiliar state police radar traps – more money out the door.  Of course, there are a host of providers who serve this market, minimizing the extra costs.  Last time I looked those suppliers charge their carrier and broker customers for that service – more money out the door.

But, I know that sometimes spot prices are below contract prices!  As the explicit relief value for the industry, spot prices respond dramatically to weak market conditions.  Moreover, during downturns, shippers favor their core carriers who are only too anxious to move all their core shippers’ freight.  Spot volumes fall more than contract volumes.  Same thing for standard contract volumes compared to dedicated volumes.  The latter get preference when times are tough.  It follows then that, during downturns spot rates may be lower than contract rates.  But then the worm turns; spot rates race past contract rates during peak markets like this time last year when they were 36% higher than contract rates.  That works out to a bunch of new Peterbuilts!

One final point:  There is the belief that the spot market, as the home to a disproportionate share of small fleets and owner-operators, is dominated by poor businessmen who keep underpricing until they go out of business.  This is true, a little, to the extent that it is home to many new entrants who just don’t know how to manage trucks.  Same thing with small businesses everywhere.  Yet, this market has existed for at least eighty-five years and is 200 billion dollars large.  That makes it a large, mature market.  It has attracted capital all these years because somebody is making money, and plenty of it.  Again, there are a bunch of Peterbuilts in this market.  If it were dominated by a collection of sad-sack losers, the trucks would dry up.  Markets work! Including spot markets.  Cargill makes much money on grain spot markets; why should this wide-open free market be any different?

There are two big ah-ha’s from this data:  First, owner-operators who sell their services direct to shippers should add in the same extra margins as the brokers.  Makes sense from a cost standpoint.  Marketing and administering payment cost money.   Makes sense from a market standpoint:  The broker’s price is the market price.  Second, the claim that the spot market share increases as the market weakens is false.  Neither the data nor logic support that claim.  Spot rates are still higher than contract rates, except for the worst times and shippers favor their core carriers.  They may rebid the business to a new set of core carriers, but they don’t dump their volume on the spot market.  Could you imagine Walmart processing 26 million transactions per year during the next downturn just to take advantage of spot rates?  How many brokers would they need?  This means for brokers and spot carriers that spot volumes, the number of loads falls more in downturns than does the whole market.  It also means that spot volumes rise faster during upturns.  2018 was a very fine year!  That’s a great example of the volatility that makes the spot market more expensive than the contract market.