Forwarders and BCOs rely heavily on tendered contracts in order to plan pricing for global ocean freight movements. But what if large swaths of the tendered contracts are simply completely irrelevant? Banking on joint research with the MIT Center for Transportation, this article challenges the basic assumption of tenders, makes a case for more strategic use of the spot market, and forces a hard, data-backed look at actual performance.
There have been plenty of examples of volatility and disruption in freight markets over the last few years, from the pandemic and port strikes to the Red Sea crisis and trade wars.
These events have triggered demand swings, impacted operations and lead times, and often sent freight rates climbing or plunging – all of which affect shipper and forwarder decisions on how to allocate freight volumes between contracts and the spot market.
Across modes, having a freight contract in place does not always mean shipments will get moved. Dr. Angi Acocella, a Freight Lab researcher at MIT’s Center for Transportation and Logistics, conducted research on procurement decisions and performance in the FTL market, and, via a joint survey with Freightos, on container shipping procurement as well. These studies explored how shippers make tendering decisions and provide insights on how to improve strategic procurement decisions across modes to reduce risk and costs and improve reliability.
See Dr. Acocella’s presentation of the survey results here.
The studies show that:
Both road and ocean shippers rely heavily on contracts – with most shipping at least 70% of volumes by tender – and mostly treat spot as a backup option. They also show that a significant share of contracts – on average 70% of FTL contracts – go unused.
Unused lanes come with unnecessary costs, including a 7% year-on-year increase in contract rates, while the strategic use of spot for these types of lanes can mean significant savings in both time spent on wasted negotiations and in shipping rates.
Index-linked contracts have also been shown to increase revenue for carriers and provide better reliability and lower costs for shippers.
And digital tools that provide visibility of contract performance, market intelligence, and a dynamic channel to communicate and share information with LSPs are also key to optimizing the freight procurement process.
What follows are the key findings from these recent surveys and the best practices for freight procurement and tendering that emerge from the research.
Are All Ocean Tenders Actually Used? The Findings
The surveys showed that in the FTL market, most shippers moved 90% of their volumes by contract with the remaining 10% going by spot. Ocean shippers also relied heavily on long term contracts, with more than half moving 70% of volumes or more via contracts.
In both FTL and container, the spot market is mostly used as a backup to contracts. The move to spot is most often due to the uncertainty, unreliability or unavailability of the contracted capacity, or to unexpected swings in their own demand. Often these pushes to spot are triggered when spot prices become significantly out of sync with contract rates.
At the same time, 40% of shippers do report using the spot market as a first option on some lanes, usually for trades with infrequent, less predictable and lower volumes than contracted lanes. But this finding also means that 60% of ocean shippers rely on contracts even for low volume lanes.
Freight Lab research found a Pareto principle at work for FTL shippers: in general, about 20% of shipper lanes account for about 80% of their volumes, with a long tail 80% of lanes accounting for just 20% of – mostly low or inconsistent – volumes.
For many of those long tail lanes, however, volumes don’t materialize at all. Acocella refers to lanes with unused contracts as “ghost lanes,” and research shows that shippers underestimate how many contracts go unused.
A majority of both FTL and container shippers estimate a ghost rate of 25% or less. But FTL data suggests that on average, closer to 70% of contracted lanes go unused.
Ghost lanes come with added costs beyond the resources wasted negotiating unused contracts. MIT research shows that high rates of FTL ghost lanes one year resulted both in lower acceptance rates that year and in 7% higher contract costs – often at levels higher than spot rates – the following year as carriers factor in a premium to compensate for unreliability.
The Actionable Insights
These findings – the volatility in these markets, the heavy reliance on contracts which can often become unreliable, the use of spot mostly as a second-choice backup, and the share of contracts that go unused – begged the key research questions:
What is the optimal balance between freight contracts and spot shipments? What approach is most likely to maximize reliability and efficiency and minimize costs?
The resulting Freight Lab research produced the following key components to constructing an optimized contract/spot procurement portfolio*
*These results are based primarily on research for the FTL market, with applicability to ocean likely based on the above survey and with more research on this area underway now.
Learn from past performance: A look at contract portfolio and spot usage and performance – its mix, utilization and reliability by lane – from the previous year is critical to decision-making for the coming year. Shippers and forwarders should determine where contracts performed well, where they were underused (or not used at all), and price levels paid relative to the market.
Based on this picture, companies can determine where and with which LSPs to renew contracts on highly or regularly utilized lanes. For lanes where little or no volumes materialized shippers and forwarders should consider a strategic direct-to-spot approach, given the high costs of ghost lanes.
Respect the market cycle: Shippers and forwarders should also consider where the market is in its cycle, and how contracts performed in previous instances of this phase. In tight markets it generally does not benefit shippers to negotiate hard for discounted contract rates as – often regardless of a shipper’s history with a given carrier – contract price competitiveness becomes the carriers’ priority. In soft markets, shippers have more leverage and should contract with their most reliable carriers. But here too, low-ball rates can often mean poorer performance, especially if market rates increase.
Index link some contracts – Contracts linked to an index allow rates to fluctuate in some relationship to the spot market. Significant spot changes are a main driver of poor contract performance: when spot rates climb too high above a contract’s rate, carriers roll volumes or apply premiums. When spot rates fall too low, shippers no-show and shift to the spot market or renegotiate contract levels.
Allowing a contract to float along with an index removes this incentive to deviate from the contract. And though index linking exposes carriers and shippers to fluctuations in revenue or costs, this risk can (either be accepted as the cost of reliable service/volumes, or) be hedged through derivatives called Forward Freight Agreements, effectively locking in contracted service at a set cost or revenue level even while paid rate levels may change.
Learn more about index-linked contracts here.
Acocella advises shippers to pilot index linking with a carrier they trust and with whom they have an existing relationship, and on mid-volume lanes – especially where volumes may not be consistent throughout the year – to start. Once the concept is proven, this tool can be expanded to other lanes. Research in the FTL market showed that index-linked contracts, especially on these types of lanes, often resulted in carriers realizing higher revenue and shippers getting better reliability, and often lower costs than when using typical contracts or just spot.
Track performance – Shippers and forwarders should not only evaluate past performance during tendering season, but should monitor performance and utilization during the contract period too. Generating visibility of your contract (and spot) portfolio, and tracking where volumes are materializing and which contracts are being underused, will let shippers understand how carriers are performing and how they, the shippers, are performing as a partner. Understanding where you stand can help you adjust in real time rather than carry unnecessary costs or incur higher costs or poorer reliability down the road.
Leverage tech – New tech tools help evaluate past performance or track the current status of freight tenders, costs, volume (or lack thereof) by lane, and spot usage, all of which is crucial to optimizing freight portfolios.
These tools also represent the opportunity for a significant leap in freight procurement efficiency: Beyond digital tools that help shippers compare their contract portfolio to market prices and provide market intelligence to support decision making, logistics tech is also enabling more efficient tendering by creating a dynamic, digital channel to communicate, negotiate, share data, and even make spot or contracted bookings with LSPs.
Tech that simplifies or automates parts of the freight procurement process, or otherwise reduces the time spent on negotiations and procurement, is increasingly key to overall streamlined procurement.
The Bottom Line: Don’t Tender Everything
Recent research shows a heavy reliance on long-term contracts for both road and ocean freight shippers, with the spot market mostly reserved as a backup. But shippers also carry significant wasted costs through unused or underutilized contracts, with analysis showing better efficiency via the strategic use of spot for these lanes.
These studies suggest certain key procurement best practices for shippers, including investing in visibility of their contract/spot portfolio and performance; the strategic use of spot on low volume lanes; consideration of the current phase in the market cycle; implementation of index-linked contracts, and leveraging digital tools to provide that necessary visibility as well as automate or digitize time-consuming tasks like requesting tender offers, spot rates and even placing bookings.
