Dealing with a huge amount of change and uncertainty in recent times, both pandemic-driven and otherwise, doesn’t exactly make the supply chain sphere unique right now. But this long moment of change may present a unique opportunity to rethink some traditional processes.
One such process is truckload procurement. In early July, the SCLA Executive Think Tank held a discussion with guest speaker Dr. Chris Caplice, Executive Director of the MIT Center for Transportation & Logistics, Founder & Director of that center’s FreightLab, and chief scientist for DAT Freight & Analytics.
Traditional Transportation Procurement
For the last few decades, shippers have typically put out annual RFPs and awarded carriers rights to haul freight on particular lanes. The resulting arrangements go into a transportation management system (TMS), which automatically tenders shipments to the correct contracted carriers.
This process covers most freight and is always pretty good, but it’s never perfect—the plan never works quite as intended all year. Instead, because carriers don’t always accept shipments, the TMS operates a waterfall tendering process starting with the contract carrier, then moving to alternates, and tendering to the spot market as a last resort.
The data show the wild shifts of recent years: for most of 2019, spot prices were actually below contract prices. But the pandemic and other factors swung us into a continuing capacity crunch.
In this tight market, shippers must resort to spot more often (the portion of freight handled under contract dropped from 80% to 63%) and at higher rates. Even relatively small deviations from contract—say, 10% percent of volume going spot and spot rates at 10% above contract—can wreck your budget.
How badly off-plan do things tend to go? It’s hard to tell. Different shippers see different levels of degradation of the contract scheme over time. Sometimes, large portions of freight have to go spot at higher-than-expected rates.
On the other hand, some plans are so mismatched with the eventual reality that Dr. Caplice’s team has uncovered a phenomenon he calls “ghost freight,” where carriers bid on and win lanes, “but no volume ever shows up on that lane… In some cases, 50% of the lanes awarded during an RFP, no volume goes on them for the next 12 months.”
Where’s the Opportunity to Innovate?
This picture of the traditional process shows the depth of the problems and helps explain why some of these issues have come on so strongly lately. So how can we take this period of change and guide the change in a positive direction? Three big opportunities stand out.
1. Analyze Lanes and Treat Them Differently
We need to understand the variation among our lanes so we can treat them differently. There might be consistent, balanced volume on some lanes and variable, irregular volume on others. If we’re using the lanes differently, why not use different procurement methods for them?
Dr. Caplice suggests that shippers look at the variation in lanes and “treat it as a portfolio.” Instead of expecting everything to work on a contract basis and then watching it fall apart to rely haphazardly on spot, recognize at least three different categories: dedicated, for long-term engineered solutions on predictable lanes; contract, using some form of the traditional process in the middle ground; and dynamic, a different way to think about spot when you know ahead of time where you’re going to use it.
Some shippers are looking at their niche lanes and never contracting them out in the first place, instead using TMS to autotender to digital freight brokers, guided by indexed rate limits.
Those guides can be crucial. Shippers who have used automated processes without limiting conditions have found themselves in disastrous situations with badly blown budgets. But if we plan ahead for the dynamic segment, it may be safe and feel less like a hated last resort.
2. Consider More Sophisticated Contract Types
The root problem with traditional contract procurement is that truckload contracts in the U.S. are binding in price but non-binding in volume or capacity. Since carriers are under no obligation to accept loads, they leave shippers hanging when rates shift and make spot work more profitable. But the “ghost freight” problem shows there are also negative effects for carriers.
We all know that contracts don’t have to work this way. But in the supply chain space, there has not been very much innovation in types of contracting relationships, which leaves open a big opportunity.
Realistically, shippers aren’t going to convert to a world of contracts that are all binding in volume, and carriers won’t agree to binding capacity requirements across the board. But that’s the benefit of looking at each lane separately.
On some high-volume but inconsistent lanes, the shipper might be willing to guarantee volume and pay a penalty when volume is low in exchange for getting a good rate on what is generally a high-volume lane. On others, the shipper might be willing to pay more for guaranteed 100% acceptance by the carrier.
TMS and the RFP auction system have struggled with tiered pricing, where the rates for a single shipper/carrier relationship vary based on volume, when tried in the past. But supply chains and technology have evolved a lot in the last few decades. It’s probably fair to say things have evolved a lot in just the last few years or months! If supply chains are in upheaval anyway, it may be the right time to get creative—though a mix of caution and ability to adjust during the ongoing disruptions is advisable.
3. Procure in Intermediate Time Frames
Beyond the non-binding aspects, innovative contracting needs to consider different time spans. The traditional model is split between year-long contracts and “on the spot” arrangements. That leaves a lot of middle ground to exploit!
We are seeing more short-term contracts as well as index-based pricing. Obviously, shippers want carriers to stick with them instead of jumping the instant that spot work looks more lucrative. But Dr. Caplice referred to research done by his group (full paper behind paywall) that found carriers have pretty short memories, so the history with a given shipper doesn’t have much effect.
Index pricing lets rates fluctuate within limits so shippers save a bit when the spot market is low, but lessens the incentive for carriers to defect when spot heats up. Adjusting rates on shorter time scales may keep carriers’ attention, but the exact best frequency is hard to determine. In pilot programs, shippers have tried quarterly and even monthly, but anything shorter is probably unreasonable.
What Truckload Procurement Innovations Are You Seeing?
We’ve seen some excellent research in our group, but there are a lot of you out there seeing these things on the ground, day to day, and we know there’s rapid change. As the evolution continues, get in touch with us at SCLA to let us know what you’re seeing and how it’s working.