The old 80/20 rule — the Pareto Principle — is alive and well in trucking, although the scale is even more out of balance in full truckload freight. Studies at DAT Freight & Analytics show that about 80 percent of a shipper’s truckload volume moves on just 15 percent of its lanes.
It’s relatively easy to procure truckload services for core high-volume lanes because the freight traffic is fairly predictable. But what about the other 85 percent?
Many shippers just throw them in with the high-volume lanes to secure contracts. Of course, a primary carrier is more likely to reject a contract rate on a low-volume lane, leaving the shipper scrambling to cover those loads.
There is a better way.
Low and high-volume lanes perform differently and, therefore, should be procured differently. Lanes with more volume tend to have greater rate stability, while low-volume lanes follow the cycles within the truckload freight market.
Rather than simply securing a contract rate and hoping for the best, shippers should ride the wave and incorporate dynamic pricing into their procurement strategy.
A Complex Commodity
Dynamic pricing can be a hard sell within an organization. The C-suite may need help understanding the ups and downs of the full-truckload market. It’s a complex commodity that deserves special attention when procuring.
The three main reasons for this:
1) The U.S. truckload market is massive, with more than US$400 billion in annual revenue (more than 2 percent of the nation’s GDP).
2) There are hundreds of thousands of individual firms, most of which are very small. American Trucking Associations reports that 91 percent of truckload carriers have six or fewer trucks, and 97 percent have fewer than 20 trucks.
3) Unlike commodities exhibiting economies of scale, truckload transportation operates under strong economies of scope: The cost to serve a lane from A to B is influenced by the loads originating out of or near B.
The result of these factors is an industry with a Herfindahl-Hirschman Index (HHI) — a measure of market concentration — three orders of magnitude below the official definition of an unconcentrated market.
Low barriers to entry and exit also contribute to market competitiveness. Pricing power flips back and forth between shippers and carriers on a roughly three-year cycle of tight (demand exceeds supply) and loose (supply exceeds demand) markets. Relationships and contracts that span multiple cycles are hard to establish, especially for low-volume lanes.
The long tail of small carriers that can enter and exit the market quickly means there are no price makers for truckload services, only price takers. Additionally, there are no economies of scale for purchasing truckload transportation. In fact, larger shippers often pay a higher average cost per mile than smaller firms.
So, what does it mean to “ride the wave” of dynamic pricing?
It means establishing an agreement with one or more transportation providers where the rate for a shipment is determined at the time of tender based on preset rules. These rules allow a transportation management system (TMS) to determine whether a shipment should flow through the routing guide for a contract rate or go directly to the spot market for dynamic or transactional pricing. Call this a “structured” rather than an “open” spot market.
One approach to consider is to create a set of four or five core truckload providers that receive the offer and then provide a rate to move the shipment. The shipper can tender the load to the carrier offering the best rate. Competition among providers places guardrails on rates, and the shipper needs to monitor and manage their response rates. This method requires providers to have models or mechanisms that produce instant rates for any lane.
Another method is for a single provider to establish a contract with the shipper to cover all offered loads, with the price determined by an agreed-upon index plus some margin. For example, a shipper would pay the DAT benchmark rate plus, say, another 5 percent to the carrier (the margin can be set ahead of time by studying the shipper’s previous buying behavior).
DAT provides rate benchmarks in real-time at the lane level and is essentially a load-level index. This differs from a lane-level index, sometimes used to adjust a rate for the upcoming month or quarter based on past performance. Analysis at the Massachusetts Institute of Technology’s (MIT) FreightLab shows that load-level programs are more successful than lane-level programs because they are more responsive.
Both methods require the carrier, shipper or a third party to have sophisticated real-time pricing tools. These models are becoming more common today; most 3PLs and larger truckload carriers use them to help them respond to bids or mini-bids.
Riding the wave of dynamic pricing doesn’t come naturally to many organizations; the tradition of wanting a contract rate for every potential lane is strong. However, forcing low-volume lanes into contractual rates wastes time and can lead to poor financial outcomes (something the C-suite will undoubtedly understand). It’s time for transportation procurement pros to embrace uncertainty and start riding the wave.