The 2020-21 freight market caught logistics departments totally unprepared. Issues that surfaced in the early months of the pandemic - port congestion, lack of capacity, driver shortages, and soaring freight rates - culminated into a full scale “supply chain crisis”, while shrinking profit margins forced price increases on goods. Coming into the 2022 procurement season, US inflation is at its highest rate in nearly 40 years.
While most shippers plan to increase budgets, without a specific eye to inflation, logistics teams will again be uniquely exposed to cost swings in months to come. This article will serve to help logistics teams to explore the budgetary risks and adequately prepare for 2022 planning cycles. It examines truckload freight market trends, predictions for 2022, and strategies for navigating inflation both in contract negotiations and the spot freight market.
Looking Back at the 2020 & 2021 Truckload Spot Freight Market
When the pandemic hit the U.S. in early 2020, shutdowns and recession fears sent freight rates plummeting, as carriers scrambled to accept any available loads. But those dirt-cheap rates were only temporary. The injection of stimulus funds created a hike in consumer spending in unexpected patterns. Unable to spend money on services like travel, dining out, or salons, Americans shifted to material goods and products. Direct-to-consumer and e-commerce orders outpaced 2019 sales by 32%. Freight rates soon surpassed pre-pandemic levels, while increases in demand led to more tender rejections, and more volume in the spot market. This cycle continued throughout the entirety of 2021 as the supply chain struggled to catch up.
By November 2021, the U.S. annual inflation rate had increased to 6.8%, the highest rate in nearly 40 years, and is predicted to stay elevated well into 2022. Rising energy and fuel costs, high demand, and supply chain disruptions continue to push consumer prices up - but what does this mean for the truckload spot freight market and logistics budgeting cycles?
Understanding Inflation & the Impact on Freight Costs in 2022
Over the last two years, rate volatility has created a frustrating gap between contracted freight rates and spot rates. Despite the fact that studies show 97% of shippers plan to increase budgets in 2022 this trend is projected to continue into 2022.
For one, standard contractual environments largely overlook inflation as a factor. Despite indications of imminent inflation, few shippers proactively addressed the issue in early 2021. Faced with increased consumer demand, the message to logistics teams was to get product delivered, period. This shifted the focus away from controlling costs and, as more freight was pushed to spot, resulted in overblown transportation budgets.
Many shippers will likely pivot back to a focus on stabilization and cost mitigation in 2022. This will be a challenge for logistics teams who rely heavily on cost-plus transportation providers. Increases in the price of fuel, labor, and equipment will mean a direct hike in rates market-wide that will be hard to negotiate against.
Critically, organizational cost measures will hinder teams’ abilities to contract effectively. An inflationary market means higher prices, but after exiting a period of such volatility, sourcing teams will be challenged, psychologically and fiscally, to meet carriers at these new market rates. Yet again, we will see a gap between contracted rates and real market rates.
To succeed, logistics teams must anticipate the impact of inflation and use it to advocate within the organization. Unlike most issues that logistics teams face - driver shortages, port congestion - inflation is a common thread tying the organization together. It provides a unique opportunity for cross-departmental discussion on risk mitigation and cost control.
Managing Contracted Freight: Revisiting Inflation Clauses
Inflation clauses have been nearly non-existent in supply chain and logistics contracts for several decades, as inflation rates have been relatively negligible. But 2021 proved just how volatile they can be, increasing from a fairly normal 1.7% in February to 4.2% in April before escalating to a shocking 6.8% in November. With no signs of a slow down or stabilization, logistics teams should consider indexing truckload freight rates to inflation in contract negotiations.
What is an inflation clause?
An inflation clause, also referred to as an escalation clause or indexation clause, is used in long-term contracts to adjust payments and/or charges in response to changes in market prices. Inflation clauses are typically tied to the Consumer Price Index (CPI) or other inflation index, and dictate freight rate adjustments in correlation to changes in the index.
What are the benefits of an inflation clause?
When applied to logistics and transportation contracts, inflation clauses provide several specific benefits:
- Ensures fair pricing from carriers. An inflation clause dictates rate increases as reflected in a predetermined inflation index and eliminates mid-contract renegotiations with carriers.
- Creates more predictable and realistic transportation budgets. Inflation clauses provide a model that can project low- and high-end budget expectations and proactively communicate that within the organization.
- Limits exposure to truckload spot market rates. In unstable inflationary environments, standard contracts with set rates are unlikely to be honored through the contract term, resulting in more tender rejections and more freight entering the spot market. By automatically increasing contracted rates based on indexed data, carriers are more likely to accept tenders and keep freight moving.
What should an inflation clause include?
General guidelines for inflation clauses should include the following considerations:
- Define the base payment or price to be indexed. An effective date must be provided to establish the period from which the base payment will be indexed.
- Select an appropriate index or indices and specify appropriate sources. An inflation clause should reference the index by its complete title, index number, and any other identifying codes.
- Specify the frequency of price adjustment. Any monthly, quarterly, or semi-annual adjustments should be clearly noted. Keep in mind price adjustments must be calculated over an interval beginning at the contract’s base period.
Please note: as with any contract negotiations, organizations should rely on legal and compliance professionals to draft and review proposed amendments.
Utilizing Technology to Mitigate Spot Freight Costs
Even with safeguarded freight contracts, most shippers will be forced into the spot market more often in an inflationary period than in stable economic periods. This is important to consider for budgeting purposes, but also seen as an opportunity to proactively develop a spot freight strategy. In the increasingly digitized freight industry, implementing automation and smart technology is essential for managing freight costs and protecting budgets.
TNX provides one such solution for navigating the truckload spot freight market. The TNX platform utilizes artificial intelligence and machine learning to predict carrier-specific pricing and drive smart tendering, pushing offers to carriers rather than relying on an open bid process. This automated system modifies pricing in response to real-time market changes and eliminates the guesswork for logistics teams, ensuring that spot freight is priced fairly, even in the most volatile market conditions.
Taking a Comprehensive Approach to Inflation Management
So how should logistics teams think about inflation? The approach should be holistic and comprehensive, and take into consideration a myriad of possibilities for the freight market. For contracted freight, rates should be tied to an inflation index in order to predictably adjust prices throughout the contract cycle, avoid frustrating renegotiations, and minimize exposure to the spot market. Inflation predictions should also be part of budget conversations, as they allow teams to communicate best- and worst-case scenarios depending on inflation rates. This allows the organization to plan proactively and sets realistic budget expectations. Finally, logistics teams should implement a data-driven, technologically advanced strategy for managing spot freight. TNX takes the uncertainty out of spot market negotiations by automating the process. Schedule a demo to learn more about how the TNX Logistics’ AI-driven platform minimizes costs in the spot market and protects shippers’ budgets.