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Outsourcing, Insourcing, Offshoring, Onshoring, Tenders
Supply Chain - Logistics - Warehousing - Transport

It's estimated that over 80% of companies globally now outsource some or all of their logistics activities, but outsourcing does not suit all companies and some organisations are not happy with their outsourcing results.  So reduce eliminate your risk and talk to Logistics Bureau first.

We assist our customers to determine whether Supply Chain, Logistics, Warehouse or Transport Outsourcing is an appropriate strategy and if required, provide specialist support through to implementation. Logistics Bureau's consultants do not have commercial relationships with any service providers and so we provide a totally objective and unbiased approach.

 

Outsourcing Experience                            Outsourcing Video  Outsourcing Articles

Our consultants outsourcing experience also includes offshore sourcing with a number of recent projects related to product sourcing in China and evaluating the down stream Supply Chain benefits.

The Logistics Bureau outsourcing approach provides our customers with the following benefits:

1. An ethical and thorough tender evaluation process.
2. Finding the right cultural 'fit' with potential outsourcing partners.
3. Getting the best value for money from the outsourcing contract rather than the lowest price.
4. Providing professional assistance and methodologies in the outsourcing process.
5. When required, throwing the net wide, including new and developing companies.
6. Evaluation of varied 'types & styles' of outsourcing partners.
7. Providing essential decision support during the outsourcing decision, which should never be a forgone conclusion

And providing all of this, in a structured, objective and unemotional process.

Our specialist outsourcing consultants have been involved in hundreds of outsourcing and tender related projects across many industries. Our thorough and meticulous approach to outsourcing ensures success for your business.

Outsourcing Stages

Here is an example of the typical stages our consultants use in an outsourcing project, whatever the level of focus. Supply Chain, Logistics, Distribution, Warehousing or just Transport.

 

Performance Based Contracts

There is a great deal of interest in the use of Performance Based Logistics (PBL) contracts, stemming mainly from the use of such contracts within the US Department of Defence. Logistics Bureau's consultants have been very successful in taking this approach to industry, and we have been pleased with the high degree of acceptance by many of the major Third Party Logistics (3PL) companies. of this style of contract. Simplistically, our approach is to reduce as much of the logistics costs as possible to variable costs, and link elements of the 3PL's rewards to achieving specific service and cost outcomes.

3PL Contract Support

As part of our outsourcing related services, our consultants also assist third party logistics (3PL) companies in developing solutions for customers, improving current contract performance and integrating/implementing new contracts.

 

For more details on our outsourcing services, feel free to contact the following senior Staff who all have considerable outsourcing experience.

 

Sydney - David Riddle Tel: +61 417 486 166 Email	Melbourne - John Cole Tel + 61 411 706 726 Email
SE Asia - Colin Airdrie Tel: +66 819 464 490 Email

 

Logistics Contract Mediation - Logistics, Warehousing or Transport

Outsourcing Logistics operations is generally very successful, but like any commercial relationship things can deteriorate.  Sadly for both parties, this can often mean the termination or at least non renewal of a contract, which can be a costly and disruptive process for all involved.

Logistics contracts may deteriorate for a number of reasons, that typically include:

• Poor service performance
• Cost escalation
• Poor resolution of issues
• Poor communication with outsourcing partner.

But perhaps the greatest issue, is the inconsistency in outsourcing expectations.

Logistics Bureau's consultants are able to provide a 3PL contract mediation / facilitation service that can often avoid the need for contract termination and get things back on track.

This service brings together a mix of qualifications, skills and experience, that include a team of outsourcing consultants with the following:

• A former Corporate Counsel, Arbitrator and Mediator who understands and is experienced in ADR (Alternative Dispute Resolution) methodology– thereby avoiding complicated, time and resource consuming legalistic issues.
• Qualified accountants with many years experience in Supply Chain and Logistics environments.
• Senior Logistics Bureau staff (Partners) with many years of experience in outsourcing.

It is this mix, that has proven to be so successful in repairing and restoring an excellent level of service or at worst, coming to an ordered (and probably amicable) parting of the ways.

For more details on our mediation services, feel free to make direct contact with Rob O'Byrne at +61 417 417 307 or Email

Outsourcing Articles

Outsourcing of Transport and Warehousing - How to be successful?

Over the last 10-15 years outsourcing of logistic activities to third party logistics service providers has become increasingly popular. Research indicates that up to 75% of firms report positive impacts from outsourcing to logistic service providers (Langley J, Capgemini 2007). But what of the balance? Why have they have struggled to obtain the results that they were hoping for?

In this article I will outline firstly, the reasons why organizations outsource Logistics activities, and secondly, what are the key drivers for outsourcing success.

Why Do Organisations Outsource Logistics Operations?

There are many apparent motives why companies outsource, but from my experience there are four principal reasons:

Warehousing and distribution management is not a ‘core’ skill.

Peters and Waterman in their best seller ‘In Search for Excellence’ identify one of the eight factors of organizational success as ‘sticking to the knitting’. They warned that companies which stray from their core business risk their employee’s attention being diverted from that business to the point where they lose focus.

Many enterprises have taken heed and determined that inbound and outbound transport and warehousing are ‘consequential’ processes of their business rather than ‘fundamental’ or ‘core’ processes. This has fueled growth of the third party outsourcing industry and expansion of scores of logistics service providers.

While many logistics service providers commenced as transport companies they have diversified to engage in contract warehousing logistics, freight forwarding plus many other value adding services. On a world scale there are thousands of providers offering third party services, yet there are only a handful of very large ones with the ability, network, systems and infrastructure needed for multinational customers. Consider the rationalization of major players over the last five years in Australia alone e.g. DHL/Exel/Tibbet and Britten, Schenker/Bax, Toll/Patricks/Brambles/SembCorp/Finemores, Linfox/Mayne/FCL/Wesgate.

The choice of which provider to use typically depends on the local and/or international scale of the customers and alignment with the size and geographic spread of the logistic service provider.

Performance is Sub Optimal.

Related to the ‘core skill’ issue, often organizations which have a strategic focus, other than in transport or warehousing, cannot attain the desired performance levels and Key Performance Indicators (KPIs) required by their customers. For example, companies who have their own in house vehicle fleets often struggle to deliver products on time. For instance, a service ratio of less than 98% of deliveries delivered on time is a major issue for modern consumers as they have become far more demanding. Merely dealing with the complexity of transport networks, contractors, inventories, industrial unions, and cost control is tough enough for many enterprises, so achieving 98% on time performance is for some, just a dream.

On the warehousing front, checking performance against just a few industry KPIs can quickly help managers determine how effective their operations are. Telling signs are low levels of inventory accuracy, low stock turns, and low order output ratios per labour hour, high levels of unexplainable losses or damage to goods, high operating costs, customer performance complaints and high employee turnover. When these signs are evident firms often choose to outsource rather than waste time developing their own remedies.

Reduction in Asset Capital

Warehouses and vehicles are expensive to purchase or lease and can tie up millions of dollars that could otherwise be invested in the core business of the firm. Consequently there is a trend for firms to remove warehouse assets from the balance sheet, and re direct capital gained from sale of assets to working capital and / core asset investments. In choosing to outsource, firms can therefore transfer all of the costs of distribution to their profit and loss account. This is a blessing for third party logistics providers who have won large amounts of new business for this reason alone.

Flexibility and Scalability

With the advent of E commerce, increasing globalization and rationalization of industries, today’s market place demands fast, flexible and efficient supply chains. Coupled with shorter strategic planning horizons, use of logistics service providers gives organizations flexibility to expand or change their method to market and volumes handled with almost immediate effect. Enterprises will typically negotiate one to two year agreements with Termination for Convenience exit clauses in case they wish to change their short to medium term strategy to market. It is simply not possible to respond quickly to market changes if there is a fully owned or leased network of warehouse and transportation assets in place.

But What about Cost of Service?

Surprisingly cost of service, although important, is seldom a deciding factor, or driver for outsourcing decisions.

Why? Very rarely do companies save money through merely ‘outsourcing’ warehousing and transport. They may attain savings over a period of time e.g. 3-5 years, but not simply from the ‘act’ of outsourcing. The reason is elementary. Third party logistics companies have to pay almost the same operating costs as other organizations (sometimes more). While they do develop purchasing power and discount rates with transport sub contractors and other vendors, there is often little disparity between the costs of a logistics service provider and their would be customers. Why? The provider has to add a margin to their costs to be profitable.

In my experience the profit margin can range from 7-15%. This means that if a firm is seeking to bank savings after outsourcing they may well be disappointed. As a rule of thumb, companies can expect to pay from 5-10% more than current costs for outsourcing. You will recall the four reasons for outsourcing to which cost is subservient. However, cost is a critical factor in judging the value proposition of potential providers who are quoting to do the work and also in their ultimate appointment. So to be clear, cost is not a reason to outsource, but a means to assist the decision as to whom to outsource to.

What are the Key Drivers for Success in Establishing a Good Customer and 3pl relationship?

Strategic Alignment.

The outsourcing Decision must align with the company’s strategic direction. This is ‘common sense’ statement, but unfortunately not well practiced. Amazingly, many companies have suffered after outsourcing decisions were made at an operational level, without due regard to the board’s supply chain strategy. Alas, in some cases, there is no supply chain strategy to speak of. This can cause organizational stress and is a nightmare to remedy after contracts are established. These days third party providers are aware that their clients may be deficient in strategy formulation, so they include clauses in contracts which enable them to change pricing and performance mechanisms if a change in company strategy or method to market occurs.

Attention to Detail

When seeking third party quotations and contracts, there is no room for intuition, or best guesses on order velocities, volumes, processes and service requirements. Very detailed specifications must be prepared by enterprises with full disclosure of all available data before a quotation from service providers is attained. There is rarely too much information that you can gather. But where there is an absence of sensible interpretation of data, this can cause major issues in the outsourcing relationship. On a number of occasions I have been asked to sort out problems with pricing mechanisms which are based on Customer Cost of Goods Sold, Volume Sold or Percent of Revenue. On the surface these appear to be simple pricing gauges, but often they force one party, either the customer or logistics service provider to prosper or lose unfairly. The supply chain interactions of physical movement and electronic information is complex and overly simple charging mechanisms deserve close scrutiny as they can lead to disputes if one or the other party decides that they are being ripped off.

Resource Wisely

Both during implementation and the ongoing partnership a competent team is essential. Both the customer and the third party logistics company must create an open and trusting working relationship. Each company’s team should include senior relationship managers from across the organizations who meet regularly to discuss and monitor progress and performance. Too often, once an agreement is signed implementation is left under the stewardship of the logistic service provider. This is a mistake. It must be a joint exercise. The best implementations are those that have a key member of the customer on the team to lead, organize and develop the solution to full implementation with the provider. Such implementations are usually augmented by robust project management methods to ensure that all milestones are achieved.

Raise potential issues early

From my experience issues that are not dealt with proactively and in good time can fester into ‘relationship breakers’ and end in disaster. So both parties should take a long term perspective and be mature in their outlook and approach, always avoiding disrespectful behavior to the other party. It never helps if one party is kicking the other. During implementation planning phases representatives from each company should meet weekly to discuss implementation tasks. Some may argue that this is too often, but in my experience the regularity maintains momentum and full attention to successful outcomes.

Use KPIs to manage

The contract and agreement should be subject to regular reviews of KPIs. Data speaks volumes in terms of performance. For both warehousing and transport, KPIs should be agreed at the outset. Typical measures include delivery in full on time, goods lost in transit, stock damage, ullage (unexplained loss or damage), inventory accuracy, time to receive goods, and time to dispatch goods.

As a rule of thumb, no more than six KPIs should be used. But make sure you choose the ones that are most meaningful to your business. In this way a focus on the ‘facts’ can help remove ‘emotionally charged’ opinions or feelings by either party.

Summary.

Whether you are an organization seeking to outsource, or a third party logistics provider, by following these tips, you will be equipped to enter to an outsourcing agreement which is ‘fertile for growth, And well placed to build into a mature and successful partnership.

In my next article I will be covering the different types of outsourcing relationships and issues to be aware of when entering contracts.

Published in Australian Freight Logistics Magazine

Author: Mal Walker

Mal is Manager Consulting with Logistics Bureau where he works with local and international organizations to guide them in specification preparation, establishment and review of outsourcing contracts. He is a Life member of the Logistics Association of Australia, Member of Council of Supply Chain Management Professionals and a Director of Smart Conferences. He holds qualifications in engineering, business operations and logistics.

 

Outsourcing Transport and Warehousing: Pricing, Honesty and Contentious Issues

(From an Australian Industry Perspective)

In the article above I outlined reasons why companies outsource and described key drivers for successful third party logistics (3PL) relationships. In this volume I briefly describe five pricing options which are commonly used in Australia and how to ensure that the 3PL is honest, together with the four most contentious issues confronting customers as they enter 3PL contracts.

Pricing Options – Warehousing

There are five common pricing scenarios used in 3PL warehousing and transport contracts.

1 Fixed Price

In a fixed fee contract the price is held for a specific term regardless of volume fluctuations. The advantage for the customer is that it knows precisely how much it will pay for services rendered. For the 3PL, it can accurately plan its cash flow and resources to service the contract. The disadvantage for both parties is that if the contracted work varies beyond reasonable expectations at the time the fees were set; one party may suffer while the other thrives. For example, the 3PL may struggle to make a reasonable margin, while the customer experiences low cost operations.

Conversely, the 3PL may be banking large margins, while the customer languishes with a higher than expected cost base. Needless to say, fixed price arrangements eventually transition to other pricing methods.

2 Percent of Sales Value (or goods value)

In the early days of outsourcing in Australia many relationships were formed with minimal information available from customers. And dare I say, it seems that some 3PLs did not really do their homework to fully audit and understand their prospective client’s business. Oddly, it was relatively easy for a 3PL to convince a client that say 6-8% of sales value would suffice as a fee for logistics services. Not that the 3PL is entirely guilty of driving this. Some clients actively pursued percent of sales value pricing. Although, over time a number of transport companies discovered that they were losing money on such deals. Ironically, their customers perceived that the 3PLs were skimming the cream off very lucrative warehouse rate structures. Regardless of whether they were or not, it was common for the parties to fall into dispute and call in consultants to mediate. Today, there are very few companies using percent of sales value pricing.

3 Activity Based Rates

The advent of public warehousing in Australia has seen growth in the use of Activity Based Rates. These are akin to ‘piece rates’ where a charge is attached to actual volumes handled. Activity rates are common for short term storage arrangements and can be lucrative for 3PLs who are able to manage effective public warehouses. For longer term agreements, customers tend to apply pressure on providers to reduce their rates, which makes activity based pricing less attractive and risky for the 3PL, especially if volumes are low or erratic. For customers, variable rates can be an appealing means of paying for services, especially if they run a business with highly seasonal products. The advantage for customers is that they can minimize cost, but this is often at the 3PL’s expense since their ability to make reasonable margins is low. In other cases the advantage can flow to the 3PL, particularly when volumes exceed expectations and revenues go wildly beyond expectations. The downside of long term use of activity rates is that both parties eventually commence arguing over which party has advantage or disadvantage from incumbent activity rates. At this point is not uncommon for the parties to establish an alternative, which is normally the ‘hybrid’.

4 Hybrid – Part Fixed, Part Variable

Blending activity and fixed rates is becoming more popular in contemporary relationships, especially where the parties have been working together for some years. The fixed cost component normally includes the charges for warehouse space, leasing of mobile and static assets, information technology and management overheads. The activity rates or variable fees are derived from actual warehouse activities movements of product and are typically invoiced on a weekly or monthly basis.

The benefit of the hybrid is that a low fixed cost structure is supplemented by realistic volume fluctuations. The downside for the 3PL is that they have to employ assets and labour resources to support the contract, even in low periods. A common practice is for the 3PL to employ permanent labour based on minimum or average volumes, while adding casual labour to the mix as volumes increase. While customers do not disagree with this practice in principle, they are often the first to complain when KPIs are below par, or customer service suffers. These days some 3PLs place ‘peak period’ exclusions into their agreements which effectively net out service failures at peak periods e.g. Easter, Christmas, End of Month, Financial Year End etc. Even so the hybrid is becoming more common and is typically used in ‘mature’ outsourcing relationships.

5 Free of Charge Service (supplemented by other services)

Believe it or not, there are some 3PLs who provide free warehousing services to clients who are prolific users of freight forwarding or transport services across the four modes (rail, road, air and sea). How do they do this? They simply incorporate the warehousing charges into the transport rates and make sure there is sufficient overhead and margin recovery to pay for the contract warehousing services. The advantage for the customer is that an all inclusive price can be negotiated into a single transport card. Yet, the downside is that customer can remain dubious about the efficacy of the rate card particularly if it perceives that the 3PL is too prosperous. In such cases transport benchmarks are used to gauge rate integrity, and / or consultants are hauled into to arbitrate.

Keeping your 3PL Honest

Now that I have outlined the pricing options, a common question put by many customers of 3PLs is: “How can I trust the 3PL’s pricing basis?” Well, in forging customer and 3PL contracts agreements there are two common occurrences.

Closed Book Relationship

In closed book relationships, the 3PL does not divulge its operating costs, overheads and margin to its customer under any circumstances. Customer audits are not allowed and the 3PL maintains its financial privacy. Any price adjustments are subject to negotiation until the customer is satisfied with the value received and/or market competitiveness.

Open Book Relationship

The open book relationship in colloquial terms is a ‘show and tell’ method of ensuring that the 3PL is being honest in its operations and pricing of its customer’s business. The 3PL allows the customer to examine books or calculation methods used for pricing to check if charges are well founded. Open book reviews can be useful for any of the above pricing options and are frequently used for Hybrid operations.

The question of which is most suitable is debatable. While some customer’s respect their 3PL’s right to privacy, others perceive advantage in combing through the 3PLs pricing mechanisms and profit and loss account to check fee integrity. Amazingly, and despite a high number of customers who elect open book arrangements, few actually audit or review 3PL cost structures once an agreement is in place.

Entering Contracts

Many managers wonder how to structure their 3PL relationship. This answer is complex, but the short answer is that it should always be under written agreement with full specification of operations, forecast volumes, rate cards and terms and conditions. There is much to cover in this area, and too much for this article, so in the following paragraphs I will allude to the four most contentious issues which cause angst, debate and posturing during negotiation of customer/3PL contracts.

1 Liability

Strangely, companies that outsource can assume that the entire risk of the product for loss and damage should be with the 3PL, regardless of whether goods are warehoused, or in transit. Practically this is unworkable, as 3PL’s are merely service entities who gain their income from fairly thin service margins. Most simply cannot sustain the total risk of products worth large multiples more than the margins they are making on the warehouse or transport service itself.

What then is the 3PL liability (in transport) for negligence, willful damage or theft by an employee?

In Australia most transport companies are ‘private carriers’ as opposed to ‘common carriers’. By default, they reserve the right to accept or reject offers for carriage and enter contracts with set terms and conditions. Consequently, transport companies tend to specifically exclude liability for loss and damage caused by negligence and/or willful acts by employees in their contracts, or accept a very low limit of liability in such instances. Yet, at common law, the principle of negligence applies a mandate to the transport company to handle goods with reasonable care and to accept liability for damage, loss or delays resulting from negligence or misconduct of employees. Should an incident be presided over by a court, such exclusions by the 3PL may be judged as invalid in the face of State and Federal fair trading laws. So what does this mean? For the customer its worthwhile negotiating an annual allowance in contracts to cover negligence, willful damage and theft. For very large claims, the onus will be on the customer to litigate for resolution.

2 Ullage

Ullage is a term which historically refers to the quantity of liquid within a container that is lost, by leakage, during shipment or storage. The word has now developed a wider logistical meaning and is often used in contracts to define inventory losses in a warehouse facility which are unexplainable. For example, short deliveries that were not picked up, inaccuracies resulting from miss counts, over supply or under supply to a customer, pilferage and data entry errors. While clients want perfect inventory management the reality is that there is no such thing.

Most companies suffer inaccuracies in the range of 0.1-2.5% of stock value. Accordingly, warehouse providers may insert a ‘no liability’ clause in their contracts that specifically excludes them from ullage responsibility. Customers, however, typically have difficulty accepting ullage allowances, believing that their 3PL should be accountable for anything short of 100% inventory accuracy. So the pre contract debate can be hot on this issue.

3 Ownership

In the majority of 3PL warehousing operations, the goods handled always remain the responsibility of the customer until passed into the hands of the end user. By implication it is the customer’s responsibility to take out ‘all risks’ insurance to protect themselves against partial or total loss or damage. In some cases 3PLs, may enter into re seller or joint venture arrangements and accept requests to take out ‘all risks’ insurance on their client’s behalf. Although, it is normally more expensive for 3PLs to secure such insurance than their customers. Additionally, it becomes complicated when insurance claims are made for losses by both the ‘handling party’ and ‘owner’ of the policy, so these arrangements are best avoided.

4 Consequential Damages

This is indeed a contentious issue. Consequential damages can be demanded by customers of 3PLs for compensation due to loss, damage and poor performance. E.g. late or no delivery, inability to supply due to damage caused by the 3PL, below par results against KPIs. Compensation sought by customers can relate to loss of sales revenue or margin, market share, reputation, and/or goodwill. However, nearly all 3PLs who contract for both warehousing and transport will not accept consequential damages under any circumstances.

This can infuriate customers, especially if they expect their 3PL to care for their products better than themselves. But the reality is that acceptance of consequential damages by a 3PL is extremely risky and akin to giving the customer an open cheque book. If they do accept consequential damages, rest assured that the customer will pay for it, either via greater margins, or contract contingency sums in favour of the 3PL.

Conclusion

In this short article I have outlined five cost options available to customers entering contract agreements with 3PLs. Each of which can operate in a closed or open book manner. In addition, I’ve touched on the four most significant issues to be aware of when drafting contracts. There are others, but by now you may appreciate that entering outsourcing arrangements can be both time consuming and complex. Therefore I recommend that both customers and 3PLs do their homework before negotiations commence so that expectations and issues are handled professionally and without angst or misunderstanding.

Published in Australian Freight Logistics Magazine

Author: Mal Walker

Mal is Manager Consulting with Logistics Bureau where he works with local and international organizations to guide them in specification preparation, establishment and review of outsourcing contracts. He is a Life member of the Logistics Association of Australia, Member of Council of Supply Chain Management Professionals and a Director of Smart Conferences. He holds qualifications in engineering, business operations and logistics.

Third party warehousing contracts – Heading North or rapidly South?

As I sit at the Airport awaiting my flight, I ponder over the meeting I have just had with yet another company, who is dissatisfied with their Third Partly Logistics (3PL) service provider and outsourcing contract.

Some times I feel like a marriage counsellor as I listen to these tales of woe. “They don’t understand us, they don’t respond to our needs, our customer service levels are way below expectation”. Sound like a similar outsourcing story? Well take heart, the future need not be doom and gloom.

I have heard many similar stories over the years that I have been consulting in the area of Logistics outsourcing. When I hear these stories, it is often because the customer has reached such a stage of frustration that they want to re-tender their logistics contract, and are seeking assistance through the outsourcing process. Such was the tone of the meeting today. But at the close of the meeting, the customer was feeling more optimistic about the future of his 3PL warehousing contract.

Firstly, most 3PL contracts that appear to be underperforming, can be resurrected. It just takes open communication, willingness, and a focus on the key issues. An independent audit of the contract, is in itself, often a sufficient wake up call for the parties involved to improve. But in 90% of cases, I would say that contract under performance, does not lie solely with the 3PL.

In many cases, contracts have been awarded and outsourced in haste, without the necessary attention to detail that underpins outsourcing success. Such was the case today. The customer had provided inadequate information regarding their needs to the 3PL, who in turn had under resourced the contract. The result? Escalating costs and finger pointing. Both parties needed to shoulder responsibility on this count.

But rather than give up on the existing 3PL and re-tender the contract, I was pleased that the customer was willing to first carry out a thorough audit of the contract, to seek appropriate improvement. Re-tendering, and potentially relocating a warehouse operation is not with out its risks, in terms of business disruption and transition costs. So this step should only really be taken once other avenues have failed.

I feel confident that the customer will retain their current 3L once the outsourcing audit is complete, and see improvements in costs as well as customer service. The audit process that they will follow with their 3PL will focus on 6 key areas as follows:

1. Commercial arrangements. Firstly, how is the outsourcing contract resourced and costed? And secondly, what pricing mechanism is in place to ensure cost visibility as well as incentives for operational improvement.
2. Contractual arrangements. Are the expectations of the customer clearly articulated in the outsourcing contract, along with appropriate Key Performances Indicators (KPIs)? Does the outsourcing contract term fairly reflect the required investment and commitment? What are the business risks involved in termination?
3. Service and Cost Performance. What has been the real performance of the outsourcing contract, when compared to expectations? What has contributed to under performance?
4. 3PL Processes. Is the 3PL adopting appropriate processes in fulfilling the contract? Can these be jointly improved.
5. IT Systems. Are there IT issues that impact the performance of the outsourcing contract, and are there some easy fixes that can be employed?
6. The Customer – 3PL Relationship. At both the operational and account management level, are there issues with the relationship? These might be due to a mismatch of culture, or more often due to individual clashes.

This simple six-point audit plan is an effective framework to apply to a poorly performing outsourcing contract. It needs to be undertaken objectively, in co-operation with the 3PL management. It is an important first step in the process to gaining the 3PL contract that you really need and want. Ultimately, some companies may find that they still need to re-tender the contract, but at least they can do so with confidence, understanding where they went wrong first time, and with a clear plan for future success.

Author: Rob O'Byrne

Warehousing Contracts – The Options

Introduction

The outsourcing of Logistics services continues to be a growing trend, and can encompass a very broad range of services. This article will focus only on outsourced warehousing contracts, and is intended to be a guide for those companies considering the outsourcing of warehousing or indeed those companies that may wish to review and renegotiate existing outsourced warehousing contracts. The specific focus of this article, is on traditional Third Party Logistics (3PL) contracts and the types of pricing mechanisms available for use within warehousing contracts, and does not cover other very important aspects such as:

• Planning and management of the selection process.
• Contract negotiation.
• Implementation and ongoing contract management.

 

Outsourcing Logistics services continues to grow globally and probably now stands at about 80%.

The reasons for this growth are many, but primarily, that Logistics Service Provider’s (LSP) customers believe they will gain benefits such as these shown here.

 

Whilst reducing cost, is generally a major objective in outsourcing, it may often not be achieved, as simplistically, it may not be possible for the LSP to carry out the same operation as the customer currently conducts in house, at a reduced cost, whilst also making a profit margin. Where the existing in-house operation is very inefficient, inappropriately resourced or could gain significantly from being incorporated into a larger operation, then of course savings may be possible.

From this point on, when referring to outsourcing, it is the outsourcing of warehousing only that is being referred to.

The primary benefit of warehouse outsourcing should probably be thought of as gaining flexibility. This can relate to being able to handle peaks and troughs in demand, acquisitions, geographic and product line expansion and the like.

A critical stage in the outsourcing process is the structure of the contract and in particular the pricing mechanism. Research has shown that up to 80% of Supply Chain costs may be locked in at the design stage of the Supply Chain. So reducing costs post implementation can be very difficult. Most of the post implementation problems that LSP customers face can probably be traced back to poor contract structure and negotiation. It is the contract and the joint process of constructing the contract that will set in place the expectations of both parties and of course the drivers of behaviour. Typical post outsourcing implementation issues can range from poor service to increasing costs, often all put down to the non disclosure by the customer of critical information.

Cost v Price

One of the key aspects of structuring an outsourcing contract is understanding the resources and hence the costs involved in its performance. This is best achieved by open discussion and analysis of the activities and product volumes involved. Storage requirements at various times through the year are one element, but the detailed picking, packing and despatching activity can be a significant cost driver.

Detailed information on SKU (Stock Keeping Unit) numbers, size and weight are important, as are the details of past and forecasted order profiles, right down to order line items. This level of detail enables the LSP to profile the number of pick locations required, and the actual number of picks being made, on a SKU by SKU level. Accurate calculations of storage and handling equipment needs as well as labour requirements can then easily be established, which all underpins more accurate contract costing.

With a high degree of confidence in the resources required and hence the costs involved in providing the service, it is then a comparatively easy step to structure the commercial framework of the outsourcing contract.

Each Parties Objectives
It is not uncommon, for each party in an outsourcing contract can have objectives or agendas that conflict.

A well constructed contract and pricing mechanism will go along way to mitigating these potentially conflicting agendas.

General Principles

There are some general principles and considerations that should be accounted for in structuring the commercial part of the outsourcing contract. These will include the following:

1. The LSP will require a base level fee, or agreed minimum level of income that is not volume related, in order to cover some fixed costs. To do otherwise exposes the LSP unfairly.
2. The fee for service paid, should fairly reflect the resources required and costs being incurred by the LSP.
3. The fee structure should encourage improved service performance.
4. The fee structure should encourage a cost reduction culture.
5. The fee structure must be sustainable, through changes in the customer’s operating environment.
6. The LSP should have the opportunity to improve profit margins through adding value and innovation beyond the basic services required.

Sadly, many companies approach a LSP outsourcing contract as procuring a commodity and the over riding goal becomes the achievement of the lowest possible unit cost. This approach can be extremely counter productive and costly in the longer tem.

Types of Outsourcing Contract Pricing Mechanisms

There are broadly three types of outsourcing contract pricing mechanism that can be used, with variations that can be bolted on. These are:

• Percentage of Sales. Whereby the LSP fee for service is based upon an agreed % of the sales value of the product handled.
• Cost Plus. Whereby the LSP declares what resources and costs are required to conduct the service and an agreed profit margin (the plus) is added.
• Rate Based. Whereby a rate or price, is agreed for each of the activities and services to be performed.

Variations that can be applied to these basic contract forms can include:

• Gain Sharing. Whereby cost savings initiated by the LSP or customer will be shared.
• Performance Based Logistics (PBL). Whereby fees or more likely contract profitability, are directly linked to agreed performance targets.

Percentage of Sales
This type of outsourcing contract is still widely used, particularly with distributors rather than LSPs. It might be considered as a rather ‘lazy’ approach by the customer to outsourcing contract pricing, as it may bear no relation to the resources and costs of the services being provided. The greatest criticism of this type of pricing is that it offers no benefit to the customer should volumes increase, and the LSP benefits from economies of scale. The reverse is also true of course.

Where this form of pricing is used, it is important to establish limits or parameters to the service that will allow fee percentages to be adjusted if required. It is also vital that the customer is involved in the analysis of the resources and hence the costs required to perform the service. Traditionally, the customer has often not been included in this process.

The actual percentage charged can vary significantly from industry to industry, and is obviously heavily dependant on the value of the product being handled. But wide variations within the same industry have been observed and would tend to indicate that the percentage charge established may in some cases not be related at all to the cost of the service being provided, but more aligned with what the market will bear.

Cost Plus

This form of pricing is still widely used and is favoured by some of the major LSPs. It can tend to favour the LSP rather than the customer and may lead to outsourcing contracts being loaded up with resources that are not really required or at least not fully utilised by the contract concerned. It can also drive undesirable LSP behaviours in that for the LSP at least, a situation may arise in a poorly constructed contract, that the more resources that are consumed, be that storage space or labour, the better.

In its favour however, this form of pricing can often be the only way of pricing an outsourcing contract at least in the short term, where it may be very difficult to establish the precise services required or the detailed volumes and order profiles to be handled. This could be the case for example in a new business start up, entry into a new market, during an acquisition, following a major new product introduction and the like. However, it is recommended that the pricing mechanism be moved to some form of rate based fee as early as possible.

Rate Based
A rate based fee structure tends to offer the best mix. This is due to the detailed work required to establish the rates and also the volume related break points that should also be incorporated. It should result in a fee for service that fairly reflects the work being carried out, as well as protection for both parties, should the customer’s business change, in relation to volumes or order profiles. These types of change can have a significant impact on the LSPs resource needs and costs.

The basis of this pricing mechanism should be an open and shared analysis of the activity to be carried out and the resources required to provide the full range of services required. Often, a fixed monthly fee is utilised to help offset the LSPs fixed costs, with a variable fee structure then being applied for the various activities being carried out. These activities might include receiving and putaway, picking, despatch and the like, with different rates being applied for unit, carton and pallet picks.

Consideration must be given to the impact of increases or decreases in storage needs, in throughput volume and changes in the picking profile. All of these can be adequately catered for within the fee structure if based on sound analysis, forecasts and fairness.

Gain Sharing

A gain sharing formula can be applied to any outsourcing contract type. The basic concept is that should the LSP, or indeed the customer, identify opportunities to improve the operation and reduce costs, that those cost savings should be shared. The exact percentage split of the saving is debatable, but it could be argued that 50/50 is the fairest.

Without some form of gain sharing incentive, there may be limited ways of encouraging innovation and cost saving within the contract. In fact it could be argued, that without such a formula, there is a disincentive for the LSP to seek performance and cost improvement.

Performance Based Logistics (PBL)

Performance Based Logistics or PBL is a term that has evolved from the US Defence industry, and as the term suggests rewards and penalises the LSP based on performance against agreed service targets.

It should not be seen as yet another adversarial means of managing an LSP, but as a genuine means of encouraging and rewarding superior performance.
This pricing approach will generally be structured so that the LSP’s profit element can be increased or decreased, rather than attacking the LSP’s total income. In this way the right performance is encouraged, without openly putting the LSP’s business at risk. An escalation clause would also be used, so that repeated performance below agreed targets, would at some stage then start to erode base fees, not merely profit margins. But appropriate review and mediation clauses should avoid this point being reached.

Summary

In summary, this article has attempted to highlight, albeit at a high level, the range of common warehousing contract pricing mechanisms that can be utilised, and some of the advantages and disadvantages of each. Which ever pricing mechanism is used, an effective pricing mechanism must be based on detailed factual information, particularly regarding customer product volumes and order profiles, as well as a willingness for joint resource planning and contract costing. (This would normally take place after an LSP has been short listed for a contract).

Considerable outsourcing experience has shown that the failure of pricing mechanisms and often the inevitable contract failure can usually be traced to poor planning, communication, resourcing and costing, right at the start. Bearing in mind that 80% of Supply Chain costs can be ‘locked in’ at the design stage (see Introduction above), this phase of outsourcing can prove to be the most critical.

On a final note, whilst this article has been focused on the establishment of new warehousing contracts, it is not impossible to also review and revise existing contracts and pricing mechanisms.

Author:  Rob O'Byrne