In my last article I outlined reasons why companies outsource and described key drivers for successful third-party logistics (3PL) relationships. In this issue I briefly describe five pricing options that 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

Warehouse Pricing

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. Percentage 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 home- work 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- age of sales value pricing.

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 percentage 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 minimise cost, but this is often at the 3PL’s expense since their ability to make reason- able 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  incum- bent activity rates. At this point it 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 and 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 sup- port the contract, even in low  periods. A common practice is for the 3PL to employ permanent labour based on minimum or average volumes, whilst 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. The  downside is that the 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

3PL Honesty

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 contract agreements, there are  two common scenarios:

1. 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.

2. Open-book relationship

The  open-book relationship is, in colloquial terms, a ‘show and tell’ method of ensuring that the 3PL is being honest in its  operations and pricing of the 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 customers 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

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, too much for this article, so in the following  paragraphs I will allude to the four most contentious issues that cause angst,debate and posturing during negotiation of customer/3PL contracts.

1. Liability

Strangely, companies that outsource tend to assume that the entire risk  of loss  and damage for the product should be  with the 3PL, regardless of whether goods are warehoused, or in transit. Practically this is unworkable, as 3PLs  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 of the margins they are making on the warehousing or transport service itself.

What then is the 3PL liability (in transport) for negligence, wilful 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 wilful 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, it is worthwhile negotiating an annual allowance in contracts to cover negligence, wilful  damage and theft. For very  large claims, the onus will be  on the customer to litigate for resolution.

2. Ullage

Ullage is a term that 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 that are unexplainable. For example, short deliveries that were not  picked up, inaccuracies resulting from miscounts, oversupply or undersupply 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 respon- sibility to take out  ‘all-risks’ insurance to protect themselves against partial or total loss  or damage. In some cases, 3PLs  may enter into reseller or joint  venture arrangements and accept requests to take out  ‘all risks’  insurance on their client’s behalf.

It is normally more expensive for 3PLs to secure such insurance than their customers and, 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 these 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.

 

 

Mal WalkerBest Regards,
Mal Walker
Email: [email protected] or call: 0412 271 503

 

 

Mal Walker is  the manager, consulting, with Logistics Bureau where he works with local and international organisations 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 the Council of Supply Chain Management Professionals and  a director of Smart Conferences. Mal  holds qualifications in engineering, business operations and  logistics.

 

 

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