Logistics Outsourcing… is like Marriage!… Really?
OK, so as I explained in Part One, in my view logistics outsourcing is like a marriage! And so I’m providing this three part article to help you with these sometimes challenging relationships. Outsourcing that is……I’m certainly no marriage counsellor.
In Part One I posed the question “Why Do It? What are you Expecting”?
In Part Two, I’ll be covering “Planning the Big Day” (The Wedding)
And then next month, we’ll take a look at Part Three, “After the Honey Moon is Over”…
I’ve been involved in so many assignments where clients have asked me to ‘fix’ a broken outsourcing relationship, that I truly hope these tips will help you avoid reaching that point.
Sadly the ‘kids caught in the middle’ are often your customers…
My aim is to share these tips with you, to help you; find the right partners, who can provide the right services, at the right cost, on a sustainable and long term basis.
Part 2 – Planning the Big Day” (The Wedding)
We’ll assume at this stage that outsourcing Logistics is the right strategy for you, or that you have decided for some reason to ‘go to the market’ if you are already outsourced.
You’ve done your research and you’ve come up with a list of potential outsourcing partners. Not too many so as to make the task of selection unmanageable, but enough to ensure that you have a good cross section of capable and suitably ‘qualified’ contenders.
OK, Stop right there! Because it’s here that most people make a big mistake.
In their enthusiasm, or pressure from their boss, they launch into the selection process ill prepared. This phase of outsourcing, from the selection of ‘potential’ partners, to the final selection process is the most critical phase to get right.
Get it wrong and your business may not only lose money and lots of it, but lose customers and you’ll have lots of sleepless nights.
You’re going to be putting a critical function of your business in the hands of a third party. A business function that is very often the only ‘physical interface’ with your customers. So let’s be careful, objective and thorough.
It’s hard to cover all the important things in these brief articles. I mean you could write a book on this stuff! In fact I have… five books. But let me boil this phase down to five key areas:
- Service specifications and expectations
- Commercial terms
- Rate mechanisms
- Partner selection
1 – Service specifications and expectations. Think of the service specification as the ‘blue print’ of your Logistics requirements. It doesn’t matter quite ‘what’ you are outsourcing, these principles will still apply. If you were going to have a house designed and built, what instructions would you give to the architect?
Would it go something like this?
I’d like a really nice house please, with quality fittings and appliances that I’ll be proud to entertain my friends in and I don’t want to pay too much.
Or would it go more like this?
I’d like a 4 bedroom 3 bathroom house, as I have 3 kids. We also like to entertain so I’d like a lounge and dining area where we can easily cater for a dozen people. Whilst we can’t afford it yet, we’d like a pool, so we need space behind the house for that. And we have 2 cars that will need a garage. Oh, and our budget is $500,000 for the design and construction.
The latter will get a design that better matches your needs. Why? Because we gave more detailed requirements. It’s the same with Logistics Outsourcing. The more detail you give to prospective partners, the better they will be able to design their services to meet your customer service needs and budget.
You don’t need to provide a lot of detail in your first approach to the market. You may add in a step called an ‘Expression of Interest’, whereby potential suppliers are given an outline of your needs and you ask if they wish to bid for the contract. But at some stage, you will need to provide lots of detail. This is usually called the RFT (Request for Tender) or RFQ (Request for Quotation). A key part of this document, let’s call it the RFT, will be the service specification.
In the service specification, in effect the requirements ‘blue print’, you need to include sufficient information for the potential suppliers to accurately plan their resources and costs, and hence their price. If you don’t, guess what? They will ‘pad out’ their cost structure to protect themselves from uncertainty. And who can blame them. So your service specification will include such things as:
- Product Profile: List of products, dimensions, weights. (for storage and handling calculations)
- Order profiles: Number of orders, size of orders.
- Customer profiles: Types of customers, demand volumes, locations.
- Storage profiles: Number of products, stock levels.
- Service needs: Service requirements by customer type.
2 – Contracts. I would always include a draft contract with your RFT. Because this allows you to be clear right up front on the type of relationship you are seeking.
The contract will include such things as; term of contract; services to be provided; service standards; asset ownership; reporting requirements; dispute resolution and so on. Making all this clear up front helps get the relationship off to the right start.
Lots of people ask me what a reasonable contract ‘term’ is. It varies.
Think about the investment that the supplier may have to make to support your contract. The higher the investment the longer contract term they will generally expect.
3 – Commercial terms. You need to be quite clear about what commercial terms you are seeking, but also be prepared to be flexible and open to negotiation. The commercial terms would normally cover aspects such as; who owns what, who has liability for what, insurances, over what ‘term’ invoices will be paid, invoice disputes and the like.
4 – Rate Mechanisms. I’ll talk about principles here rather than specifics. Because warehousing rates will vary from transport rates and both can be quite complex in their detailed structure.
But the over riding principle here, is that wherever possible you should be paying a variable cost and a cost that fairly reflects the service or activity being provided. Let me give you two extreme examples that are based on real life case studies.
The percentage. A 3PL was storing and distributing pharmaceutical products. The basis of the fee for service was a % of the sales value of the product. OK, ask yourself this. What has that got to do with the cost of providing the service? Nothing! Quite honestly it’s a lazy way to charge for a service and is based purely on establishing the total cost of providing the service and balancing that against the value of the goods being distributed. i.e. It costs $10 million a year to provide the service, and we deliver $200 million of products at sales value, so we’ll charge 5% of sales as a warehousing and distribution fee.
OK, but what if the product range changes? (because the value will change). What if the customer base changes? What if customers order more frequently in smaller quantities? Is that happening to you now? Because the cost of storage and distribution on a per unit basis will go up!
Cost Plus. is another rate mechanism you will come across, whereby the supplier determines what resources are required to perform the service for you and then charges that cost ‘plus’ an agreed margin. That’s lazy too. And is really only appropriate for start up operations where the resource requirements are hard to establish. It’s also a means whereby unscrupulous suppliers will charge multiple customers for the same resources…..
Fixed and Variable. I much prefer a fixed and variable rate structure. In this way a fixed fee is paid, usually on a monthly basis. It covers some of the suppliers fixed costs, regardless of the volume of product being stored or distributed. Then the variable cost, rather like activity based costing, will add an additional fee based on the actual volume of product being handled.
In this way both parties have a degree of protection should product volumes or customer profiles change over time. I often structure these types of rates by having both parties agree what resources are required regardless of product volume and then, what resources are more volume related. We then look at the actual resource requirements of the contract, the resource costs, apply some volume sensitivities and end up with a fair rate structure.
5 – Partner Selection One last thing and vital thing I should add; is the selection of your outsourcing partner. And let me first make a plea. Maintain total objectivity for as long as you can in the process! Involve a cross functional team in the evaluation and selection process. Use an objective scoring matrix during the evaluation. Then at the final stages, allow the emotion some space. Who do you really feel comfortable with, who do you trust?
Other important factors are these:
Resources and Costs. Take your time to go through the proposed solutions so that you fully understand the resourcing of your contract. The head count, the facilities, equipment and so on. Then look at the resource costs and how this ‘rolls up’ into the contract pricing.
The People. I have touched on this already, but make sure you understand who you will be dealing with on a day to day basis. Who will manage the overall contract? Who will manage the implementation? Have you met all of these people? Are they a good fit with your organisation?
Implementation. I’ll cover a bit more about implementation in Part three. But at this stage, let me just advise that you need to make sure the supplier is providing an experienced implementation team and implementation manager, that the time frames are realistic, and that you understand who is doing what and who is paying for what! All too often things fall through the cracks. And usually it is around responsibility and accountability for implementing IT.
So that covers Part two. Planning the big day. Or the day we award the contract.
There is so much more I would love to share with you, but space is against us. So what I’ll do instead; is to share some specific materials from my books to give you more detail on the topic.
And here is Part 3: Logistics Outsourcing Part 3
I hope you find this information of value. Feel free to let me know what tips you would like to hear about in our next Bulletin. Just send your requests to my PA Rose.