How to Compare Internal Fulfillment Costs to a 3PL Approach

Using third-party logistics (3PL) can be cost effective and provide high customer service as an alternative to internal fulfillment for some ecommerce and multichannel companies. As we consult with clients to assess the 3PL option, the burning question is: How will it compare to my internal costs?

Each business’ costs and fulfillment environment are different and you have to provide detailed statistics to 3PL vendors by year to calculate accurate proposed costs.

In order to get an accurate apples-to-apples comparison, make sure you’ve arrived at fully loaded costs for both options. For example, fulfillment managers approve expenses for leases but generally don’t incorporate them into their cost per order thinking. This may represent 15% to 20% of the fully loaded costs. They rightfully focus on costs they control that impact order processing such as direct labor and packing supplies. They may not include IT costs or allocation of management.

A 3PL however generally bases invoicing on services and types of transactions, activities performed and service levels. They’re not on a fixed cost per order basis because of the variability of these contracted services.

To get an accurate comparison, it’s important to account for internal fulfillment services provided by other departments. This is important because a 3PL will include all costs such as fulfillment center space and utilities, IT, communications and equipment, recruiting, benefits and management.

These 6 considerations will help you arrive at fully loaded costs per order for each option:

Steps in Analysis

  • Create a business profile of the services required and transaction volumes.
  • Identify every component of the fully loaded cost per order for your internal fulfillment.
  • Send out an RFP to qualified 3PL vendors that meet your high-level criteria. Request a three-year projection of all costs by year indicating any factors used to increase services.
  • Develop an accurate apples-to-apples comparison between internal fulfillment and each individual 3PL providers’ proposed costs.

The details of these steps follow. If this is not done at a low enough level, the planned internal budget and proposed 3PL costs may be understated.

Business Profile

For 3PLs to give you an accurate cost proposal, outline your business in terms of services, expected usage and transaction volumes by year. We recommend a three-year time horizon which aligns with typical contract length.

Each vendor has a questionnaire to identify services, transactions and service levels. Here are some measures which directly affect proposed costs:

  • Number of SKUs
  • Number of forward picking and bulk locations by type (pallet, shelf, floor stacked for average and peak)
  • Major transactions by month (number of receipts, shipped orders, returns and drop ship orders)
  • Order profile: Unique SKUs and units per order; projected orders by month; peak and average order weeks; number of single line and multi-line orders annually.
  • Returns and exchange profile: Projected number by month and for peak and average weeks; average units returned; percentage of returns exchanged
  • Types of value-added services
  • On-hand inventory for peak and average week in units and pallets; inventory turnover; number of physical inventories conducted annually
  • Expected service levels: Percentage of orders taken and shipped the same day; returns goals (i.e. inventory back in stock and credited to customer accounts in 48 hours)
  • Shipping carriers, by plans (overnight, two day, etc.) and total volumes shipped.
  • Shipped orders and weight by state, to determine cost changes for each 3PL vs. internal
  • Targets for inventory accuracy
  • Picking and returns error rates

Keep in mind you’ll need both marketing’s projected order counts and fulfillment’s shipped orders. The number of shipped orders by carton is always higher than marketing because of back orders and ship-alone products.

If you have B2B business, the statistics will be somewhat different. For example, you’ll want to compile the number of pallets picked and shipped as well as full cases.

Develop Your Fully Loaded Cost Per Order

For internal fulfillment, what are your expense categories? Typically, these include items such as direct and indirect labor, facility costs and packing materials. What are the other allocations of fulfillment costs? What other departments provide services to operations which would no longer be incurred? Include these in your internal cost per order.

State in your RFP that you are doing a fully loaded cost analysis. Tell them you must have all expected costs. Not everything is transaction driven so you need to determine service costs on an hourly basis. There may also be surcharges for managing supplies and inbound freight.

Incorporate Overhead in Cost Per Order

One of the benefits of using a 3PL is that management in SMB merchant companies tends to focus their time on marketing and merchandising to grow the business. How much of senior management’s time is spent on fulfillment and customer service? Convert that to dollars spent.  Include this expense in the fully loaded cost per order.

What is the salary cost for your internal liaison to the 3PL? Include a travel budget for periodic visits.

Expenses managed by other departments need to be incorporated into the cost per order calculation, such as IT, programming, communications and servers.

Understand Future Costs

How will your budget increase in each of the next three years to meet order and service-level goals? Will labor costs increase, including benefits to remain competitive?

As you negotiate with 3PLs, how will their costs increase by year? For example, agreements may factor in future costs with the consumer price index (CPI).

Thinking about your company’s growth and needs, will a 3PL partnership allow you to avoid facility expansion or a move to new facility, or eliminate projects requiring capital expenditures for technology and automation? Include this in your comparison.

Calculating Cost Per Order

You can see that doing a 3PL cost analysis is not a quick task. When you’ve determined your best projections for both options, calculate the cost per order. Divide the total costs for a year by the number of orders to get a fully loaded cost per order for each option. We find this often gives senior and fulfillment management a totally new perspective.

Determining a cost comparison requires detail projection and analyses. Without it, you’ll end up understating costs.

Brian Barry is President of F. Curtis Barry & Company

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