Prep School

Solve this problem: You’re planning to outsource your logistics and must find and negotiate with a third-party provider. What’s the one thing you need to make the process run smoothly? If you answered “Preparation,” you’ve scored an A. The ultimate goal of any contract with a 3PL provider is to establish a fair, solid, and productive partnership. Preparation has five main components: (1) Determine whether outsourcing makes sense for your company; (2) clearly define your operating and system requirements; (3) research and select the 3PL; (4) understand the negotiation criteria; and (5) make the deal.

The most important thing to confirm early on is your own company’s interest in outsourcing. You’ll need support for this endeavor from all levels of the company, as well as a variety of resources to evaluate and define your outsourcing requirements. It will take a serious commitment of time and money to develop the critical data (such as storage and throughput requirements) that form the basis of 3PL contract negotiations.

An effective method of proving the benefits of outsourcing to upper management is to compare existing costs to the potential results of outsourcing. A payback analysis showing that outsourcing saves time, space, and money will allow you to achieve internal support for it.

Don’t overlook qualitative factors. Though it’s often difficult for management to trust that an outsourcer will represent your company’s quality and customer service adequately, there are a variety of ways to improve internal comfort levels. One is to be sure to obtain 3PL client references. It is important to investigate a potential vendor’s track record. Agreement at all levels within your company that outsourcing is the right approach will strengthen your position during negotiations.

Study hall

To negotiate a contract effectively, you must define your requirements clearly. First, outline exactly what operations or tasks you plan to outsource; services you might require a vendor to provide include warehousing, transportation, inventory management, value-added functions (packaging, labeling, kitting and assembly), and IT support (online product tracking, electronic bills of lading, and proof of delivery). Then, detail all the parameters surrounding these operations. Finally, build in growth factors. These future needs should be the foundation of your vendor selection criteria. Determine whether the 3PL provider can handle unexpected changes in your operation, such as shifts in the number of products, sales volumes, and customer base.

Term paper

Once you have clearly defined your requirements, you can begin developing a short list of best-fit 3PL providers. There are many potential choices, and spending the resources to be certain that your selection is a good match will significantly reduce the possibility of future problems.

Summarize your requirements in an evaluation form that you can use to develop a list of three or four providers. Weight each requirement to ensure that the most important criteria are satisfied. A simple weighting method is to mark requirements as either (A) absolutely required, or (B) preferred, but not necessary. Based on this evaluation, generate a list of vendors to consider and then trim it down to the most promising one or two.

Your final selection process should involve a visit to the providers’ sites to help obtain an idea of how they operate. Listen carefully to vendors’ presentations and give each candidate a fair chance to describe how he can meet your needs.

Make sure to assess the operational and infrastructure flexibility in each supplier’s facility. You can avoid many of the common problems with 3PL providers by understanding what pains actual users have experienced. Considering the potential length of the selection process, you might be tempted to skip tours and interviews. Don’t. Site visits are a crucial step in making the right 3PL provider selection.

Keep in mind that the ultimate success of your choice depends on whether the the vendor can support your requirements. Price is important, but let price be one of the key tie-breakers between two providers that meet your specifications one hundred percent. No matter how costly or cheap a solution is, if it doesn’t fit your requirements, the venture is headed for problems.

Contract negotiating criteria vary from provider to provider. Apply the requirements of your business to these contract terms to calculate your 3PL costs. In general, the cost for outsourcing common warehouse services includes the amount of space required, the activity or touches essential to move product through the warehouse, and any value-added functions. Typical methods for determining the cost of 3PL warehouse services involve a cost per square foot of space used, a cost per product touch, and a cost per shipment. The 3PL provider should explain these terms in detail. Three common pricing schemes are available:

  1. Cost-plus pricing

    Create a best-guess budget when the client fails to provide precise information, and determine what margin the provider will receive. Usually, the customer pays all expenses associated with this plan.

  2. Set pricing

    Both parties agree on a flat rate (e.g., the 3PL will operate a given warehouse for $2 million per year).

  3. Variable pricing

    This cost is based on volume, and is one of the more risky ventures for any provider.

There are many variations of these pricing schemes. For example, fixed-variable fees help reduce risk for the 3PL. Fixed-variable plans set fixed costs based on things that cannot be controlled (such as racks and space) and assumes that the variable portion (staffing) can be managed. Make sure you ask if you don’t understand any of the terminology.

The most important negotiating factor for a third-party logistics business is relationship management. While a typical contract with a client may last between three and five years, longer contracts are always a plus for a vendor. Knowing this, a potential customer can use the length of the term to some advantage in the negotiating process.

Score points

Now it is time to make the deal. Your company supports the outsourcing decision; you have defined the requirements for your system, selected the most promising candidate, and know the negotiation criteria. The next step is to sit down and hammer out the contract verbally.

At this point, the 3PL involved should have a strong grasp of the requirements of your system. Make sure that all of these points are covered in the contract and that you achieve a clear understanding of your logistics solution. This portion of the negotiations should be relatively simple, since you will have gone over all of these requisites many times.

The actual terms of the agreement are going to be more complicated. Third-party service providers often wish to retain the ability to set the terms regarding origin, destination, and routing of goods. Also, they provide rates for transportation, warehousing, and management. This gives you an opportunity to specify the corresponding terms — for example, scheduling pick-up and delivery times — along with the price you are willing to pay for the services provided. The bidding volleys back and forth with modifications until these topics are agreed upon.

Another important item is to collect a list of scenarios that will allow the contract to be revised. This built-in flexibility can prevent the entire partnership from dissolving if situations change. Other points to cover during the negotiations are actions for legal recourse and penalties for violating the contract. You might find it helpful to consult an attorney if you don’t have in-house counsel.

Once you and the 3PL agree on the terms for each service discussed, you can document the verbal contract in writing.

Dean’s list

Having a clear understanding of the contractual relationship is valuable in maintaining the healthiest sort of connection for each of the two parties involved. Is the relationship closer to a partnership, or is it just a case of a customer purchasing services from a provider? Whatever the nature of the alliance, it is important to set key performance indicators to monitor how each side is maintaining its end of the contract. Ensure that this expectation is clearly described within the contract itself. Reduce the opportunities for finger-pointing. To avoid playing the “blame game,” define where the responsibilities lie with respect to theft, damages, risk, and other liabilities.

Remember that even if conflicts arise, there are ways to alleviate them and prevent them from recurring. In tests like this, clear communication and documentation will almost always make the grade.

Norman Saenz Jr. is manager of logistics at architectural/engineering design and logistics firm Carter & Burgess Inc. of Fort Worth, TX. He can be reached by phone at (817) 222-8689 or by e-mail at

A Separate Piece

Outsourced Services 2000 2001
Warehousing 63.3% 73.7%
Outbound transportation 60.7% 68.4%
Freight bill auditing payment 59.8% 61.4%
Inbound transportation 44.6% 56.1%
Freight consolidation distribution 32.1% 40.4%
Cross-docking 25.0% 38.6%
Marking/labeling/packaging 19.6% 33.3%
Selected manufacturing activities 39.3% 29.8%
Product returns and repair 17.9% 22.8%
Inventory management 10.7% 21.0%
Traffic mgmt./fleet operations 21.4% 19.3%
Information technology 8.9% 17.5%
Product assembly/installation 8.9% 17.5%
Order fulfillment 10.7% 15.8%
Order entry/order processing 2.7% 5.3%
Customer service 4.5% 3.5%
Source: CapGemini Ernst & Young, 2001
Note: Survey of 93 companies