3PL vs. Internal Fulfillment: Comparing Costs

For some ecommerce and multichannel companies, using third-party fulfillment (3PL) can be a viable alternative and provide high customer service as an option to internal fulfillment. As we consult with clients to assess the 3PL option, the burning question is this: “how will it compare to my internal fulfillment costs?”

In order to get an accurate apples-to-apples comparison, you have to be sure to use fully loaded costs for both internal fulfillment and 3PL. Internal costs should include direct and indirect labor, facilities costs and utilities, packing supplies, management, IT and communications allocations and benefits.

In comparison, 3PL providers generally base their invoicing on services and types of transactions (e.g., picked order and line-item charge), activities performed, space used, value added services (e.g., kitting) and agreed-upon service levels.

Steps in Analysis

These are the steps in planning and analyses:

  • Create a business profile of the services required and transaction volumes for your business.
  • Identify your total costs which will make up the fully loaded cost per order for your internal fulfillment costs.
  • Send out an RFP to qualified 3PL vendorsthat 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 comparison between internal costs and each providers’ proposed costs.

The details of this analysis are explained below. If this is not done at a low enough level, the planned internal budget and proposed 3PL costs may be understated.

Your Business Profile

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

  • Number of SKUs to be warehoused
  • Number of forward picking and bulk locations by type including pallet, shelf, floor stacked for average and peak
  • Major transactions by month such as number of receipts, shipped orders, returns and drop ship orders
  • Order profile: unique SKUs (lines) and units per order; projected orders by month; peak and average order weeks; number of single line and multi-line orders
  • Returns and exchange profile: Projected number by month and for peak and average weeks; average units returned; percent of returns which are exchanges (creates shipped order)
  • Types of value-added services such as kitting and personalization
  • On-hand inventory for peak and average week in units and pallets; inventory turnover; number of physical inventories annually
  • Expected service levels for orders, such as percentage of orders taken and shipped same day and returns goals (inventory back in stock and credited to customer accounts in 48 hours)
  • Shipping carriers, by service plans such as overnight, two-day delivery, etc.) and total shipped
  • Shipped orders and weight by state to determine shipping cost changes for each 3PL versus internal
  • Inventory accuracy meaning the expected goal
  • Error rates for order picking and returns

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

If you’re in B2B, 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 picked and shipped.

Develop Fully Loaded Costs

State in your RFP that you are doing a fully loaded cost per order analysis. Identify that you must have all expected costs you will be invoiced for. Not all costs are transaction driven, so you’ll need costs for services planned on an hourly basis. Additionally, there may be surcharges for managing supplies and inbound freight.

One of the benefits of using a 3PL in our clients’ multichannel businesses is that management can focus their time on marketing and merchandising tasks to grow the business. What part of senior management’s time is spent on managing fulfillment and customer service? What will be the salary and travel costs for a person to be the liaison to the selected 3PL?

There are expenses managed by other departments that need to be incorporated into cost per order, including IT costs for operations, programming cost expended, communications and servers used.

Understand Future Costs

  • How will your budget increase in the next three years (by year) to meet order and service level goals?
  • Will labor costs increase in your market?
  • How will your company benefits increase 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).

Will using a 3PL allow you to avoid facility expansion or a move, or eliminate projects requiring capital expenditures for technology and automation?

Calculating Cost Per Order

After arriving at the projections, calculate the cost per order. Divide the total costs for a year by the number of orders to arrive at a fully loaded cost per order for your internal fulfillment operation and the 3PL proposals.

This determination requires detailed projection and analyses. Without the detail, you will end up understating costs.

Brian Barry is president of F. Curtis Barry & Company