There is no perfect contract model to apply when engaging in a partnership with a third-party logistics service provider. Everyone’s operation is different. But there are some basic principles that we should follow in the selection process. These include doing our due diligence: establishing their technical capacity and certifications, taking customer references, and ensuring their financial stability. A logistics contract is a medium-to-long term commitment for both parties and it should be entered into with caution.
Trends in pricing
The buyer wants value for money and to not be overcharged: the proposed service provider must make a fair profit, or their business will fail. Whatever the agreed pricing model, it should be flexible enough to accommodate business growth and market fluctuations without having to renegotiate the contract terms. The pricing or tariff structure must be easy to understand so that charges can be reconciled against the services provided. The trend is towards more transparency in supplier pricing where the cost drivers such as labour, materials, overheads, and profit are revealed.
The difference between closed and open-book pricing
In an open book agreement, in its simplest form, the service provider bills the actual costs incurred plus an agreed profit margin. This is sometimes called a cost-plus contract. Open book contracts allow us to see into our supplier’s business and understand their pricing. No one wants to risk paying a premium or an inflated margin. The open-book relationship should ensure that a competitive price is obtained and that the partner or 3PL is being honest in its operations. Where it works well:
- when the services are difficult to specify precisely up front.
- when there are seasonal peaks or market fluctuations in your business
- when there is a big change in global supply chain volatility
The challenge is that it requires an increased level of actual monitoring and oversight from the buyer. We have to ensure that the costs are market-related and that he is managing these adequately. It takes time and effort to motivate the service provider to control costs and improve productivity. Both open-book and closed-book models have their advantages.
Closed book pricing
In a closed-book agreement, the service provider bills the customer based on his fixed price list for you. These items may include set prices for delivery based on destination and item size, prices for receiving, put-away, and storage costs, either per pallet or carton. Similar menu items would be given for picking, packing, and despatch. On acceptance of his pricing, the buyer only has to check the invoices and not get involved in the detailed cost elements of the service provider’s costs. Where it works well:
- when the services are clearly specified
- when the level of service is expected to change very little over the term of the contract.
- when both the time and expertise available to monitor suppliers are limited
Hybrid solutions
Where the need is for a full range of logistics services, including warehouse management, there is a middle road, a hybrid of some fixed price elements, and some variables. The fixed-cost component normally includes the charges for warehouse space, leasing of mobile and static assets, information technology, and management overheads. The variable fees are derived from actual warehouse activities and the physical movement of products. The benefit of the hybrid is that the fixed-cost portion is a given and the variables are unit prices based on real volumes. Both parties must agree on pricing for the fixed and variable portions and how these will be adjusted as volume and capacity change.
The role of technology
One of the main benefits of using software solutions in open-book pricing contracts is the ability to track and monitor costs in real-time. An open book means transparency and access to operational and financial information for both parties. Online portals or platforms enable easy collaboration and communication and facilitate the sharing of documents, negotiation of terms, and quick resolution of any issues that may arise during the contract period. Technology tools allow for data integration and analysis, enabling suppliers and purchasers to compare costs across different periods and make informed decisions about pricing strategies. However, in practice, the service provider may not have the funds to invest in new digital solutions and is working with outdated legacy systems. This is a consideration when selecting a service provider. Quality information is a prerequisite to be able to drive benefits.
What is the best pricing model for you?
Whether the choice is open-book, closed book or hybrid, the solution should.
- be simple to understand and administer.
- avoid rewarding the contractor for poor performance and low productivity.
- drive innovation and reward cost reduction
- enable changes to be made without renegotiation.
Supply risks
Whichever type of pricing model is chosen, best-practice principles in contract management apply. Risk issues can include stock breakages and losses, ownership of assets, contingency plans, consequential damages, and customer satisfaction. Many of the potential risks can be mitigated by the continued use of key performance indicators (KPIs) along with scheduled contract reviews and site audits.
Final tips
Choose a partner that has a similar approach to business, who understands your industry sector, and who has the foresight to embrace the new digital technologies that will benefit both your businesses. The level of technical and operational support expected from the service provider should be specified in the agreement. Is it included or is it an extra?
The Supply Chain Consulting Group can help you manage the tender process and work with you to negotiate pricing to achieve the best outsource logistics contract. Our directors are experienced logistics consultants who have worked closely with clients in a range of sectors and countries to improve or expand their warehouse and distribution businesses.
Comments are closed.