Best Practices in 3PL and Fulfillment Contract Procurement

With the proliferation of online shopping, the eCommerce industry is growing exponentially. As a direct result, Third Party Logistics (3PL) fulfillment support services are a rapidly growing and considered a critical part of the customer experience. 3PL fulfillment support services are not only important to completing the last leg of the eCommerce and B2B transactional process, but also impact customer satisfaction, long-term customer loyalty, and the overall brand experience.

The 3PL fulfillment market has changed significantly over the last 50 years, and the scope of the support services has also changed throughout the decades. Overall direction of the industry changed forever on July 5th, 1994, when Amazon was founded and began operations. In the late 20th century, online commerce launched a modern-day gold rush and, with newfound fortunes to be made, the fulfilment market was flooded with new companies from various industries that all wanted to stake their claims.

Today, understanding the 3PL market options, pricing methodologies, and Service Level Agreements (SLAs) is critically important to selecting the best 3PL partner to support your current needs and help you scale your business for the future. The 3PL contract optimization process starts with selecting the right partner, developing the appropriate contract terms and conditions, scope alignment and performance incentives to lay the foundation for a successful partnership. Ongoing contract optimization requires a formalized process to evaluate performance, review market alternatives and deliver efficiencies. The ideal state of fulfillment services contract optimization is achieved when the 3PL relationship delivers maximum shareholder value from best-in-class pricing, outstanding service, and long-term goal alignment.

The fulfillment services market has been evolving and adapting to changing market conditions over the past 50 years. In its infancy, the fulfillment services industry was primarily catalog order pick and pack, point-of-sale distribution, and product warranty support. In the 80’s and 90’s consumer rebates and direct response support services grew dramatically. During that period, these companies were commonly referred to as fulfillment centers rather than 3PLs.

Little did these fulfillment industry pioneers know that their market, and the entire scope of the support services landscape, would forever change when Amazon entered the market on July 16, 1995, selling books online and accelerating the emergence of the eCommerce channel.1 During the late 1990’s, eCommerce as we know it today, was just getting started, but quickly adapted to consumer demand and changing market forces.

By the end of the 20th century, the future of the eCommerce market, and the services required to support the accelerated market expansion, became clearer. The need for efficient parcel and LTL transportation solutions to deliver products to consumers and trade partners also increased. As the amount and complexity of these services became increasingly more dynamic, the business classification of fulfillment center was no longer appropriate, and these companies were dubbed 3PLs.

At the start of the 21st century, with the eCommerce boom unquestionably taking shape, the demand for 3PL fulfillment services grew exponentially. It was a modern day goldrush. Companies from all different industries that were seemingly well positioned to take advantage of this opportunity, entered the market to stake their claims. The longstanding, traditional fulfillment companies quickly pivoted and retooled to meet eCommerce product fulfillment support needs. With new companies, from a multitude of industries, also wanting to capitalize on the growth of the Direct-to-Consumer (DTC) and Business-to-Business (B2B) 3PL market, the market became flooded. Printers, LTL & FTL transportation companies, and even eMerchants, entered the market at a staggering pace. In addition, Venture Capital money was in abundance for these next generation startups that wanted to profit from this growing industry.

Fast forward to 2021 and the 3PL market is now a complex, and different, landscape. Overall, the 3PL Fulfillment Services market is saturated, with over 700 3PLs in North America alone and over 90% of those companies offering DTC fulfillment support services. Today, there are many kinds of 3PLs all trying to grow their piece of this multi-billion-dollar industry. There are micro, local, regional, national, North American, and global 3PLs. There are 3PLs that specialize in DTC, B2B or both. There are also industry specific areas of specialization like apparel, health & beauty, FDA, hazardous materials, cold-chain and frozen foods. The market will continue to evolve, and if you’re an eMerchant, you need a great 3PL partner. The ultimate key is to select the right partner and optimize that relationship over time.

One of the most difficult tasks in developing an outstanding 3PL partnership is selecting the best 3PL to support, not only your current needs, but your future needs as you scale your business. It is critically important to your company, your customers, and your shareholders to find a strong 3PL partner, the first time. Selecting the wrong 3PL can have a negative financial impact on your business, and adversely affect the customer engagement experience, increasing customer attrition rates. Companies end up burning valuable resources managing 3PL issues that could have been deployed for more constructive purposes, like growing their business. This situation can easily be avoided with the help of the proper industry experts to vet and help select the ideal partner.

Finding the ideal 3PL partner sounds easy, but there are over 700 3PL fulfillment options in North America alone. With so many options, how do you best understand the market and your options? Clearly, you can use the conventional sourcing strategies of market research, leveraging your network, and reviewing available data from trade associations.

Unfortunately, for the 3PL fulfilment services market those methods will only yield limited benefit. Online market research will lead you straight to a relatively small number of 3PLs that do a great job with search engine optimization and brand promotion, only to provide you with mostly biased marketing rhetoric. Leveraging your network of contacts is a good way to get referral recommendations. However, unless your contacts are experts in the 3PL fulfillment market and your specific support needs (which most aren’t), that will likely fall short of the desired goal. Trade associations can be an excellent source of unbiased market knowledge, but in the 3PL fulfillment market they are almost non-existent. The trade associations that are well positioned to focus on the issues important to the 3PL fulfillment industry, primarily focus on the 3PL logistics and transportation segment of the market. As a matter of fact, if you search on Google for 3PL fulfillment trade associations, the results mostly yield the same 3PLs that you find when performing online market research for 3PL fulfillment services.

To effectively understand the 3PL fulfillment market and your options, the best source of unbiased, comprehensive market intelligence is the small number of consultants and subject matter experts (SME) who specialize in the space. The leading 3PL fulfillment marketing consultants include, but are not limited to Shipware, LLC, Armstrong and Associates, Inc., F. Curtis Barry and Company and Sedlak Supply Chain Consultants. Consultants and SMEs can be an invaluable resource in helping you shorten the timeline and improve the results of your 3PL fulfilment market assessment and partner selection process. This strategic sourcing strategy will pay dividends that go straight to your bottom line.

Once you have identified a select number of qualified 3PLs seemingly well suited to support your needs, it is important to have a formal vendor/partner selection process. This process normally starts with a formal Request for Proposal (RFP) or a less formal Request for Quote (RFQ). The RFP or RFQ should document, and clearly communicate, your support requirements, service objectives, and relationship goals. Once you communicate your requirements, request a formal services proposal from each 3PL to better understand their capabilities, technology, value proposition, level of professionalism, fee structure, and total cost of ownership. Getting to know and evaluating each 3PL is collaborative process that takes time, effort, ongoing dialog, and due diligence.

Once you better understand your options, there are several key considerations when evaluating prospective 3PL partners:

• – Overall value
• – Culture
• – Willingness to invest in the relationship
• – Technology capability
• – Fee structure and pricing
• – Vertical market expertise
• – Geographic footprint
• – Size, scalability and infrastructure
• – Available capacity and expansion plans
• – Inbound and outbound transportation options and pricing

After you select a 3PL, it’s time to negotiate and execute the Master Services Agreement (MSA) and Statement of Work (SOW). For the most part, standard 3PL MSAs are one-sided agreements, developed specifically to protect the 3PL’s best interests. Also, they are among the most complicated agreements encountered in business.2 Standard 3PL SOWs are typically much more bilateral, and document the agreed upon client fulfillment support requirements and specific operational workflows to achieve the desired results. In practice, many merchants do a decent job of incorporating their required terms and conditions into the MSAs, however overall, most agreements do an inadequate job of protecting both parties’ best interests and clearly defining support requirements. It is vital to structure your 3PL contracts to clearly define the support requirements, memorialize the agreed upon terms and conditions, and provide the foundation for future optimization opportunities.

Once you have a 3PL relationship established, contract optimization is a continuous process that requires commitment, focus, and attention to detail. It is important to have a formalized and structured process that can deliver ongoing, incremental results over time. When developing and executing a formal 3PL contract optimization process, the first step is to answer a few relatively simple questions (Figure 1) to determine if further optimization is required:

Figure 1: 3PL Fulfillment Optimization Questionnaire

If you answered yes to all the above questions, congratulations. You most likely have an optimized 3PL relationship and contract. That being said, there may still be room for cost improvements. If you answered “no” to one or two of the above questions, it’s very likely that there’s an opportunity for contract and relationship optimization. If you answered “no” to three of more of the above questions, your 3PL is most likely not a strategic business partner but a vendor, who is probably negatively impacting your business, and there is a significant opportunity for improvement.

If you determined that contract optimization is required, the first step is to identify the shortcomings and develop a structured plan. Are most of your areas for improvement related to cost, service, communication, or goal alignment issues? After you’ve identified the areas of opportunity, you need to develop the formalized action plan. Determine if you want to work on continuing the relationship with the current 3PL or change providers. You may not know at this point, but one thing should be very clear: If you are unsure if you want to continue your relationship with you current 3PL, you should perform a comprehensive market assessment to evaluate your alternatives.

Let’s start with the assumption that you value your relationship with your existing 3PL and want it to continue. In that scenario, you should first identify the key issues that need to be addressed. Is your focus to reduce costs, improve service, have better goal alignment, or a combination of those factors? Once you’ve identified the key challenges, develop a formalized plan to address those issues with your 3PL. It’s very important to take a partnership approach to the process. If your 3PL is a true partner, they will openly help you improve areas of deficiency.

Next, discuss the issues directly and openly with your 3PL. If possible, have the meeting in person or, at minimum, by video conference, so you can see their reactions and read their body language. If they are receptive, engage in constructive dialog to develop of a formalized strategic plan to address your issues and the opportunities for improvement. If they push back, get defensive, or make excuses, you may want to consider an alternative course of action.

Whether you want to change providers, evaluate alternatives or just gain leverage with your current 3PL, the next step is to perform a market assessment to evaluate your options. The process is the same as selecting the best 3PL partners in the section above, but you will need to decide if you want to perform a formal RFP process or take a less formal approach. Figure 2 below highlights the major milestones of the 3PL optimization process:

Figure 2:  3PL Optimization Process

Since the main objective here is to focus on contract optimization best practices, we will not get into details of the procurement tactics, but rather review the process for maximizing the overall 3PL relationship value.  Next, we will focus on working towards the ideal state of 3PL contract optimization to achieve maximum 3PL relationship value.

The value that you receive from your 3PL relationship is a function of three main factors: cost, service and goal alignment. We will elaborate on each of these factors in the next three sections.

Let’s start by reviewing the cost of 3PL fulfillment services. The overall value that you receive from your 3PL has a direct correlation to the overall cost and detailed transaction pricing for each of their services. Within the 3PL fulfillment services market, there are numerous pricing strategies, so it’s important to understand the differences.

The various 3PL pricing strategies aren’t difficult to understand, but what is significantly more challenging, is estimating and comparing the cost per order and total cost of ownership between the various pricing methodologies. As reviewed above, the 3PL market expanded rapidly when a host of companies, from vastly different industries and market segments, entered the fulfillment services space. These new market players brought with them their own set of pricing models and industry-specific best practices. Unfortunately, the are no formal industry standards regarding 3PL pricing guidelines and, as a result, there are numerous pricing strategies and hybrid models that have emerged over the years.

Some 3PLs price their services based on a detailed menu of services with specific line items, for example: receiving, storage, order processing, pick and pack, small parcel, and less-than-truckload (LTL) freight. Each line item includes a gross margin anywhere from 10% – 80%.

Other companies use a bundled pricing model wherein they provide multiple services for a lump sum price per order. This model is appealing to some customers because they have a good understanding of their all-in cost per order.

Then there are companies that add literally no markup on their warehousing and pick and pack services and make almost 100% of their margin on transportation services. These 3PLs tend to be the larger companies that have negotiated superior parcel and LTL contracts.

The last group of 3PLs are those companies that make 100% of their margin on warehouse, pick and pack transactions and pass-thru the parcel and LTL charges at cost. This group of 3PLs are typically fully transparent regarding their parcel and LTL cost structure.

The common denominator for all these pricing strategies is that they build profit margin into different aspects of their pricing models and it’s not always easy to understand where, which is key to optimizing and controlling your costs.

When cost reduction is a primary goal of the contract optimization process, it’s important to understand the various pricing models, and to focus your negotiations on the areas that will deliver maximum impact. Clearly, transportation costs (small parcel and LTL) are the single largest expenditure for most companies outsourcing DTC and B2B fulfillment services and should be a primary area of focus. It’s important to understand how your 3PL prices their transportation cost, and the easiest way to accomplish that, is to ask them. In most cases they will be open and transparent. If not, that’s a big red flag.

Some 3PLs have negotiated superior small parcel and LTL contracts and pass all, or part, of those savings onto their clients. In general, the larger 3PLs have more favorable carrier agreements, but they don’t always offer the most aggressive rates to the customers. Furthermore, the amount of transportation spend does not always equate to high discounts off published rates. It really comes down to how effective the 3PL is at negotiating their own carrier agreements. Each 3PL has their own carrier contract “sweet spots”. As an example, some 3PLs have great rates for lightweight shipments, while others specialize in heavier packages. Most have negotiated their carrier agreement based on their volume and unique package characteristics. It’s important to take all these factors into consideration when selecting a 3PL partner and/or optimizing your contact.

Regarding LTL rates, it can be difficult to compare 3PLs. When evaluating options, it’s important to understand the 3PL’s level of sophistication, carrier relationship, and flexibility. You should work to understand which LTL carriers the 3PL works with, the nature of those relationships, and how rigid or flexible those carriers are. Since LTL tariffs can vary widely, it’s wise to price some sample shipments during the cost evaluation process.

Two other areas, which can largely impact cost and an area for contract optimization focus, are storage and pick and pack fees. Storage fees can add up quickly and there are copious ways that 3PLs charge for those services. Current pricing strategies include, but are not limited to, cost per pallet, bin, cubic foot, square foot, etc. Pick and pack fees can also vary widely and can be a large component of your overall cost equation. Efficiencies like pick-to-light, forward picking modules, robotics, and conveyor systems can deliver efficiencies and lower costs.

The second component of the value equation is service. 3PLs are the last step in the eCommerce consumer engagement process and customers expect a seamless and efficient experience. If the fulfilment process isn’t executed flawlessly, it will negatively impact consumer satisfaction, long-term loyalty, and the overall brand experience.

Receiving exceptional service from your 3PL starts with clearly communicated support requirements, followed by incorporating those requirements into your MSA, measuring service performance metrics, and reviewing the results on a regular basis. 3PL MSAs memorialize the terms, conditions and services relationship between the parties. Therefore, it’s imperative to have clear SLAs in the MSA to protect your best interests but it’s very common for contracts to lack key SLAs.3

To ensure that you receive maximum value from your 3PL relationships, every MSA should have focused and measurable SLAs. SLAs are not the “Big Stick” of contract enforcement, but rather the guiding principles that ensure performance metrics are clearly defined so the 3PL is consistently working to achieve the common goals of the partnership.

In my experience, over 80% of 3PL contracts either have:

• – SLAs that are not in alignment with relationship goals
• – SLAs that cannot be measured
• – SLAs that can be measured, but are not
• – No SLAs at all

It is troubling that in today’s day and age, everyone wants to talk about strategic partnerships during the sales process, but when it comes to mutually beneficial business goals and delivering services that are in alignment with those goals, many companies don’t even take the time to develop thoughtfully focused and measurable SLAs.

SLAs should be formalized, documented, measured, reviewed often and adjusted as support requirements change. SLAs will be slightly different for each business, but it important to structure SLAs to support the business objectives and provide financial penalties for non-conformance. You may also want to consider providing additional, incremental compensation to the 3PL when they consistently exceed SLAs, especially during peak volume periods. Figure 3 below highlights the industry standards regarding the minimum SLAs to incorporate into your Services Agreements:

Figure 3: 3PL fulfillment SLAs

Having specific and measurable SLAs will pay significant dividends throughout your 3PL relationship, ensuring goal alignment and a memorable customer experience.

The final area of focus for 3PL contract optimization is goal alignment, as it will deliver outstanding tangible, and intangible, return-on-investment.

The goal alignment process begins well in advance of selecting a 3PL and is an ongoing process throughout the course of the relationship. Relationship goals can differ greatly, but are primarily focused on quality, continuous improvements, and cost reduction or cost containment. As we’ve reviewed, quality is critically important to brand integrity, customer satisfaction, and long-term growth. SLA compliance is a foundational requirement for quality, and must be defined, measured, and reviewed often.

Continuous improvement is the ongoing effort to enhance services or processes, and requires consistent, incremental advancement over time. It is extremely difficult to deliver without a common foundation to build upon, so establishing that foundation is vital to successful 3PL partnerships. The foundation starts with clear relationship goals and objectives between all parties and will yield substantial results with clear communication and attention to detail.

Cost reduction or cost containment is much easier to achieved with goal alignment. By defining quality objectives and executing continuous improvements strategies, you will see cost reduction opportunities materialize over time. Add cost reduction goals into the MSA and provide 3PL financial incentives for identifying operational efficiencies that deliver service improvement and cost reduction. By offering material financial incentives for creative cost reduction strategies, it will provide a platform for innovative ideas and workflow improvements. Another best practice is to encourage your 3PL to incentivize their employees, as well. Financial incentives clearly motivate and encourage proactive ideation at all levels.

The most effective way to drive your quality, continuous improvement, and cost reduction goals is to leverage periodic business reviews with your 3PL. Business reviews should be completed on a regular semi-annual or quarterly cadence, as needed. They should focus on strategic goals, SLAs, performance improvement opportunities, and cost reduction strategies. Business reviews are a great opportunity to strengthen your partnership with your 3PL and improve overall results.