3PL Contract Optimization: Cost & 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.