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 rapidly growing and increasingly considered a critical part of the customer experience. 3PL fulfillment support services are not only integral 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 foundations for this current 3PL fulfillment market first began changing over the last 50 years, and the scope of the support services alongside it. Most significantly, the overall direction of the industry changed forever on July 5th, 1994, when Amazon was founded and began operations. This launched a modern-day gold rush via eCommerce and, with newfound fortunes to be made, new companies from various industries flooded the fulfillment market attempting to stake their claims.

Today, understanding the following is crucial to navigating the resultant developments and selecting the best 3PL partner to support your current needs:

• 3PL market options
• Pricing methodologies
• Service level agreements (SLAs)

The right choice will 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 last half-century. In its infancy, the fulfillment services industry primarily provided services consisting of:

• Catalog order pick and pack
• Point-of-sale distribution
• Product warranty support

In the ‘80s and ‘90s, 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 joined them on July 16, 1995, selling books online and accelerating the emergence of the eCommerce channel.¹ During the late 1990s, eCommerce—as we know it today—was just getting started, but it 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 its 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.

These companies were dubbed third party logistics providers, more commonly 3PLs.

The Development of Modern 3PL Fulfillment

To understand why businesses use third party logistics, it helps to understand how 3PLs started and how far they’ve developed. 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 gold rush.

Companies from all different industries that were seemingly well-positioned to take advantage of this opportunity entered the market to stake their claims on logistics service providers. The longstanding, traditional fulfillment companies quickly pivoted and retooled to meet eCommerce product fulfillment support needs. But with so many wanting to capitalize on the growth of the Direct-to-Consumer (DTC) and Business-to-Business (B2B) 3PL market, that market became flooded.

Printers, LTL & FTL transportation companies, and even eMerchants entered the market at a staggering pace. In addition, Venture Capital money became abundant for these next-generation startups seeking to profit from this growing industry.

Fast forward to 2021, and the 3PL market is now a different, substantially more complex 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’s numerous types of 3PLs are all trying to grow their piece of this multi-billion-dollar industry through their different service offering variations:

• There are micro, local, regional, national, North American, and global 3PLs.
• There are 3PLs that specialize in DTC, B2B, or both.
• There are industry-specific areas of specialization, including:
  • Apparel
  • Health and beauty
  • FDA
  • Hazardous materials
  • Cold-chain and frozen foods.

This market and its available services 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 provider 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 provider or partner 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.

3PL Partner Selection Challenges—Conventional Approaches Don’t Work

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

Unfortunately, those methods will only yield limited benefits when applied to the 3PL fulfillment services market:

• Limited digital presence of trusted 3PLs – 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.
  
• Limited network expertise – Leveraging your network of contacts could generate 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.
• Few trade associations with 3PL knowledge – 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 this industry primarily target the 3PL logistics and transportation segment of the market.  As a matter of fact, a Google search for 3PL fulfillment trade associations mostly returns results for the same companies that you’ll 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.

Leading 3PL Fulfillment Market Consultants and SMEs

The leading 3PL fulfillment market consultants include, but are not limited to:

• Shipware, LLC
• Armstrong and Associates, Inc.
• F. Curtis Barry and Company
• 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 fulfillment market assessment and partner selection process. This strategic sourcing strategy will pay dividends that go straight to your bottom line.

The 3PL Partner Selection Process

Once you have identified a select number of qualified 3PLs that are 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
• Total cost of ownership (TCO)

Getting to know and evaluating each 3PL is a collaborative process that takes time, effort, ongoing dialog, and due diligence.

Key Considerations for 3PL Partner Evaluation

When it comes to third party logistics outsourcing, there are certain aspects of a service provider to look out for. 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

All of these considerations are important, but you may want to rank their priority to help assess and compare multiple potential partners when outsourcing third party logistics.

3PL Insurance for Damaged Products and Other Scenarios

When considering which 3PL partner to select, you also want to consider their documented processes and coverage for when fulfillment fails or products are damaged and it’s your 3PL’s responsibility. Unfortunately, in an industry this complex, there will always be some chance of that happening, so it’s much better to know ahead of time how these situations will be handled.

Every prospective of 3PL you evaluate should be able to readily provide their insurance coverage, product damage liability, and claims submission information alongside a formal services proposal. Depending on the services offered by 3PL partners, their coverage may be different (e.g., warehousing and transportation vs. transportation only).

3PL insurance policies generally cover the following:

• Warehousing – For circumstances in which your goods were negligently damaged by the 3PL in their facilities or distribution centers.
• Transportation – For circumstances in which your goods were negligently damaged by the 3PL during transport.
• Business interruptions – For circumstances in which the third party logistics companies are unable to complete their contractual obligations. Crucially, business interruption insurance only covers your losses incurred during and due to the paused or ended services—that is, it will not cover products but your lost revenue.

You should also note that 3PL insurance coverage generally protects only a portion of your products’ value. Beyond what their insurance and your contract stipulate, your own insurance will cover responsibility for the remaining cost of lost or damaged goods, or you will take it as a loss.

Furthermore, 3PL insurance coverage typically contains numerous clauses detailing circumstances that absolve them of liability. For example, third party logistics companies often bear no liability for damaged products in the event of an “Act of God” (e.g., natural disasters) that impacts their facilities or transportation network.

Circumstances of 3PL Liability

In what situations, then, do these insurance policies take effect? Generally, a 3PL is responsible for its people, facilities, and equipment. While this may seem to cover you in most circumstances, that’s less the case than you may think.

You might have noticed the presence of “negligently damaged” in the above explanation of 3PL insurance. This is the primary circumstance in which 3PL insurance coverage activates.

Per § 7-204 of the US Uniform Commercial Code (UCC), a 3PL must have committed negligence and incorrectly handled your products to be liable for any damages or loss. Specifically:³

“A warehouse is liable for damages for loss of or injury to the goods caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances.”

Should a 3PL be liable in such situations, you’ll need to be able to demonstrate their negligence in the warehouse space or during transportation. You’ll also want to quickly submit any claims, as there will be a window for doing so (e.g., 90 days). The exact window will be specified in their documented processes.

Given these limited liability circumstances, you may want to consider supplemental insurance to protect you against any significant product (and revenue) losses.

Beginning Your 3PL Partnership

After you select a 3PL service provider, 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. ⁴Standard 3PL SOWs are typically much more bilateral, documenting 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:

• Support requirements
• Memorialize the agreed-upon terms and conditions
• Provide the foundation for future optimization opportunities

Once you have a 3PL relationship established, contract negotiation and 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, although 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 or more of the above questions, your 3PL is most likely not a strategic business partner but a vendor that is probably negatively impacting your business.

The good news is there’s a significant opportunity for improvement.

A Quick Step-By-Step Guide to 3PL Contract Optimization

If you determine 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 a formalized action plan. Determine if you want to work on continuing the relationship with your current 3PL or change providers. You may not know at this point, but one thing should be very clear: If you are unsure whether you want to continue your relationship with your current 3PL, you should perform a comprehensive market assessment to evaluate your alternatives.

Retaining Current 3PL Partnerships

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 primary 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 a minimum, by video conference so you can see their reactions and read their body language. If they’re receptive, engage in constructive dialog and collaboratively develop 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.

Evaluating New Potential 3PL Partners

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 Section 02, 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. Instead, we’ll review the process for maximizing the overall 3PL relationship value. Next, we will focus on working towards the ideal state of 3PL contract optimization for achieving maximum 3PL relationship value.

The value that you receive from your 3PL relationship is a function of three main factors:

• Cost
• Service 
• Goal alignment

We will elaborate on each of these factors in the next three main 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.

3PL Pricing Strategies

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 methodologies. As reviewed above, the 3PL market expanded rapidly when a host of companies—from vastly different industries and market segments—becomes a 3pl service provider.

These new market players brought with them their own set of pricing models and industry-specific best practices. Unfortunately, there are no formal industry standards regarding 3PL pricing guidelines and, resultantly, there are numerous pricing strategies and hybrid models that have emerged over the years:

• Line-item pricing – Some 3PLs price their services based on a detailed menu of offerings with specific line items achieving 10% – 80%. Line items may include:
• Receiving
• Storage
• Inventory management
• Order processing
• Pick and pack
• Small parcel
• Less-than-truckload (LTL) freight.
• Bundled pricing – 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.
• Transportation-exclusive pricing – Some companies 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.
• Miscellaneous margins – The last group makes 100% of their margin on warehouse, pick, and pack transactions, passing through the parcel and LTL charges at cost. This group of 3PLs is typically fully transparent regarding their parcel and LTL cost structure.

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

Identifying Cost Reduction Opportunities

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. Of course, transportation costs (e.g., 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.

So, it’s crucial to understand how your 3PL prices their shipping 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 spent does not always equate to high discounts on published rates.

It really comes down to how effective the 3PL is at negotiating their own carrier agreements.

Understanding 3PL’s Carrier Contracts

Each 3PL has its 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
• Which LTL carriers the 3PL works with
• The nature of those relationships
• 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 can largely impact cost and an area for contract optimization focus: storage and pick and pack fees.

Storage fees can add up quickly, and there are myriad ways that 3PLs charge for those services (e.g., cost per pallet, bin, cubic foot, square foot). 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 fulfillment 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.⁵

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:

• Out of alignment with relationship goals
• That cannot be measured
• 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.

Assessing Your 3PL SLA

SLAs should be formalized, documented, measured, reviewed often, and adjusted as support requirements change. SLAs will be slightly different for each business, but it is 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 they’re primarily focused on:

• Quality
• Continuous improvements
• 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 it requires consistent, incremental advancement over time. It is extremely difficult to deliver without a common foundation to build upon, so establishing that foundation early is vital to successful 3PL partnerships. It starts with clear relationship goals and objectives between all parties and will yield substantial results with clear communication and attention to detail.

3PL Cost Reduction Through Goal Alignment

Cost reduction or cost containment is much easier to achieve with goal alignment. By defining quality objectives and executing continuous improvement strategies, you will see cost reduction opportunities materialize over time.

Add cost reduction goals into the MSA; provide your 3PL with 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.

Still, 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.