You can't manage what you don't measure
Shippers that carefully monitor 3PL performance and tie it to compen-sation maximize the benefits of logistics outsourcing. But many aren't even taking rudimentary steps toward performance evaluation.
By Thomas Foster -- Logistics Management, 5/1/1998
Though shippers continue to outsource transportation and logistics activities at a record pace, there is mounting evidence that they don't really know what they are getting for their money."The old adage that you can't manage what you don't measure is especially true when you are outsourcing the activity you are supposed to be managing," says Robert Spira, a transportation attorney in Cleveland, Ohio, who specializes in third-party logistics contracts. "Performance standards and measurements are probably the two key issues that shippers and third parties should
negotiate before an outsourcing deal is signed, but a surprising number of contracts fail to address these issues adequately. As a result of this failure, the vast majority of disputes that arise between shippers and their third parties revolve around performance problems."
Spira has intimate knowledge of these contract issues. He spent more than 20 years drafting and negotiating contracts for a major third-party logistics provider. He also recently served as president of the Association of Transportation Law, Logistics and Policy (ATLLP), the industry's leading legal trade association. While president of the ATLLP, Spira conducted a survey of shippers and third-party logistics providers to learn more about the contracts these parties used to govern their relationships. Performance measurement proved to be among the most troublesome issues.
According to this survey, setting service standards and metrics are the most important issues to resolve in the negotiation process. Issues involving service standards account for three of the five most difficult problems to resolve during contract negotiations. The single greatest source of disputes after a third-party logistics agreement is put into operation is shipper dissatisfaction with the logistics provider's performance. (See Figure 1.)
Perhaps the most remarkable finding in the entire survey is that in nearly 8 percent of all logistics contracts, there are absolutely no performance standards that the provider must meet. According to Spira, there are at least five reasons that shippers ignore, or more often under-emphasize, performance standards in their contracts:
* Unclear expectations. Shippers do not always know what they want from the provider.
* Poor preparation. Even if shippers know what they want, they do not spend enough time setting performance standards and ways to measure them.
* Negotiation pressure. Shippers put themselves under such time pressure that they have their backs to the wall when they enter negotiations.
* Inaccurate data. Shippers make assumptions about service level needs that are not based in reality.
* Lack of trust. Shippers are reluctant to reveal their true long-term financial goals to providers.
* Too much trust. Shippers allow providers to set performance standards or to delay setting standards.
"If there is one thing that shippers should remember, it is that they should allow enough time and attention to negotiating a good contract with the right people involved," says Spira. "Don't let the pressure of the moment govern the performance standards that end up in the contract."
Contract Basics
Though a small percentage of contracts contain no performance standards whatsoever, the majority of third-party logistics contracts include some form of measures, according to the ATLLP survey. For the most part, the performance standards are very basic and include such measurements as on-time pickup, loss and damage levels, and on-time delivery. (See Figure 2.)
One company that believes basic is better is Nabisco Inc. of Parsippany, N.J. "We focus on the basic performance benchmarks for our third parties," says Doug Warrington, Nabisco's senior manager of operations, who manages the third parties that provide warehousing and consolidation services. "We prefer that what we measure be systematic and easy to track. We must use our time effectively to collect data on third-party activities."
According to Warrington, on-time delivery and cost are the key measurements. Other basic measurements include freight claims, timeliness of returns, freight-bill rejects, proof-of-delivery response time, and tracing response time.
Warrington reports that even the basic performance criteria are not always easy to measure. There are at least two ways to measure on-time delivery, for example. If a shipment leaves the warehouse on Thursday and is delivered on Monday based on an appointment the carrier makes with a receiving department, was that on-time delivery? To the carrier, the answer is yes, because the carrier arranged a Monday appointment. But from the viewpoint of the consignee's buyer, who was expecting the shipment on Friday for a weekend promotion, the delivery was late and the customer is dissatisfied.
"We have to focus on the customer expectations, and that is how we have to measure the third parties," says Warrington. "That is why we measure on-time delivery by customer date, not by appointment."
Nabisco hopes to include in its contracts more specific measurements that could allow monetary incentives to be built in for the third parties that produce superior results. "The difficulty is how to measure performance objectively with a focus on producing results that improve our competitiveness," says Warrington.
Though Warrington says he would like to depend on the third parties to initiate new, value-added services that can become measurements of effectiveness, Nabisco is considering a number of measurements for its third parties doing consolidations. These include:
* Consolidation percentage. What percentage of Nabisco's orders are combined with other shippers' freight, resulting in fuller trucks and higher weight breaks?
* Average weight per load. The higher the better for all parties.
* Inbound/outbound match percentage. How often do you have an inbound load to match an outbound haul that reduces a carrier's deadhead, thereby benefiting all parties?
Nabisco has only started to look at these more sophisticated measurements. "There are many unresolved issues regarding performance incentives as a means to manage third parties effectively," says Warrington. "On the one hand, we want to get closer to our third parties so we can improve overall service to our customers. On the other hand, we do not want to insert ourselves so deeply into the third parties' businesses that we are running them."
From the perspective of many logistics providers, however, the goal of all third-party arrangements should be to create such a close partnership that the parties can share the financial benefits produced by the relationship. This so-called gain-sharing arrangement is a growing trend, says Spira, especially among large shippers and third parties, but there is still much more talk than action.
"Our survey says that only about 5 percent of logistics contracts are totally based on gain sharing," says Spira. The main reason, he notes, is that such arrangements demand that a baseline be set from which the gain sharing is measured. "Shippers rarely have the data on hand to set this baseline," he says.
Establishing a Baseline
One company that firmly believes that provider performance and gain sharing should form the basis for outsourcing arrangements is Caliber Logistics of Hudson, Ohio. "Our contracts are structured to include continuous improvement processes and contain specific gain-sharing accords," says Craig Cullinan, Caliber's vice president of retail and consumer products. "The first step in setting up our operations is to create a baseline, so we can show improvement and form the basis for a win-win relationship."
Cullinan reports that key performance indicators are established mutually by Caliber Logistics and the customer. These KPIs, as they are called, can be simple measurements such as on-time performance, but they often include more complex metrics such as inventory accuracy, return on sales, and quality.
To create the initial baseline, Caliber helps the shipper benchmark its current operations. "Some shippers can do this very well on their own, but many do not have the staff or the expertise to do it," says Cullinan. "We have that expertise. We also have access to our own [best-practices] database as well as other metrics useful in establishing the list of KPIs that the customer decides are important."
The KPIs are in place on the first day that the contract goes into effect, Cullinan reports. "All members of the team are advised of the customer's KPIs and what they must do to meet the performance standards," he notes. He adds that all team members are given incentives to beat the benchmarks and are compensated quarterly. Gain sharing goes down to the individual level. "This direct connection between performance and compensation keeps the work/reward cycle short and in focus," he says.
Performance is reported to the shipper daily and then compiled into weekly reports. Actual reviews with the shipper are held monthly or quarterly, depending on the customer's needs. With this reporting and review process, there are no surprises.
"We know how well we are doing," says Cullinan. "The client knows where our performance is meeting the established goals and where it is not. The client then can use these results to improve performance with its suppliers and customers. It all starts with good performance measurement."
Five top issues to resolve in contract negotiations
1. Performance standards and measurements
2. Rates
3. Problem-resolution mechanisms
4. Insurance and liability
5. Gain sharing
Five issues most difficult to resolve during negotiations
1. Compensation
2. Insurance and liability
3. Gain sharing
4. Setting performance standards
5. Measuring performance
Four issues that cause the most disputes during a contract's term
1. Actual performance vs. shipper expectations
2. Liability and claims
3. Shipper failure to produce promised volume
4. Rate adjustments
Source: Association for Transportation Law, Logistics and Policy (ATLLP) survey
Performance aspects most commonly measured
% of Shippers and 3PLs
Activity Measured Measuring Activity
On-time delivery 37.8%
On-time pickup 26.1%
Loss and damage levels 13.5%
Overall system cost reduction 10.8%
Satisfaction of shipper's customer 10.8%
Cycle-time reduction 7.2%
Other 7.2%
Numbers add up to more than 100% because of multiple responses.
Source: Association for Transportation Law, Logistics and Policy (ATLLP) survey
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