Contracts? We don't need no stinkin' contracts!

By Tom Foster -- Logistics Management, 12/1/1998

The traditional approach to setting up a third-party logistics (3PL) arrangement is to have extensive--sometimes exhaustive--negotiations that eventually result in a detailed contract. Only after the contract is signed is the service actually implemented. After all, what shipper in his right mind would allow a logistics company to begin service before performance levels and total costs were spelled out? What 3PL would invest months of man-hours in a project without the legal protection of a long-term contract?

Increasingly, however, shippers and 3PLs are putting off the contract drafting until there are at least six months' worth of experience and real benchmark data. "Our contracts are only written after there has been enough experience to set the long-term expectations and legal obligations," says Larry M. Sur, president of Schneider Logistics. "Even then, the contract still must allow enough flexibility to make changes in terms and prices."

For Schneider, the key documents at the beginning of a new relationship with a shipper are a statement of expectations (SOE) and a letter of intent. The SOE expresses in as much detail as possible what each party will provide and what each expects from the other. The letter of intent serves as a primary legal document that sets the rules for a trial period of about six months.

During the trial period, both parties look at cost structures, service levels, customer needs, and other data that are produced from actual logistics operations. If compensation for the 3PL includes any gainsharing, where the provider earns a portion of the savings or is rewarded for productivity gains, this trial period is critical.

"Benchmark is the key," says Larry Sur. "Before a contract can be written, both parties must gather performance detail, which is why a six-month period is needed to provide a baseline against which improvement can be gauged."

Creating these baselines during the startup period can be tricky because operational problems are bound to occur. In many cases, logistics costs actually go up during the first few months of operations, so both the shipper and the 3PL must make allowances for this shakedown effect.

Eventually, the operation will smooth out. Savings will appear, and they should be substantial (see table). When both parties are comfortable with the operation and its likely results, it is time to write the contract. This document creates the legal structure of the relationship. But a contract also must be a communications tool that explains what each party will do, what performance is expected, and how this performance will be rewarded. If the contract is based on actual operational data gathered over a period of months, it will speak with more authority and with the voice of experience.

Savings Potential From Outsourcing Logistics

Description Savings Realized

Consolidate LTL into TL 15-25%

Static route redesign and optimization 10-13%

Revenue sharing and closed loops 15%

Select appropriate mode 10-15%

Use of proper equipment 6-8%

Core carrier management 3-5%

Negotiation and audit 2-6%

DC location 10-12%

Inventory and carrying-cost reduction 7-10%

Source: Schneider Logistics

Tom Foster is publisher of Supply Chain Link, a portal Web site for the supply chain industry. He is the former editorial director of Distribution Magazine and has been involved with the logistics industry for 25 years. He can be reached at (610) 964-4300. His fax number is (610) 964-2989. His e-mail address is tafoster@cahners.com.