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Moore on Pricing: Pricing models for 3PLs

By Peter Moore, Adjunct Professor of Supply Chain
September 01, 2012

As shippers consider entry into an outsourcing arrangement for freight management, they quickly discover a range of pricing options from various service providers. These service providers have a variety of business models that drive their market offers, and shippers need to understand what these models are so they can evaluate not just the offer, but the potential for long-term satisfaction with the contract.

A shipper that discovers that the third-party logistics provider (3PL) has made larger margins than expected often attempts to terminate early; on the flip side, shippers that find out that 3PL margins are too slim to support their service needs will also try to terminate early.

I tell shippers to consider three main 3PL freight management business models: execution; arbitrage; and dynamic transparent. While there are variations, these descriptions should help sort out what the provider is selling during the evaluation stage.

Execution refers to the outsourcing of the execution of carrier rates already negotiated by the shipper. The shipper relies upon their own market strength and negotiating skills, but turns over dispatch, tracking, audit, settlement, and claims administration to the 3PL. Often this model works in combination with warehousing, but not necessarily. In this case, the contract is transactional and transparent. The value-add is in simplified administrative steps for the shipper and aggregation of data that the shipper might not be able to process well.

Transparency implies that the shipper knows what to do with the information and is capable of providing part of the shared management responsibilities. 

Arbitrage includes an arrangement where the 3PL pays the carrier and charges a higher negotiated rate to the shipper. These are less transparent, and freight brokers rely on this model for at least one transport mode managed for their shipper clients.

The 3PL/broker is in a position to propose lower management fees as they plan to make margin in the market aggregating several shippers’ volumes in their offers to carriers. The shipper needs to understand this business model and insist on openness at least in the business proposal stage. I have seen numerous shipper/3PL contracts end early and in litigation where the arbitrage was not made clear up front. 

Dynamic transparent refers to models where the volume and market strength of the 3PL are leveraged to assist the shipper to make a more successful network fit with carriers. The 3PL should be capable of disaggregating the freight cost elements with the carrier to optimize for their multiple shipper clients. 

At the same time, the 3PL provides transparency to their process and costs and agrees to a fix fee or margin for transactions. With establishment of a cost baseline there are opportunities for innovation and further leverage incentives; and as a rule, I suggest that the base transaction margin is conservative relative to the market, but that the 3PL has the opportunity to make multiples of the market margin through innovation. 

This model incents all parties to be creative, including the carrier. The carrier gains by having a single 3PL team with which to optimize operations, invoicing, claims, and sales coordination. The disaggregation of costs allows the 3PL to work with the carrier to modify operations to drive out mutual costs, hence the “dynamic” reference.

The 3PL can do this with the opportunity to improve margin without the loss of perceived fairness that leads to early cancellation and litigation.

Each model has its place, and all can benefit the shipper. However, the shipper needs to identify what kind of business model they want to work with.

About the Author

Peter Moore
Adjunct Professor of Supply Chain

Peter Moore is Adjunct Professor of Supply Chain at the University of Denver Daniels School of Business, Program Faculty at the Center for Executive Education at the University of Tennessee, and Adjunct Professor at the University of South Carolina Beaufort. Peter writes from his home in Hilton Head Island, S.C., and can be reached at .(JavaScript must be enabled to view this email address).

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