Real-World Scenario: Best Practices for Warehouse Contracts

Who doesn’t love a good contract? Of course…everyone…right? Well, not entirely. When it comes to the logistics industry, whether it’s transportation management contracts or warehouse contracts, there are a million moving parts and as many questions. In the below is a real world example of a consultant coming to a third party logistics company with the goal of choosing a warehouse and 3pl provider. This two-part blog series will take you thru the RFP questions along with the answers you’d expect to see from the 3PL.

The Client Details

Our client is a leading player in the US FMCG/CPG market and is a Fortune 500 company. Currently they incur an annual spend of USD 380-420 Million for their warehousing needs, of which ~60% spend is for brand new six warehouses (average space of 1.5 Mn. sq. ft. each) and the rest 40% spend is for 25 Warehousing (anywhere between 300,000 to 1 Mn. sq. ft.). All these warehouses are used for storage and distribution of finished goods, the six new warehouses are brand new and involve complex operations (full pallet in and mixed pallet out or case deliveries) while the 25 warehouses have more standard /generic operations (full pallet in and full pallet out).

Currently, the real estate for all these warehouse is owned by our client, and the operations are completely outsourced to multiple 3PL players. And our client engages with 3PL by open book cost plus contracts and gain share and pain share incentive. About this, our client would like to understand what is the best practice followed in the industry for open book contracts.

Looking at the Core Components of Warehouse Contracts

We will cover the main segments of what is to expect in the best practices of constructing warehouse contracts. Every good contract starts with a query or question during the RFP phase. Typically, a service provider will then have an answer to those questions. The question and answer process drive the construction of warehouse contracts. In this two-part blog series we will take you through the main sections of what to ask during an RFP which will beget warehouse contracts you should expect when making the ultimate decision to lease a warehouse or engage with a 3PL who is providing a warehouse asset. Below, in each of the segments, we’ll pose the RFP question, along with the answer.

Key Performance Indicators in Warehouse Contracts

KPIs Question 1

What are the major KPI’s to be followed under the below attributes:

  • What are the major KPI’s to be followed under the below attributes:
  • Cost or Cost Savings
  • Performance or Service
  • Quality
  • Safety
  • Customer metrics

Also please indicate the leading and lagging indicator for each attribute? Please include if any other attributes have to be included.

3PL Answer 1

  • Cost or Cost Savings: Re-engineering/continuous improvement: Implement Lean initiatives to eliminate all wastes, improve processes, increase throughput, and bring much more value to the customer beyond their expectations: Lean consists of a culture/behavior change. Leadership and their employees work together to solve problems and improve processes. People then solve daily problems and improve processes DAILY not after they finish their “normal” work. Lean IS their DAILY work.  6S is: sort, set in order, shine, standardize, safety and sustain. Sustaining being the hardest of the 6 S’. Lean is DAILY continuous improvement, pull systems to reduce inventories (versus push that increases inventory), Lean Six Sigma to improve quality to .003 per million touches (almost ZERO DEFECTS)
  • Use Value EngineeringReduce the Cost and retain the function of anything. Use Warehouse/3PL cross-functional teams to contribute Cost Savings Ideas: Lean initiatives alone will bring cost reduction and process improvements. Use Gainsharing so both the Warehouse/3PL and customer/shipper gain where cost reduction is found. Create a “win-win” partnership. Use the Warehouse/3PL Transportation Management System (TMS) to optimize lanes and routes to save 15% + cost Reduction.
  • New concept: Embed a 3PL representative in client/customer to help customer improve relations with the 3PL. Leading/lagging indicators: collaboration, transparency, and partnering. Are new cost Savings methods being investigated? Like: Robotics, Automated Warehouse Systems, Space Modification Systems, IoT, Trading Partner Interface (TPI)? These can be lagging indicators as well.
  • Engage employees: Why not have a suggestion box for employee suggestions or use Idea Scale software for employee cost reduction ideas/suggestions? Recognition awards for employee cost reduction ideas. Your employees have many ideas; listen to them/consider them.
  • Performance or Service: Reduced turnaround time from date of the order from the customer/shipper to the ultimate consumer. Customer Relationships: Is customer delighted with al services from 3PL Leading/lagging indicator: collaboration, transparency, and partnering.
  • Quality: Does customer/shipper want Lean Six Sigma Quality or Accepted Quality Levels (AQL)?  Metric: Goal/KPI: Zero quality reports upon the receipt of goods at Warehouse or ultimate consumer; Embedded 3PL rep to help improve 3PL service by monitoring 3PL deliveries and daily service. Leading/lagging indicators: KPIS for continuous improvement in problem/process issues; collaboration, transparency, and partnering.
  • Safety: Safety is the top priority in any Warehouse or 3PL: Insurance Coverage Ample? Safety Manager in place? Goal: Zero Safety Issues. Safety KPI: Bring down Safety RIR: Record Incident Rate; Re-engineer, process and product damage which can cause safety issues; Follow OSHA: Occupational Safety and Health Organization: Rules Have OSHA visit your organization and measure Safety. Safety on forklifts; Safety marking/Lines throughout the organization; Safety Signage; Safety Meetings to review Safety Management Monthly.
  • SOS Cards: Safety Observation Cards: employees recognize good Safety Performance and suggest something that needs fixing to improve safety.  KPI: Signs showing consecutive safety days without an accident. Safety postings listing Safety Requirements. Leading/lagging indicator: collaboration, transparency, and partnering. In a mature Safety culture, safety is truly sustainable, with injury rates approaching zero. A robust safety culture can help improve safety performance, reduce costs, foster a happier and more productive workforce and make facilities more efficient. Continuously using SOS cards.
  • Customer Metrics: KPI: Fill orders accurately and on time to meet customer’s needs; Use Voice of the Customer (VoC) techniques, and internal customers/associates/employees. Techniques (VoE): send the questionnaire to customers/employees asking pros/cons of doing business with 3PLs: on-time delivery? Quality? Driver relations? Pre-alert to any delivery; Shape of goods upon arrival? KPIS: Additions customers/month/year? Customer visits to the 3PL; 3PL visits to the customer. Leading/lagging indicator: collaboration, transparency, and partnering.
  • Shipper/Customer and 3PL mustinclude all KPIs in a Service Level Agreement. Are all IT systems in place? Warehouse Management System (WMS), Transportation Management System (TMS), Yard Management System (YMS), and Electronic Data Interface (EDI): are all partners integrated to these IT systems. Is there a Service Level Agreement (SLA) with KPIs on these IT systems? Are newer methods being investigated for Cost Reduction? Create a seamless Supply Chain working n collaboration with a 3PL.

KPIs Question 2

What is the best practice regarding framing the KPI’s i.e. should it include only lagging indicators or mix of both leading and lagging indicator?

3PL Answer 2

Mix both leading and lagging KPIs. Use slotting/re-slotting in the warehouse to manage fast-moving (leading) SKUs versus slower moving (lagging) SKUs based on Sales/Usage. Re-slot the next month based on NEW sales/Usage. A list by priority of relevance to shipper/customer. Use Pareto’s 80/20, ABC principle.

KPIs Question 3

While measuring the KPI’s for gain share incentive, which of the above attributes should be given higher weightage and what is the justification? E.g., Performance  should be determined at 45% due to reason 1

3PL Answer 3

The use of collaboration, transparency, and partnering. Performance/Customer Service should be at least 50% + as you must always ensure that your customer is happy with your service. If not, they will go elsewhere. Quality: 30%: Goal: No quality issues for the customer to manage: this is irritating to the customer. 10% Safety; 10 % Cost Reduction

KPIs Question 4

Currently, our client re-negotiates the KPI targets very year and finds negotiation to be very challenging. In this case, how can they avoid re-negotiation every year? What is the industry practice for this i.e., annual re-negotiation or once in 2 years?

3PL Answer 4

A Service Level Agreement (SLA) should be reviewed and negotiated monthly, at first. The SLA is a living document. It should be reviewed frequently. KPIs must change as times, laws, and experience change. Yearly is used only if the shipper/customer relation has been in place for a long while. If the SLA with KPIs is to too lengthy, perhaps that’s why a yearly review takes place. Shorten the SLA/KPI to be only critical issues, as listed: Cost Reduction, Service, Quality, Safety and Customer Metrics.

KPIs Question 5

How can our clients quantify the impact of increasing KPI targets?

3PL Answer 5

You can quantify the impact of increasing KPI targets by the effect of these KPIs on the partnership and the ultimate customer. The major KPI should be to keep the customer happy and the shipper/customer and 3PL relationship a partnership in collaboration.

KPIs Question 6

How can our client motivate the 3PL’s to reduce FTE’s? Should this be part of the KPI’s and gain share?

3PL Answer 6

Yes, FTE’s should be part of the Service Level Agreement with KPIs and gainsharing on Cost Reduction and Transportation. Lean initiatives will minimize FTEs if used effectively. Improving processes can mean less FTE’s.

KPIs Question 7

How can the 3PL’s be motivated to drive cost savings?

3PL Answer 7

When you work as partners, collaborate and have a Service Level Agreement with KPIs part of this SLA should be monthly percentage of cost savings. Ask for 5 % cost reduction a month. Work together to achieve this 5% cost reduction and next month increase it to 8% cost reduction: continuous improvement monthly working together

Cost Plus and Management Fees in Warehouse Contracts

KPIs Question 1

Under cost-plus contracts, what is the best management fee? Say if 7% what is the justification for this?

3PL Answer 1

I have seen from 5-8% management fees. This should be negotiable. It should be changed as time and cost plus contracts change. This management fee should be negotiated and re-engineered by both the 3PL and client working together to reduce this management fee.

KPIs Question 2

How is the management fee structured for payment? Say fix 1/3rd as base guaranteed charge and 1/3rd at risk for cost and 1/3rd at risk for KPI? What is the industry best practice?

3PL Answer 2

Management fee industry standard: this again, is negotiable: Typically, the management fee is negotiated monthly based on ALL activities during that month. Most use 50% each, others 70/30 and yet others 33% for each: base, risk, and completion of KPIs. The industry best practice is 50%/50%.  But this again can be negotiated or a “win-win” for both parties.

KPIs Question 3

Instead of negotiating with the 3PL for the best management fee (say 7%), is it wise to agree to a higher management fee (say 10%) and tie up more risk towards best service levels and KPI’s? What would the pros and cons of this approach?

3PL Answer 3

Anything can be tried on management fee, BUT it has to be good for both as it should be a collaborative partnership. Pros/Cons: Don’t push these issues: work in the spirit of collaboration and trust. If you push too hard, you can create an adversarial relationship. You do not want this: it does NOT work.

Stay tuned for part two tomorrow where we continue the conversation in incentives, cost models, governance, and other best practices.

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