Beware those inflexible contracts

I had a call the other day to be a 'marriage guidance' counsellor for a third party logistics provider (3PL) and a customer who had fallen out over rising contract costs. The moral of the story? If you don't protect contractual relationships against changes in customer demand you could be in trouble.

The contract was a bog standard 'cost plus incentivised management fee'. But picking costs were rising as labour productivity fell and the customer was paying the cost of this through the standard terms of the warehouse contract. Transport costs had also risen but the 3PL was not recovering the increases because of contractual terms that set the charging rate at a fixed cost per case.

There had been an increase in the percentage of picked cases (and a reduction in full pallets) required to fulfil customer orders. As the number of picked cases rose, the cases per pick had fallen and productivity on the pick face fell. On transport the average drop size had fallen by 15% since the start of the contract, so unit costs had risen. With a fixed charge per case, the 3PL was clearly out of pocket.

So we rewrote the contract such that, as demand changed, so did the charging mechanism. The new contract recognised that, if the warehousing task became simpler, the unit costs would fall and vice versa.

For customer delivery we adopted a fixed plus variable charge. It recognised the cost-to-serve curve that shows unit costs rising exponentially as drop size falls, but also accepted that a dedicated fleet is never as commercially flexible as a multi-user solution.

Were both parties happy with the outcome? No! The 3PL no longer had the automatic right to spend money and reclaim it from its customer in warehousing. The customer, conversely, had to recognise that his costs had been driven up by changes in his customers' ordering patterns and further movement in that direction would mean more increases.

While neither party was happy, they had at least avoided a costly divorce and the new contract was fair, mutually robust and perfectly transparent.