Introduction
It is now apparent that the UK economy has entered a particularly challenging time. The brief flirtation with easing fiscal constraints in favour of economic growth has given way to the more traditional approach of seeking to ‘balance the books.’ Consumers and businesses alike will now feel the impact of increased interest rates and the effect of high energy costs. This will have a particular impact on those sectors of the economy that are reliant on discretionary spending power.
Reduced consumer demand will require a review of supply chains to determine how costs can be reduced. At a time when so many supply chains are outsourced, contractors will be required to play a full part in helping to realign supply chains to changing requirements. For some service providers, such as those providing haulage services, increased direct competitive pressure resulting from reduced demand will automatically cause a review of charges. For other more complex outsourced operations, such as those involving warehousing and transport, the pressure to reduce costs is not automatic and therefore a different approach may be required. So where to start?
Contents
Review of Commercial Agreement
The initial starting point with an existing logistics contractor is with the contractual agreement. Key questions to ask are: -
- How long does it have left to run?
- What is the pricing mechanism? Is it cost plus, activity based, tariff based etc?
- Will the pricing mechanism automatically reflect changes in throughput or is there a significant element of fixed cost?
- Does the pricing mechanism naturally encourage greater efficiency by the contractors?
- Is there a pre-determined process for modifying the operation and charges if the operational requirement changes?
- Is the contract exclusive or non-exclusive?
- What is the penalty for terminating the contract early if the operation is no longer appropriate?
Clearly, it is helpful if the contractual agreement has been written in a way to facilitate modifications to the operation and resultant charges if the operational requirement changes. However, even if the contractual agreement does not automatically allow for such changes, most contractors will be receptive to modifying the operation in the interests of maintaining and building a long-term relationship. The costs and risks associated with winning new business means that most contractors will prefer to retain what they already have and seek to work with their clients. Also, by focusing on seeking to reduce resources rather than cutting margins, significant cost reductions can be achieved with the cooperation of the contractor. In addition, difficult decisions by the contractor can sometimes be overcome by extending the term of the agreement or phasing in changes over a period of time. Ideally, companies need to be determined in what they need to achieve whilst avoiding conflict and a breakdown in the relationship.
Operational Review
Where an operational requirement has evolved or market conditions have changed, consideration should be given to carrying out a comprehensive review of the operation. Ideally this should be undertaken by the contractor. This could include:
- Reviewing whether the order lead times are still appropriate. If volumes have fallen, would it be more cost effective to deliver into some areas on a named day basis?
- Is the mix of dedicated vehicles and outsourced services still correct?
- Could improvements in the IT system reduce cost and improve service levels?
- Would the operation benefit from greater automation in order to reduce space and labour costs?
- Is the warehouse layout and processes still the most appropriate for the current operation? This is particularly important where the operation now includes home delivery.
- Would it be more beneficial to use a different mix of network service providers for different parts of the Country or for different order sizes?
- Would it be possible to increase the minimum order size?
- Would it be possible to reduce minimum order quantities in order to reduce stockholding?
- Could the number of SKU variants be reduced?
The challenge for many contractors, is as the economic environment becomes more challenging more customers ask for reviews to be carried out resulting in the available planning resource becoming over stretched. If appropriate, it maybe necessary to pay for a third party to undertake the review and simply seek cooperation from the contractor. Whilst this is not ideal, it may be simpler and quicker than relying on a contractor that is under resourced for the task in hand and reluctant to invest the necessary time and effort. Typically, such a review will pay for itself in a matter of weeks.
Benchmarking Current Rates
The most effective and true way to determine if rates are competitive is to undertake a tendering exercise. However, if the current contract has sometime left to run it may be preferable to undertake a benchmarking exercise. This is likely to require the support of a third party with access to a comprehensive database of productivity standards, operating costs and contractors’ charges. For complex logistics operations, the most effective benchmarking approach is to review the operation at the ‘micro’ level:
- What productivity rates are being achieved in the warehouse for the various activities?
- What level of vehicle productivity is being achieved?
- What driving times and drop rates are being achieved on dedicated vehicles?
- What is the hourly labour cost for different categories of staff?
- What unit costs are being achieved that feed into the overall cost?
- What carrier costs are being incurred by the contractor?
- What is the level of indirect cost for management and system support?
The level of cooperation received will depend on the contractor. Where cooperation is not forthcoming, some key information can be obtained from management reports particularly in a cost-plus operation. Other information might need to be obtained by observation. As a general rule, contractors will be more likely to cooperate, if they believe the customer is keen to develop a long-term relationship based on jointly improving efficiency and productivity rather than simply seeking to cut the contractors’ margin.
Tendering
The most effective way to ‘market test’ an operation to see if the costs are competitive is through tendering. Tendering not only market tests the charges but also provides an opportunity for the marketplace to advise on the best operational solution. It also means that contractors, under the threat of competition are more likely to invest time and effort in reviewing the operation in order to ensure that the contract is renewed. Key points for effective tendering include the following:
- Allow sufficient time to run the tender process and implement a revised operation with another contractor if necessary. Potential replacement contractors are less likely to take part in a tendering exercise if they do not believe the client is genuinely open to change
- Research the marketplace to ensure that you include in the tender process the contractors that are most qualified to undertake the operation
- Provide detailed data for a suitable representative period that provides a clear ‘picture’ of the operational requirement
- Give careful consideration the service levels required
- Ensure that charges / costs are requested in a format that enables a like for like comparison
- Adopt a contract length that acknowledges the investment required and the risk to the contractor
- Invite contractors to respond to the brief as presented but also to submit their own ideas how the operation and service could be improved. Tendering exercises are excellent opportunities to consider new ideas and new ways of working
- Take time to meet with contractors to explain the operation and answer questions
- Consider carefully the most appropriate pricing mechanism for the operation
- Prepare a comprehensive contractual agreement and invite contractors to provide their response before making a final decision.
Run properly, a tendering exercise absorbs considerable management time for all those involved. However, they are the only sure way to ensure the best operational solution at a fair market price.
Conclusion
Davies & Robson has a lifetime of experience designing supply chain solutions and outsourcing. Our familiarity with the industry and relationships with key players means we are ideally placed to support organisations get the best out of their outsourced operations or source suitable partners. We have a wide database of productivities and costs and the services available from within the marketplace.
If you would like to learn how we could be of help to your organisation we would be delighted to speak to you, call us on 01327 349090 or email info@daviesrobson.co.uk
