A key factor when tendering a logistics operation is deciding upon a suitable pricing structure. However, unlike haulage operations or parcels services, there is no standard system for Contract Logistics agreements and the range of pricing structures varies considerably.
Generally, a suitable pricing structure should:
- Require the service provider to control operating costs and maintain a good standard of productivity in order to make a satisfactory profit
- Enable the service provider to recover their costs in line with the resources used
- Be easy to operate and understand so that the service user is able to reconcile charges to the level of activity that has taken place
- Be adaptable to activity changes arising from weekly or daily variations, seasonality or the changing needs of the service user. Most Contract Logistics agreements will operate over several years, during which time the needs of the user could change considerably. Ideally, the pricing structure should be able to accommodate changes without the need for re-tendering or major contract re-negotiation
When considering alternative pricing structures, there are two fundamental alternatives; Open Book and Closed Book.
Under an Open Book pricing arrangement, the contractor passes on the actual costs incurred plus an agreed margin. The primary advantage of this is that the price to the user is directly related to the costs incurred. This can be particularly useful where the activity is volatile or unpredictable and difficult to plan. On the other hand, the user could end up paying for the contractor’s failure to manage costs or maintain a high level of productivity. Even in the best organisations it is all too easy for managers to become complacent or step back from actively managing costs or actively driving productivity. Often this can result in the user becoming directly involved in monitoring the costs that the contractor is incurring and the productivity that is being achieved. In the worst possible cases, users can feel that it is they that are managing the operation rather than the contractor.
To address this, users can adopt a hybrid solution involving pre-agreed unit charges and minimum productivity standards. This requires the contractor to charge a fixed amount for particular resources, for example a warehouse operative or a particular type of fork lift truck, taking into account all costs associated with that resource. In the case of the warehouse operative, the unit charge would cover total anticipated employment costs while the unit charge for a forklift truck would cover depreciation, finance charges and all repair and maintenance costs. The advantage of this is that it requires the contractor to manage costs arising from sickness, absenteeism and repairs, rather than simply passing them onto the user.
With regards to productivity standards, the contractor has to achieve an agreed minimum and is responsible for meeting any additional costs arising from a failure to achieve this. This goes some way towards protecting the user from a badly managed operation although the user does need to be actively involved in agreeing costs that fall outside the agreed productivity standards.
Useful Resource: Avoiding the Pitfalls of 'Open Book' Agreements
Under a Closed Book pricing arrangement the contractor will charge for the service under some form of pricing matrix. The exact form of the matrix will vary according to the features of the operation but typically includes some or all of the following:
- Postcode and drop size for delivery operations
- Pallet or carton charges for storage
- Cost per pallet or carton for receipt and put away
- Cost per carton for picking and replenishment
- Cost per pallet for loading and despatch
The advantage of a Closed Book pricing system is that it requires the contractor to manage their costs within a pre-agreed pricing structure. In addition, it should be possible to generate operational reports that make the checking of invoices relatively straightforward and not require the user to actively involve themselves in monitoring the contractor’s costs and productivity levels.
The primary obstacle to establishing an agreed pricing matrix, acceptable to both parties, is the ability of the contractor to determine their costs. Operations that are highly volatile or unpredictable can be difficult to resource and cost. The risk is that the contractor attempts to factor in additional costs to cover the perceived additional risk which can make the proposed charges unattractive for the user.
Determining A Preferred Pricing Option
In some instances the preferred pricing option can be clearly identified and implemented, for example, where the operation is relatively predictable and there are a number of contractors with the necessary skills and experience to predict and control their costs. In other situations it may require intensive discussion and negotiation between the user and the contractor to arrive at an acceptable pricing system.
Prior to agreeing a pricing system and charges the following prerequisites are recommended:
- Conduct a well structured tender process to ensure that shortlisted contractors are well-suited to the operational task. The greater the contractor’s experience, the greater their ability to accurately forecast costs and productivity.
- Insist on total transparency of costs. Understanding the contractor’s costs is essential in evaluating proposed charges and will be essential for agreeing annual rate reviews or changes to the charges resulting from changes to the operational task.
Understanding the resource requirement and associated costs also assists in identifying contractors who, either deliberately or in error, may have under-costed the operation in order to win the business. In an Open Book environment, this means the user can be left paying more than anticipated while in a Closed Book environment the user will be faced with a contractor who will use every opportunity to increase the charges in order to offset losses.
In conclusion, the combination of a competitive environment and a good understanding of the resources and costs required will encourage shortlisted contractors to adopt a pricing structure acceptable to the user, with charges that are both fair and simple to reconcile with activity levels.