In logistics outsourcing, a subject that is often frequently overlooked is that of deciding on the most appropriate pricing method under which the contractor will provide services to the user. In many cases the user simply accepts the charging structure proposed by the contractor or simply fails to recognise the alternative structures that might be available to them.
3PL Pricing Structures
Typically, users will go into considerable detail to ensure a like for like comparison with alternative contractors, whilst negotiating hard for the best price, but give little thought as to the implications of the charging structure once the operation goes live. The result can be that all the hard work undertaken during the tender process is wasted once the contract is implemented as charges increase above the tender price.
Why is there a problem?
Logistics contracts differ from many other types of commercial agreements because of their particular characteristics:
- They tend to operate over several years
- The services provided can be quite varied and complex
- The activity can vary considerably over time through seasonality and growth
- They can include a mixture of fixed and variable costs
- Some costs vary with time others don’t
What is the answer?
In considering the most appropriate pricing system for a particular operation, it is worth reminding ourselves of some key requirements, if it is to be acceptable to both the contractor and user of the services. A good pricing system should:
- It should provide the agreed level of remuneration to the contractor over time
- It should be simple to administer
- It should avoid rewarding the contractor for poor performance and poor productivity
- Ideally it should drive cost reduction and improved productivity
- It should enable change to take place without the user losing financial control
5 Common Pricing Models
The most common pricing systems may be summarised as follows:
1. Cost Plus
The contractor discloses all costs. A management fee is transparent and agreed in advance and usually covers indirect costs and profit margin.
Advantages
- Total transparency of resources and costs
- Customer pays for the resources employed and the costs incurred
- Contract can be set up without a detailed specification of the services required and detailed data
- Increases the number of contractors prepared to quote
Disadvantages
- Time and expertise is required to effectively manage the contractor
- There is a risk that the contractor looks to pass costs on rather than find an alternative solution
- Can be difficult to require the contractor to control costs and improve productivity
Comments
- Is particularly advantageous where the operation cannot be defined in advance or it is difficult for contractors to determine resources required and costs that will be incurred
- Can be useful when constant change is involved
- Not recommended for lengthy contracts
2. Throughput Based
The contractor recovers costs through a series of closed book charges relating to products handled eg cases, pallets etc. The more efficient the contractor can be the more money they make.
Advantages
- Usually simple to operate
- Prices linked to appropriate measures to determine inflationary increases
- Transport can be linked to a postcode matrix
Disadvantages
- Improved operational efficiencies are retained by the contractor and not necessarily passed onto the customer
- Charges may need to be renegotiated if the traffic profile changes
Comments
- Is effective where the operation is relatively straightforward and there are a number of competing suppliers to ensure competitive charges
3. Activity Based
The contractor recovers costs through a series of closed book charges relating to activity eg pallets in, cases picked, roll cages loaded etc. Works well where the cost can be readily identified in advance.
Advantages
- Usually simple to operate providing data is available
- Prices linked to appropriate measures to determine inflationary increases
- Allows for some changes in the traffic profile
Disadvantages
- Improved operational efficiencies are retained by the contractor and not necessarily passed onto the customer
- Charges may need to be renegotiated if the traffic profile changes
Comments
- Is effective where the operation is repetitive and the activities fairly consistent
- It is important that the activity can be accurately measured
4. Resource Based
The contractor recovers costs through a series of closed book charges relating to the resources provided eg cost per man, cost per fork truck etc. The contractor can only make more money by operating each type of resource within its agreed budget.
Advantages
- Usually simple to operate providing data is available
- Prices linked to appropriate measures to determine inflationary increases
- Allows for changes in the traffic profile
- Can work well for transport using a combination of fixed and cost per mile charges
Disadvantages
- The customer picks up the cost of poor productivity
Comments
- Similar to cost plus but contractor is required to operate resources within budget
5. Productivity Based
Contractor charges for resources subject to meeting productivity guarantees.
Advantages
- Particularly powerful if linked to a resource based charging structure
Disadvantages
- May need to amend productivity standard if distribution profile changes
Comments
- Will require careful analysis to ensure that productivity measures are workable
There is no single pricing system that is right for all operations. The challenge is to understand the particular characteristics of an operation and tailor the pricing system to the requirement, supported by a well written agreement that is fair to both parties. In many cases, this will involve a combination of pricing techniques, for example, open book for property related costs, closed book for transport and, perhaps, productivity based for warehouse operations.
Logistics Outsourcing with Davies & Robson
Companies for whom Davies & Robson has provided advice and support in determining the optimum pricing system include Hain Daniels, Rettig, The Entertainer, AQA, Bacardi, The Highways Agency, EAT, Tragus and Kumho Tyres.
Contact us for help with your 3PL contracts and pricing on 01327 349090 or email info@daviesrobson.co.uk
