As a consumer we are used to 1-year contracts,
such as health insurance, club memberships, and other subscriptions. Most of
these contracts are automatically renewed after a year. Should this be any different
with regards to your contract with your logistics service provider (LSP)?
Most manufacturers and traders (shippers)
outsource their transportation, warehousing, value added logistics, freight
forwarding, and supply chain management to a LSP. Shippers want the contract as
short as possible (1 or 2 years), whereas the LSP prefers the contract duration
as long as possible (5 to 10 years). As competition is fierce in today’s
logistics industry, many contracts with LSPs today are just 2 or 3 years. But what
is the most optimal contract period?
Risk
management
Shippers are traditionally hesitant to engage
in a long term outsourcing engagement for the reason that they become overly dependent
on the LSP. Furthermore, shippers might be concerned with the continuity of
operations and LSP commitment in case of big organisation (like merger or
acquisition) or market changes during the contract period, demanding major
adjustments in the supply chain.
LSPs on the other hand need to optimise
logistics operations and supply chains for their customers, requiring significant
investments in specialised buildings, racking systems, conveyor systems,
automation, trucks and people. This becomes a big risk when the payback period is
longer than the contract duration.
Guidelines
on contract terms
Basic transportation and freight forwarding
contracts can be 2 years. There should be of course a cost escalation clause in
case of for example significant petrol price changes, which are outside the
control of the logistics service provider. In this way the transportation rates
can be adjusted accordingly to maintain a win-win business relationship. However,
transportation contracts where the logistics service provider is expected to
invest in a specialised fleet (like refrigerated trucks, double decker trucks),
contract terms should be longer. In these cases, I would suggest a contract period
of 5 years.
Warehouses used to be basically sheds: a
storage space under a roof. Unless you are dealing with bulky construction
materials, these times are far-gone. Warehouses today need tailored mechanised
and automated operations, meeting high environmental standards through
investments in solar energy and water catchment, and specialised equipment and
training of manpower. Many warehouses also require various licences and
certificates (like food safety, halal) that are facility specific. Obtaining licences
and certificates for the best location of the warehouse takes time. Warehouse
contracts of 2 years are therefore absurd, making it impossible for logistics
service providers to seriously invest. Warehousing and value-added logistic
contracts should be in the range of 5 to 10 years.
In supply chain management outsourcing
engagements, also called fourth party logistics, the LSP controls and optimises
client supply chains. However, the biggest cost reductions and synergy
advantages are only generated through intensive vertical (within your own
chain) and horizontal (with similar chains) collaborations. Contracts up to 3
years, will not allow a LSP to embark on these advanced collaboration models,
leaving the biggest savings potentials on the shelf. Supply chain contracts
should be preferably 5 years.
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