strategicinsight
BY SUSAN K. LACEFIELD, ASSOCIATE MANAGING EDITOR
pay for performance
Most shippers pay
THEY MAY NOT KNOW IT BY NAME, BUT MOST USERS OF THIRD-PARTY
logistics services are familiar with the concept of “savings leakage.” In the outsourcing
world, the term refers to the phenomenon in which a customer sees dazzling returns
in the first or second year of its contract only to see the savings slow to a trickle later
on, according to Kate Vitasek, a consultant with Bellevue, Wash.-based Supply Chain
Visions.
“In essence, you negotiate a deal and then you don’t realize the savings that you
thought you would over time,” she explains.
The reason is pretty obvious. The biggest savings come in year one as the service
provider assumes labor and asset costs, and focuses on the projects that will deliver the
greatest returns. “In the first year, [the contractor] comes to the table with a different
solution, whether it be dollar savings, productivity savings, or re-engineering the network by taking assets out of the network or putting resources into it,” says Will O’Shea
of 3PD, a third-party logistics service provider (3PL) that specializes in last-mile logistics and delivery services. After that, the relationship settles into more of a maintenance
mode. “It’s unreasonable for any shipper going into a relationship to expect the same
year-over-year savings,” O’Shea says.
That’s not to say companies can’t expect to see year-over-year savings later on in the
relationship. But it takes some effort. The customer must be willing to roll up its sleeves
and work with the service provider to find new tools, methodologies, and process
improvements, says Tony Zasimovich, vice president of global international logistics
services at the 3PL APL Logistics.
Oftentimes, however, customers don’t make that effort. Once the outsourcing
arrangement is up and running, they start focusing their attention and energies elsewhere. Only later do they realize that although the contractor has done exactly what it
promised to do, the savings have dropped off.
It doesn’t have to be that way, says Vitasek. It’s possible to keep the momentum going
beyond the second or third year. But it takes some work on the shipper’s part, she says.
In fact, fixing the problem requires nothing less than rethinking its relationship with the 3PL and the way it contracts for services.
their 3PLs based on
the services provided.
But some say they’d
be better off paying
for results.
Results, not activities
Before you can address the problem of savings
leakage, you have to understand the cause. In
many cases, Vitasek says, the problem lies with
the original service contract. Traditionally,
shippers have structured their outsourcing arrangements around activities—
that is, they draft contracts that
focus on specific tasks to be performed and compensate the 3PL
accordingly. For example, “We
will pay you a dollar to pick a
product, a dollar per month to store
