Reviewing contracts for third party logistic (3PL) providers can be a daunting task – especially for those not familiar with the process. One of the most critical aspects in any 3PL contract is the language surrounding pricing and rate increases. It is vital to ensure that the language is fair for both the customer, as well as the 3PL.
Many of our engagements relating to 3PL contract reviews and negotiations center around educating customers as to how and why 3PLs do what they do. This article will help you to understand certain aspects that should be reviewed prior to executing a 3PL contract. This is not legal advice, nor intended to be, every company must seek proper legal advice with suitable attorneys prior to signing a contract.
It is expected to have rate increases each year, the cost of doing business increases in every way; payroll increases, shipping supplies increase, warehouse leases escalate. You can’t expect a 3PL to lock in on rates for a three term. At the same time, you can’t leave a 3PL contract wide open to subjective, or punitive, rate increases.
3PL vendors often will use language regarding increase, such as “by up to 3%”. We would rather see rate increases tied to various indices or metrics. Some examples of this would be:
- Labor tied to the Employee Cost Index (ECI), this index is currently reflecting wage and benefit increases of 2.7% over the last 4 quarters.
- Freight increases tied to the General Rate Increase (GRI), which is used to track rate increases.
- Material and supply costs tied to inflation for instance.
This approach makes it fair for both parties and allows the customer to reasonably plan for rate increases through the 3PL. As previously stated, it is unreasonable for most companies to expect a 3PL to hold prices flat for a period of years.
Capping Rate Increases
The next aspect you will want to consider is ensuring there is a reasonable cap to rate increases. Even if cost increases are tied to an index as previously discussed, some vendors may choose to tie increases to the rate of inflation, plus a percent. An example would be the rate of inflation plus 0.25%. In any event, most 3PL contracts are negotiated to cap the rate increase at no more than 3%.
There are some exceptions to this that are common, these include:
- If you are located in a facility where the state has a mandatory minimum wage increase, you may need to negotiate how those cost increases will be implemented.
- Major freight carriers implement significant freight increases from time to time. If your freight is passed through the 3PL, you will need to understand how this has historically impacted the 3PLs customer base.
- If your business has significant swings in the orders, lines and units – beyond what is forecasted, you may trigger a clause that protects the 3PL vendor. Generally, you must be careful that these unplanned swings do not negatively impact the vendor. Safeguards are generally in place that give them the right to revisit the rate card and adjust pricing.
Vendors need to be able to have annual increases. You want your 3PL to continually pay workers more, thus retaining strong employees and paying fair, competitive wages. These people are the last touch point prior to your customers receiving their orders.
Frequency of cost increases
One of the final pieces you want to understand, is the frequency of rate increases. Recently, while reviewing and negotiating a 3PL contract for a client, the contract stated, “fees subject to change with 30 days' notice”. To us, this is unacceptable as it doesn’t limit the number of rate increases within a year.
We typically want to negotiate an annual rate increase, occurring at either a contract renewal, or an anniversary date. Do not be surprised if your preferred 3PL vendor wants safeguards in place to review rates if the orders, lines or units per order are significantly over - or under the stated order forecast over the span of several periods.
Most companies will have 3PL contracts with rate increases. Contracts should be negotiated in a way that are fair and balanced to both the customer and the 3PL. You're entering into an agreement with a strategic partner that is filling a vital role for your company. Your goal should be to remove any unknowns related to rate increases, the amount of increase and the frequency of increase. Each customer needs to understand that there may be aspects that are unique, and that these uniqueness's may justify certain rate increases, or renewal periods. Seeking proper legal counsel is paramount with any contract review.