After months of working with prospective third-party logistics (3PL) vendors, you likely received hundreds of pages of selling materials, email correspondence, and many verbal promises. The 3PL contract is important as it will record for you:
- the statement of work (SOW) and the 3PL services you are contracting for
- the standards of performance
- the pricing of various 3PL services
- the payment terms
- a host of legal clauses such as warranty and guarantees, and termination of the agreement
This blog acts as a checklist of contractual considerations to assist you in negotiating a 3PL contract that is fair and a win/win for the client and the 3PL provider acting as your outsource fulfillment provider.
Customizing a Contract
As you finalize the contract, look at the deliverables, services, standards, and pricing in the context of the 3PL contract and your company’s requirements. In most cases, 3PL contracts are three years or longer. Ask these questions as you review any 3PL contract for your business:
- How will costs increase and be limited annually?
- How are 3PL contracts terminated by either party?
- What can you do to keep service performance high?
Oftentimes, 3PL providers use a “master agreement,” which is generally a boilerplate contract. These standard contracts are difficult to change. The customization to your company will generally be attachments or Addendums.
Additions to the master agreement are specific to each client and can specify the services provided and at what cost. These Addendums may also include:
- the Statement of Work (SOW)
- Client Procedures
- Project Schedule
- IT changes
Addendums can be updated as separate documents at a later time if the services, standards, and costs change.
Negotiating a 3PL contract requires a combination of business sense and legal guidance. Our blog about how vendors look at negotiating deals helps you manage expectations and reach a mutually beneficial agreement.
Read: 9 Considerations Vendors Evaluate in Negotiating Deals
Here are the major terms, conditions, and issues we commonly encounter when assisting companies committing to a 3PL partner:
Statement of Work (SOW)
The SOW and contract summarize all of the selling materials and promises made by the vendor during the sales process into a relatively short document. If it’s an important promise - get it into the contract.
Selling materials are not contractual. The SOW summarizes the services that you and the 3PL are contracting for. The SOW should work in concert with other sections of the contract, such as Standards and Pricing of Services.
Here is a partial list of services that the Statement of Work may include:
- Advance shipping notices (ASNs) for inbound transportation of the product, time to receive and inspection for inventory to be available for sale
- Inventory management and storage
- Order fulfillment of ecommerce orders
- Retail store replenishment orders
- Outbound shipping all order types
- Returns processing from customers
- Kitting component inventory into products for sale
- IT services ASN, order fulfillment, invoicing utilizing EDI, standard reporting and analysis
Incorporate a detailed project schedule:
- Is the implementation plan previously provided sufficiently detailed or just a high level?
- Is it detailed enough you feel comfortable committing your company to it?
Spell out the client and 3PL responsibilities. Identify Go Live Dates for receipt of first inbound product and for shipping for first customer orders.
Read: How to Select the Best 3PL Vendor For Your Business
Length of agreement
As stated, many agreements are for three years or longer. While it is a long time, think about this. Facilities only have a certain fixed capacity to store product and in turn processing orders. It’s expensive and disruptive - for both the client and the 3PL - to move in or replace businesses. Longer term agreements make sense if they are a win/win for both parties.
It is not uncommon to see optional 1 or 2 year renewal terms once the initial term length has passed.
Pricing of services
Third party pricing is typically accomplished with four types of service pricing. A 3PL Price Sheet may detail a couple of dozen ways charges are incurred for the various services.
As an illustration in the SOW paragraph above, order picking for ecommerce and store replenishment orders are two services. The two services will have different order sizes (lines per order, unit quantity) and probably different standards. Ecommerce orders may be picked and shipped the same day. Whereas store replenishment might be scheduled by the store on a weekly calendar. On a weekly calendar, the Tyson’s Corner store may only receive orders on Tuesday and Thursday.
Therefore, ecommerce and store replenishment will be priced differently. As you deal with wholesale and B2B, these may be all case picks and have different pricing for picking; more comprehensive use of EDI and electronic document exchange; and by store sortation of product, boxing, and carton labeling.
The SOW, Standards, and Pricing may be separate sections, but it is important that they all clearly tie together.
In our blog post on how to select a 3PL, we emphasized how important analyzing and projecting the detail services is to get an accurate budget. Ask the 3PL partner if they are willing to include this business proforma in the contract as a budget target? At the very least, asking should prompt prudent partners to double check the numbers.
How does the agreement pricing increase costs over the term of the agreement? Generally, prices for services are guaranteed for a 12-month period. After this period, there is an annual cost escalator such as a set percent increase or an increase based on the Consumer Price Index (CPI).
A thorough contract identifies where the potential for price increase will happen with the 3PL.
Standards for performance should be spelled out. Keep in mind, standards which are too tight can radically increase the price.
Some key standards are:
- order fulfillment cut-off times for processing same day orders
- return processing, including customer credits and refurbishing
- international orders shipping time, such as same day or next day
- operating days per week
- holidays closed
- how backorders will be processed? For example, for multiple items – will the 3PL ship as items come in stock or hold to ship the complete order
- error rates for order fulfillment and inventory shrinkage
To keep service levels high, establish in the agreement a short (less than one hour) monthly recurring call between both companies’ senior management. Even though both parties’ people talk every day, management doesn’t, and this will help keep service levels high.
Read: 11 Key Indicators to Keeping 3PL Service High
Are there specific procedures important in delivering the customer service you expect? If so, attach them to the agreement.
Some commonly requested procedures include:
- standards for customer order appearance of shipping boxes, such as without excessive tape
- dust free product
- elaborate kitting instructions for gift baskets
Terminating an agreement and renewal of agreement
A contract will identify the specific conditions the agreement can be terminated. Does the 3PL's performance to contractual standards, error rates, service levels and account management allow you to terminate the agreement? Consult your attorney and identify the specific conditions and language.
Agreements often have automatic renewal clauses. In these agreements, the contract renews unless the client notifies the 3PL of termination within a specified period of time before the end of the contract. Most commonly, this period is 90 days.
Remember, it takes months to select a new 3PL and months to move your business elsewhere. Opening an internal fulfillment center takes 9 to 12 months to plan and open a fulfillment center. Make sure the termination language protects both parties and never terminate an agreement without a firm plan in place.
Agreements often specify payment of all invoices upon the termination of the contract by either party. Inventory can be held until invoices are paid, which can prevent a move.
Warranty of service
Putting your order fulfillment in the hands of an outside party is a big move. It is understandable that every company wants to have protection for their business. The standards section discussed earlier outlines your expectations for performance. Your attorney will need to advise you on warranty of service to protect your company.
From a legal standpoint, your attorney will review and guide your thinking on damages. The agreement might specify that neither party shall be liable for the following damages:
- special, such as loss of profits, data, or sales
Loss of inventory due to vendor negligence is often limited to a percentage or specific dollar amount of the cost and will have a cap per incident. Other damages may be limited to the amount paid for services.
Remember that inventory is one of the largest balance sheet assets in retail and ecommerce businesses. Most agreements state that the inventory is purchased by the client for their use in selling to the customer. The client carries insurance against loss and casualty. The client also pays for transportation directly from the vendors, unless otherwise agreed upon with the client.
Some agreements have a Warehouseman’s Lien against the inventory for charges incurred in performing services. The 3PL may reserve all rights and remedies under applicable law.
The 3PL also has no responsibility for claims or warranties involved with the product. When product recalls are necessary, the 3PL will be notified immediately and recalls conducted quickly.
Early on the client and the 3PL should have signed a mutual non-disclosure agreement (NDA) to protect detailed discussion of the project and 3PL capabilities. Mutual means that the NDA equally protects both parties’ intellectual property.
The contract often has different wording from the earlier, standalone NDA. Decide with your attorney how to carry forward the original NDA’s provisions.
Agreements should define your intellectual property, including but not limited to:
- business plans
- product specifications, vendor name, and address files
- customer order, return, and contact files
- promotional calendars and brand and channel marketing techniques
- internal processes and copyright protected materials
When in doubt, clearly label all of your company's copyrighted and confidential materials.
The 3PL’s intellectual property includes, but is not limited to:
- software vendor intellectual property protected by copyright through licenses granted to the 3PL or provided by suppliers, such as carrier shipping systems
- software tools
- any knowledge base
- any carrier rate tables
- 3PL internal sales plans
- other internal client processes
- promotional materials
- methodology in selling and installing
IT services and reporting
There are three categories of IT services and corresponding charges.
- Agreed upon analysis and reports
These may be scheduled or on-demand analysis or reports which are part of the charges for the services. One thing that often gets overlooked is top management’s favorite reports. Minimize future charges by including in the contract either a corresponding report or the data access to generate a report quickly upon request.
Does the potential 3PL partner have a vendor portal for you to access your data and a report book of all the analysis and reporting available? Reference the report book.
- New requests for reports and functions
These will be charged back to the client typically at several hundred dollars per hour.
- Implementation charges
These functions include those that are part of the implementation or integrations to your systems and EDI requirements. Identify these costs and include them in the implementation costs.
Invoice and payment terms
These are the categories of expenses you should expect:
- The implementation activities included with hours and fees, such as:
- on-site analysis
- file conversion
- management meetings
- 3PL internal project management and meetings
- Activities charged back on as hourly charges or on a project basis - example kitting or cycle counting.
- Detail processing charges based on the services and pricing sections, such as picking.
- whether the implementation is a fixed fee or is billable by major activity, such as programming and testing
- whether the implementation costs are billed upfront or spread over time
There will be advances for fees which the 3PL will make on your behalf, including:
- postage (e.g. catalogs requests, collateral mailings, sample distribution)
- carrier shipping payment and freight surcharges
- packing supplies
- taxes and import fees
- document transmission
Is the advanced payment purely a pass-through or is it marked up (e.g. 5%)? Replenishment of these funds is generally payable upon receipt.
Some 3PLs invoice weekly; others monthly. What are the payment terms – upon receipt, Net 15 or Net 30 days after receipt of invoice? Are there late fees and interest charges? In extreme cases of slow payment, 3PL may reserve the right to stop processing and shipping until all payments are made.
Does the contract specify payment by check or electronic funds transfer?
Dispute resolution of invoicing
A client should reserve the right to audit and review invoices for their account. Some 3PL invoicing systems are very easy to understand and cross-reference transactions for services and rates, as well as hours worked by the activity.
Others are very difficult to clearly understand and may require 3PL assistance monthly. Generally, the client is required to pay the undisputed portion of the invoice and cannot hold back the entire invoice. What is the billing resolution process in your contract?
Filing legal claims and governing law
The agreement will specify the method of settling legal disputes, either through arbitration or the courts. Many companies use arbitration because arbitration has the full force of the law and it is less expensive. Because the 3PL is the seller, it has the choice of which state legal proceeding and arbitration are subject to and held in.
Inventory losses can occur from paperwork problems, computer issues, processing errors, and theft. Many 3PL inventory systems and processes are fully barcoded and have high accuracy.
The agreement should have a shrinkage loss specified, typically up to 0.5% shrinkage. What this means is that the client will absorb the first 0.5% loss and the 3PL will absorb the costs over 0.5%. This is generally calculated on an annual timeframe based on actual cost. But, monthly inventory accuracy accountability, such as inventory audit trail of adjustments, will allow you to have a better handle on any inventory losses.
The 3PL is not responsible for the negligence of client, agents, or shipping companies in handling inventory.
As your fulfillment partner, the 3PL needs to know what your annual order and receipt plans are, as well as any promotional plans and daily/weekly order projections. Some forms of marketing, like DRTV or infomercials, can generate high spikes in orders.
Other industries may experience holiday peaks that are 10 times higher than their average week. Keeping promotional plans and order levels projections are standard in most agreements. Generally, there is a rolling 13-week sales order forecast (financial quarter) so that the 3PL can plan staffing.
There often is a provision that if the actual is more than X% in error (e.g. 10%) of the forecast, then the 3PL has the right to do something in return. Consequences for inaccurate forecasts include:
- the 3PL not meeting standards during the error period
- charging overtime labor costs back to the client
- charging back a premium for services
In practice, there should be a weekly call to discuss promotions, anticipated orders, and inbound receipts. If there is a significant decline in processing volume, there may a remedy for the 3PL, such as proposing new pricing. It is the client’s responsibility to have on-site current literature and inserts at 3PL.
3PL visits and account management
How much notice does the client have to give to visit the facility? The liaison for both the client and the 3PL are very key. Can either ask for the account manager to be replaced if there is justification?
What insurance will each party keep in force during the agreement? What is their dollar coverage?
Typical insurances include:
- General Liability
- Employee Dishonesty and Fraudulent Acts
- Workmen’s Compensation
Agreements often include whether either party can hire each other’s employees. Is there a waiting period to hire after termination?
The 3PLs are independent contractors, not partners or joint venture partners unless otherwise specified.
This is an area where you will want to consult your lawyer. Most agreements list out circumstances outside the 3PL’s control which prevent them from fulfilling the contract. Examples are acts of God, labor disputes, breakdown of facilities, government action, and weather.
Because of this clause, it is important to understand the 3PL’s disaster planning as part of the selection process. This includes any concurrent systems backup of data and other major potential failure points.
This is another area where your attorney knows best. Indemnification shifts the cost of a suit to another party. For example, 3PL will ask the client to bear the costs, including attorney’s fees, to protect its management and employees if the client is sued by a third party for something resulting from use of the client’s product. Exceptions may be if 3PL is found to be negligent or have willful misconduct.
Agreements often give the 3PL the right to use the client’s business name in advertising, brochures, selling materials, trade show booths, and social media. Are there any stipulations you want to make about the use of your personal name, company name, or logo, such as usage is only allowed after successful implementation and Go Live?
Can this contract be assigned to another company without the permission of the other party, such as in the event either company is acquired?
A few thoughts
Here are a few more things to consider about contracting with a 3PL:
- 3PLs often specialize in categories of products or services, such as apparel, pharma, cold storage, or vendor compliance to “big box” retailers to name a few. Generally, 3PLs will not accept restrictions on services - even to your competitors - because it restricts their business and it’s hard to define who is a direct competitor. If you don’t trust, don’t contract.
- Don’t overstate your sales forecast to make your company look more attractive to providers. Ultimately, you lose credibility and have to face higher pricing from lower volume, anyway.
- 3PL carrier shipping rates may be lower, but you have to be willing to advance the fees.
- Language regarding the warranty of service, guarantees, and damages are tricky. Rely on your attorney.
- Get the important 3PL promises regarding performance, pricing, and schedule in writing.
- Spend the time analyzing and planning the three years’ business proforma so that you don’t incur higher costs than expected.
- Negotiating the agreement takes time. Think out the consequences of various actions and potential problems. Review the agreement with all stakeholders, attorneys, and management.
- An experienced 3PL fulfillment consultant working with you, your attorney and the 3PL will be beneficial and move the process along.
Note: This blog post may not use proper legal terminology and should NOT be considered legal advice as we are not attorneys. This knowledge comes from working with clients, their attorneys, and management to develop 3PL agreements that are fair to both parties and deliver the results the client companies are expecting.