After months of working with prospective 3PL vendors to support your supply chain, you likely received hundreds of pages of documentation and verbal promises. Once you have determined your preferred 3PL partner, it is time to begin to negotiate the contract.
All of the critical documentation from the sales process is important to capture in a 3PL agreement. This step is critical to protecting your business. In this final phase, you will want to have two parties review the agreement, the first being your attorney.
Your attorney will provide you legal advice to protect your business, do no skip this review for the sake of just moving ahead.
Secondly, you will want to have a 3PL consultant analyze the contract language from a business perspective. This review will help you to understand if the 3PL contract meets industry standards and expectations.
A typical 3PL agreement will include:
This checklist is designed to provide you with a high-level understanding of how many 3PL contracts are structured. Additionally, it provides recommendations for how and where to negotiate with 3PL fulfillment and logistic companies.
3PL contracts must be fair and balanced between he client and the vendor. Your goal, with your attorney’s input, is to find the balance. This article is not intended to provide legal counsel.
Typically, the process begins with a “master services agreement”, think of this as a 3PL contract template. These documents are typically the baseline developed by the vendors attorneys which can favor the vendor.
As you begin to finalize the contract, look at the deliverables, services, standards, and pricing. Validating that they meet your company’s objectives and requirements. Remember that services or service-level agreements discussed with the sales team are not enforceable if they are not in the contract.
You only need a good contract when you need a good contract. Meaning when you need enforcing services or standards to protect your business and customers is not the time to discover that you have a worthless contract. Do not just accept a 3PL agreement template without a review.
In most cases, 3PL contracts for fulfillment services are three years or longer. Ask these questions as you review any 3PL contract for your business:
Additions to the master services agreement are specific to each client and can specify the services provided and at what cost. It is not uncommon for 3PLs to supplement this with addendums to cover:
Addendums should be updated as the services, standards, and costs change. Both parties will want to execute the addendum reflecting the changes.
Negotiating a 3PL contract requires a combination of business sense and legal guidance. Below are the major terms, conditions, and issues we commonly encounter when assisting companies committing to a 3PL partner.
Read: 9 Considerations Vendors Evaluate in Negotiating Deals
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.
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:
Generally, the SOW outlines services at a higher level. You and your attorney have to judge how detailed the SOW needs to be for your company.
Incorporate a detailed project schedule, detailing the onboarding in their distribution centers:
Spell out the client and 3PL responsibilities. Identify go live dates for receipt of first inbound product and for shipping for first customer orders. Most project plans will include only the tasks required by the vendor to support the logistics service quoted.
Read: How to Select the Best 3PL Vendor For Your Business
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 to process a certain volume of orders.
It’s expensive and disruptive for both the client and the 3PL to move in and out of a facility. Long term agreements make sense if they are a win for both parties. A short-term contract may have higher front end cost to cover any material handling equipment needed by the vendor.
It is not uncommon to see optional 1 or 2 year renewal terms once the initial term length has passed.
How does the agreement structure 3PL price increases 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.
The 3PL service level agreements and performance should be spelled out. Keep in mind, standards which are too tight can radically increase the price. Consider what penalties should be in place for failure to perform. If your demands are too extreme, you will probably not get acceptance by the vendor.
Some key standards are:
To keep 3PL service level agreements high, establish a short monthly recurring call between both companies’ senior management. Even though both parties 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:
A 3PL 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 between 60 and 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.
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.
Inventory
Remember that inventory is one of the largest balance sheet assets in retail and e-commerce 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 damage. 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.
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:
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:
There are three categories of IT services and corresponding charges.
These are the categories of expenses you should expect:
There will be advances for fees which the 3PL will make on your behalf, including:
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?
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?
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:
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.
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:
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?
Here are a few more things to consider about contracting with a 3PL:
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.