Success factors for contract logistics

by Prof Dr Thomas Mühlencoert

Contract logistics is the segment of logistics with the highest growth rates. However, it is incomparably more complex and characterised by many services that are unusual for freight forwarding and are no longer covered by standard insurance policies. The liability risk increases.

Contract logistics is often tied to a warehouse location (fulfilment location) of a logistics service provider (LSP), so the regional location and real estate facilities are decisive factors for customers (contractors) when making their selection. The third decisive factor is the correct organisation of the business relationship, which should differ from the classic call-off business of freight forwarding logistics and which is discussed below.

Firstly, a conscientious invitation to tender is necessary; the level of detail in the tender documents should be seen in relation to the required billing basis: If the pricing offered is to be fully or almost variabilised, i.e. based on units of service (price per picked order, etc.), the requirements must be specified much more precisely than if a cost-plus model is to be used. The quantity and seasonal profiles and their forecasts also play a more important role in the calculation of prices for service units. Not only process requirements, but also KPI requirements, liability requirements and bonus-malus rules have an impact on the calculation; these are often missing in tender documents and are only disclosed during contract negotiations. A model for continuous improvement and the handling of productivity gains (win-win) should already be included in the tender documents.

The tender documents should be converted into a detailed service description (specifications) before the contract is concluded and after the LOI is signed. Insurance cover should be arranged for various causes of disruption, contingency plans should be drawn up and central KPIs for performance monitoring should be agreed and linked to an incentive system.

An LDL is generally reluctant to invest in capital-intensive systems. In the case of systems that are even customer-specific and can hardly be used elsewhere, the question of the imputed amortisation period arises. The most important incentive for the service provider here is the contract term, which should be in a fair relationship to the investment. It is also possible to agree on financial compensation in the event of premature cancellation for specific capital investments or a takeover (purchase at residual value).

Personal contacts with customers or suppliers are often of great importance to the client when it comes to resolving day-to-day difficulties (e.g. delivery problems). Outsourcing can break off these contacts. A precise allocation of roles (e.g. for complaints management) and special rules of co-operation must therefore be agreed.

Not only extraordinary but also ordinary termination (non-renewal of contract) is a critical phase in the life of a business relationship. The contract must already address the termination scenario. For example, it must be clarified how a smooth transition is possible and what obligations to co-operate (e.g. provision of order structure data for the tender) and subsequent performance obligations exist. It must be regulated who takes over which resources and under what conditions, to what extent third parties have inspection rights and a relocation concept should be described in principle (e.g. parallel operation during the relocation phase).

If the client works with the same LSP for many years, it can happen that over time it is no longer able to assess whether the logistics system being operated is still based on standard market costs and the latest and most suitable concepts or whether potential for improvement remains unrealised. A periodic invitation to tender before upcoming contract renewals in the sense of a pure price and market sounding can provide information here, but has the risk that it becomes known in the logistics market that no change of provider is actually planned and then tenders from such a company are no longer (seriously) processed. It is better to make arrangements from the outset, e.g. to periodically agree on external assessments or joint improvement projects.

The longer the contract term, the greater the risk of dependency on the LDL, as the company's own logistics expertise is lost over time. It becomes increasingly difficult to reverse an outsourcing decision. The increasing complexity of outsourcing projects also makes it more difficult to substitute an LDL. The following realisation should apply: A dependency risk can never be eliminated. This makes an undisturbed relationship between the contracting parties all the more important. To this end, escalation and arbitration or mediation rules should be agreed. If necessary, you can try to retain know-how to a limited extent. Daimler AG, for example, still handles the CKD business for certain top models itself. This protects against a complete loss of expertise and strengthens the negotiating position when contracts are extended. If necessary, services can be transferred to several service providers.

Not all aspects can be explained here. However, the recipe for success in contract logistics is to think through all phases of the business relationship with their main risk factors at an early stage and develop rules for them! Project initiation takes time! Then even complex logistics projects will lead to success.