How to manage logistics contracts

“Manage complex logistics contracts very carefully,” is a message often heard at logistics seminars. So you would expect that almost every company does so. And that as a minimum, they review monthly key performance indicators (KPIs) with their suppliers in order to improve logistics performance. But do they?

 

In practice, logistics contract management that focuses on value optimisation is a difficult process for many companies. The contract management process contains several common pitfalls that can prevent you from getting the most out of the relationship with your logistics service provider (LSP).

 

We take a look at logistics contract management from both sides of the table: where the most common pitfalls lie in managing the client-LSP relationship, how they can be identified and – more importantly – how to avoid them.

 

Costs are the single most important aspect during contract negotiations. But this means that opportunities for incorporating other aspects often get overlooked. Aspects that can generate a lot more value than the savings made from negotiating a few extra percentages of discount. For example, creating a joint planning process between the logistics service provider and the shipper could potentially yield more value than a 5% discount on storage. Develop a number of concepts where extended services will add direct value to your logistics operation, and consider introducing them during contract negotiation. LSPs are often more open to discussing an extension of the activities than negotiating rock-bottom tariffs. Think in terms of how to create value and include these in the contract. “Price is what you pay; value is what you get,” as Warren Buffett said – let yourself be guided by what you will receive.

 

It often becomes clear, as soon as the contract management phase starts, that the framework has been based on how the negotiators expected the operation would run at the time of contract negotiation, instead of the actual daily operation. In many cases, the defined KPIs are irrelevant or impossible to measure in daily practice and, as a consequence, the quality of the performance cannot be measured or is perceived as bad. Agree to review and revise the cost base and standardisation after a certain time, e.g. 6 months into the contract, to align the initial plan with reality. During this initial contract period, a joint team should be responsible for evaluating the performance quality, terms, conditions and assumptions agreed upon during contract negotiations. Building on the experience gained in this first part of the cooperation will strengthen the contract and boost mutual trust.

 

Strategy can be an over-used term, but in a supply chain context, the logistics strategy defines a company’s approach to ensuring the logistics process contributes to the distinctiveness of its offering. In short, how do we differentiate ourselves, or outperform our competitors, by optimally using our (or our LSP’s) logistics capabilities? An LSP that has no match with your own logistics strategy will at best fulfil its operational obligations at the start of the contract. Soon, however, the discrepancy on where you want to go and the ‘opposing’ strategic direction of the LSP will develop into a serious obstacle for the overall competitiveness and distinctiveness of the entire company. Consider aspects such as the LSP’s long-term plans and investment into areas such as IT landscape, visibility, industry-specific solutions, footprint and product development. Request details of the supplier’s strategy; ask for a thorough explanation by one of the board members and translate this into a specific logistics strategy. Know which standards are needed for the processes in order to outperform the competition. These standards can subsequently be addressed in the logistics contract.

 

Obviously there are instances in which it makes sense to split warehousing and distribution. From a contract management perspective, however, this type of set-up adds complexity. Apart from perpetual investigations into who was to blame, whether the address was wrong or the order was picked too late for dispatch, planning and reviewing is shared among various parties, with the shipper being responsible for orchestrating the flow between the providers. This set-up does not suit all, and there should be a clear business case in favour of separate contracts. The renewal frequency of distribution contracts should be seen as separate, and can be re-negotiated on an annual basis.

 

Many buyers, in their role as logistics managers, are not in charge of the budget and therefore are not allowed to make final decisions. Instead, the final responsibility for approving supplier contracts often lies with purchasing departments, who sometimes negotiate unsuitable or different contract terms and specifications. These will only become apparent in the implementation phase, by which point the relationship will likely already be under stress. The end user is best positioned to assess the supplier’s performance during the contract management phase, but is unlikely to be fully informed about the contractual service levels. Even if the end user is involved in the specification phase of the purchasing process, he or she is usually unable to influence the final details of the contract, which are in the hands of purchasers and lawyers. The translation of the operational paragraphs in the contract into daily practice plays a significant role during the contract management phase. Don’t get caught out: create a team that is responsible for the complete process from start to finish and that is knowledgeable about the specifications that are linked to actual daily practice. The team makes all decisions throughout the entire process. This is much more effective and prevents conflicts of interests and misunderstanding in communications.

 

Changes in the supply chain are usually heavily scrutinised by the client’s commercial organisation. These changes will often be justified in terms of substantial savings or quality improvements. The exact service level of a new logistics contract is often interpreted differently, or its scope and limitations are not clearly communicated, resulting in the commercial organisation of the client overselling to its end customers. We have seen examples of ‘On Time In Full’ (OTIF) commitments including bonus-malus agreements and liability acceptance at order level. It is very important that the commercial organisation knows what it can – and more importantly what it cannot – sell to its clients. It is vital that the logistics team on the client side proactively communicate the limitations of the logistics operation and Service Level Agreements internally.

 

The final pitfall is in fact the most common one. There is often an unclear barrier for shippers to terminate a contract and change suppliers. This can be caused by a variety of reasons, such as reluctance to enter into a demanding move project, good relations with the provider, or the fear of service disruption for example. The incumbent logistics provider is familiar with the procedures and methods used by the shipper, and the people involved on both sides know each other well. The more long-standing the relationship, the more disappointing the service needs to become before that relationship is ended. In such a case, it should be clear how the existing contract can be terminated effectively when a fruitful long-term collaboration is no longer viable. Include the exit criteria in the contract. Furthermore, create a step-by-step build-up of the relationship. Let the provider first prove that it can meet the standards that have been set before further integrating the processes and systems.

 

Contracts are usually regarded as lengthy, bulky and complex legal documents. When contracts are well-structured so that their contents are clearly visible, they become great control instruments. Logistics contract managers from both the shipper and the provider should not need to frequently refer to the legal text and small print, as the basis for daily operations should flow from within the well-defined boundaries of the contract.

 

Manage your logistics contracts with greater clarity and get the basics right. See our expert insights on how to negotiate logistics services contracts.