Complex logistics contracts should be managed closely,” is an often-heard message at logistics seminars. One would expect companies nowadays to have collectively adopted this approach and at least review monthly KPIs with suppliers in order to increase logistics performance. But do they really?
We notice in practice that logistics contract management focused on value optimization is a difficult process for many companies. The contract management process contains a number of common pitfalls. These pitfalls prevent you from getting the most out of the relationship with your logistics service provider (LSP).
In this article, we will look at logistics contract management from both sides of the table. We will explain where the most common pitfalls lie in managing the client-LSP relationship, how they can be identified and, more importantly, how to avoid them.
1. Choosing a supplier focusing on cost alone: “How low can you go?”
Costs are the single most important aspect during contract negotiations. Sometimes, however, opportunities are overlooked for bringing in additional aspects that can generate a lot more value rather than minimizing the core service costs. For example, creating a joint planning process between the logistics service provider and the shipper could potentially yield superior value than a 5% discount on storage. It is wise to develop a number of concepts where extended services will add direct value to your logistics operation and consider introducing them during contract negotiation. LSP’s are often more open to discussing an extension of the activities than negotiating rock-bottom tariffs. Think in terms of methods of value creation 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!
2. Negotiating contract terms and KPIs out of line with the daily operation: “Things turned out to be quite different in practice”
It often becomes clear, as soon as the contract management phase has started, that the framework has been based on how the negotiators supposed the operation was going to run at the time of contract negotiation, instead of the actual daily operation. In many cases, the defined KPIs are irrelevant or are impossible to measure in daily practice and, as a consequence, the quality of the performance cannot be measured or is perceived as bad. It is good practice to agree to review and revise the cost base and standardization after a certain time, e.g. 6 months into the contract, to align the initial plan with the reality. During this initial contract period, a combined 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.
3. Strategy mismatch: “We lost each other along the way”
Strategy is an often-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 translated into the logistics contract.
4. Multiple contracts for warehousing and distribution: “Now I have two Single Points of Contact”
Obviously there are instances in which it makes sense to split the warehousing part and the distribution part. From a contract management perspective, however, this type of set-up will add complexity. Apart from perpetual ‘whodunnit’ investigations into 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 one should have a clear business case in favour of separate contracts. The renewal frequency of distribution contracts should be seen as separate and can be renegotiated on an annual basis.
5. The buyer is not the user: “Well, I didn’t agree to that!”
Many buyers, in their role as a Logistics Manager, are not in charge of the budget and therefore are not allowed to make the final decision. 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 already be under stress as additional aspects in the owner’s interest need to be included in the contract. The end user is best positioned to assess the actual performance in the contract management phase, but he is not fully informed about the contracted service levels. Even if the end user is involved in the specification phase of the purchasing process, he is usually unable to affect the final arrangement of the contract. That control then once again lies in the hands of purchasers and lawyers. The transfer of the contract (meaning: the translation of the operational paragraphs into daily practice) plays a significant role during the contract management phase. So 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 which are connected to actual daily practice. All decisions are made by the team, throughout the entire process. This is much more effective and prevents conflicts of interests and communicative misunderstandings arising.
6. Overselling“We deliver anything, anytime, anywhere – or your money back!”
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 the 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 communicates the limitations of the logistics operation and Service Level Agreements internally.
7. The lock-in: “You can check out anytime you like…”
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, social 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 stepwise 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, since the basis for daily operation should flow from within the well-defined boundaries of the contract.
About the author
Jan Runge Petersen has been active in the logistics industry for 34 years, during which time he has held various management positions within logistics and freight forwarding globally. He has spent the last 11 years at DSV. He started out as a Division Manager with DSV Road and currently holds the position Director of Contract Management within DSV Solutions Group in which he is regionally responsible for managing contracts for large accounts. Jan is based out of the DSV headquarters in Copenhagen, Denmark.