What is a 3PL Agreement?
A 3PL or third-party logistics provider provides outsourced supply chain management and/or logistics services to businesses. A 3PL partner may provide a broad range of services for freight consolidation, storage, inventory control, order fulfillment, distribution, and/or managing logistics in the supply chain for its customers. Although there are a number of business models utilized by 3PL providers, a common model is for the 3PL to receive products from one or more suppliers at its warehouse facilities, consolidate or inventory the products in its warehouse(s), and then ship from its warehouse(s) to end customers.
A 3PL agreement is a contract that sets forth the terms and conditions governing the commercial relationship between a shipper or customer ("customer") and a third-party logistics provider ("3PL") . 3PL agreements may cover a number of terms including the scope of services, compensation, term, confidentiality, insurance, and/or liability. A well drafted contract protects both the 3PL provider and its customer in the event of a dispute. Where the scope of services provided by a 3PL includes controlling the storage of inventory or products belonging to a customer and/or receiving and processing orders from customers before shipping to end customers, there is often overlap between 3PL contracts and warehouse agreements. The purpose of a 3PL Agreement is to define the scope of the services to be provided and the commercial relationship between the parties.
Essential Components of a 3PL Agreement
At the very least, a 3PL Agreement should include a description of the scope of services to be provided by the 3PL provider. In addition to outsourcing, management and execution of tasks, the parties may structure the 3PL Agreement so as to outsource ownership and/or lease of part or all of the assets necessary to perform the services, which in turn can impact the value of the agreement to both parties through the tax impact of an Asset Purchase Agreement versus an Asset Lease Agreement. Sometimes the description of services will be so complex and factual that parties include a detailed Statement of Work, separate from the 3PL Agreement, so that there are no substantive gaps from a performance standpoint. Additionally, the detail set forth in the description of services is relevant to the scope of the indemnification obligations, for example if the scope includes customs brokerage services, the 3PL provider may seek indemnification from the client in the event of an investigation by U.S. customs.
A 3PL Agreement will typically set forth the terms of payment in some quantity/volume-based fashion, with pricing changes based on volume (e.g. 20% discount off the fee schedule for shipments between 5,000 and 15,000 kilograms), allowing the client to get the benefit of a lower price for higher volume, but also giving the 3PL provider some assurance that the client will be shipping or paying for lower volumes at a higher price at some point during the term. If actual payment is not based on volume, the fixed fee structure is often broken down into component parts, so that for example, the 3PL provider may receive a fixed fee for transportation-related charges, separately for warehousing-related charges and separately the handling-related charges. The agreement may also separately state a fee for other services such as customs brokerage, license issuance and other value-added tasks.
The 3PL Agreement will also address how the parties will monitor the service levels achieved by the 3PL provider. This provision could range in complexity from simply specifying whether penalties will be assessed for any days during which certain service level metrics are not achieved, to a list of specific task-based service level metrics such as an agreed percentage of on-time truck deliveries or agreed-upon maximum number of shipment errors per month. In addition, the parties may elect to specify the penalties for failure to achieve the agreed upon metrics such as a list of credits for late shipments. It is important that this clause be clear as the parties may over-estimate the significance of the metrics to be monitored, or create vague or unrealistic standards for the 3PL provider’s performance. Regardless of how service levels are memorialized, it is critical that both parties understand the importance of achieving the service levels to the relationship as a failure to meet agreed-upon service levels may give rise to a significant or even material breach.
3PL agreements may also include Non-Disclosure Agreements (NDAs) not only to protect the data that may be contained within the 3PL client’s systems and the 3PL provider’s systems, but also the list of potential vendors that both parties may be exposed to, especially if one or both of the parties is negotiating the 3PL agreement on behalf of affiliated companies. Where the client or 3PL provider may be exposing their vendors’ information to the other party, the parties should consider specifying that neither the client nor the 3PL provider can disclose the other party’s list of vendors to others. If the client or 3PL provider will be disclosing pricing to the other party, the parties should also consider including a pricing NDA, which protects the pricing each party has secured with its vendors.
Advantages of Engaging in a 3PL Partnership
Merchants who enter into "third party logistics provider" (or "3PL") agreements obtain significant advantages, as explained below:
Cost Savings
Naturally, the ability to integrate multiple operations into one single warehouse facility saves merchants money. However, there are other cost savings specific to 3PL agreements. For example, 3PL providers can purchase bulk insurance and other expenses at discounted rates. Moreover, by outsourcing certain activities, such as pick and pack, merchants can save on labor costs (a merchant will typically only pay for the labor and overhead involved in executing the specific functions). As a result, merchants are able to more efficiently allocate their resources.
Increased Efficiency
3PL providers are highly experienced in their specific industry and often provide merchants with efficiencies that would otherwise be unavailable. For example, many 3PL providers have sophisticated, integrated computer systems that enable them to accurately manage their inventory control. Similarly, skilled 3PL providers can accurately manage their transportation and distribution of goods. 3PLs are often able to assist clients with returns and other after-sales support better than the merchant.
Scalability
Many merchants experience seasonality or cycles in their demand. Or, a new customer may require a merchant to double its inventory so that it can meet a new contract or deal. A further example is a start-up company who needs to "test the waters" prior to committing to a fixed cost. 3PL providers have much greater flexibility than merchants to scale services and operations (fewer employees and less equipment means lower overhead). Thus, a 3PL can move more aggressively than its client.
Challenges Commonly Arising in 3PL Agreements
While 3PL relationships can be immensely beneficial, they also present their fair share of risks. One significant challenge is the failure to clearly define the scope of the agreement. With different players involved in the supply chain for any given business, the boundaries of responsibility can become murky. For example, the third party provider may have its own sub-contractors who become involved. Each additional party adds a layer of distance between the original shipper and its goods, meaning that the shipper has less control over the process. That can create risk not only for the cargo itself, but in terms of insurance coverage or any liability particular to the supply chain. All parties need to share information and be on the same page in order to avoid problems, which sometimes simply does not happen.
Another problem occurs when the agreement does not properly address shifting business needs. Most contracts run for several years. Over that time, the parties’ needs may evolve. This is also the case with technological changes — the agreement may need to be updated to allow for greater efficiency. To address this risk, best practices include implementing regular, at least annual, reviews of the agreement terms with your third-party provider. Even better is to include specific terms in the agreement that require such reviews.
Overreaching agreements also pose issues, such as when the contract inappropriately or unfairly limits the liability of the third party provider or forces the shipper to incur costs that would typically be the provider’s responsibility, like administrative tasks, inspections or random check-off audits. In addition, some agreements impose strict requirements or unreasonable penalties for shipping schedules, while others delay responsibility for damage until after the claims process has been completed. Those types of terms can create issues in the event of a problem, including increasing liability for shippers that organized a trusted relationship based on insufficient due diligence.
These problems can be avoided through careful and thoughtful negotiation. Business concerns as well as industry standards should be taken into account when developing an agreement, and escalation processes (for a number of different issues) should be defined in the contract; signed by both parties.
How to Negotiate a 3PL Agreement: Tips and Strategies
Understanding the priorities and objectives of both parties despite their inherent limitations creates a framework for negotiation. Open and honest discussions regarding service standards, performance metrics, and future business growth will not only benefit individual parties but also instill faith in business processes that are often viewed with skepticism inside and outside the industry. The reward is a transparent and effective method employed to ensure that parties are adequately protected. The key is balance. If either party aggressively seeks to diminish or eliminate all of its potential liability while leaving the other party exposed, it is highly unlikely that concluding an agreement will be possible .
Service Level Agreements: Commercial agreements generally contain express representations and warranties which are among the most significant legal protections that can be provided for either a shipper or a 3PL. A 3PL will want to limit the scope of its representations in several important ways: a. The capacity of its facilities and if necessary, what recourse the shipper has in the event the capacity of those facilities is overstated. b. Limiting its liability for damages caused by the delay in the shipment of goods to the value of the goods. c. A representation that it has all necessary permits and licenses. d. A representation as to the qualifications of the employees that will service the agreement and the scope of that service. e. A warranty that the services will comply with all applicable federal, state, and local laws. f. A liability cap which limits the scope of damages to be recovered.
Ensuring Performance and Compliance
Regular audits and reviews are recommended to verify compliance and adherence to the performance standards set forth in the 3PL agreement. Systems should also be in place to ensure immediate corrective action when requirements are not met. Customers should also be a source for performance feedback and assessments. Other customers and suppliers are good choices as a source of information on the 3PL. Forums such as trade shows and group meetings can also provide venues for information/impressions to be shared. The contract should provide for termination for failure to meet standards by the 3PL. While business needs may prevent termination, the threat of enforcement is helpful. It is recommended that the enforcement provision be strengthened by providing damages, expense reimbursement and deducting amounts owed under the contract from future payments.
Future Trends in 3PL Agreements
Looking ahead, it is clear that technology will play an increasingly important role in the future of 3PL agreements. The rise of artificial intelligence and machine learning have the potential to streamline and optimize supply chain management processes, from inventory management to route optimization to load consolidation. As advances in quantum computing come online, this capability will only increase. Furthermore, as e-commerce continues to drive demand for more complex and flexible supply chain solutions, the need for technology-driven 3PL agreements will only grow.
Another emerging trend in 3PL agreements is the shift towards a greater focus on sustainability and environmental responsibility. With an increasing number of companies taking steps to reduce their carbon footprint and otherwise embrace environmentally responsible business practices, their 3PL partners must be able to demonstrate the same commitment. This means that 3PL agreements will need to include provisions related to green logistics and other environmentally responsible practices, such as the use of alternative fuels, waste reduction, and energy efficiency.
The rise of big data and data-driven decision-making will also have a major impact on the future of 3PL agreements . Big data analytics can help companies better understand their supply chain operations and identify areas for improvement. This can inform 3PL agreements with more specific expectations and standards, based on data-driven insights into performance and customer preferences.
The future of 3PL agreements will require greater collaboration and transparency between shippers and their 3PL providers. As supply chain operations become more complex and interconnected, shippers and 3PL providers must work together more closely than ever before to ensure smooth and seamless operations. This means that 3PL agreements will need to include provisions related to communication and reporting, as well as dispute resolution and other mechanisms for addressing disagreements or misunderstandings.
Overall, the future of 3PL agreements is likely to be shaped by a combination of technological advancements, increased focus on sustainability, and the growing complexity and interconnectivity of supply chain operations. Companies that want to stay ahead of the curve should consider how these trends may impact their 3PL agreements and what steps they can take to remain competitive in the years to come.