Understanding Fulfillment Services Contracts

When you outsource fulfillment services to a third-party logistics provider (3PL), you’ll sign a fulfillment services contract. These contracts are designed to protect the interests of both parties. Where the contract process can go astray is when the contracting party tries to negotiate a “win-lose” contract that is more favorable to his company. But such contracts are not sustainable. If the agreement is one-sided in favor of the shipper, both parties suffer if the 3PL is unable to operate profitably.

While many of the terms in a fulfillment services contract are standard across providers, all contracts are negotiable. If both parties enter discussions with an open mind and mutual respect, negotiating fulfillment contracts can be quick and painless. Here are 5 common clauses in fulfillment agreements that can trigger discussions.

Cost of Living Adjustments (COLA)

Customers are sometimes surprised when annual cost of living adjustments are higher than government-reported increases. But those government numbers don’t really address the major cost drivers for a 3PL. For instance, industrial real estate rates have risen 5% this year and, according to the Business Group on Health, employers will pay 5.3% more for employee health benefits in 2021. These costs are unavoidable and must be passed on for providers to remain profitable. That said, it’s fair for customers to ask questions and fully understand the math behind any increases.

Material Change in the Business

The most important part of a fulfillment services agreement is, of course, the price, and customers expect the 3PL to honor the price provided. Pricing is calculated based on data from the customer on things like number of orders per day, average lines per order and SKU count. When that data changes dramatically – let’s say the number of orders and SKU count doubles and the units per order is halved – it could make it impossible to execute the service for the contracted rate. While such a circumstance is unusual, 3PLs will want to protect themselves should it happen.

Early Termination

For a variety of reasons, customers may want to terminate a contract before its full term. This can create serious financial hardships for 3PLs, since they may invest money and time early in the relationship, anticipating that they will recoup these costs over the term of the agreement.

• 3PLs may invest in capital equipment at the start and amortize these costs over time.
• 3PLs may operate for less/no profit in the early stages of a relationship as processes are fine-tuned and productivity ramps up.
• 3PLs do not always bill the customer for many start-up costs, like setting up the facility, documenting SOPs, participating in start-up calls, and hiring and training of associates.

Shippers will want maximum flexibility in the contract as it relates to termination, but the agreement should recognize that 3PLs’ investments are skewed toward the early stages of the relationship and provide a way for them to recoup these costs.

Inventory Shrinkage

Most customers understand that a small amount of inventory shrinkage (typically .5% of throughput) is allowable. This can sometimes become an issue for customers that have little experience with warehousing contracts, even corporate attorneys (“You’re going to lose some of my inventory and not pay?”). Inventory shrinkage can originate outside the warehouse (e.g., a supplier was short on an inbound shipment) or inside the warehouse (3PL error). Most 3PLs will not hide behind contract language to skirt responsibility for a loss traceable to their negligence, such as product damage. They will do the right thing.

Warehousemen’s Lien

Any good contract, in any industry, includes a provision for non-payment. For some businesses, it’s easy. Utility companies can turn off your services if bills are long past due. Banks can exercise their rights to collateral if you default on a loan. But when a customer plans to leave a warehouse without paying outstanding invoices, 3PLs have little leverage other than the inventory they hold on the customer’s behalf. A standard clause in just about every warehousing agreement addresses the rights of the provider to hold this inventory as collateral until the outstanding balance is satisfied. In general, this warehousemen’s lien clause is not an issue. But it can create ill feelings from customers who regard themselves as a good credit risk.

Closing Thoughts on Fulfillment Services Agreements

Negotiating fulfillment services contracts can be long and arduous. But it doesn’t have to be if both parties enter discussions with mutual respect and the intention to create a win-win agreement. To ease the process:

• Involve people, including attorneys, familiar with warehousing law
• Avoid a committee approach to contract review, where many people offer comments, often without collaboration. Appoint a decision maker to reconcile conflicting input in the redlined version.

Negotiating fulfillment services contracts may not be the most enjoyable part of running an online business, but it’s necessary and important. The best approach seeks protection of your business but, ultimately, fairness for all.

If you are evaluating third-party fulfillment providers, we’d love to learn if Staci Americas' nationwide fulfillment solution could be a fit. Contact one of our fulfillment experts to arrange a discussion.