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Today’s blog is a continuation of yesterday’s where we discussed cost management and KPIs with warehousing contracts using a real-world scenario. Now we dive a bit deeper with incentives, gain sharing, should-cost models, and governance in warehousing contracts.

Since this is a real-world scenario, here’s a quick recap on the client.

Our client is a leading player in the US FMCG/CPG market and is a Fortune 500 company. Currently they incur a annual spend of USD 380-420 Million for their warehousing needs, of which ~60% spend is for brand new six warehouses (average space of 1.5 Mn. sq. ft. each) and the rest 40% spend is for 25 warehouses (anywhere between 300,000 to 1 Mn. sq. ft.). All these warehouses are used for storage and distribution of finished goods, the six new warehouses are brand new and involves complex operations (full pallet in and mixed pallet out or case deliveries)while the 25 warehouses have more standard /generic operations (full pallet in and full pallet out).

Currently, the real estate for all these warehouse is owned by our client, and the operations are completely outsourced to multiple 3PL players. And our client engages with 3PL by open book cost plus contracts and gain share and pain share incentive. About this, our client would like to understand what is the best practice followed in the industry for open book contracts.

Incentives & Gain share and Pain share in Warehousing Contracts

KPIs Question 1

Currently, our client provides an incentive to a supplier via gain and pain share. Is it the best way to provide incentives?

3PL Answer 1

 No, I feel continuous improvement, partnership, and effective KPIS are the best incentive. If there are late deliveries, poor quality, etc., PENALTIES should be in the contract or Service Level Agreement.

KPIs Question 2

What is the industry best practice to calculate gain share and pain share?

3PL Answer 2

Gain and pain share are split 50% each. But, the key is: Is it working effectively for BOTH parties?

KPIs Question 3

What are the other incentives followed in warehousing industry?

3PL Answer 3

More warehouses are using Lean initiatives. Some incentives are reducing UNIT PRICING. Reducing absolute quantities required. Reducing transportation costs by using the optimization of lanes and routes in the transportation management system (TMS). The fuel surcharge (FSC) should be capped and not increased frequently. This is also a negotiable issue. Decreasing prices based on increasing sales, i.e. sales incentives: additional customers closed; more warehouse activity; filling warehouses space with new customers.

KPIs Question 4

Should gain share be eliminated and moved to a different incentive? If so, please explain the justification.

3PL Answer 4

In a collaborative relationship, gain sharing motivates BOTH the shipper/customer and warehouse/3PL.  More 3PLs/Warehouses are using Lean and continuous improvement, as incentives: a %age improvement per month, a dollar value per month/specifics critical to BOTH partners.

Should-Cost Models in Warehousing Contracts

KPIs Question 1

Currently, the should-cost model for warehouse operations is devised and owned by the 3PL, and our client feels that it is too cumbersome and opaque. How can this be rectified with 3PL?

3PL Answer 1

I suggest the use of cross-functional teams for cost modeling: team members from the shipper/customer, warehouse, and 3PL.nThe 3PL should have cost-model simulation software for cost-modelling simulations. Your client should be integrated to the cost-modeling

KPIs Question 2

Would it be wise for our client to develop its cost model and take ownership? This is not to increase the control over 3PL but to increase the transparency over the cost calculations. What is the industry best practice for this?

3PL Answer 2

No, integrate to the 3PLs cost-modeling simulation software. Both share in all activities. Trust and collaboration work very well.

Governance in Warehousing Contracts

KPIs Question 1

The current structure for governance across multiple warehouse locations is highly localized and de-centralized, i.e., each warehouse has different expectation setting, roles and responsibilities, accountability, financial/safety/operations/quality reporting. This leads to cumbersome management and how can this be rectified to a structured, centralized governance?

3PL Answer 1

I recommend a Lean standard, structured (NOT-localized/decentralized) expectation setting, roles and responsibilities, accountability, financial/safety/operations/quality reporting

Governance. Write Standard Operating Procedures (SOPs) for each area and have Goals and Objectives with KPIs for each area: expectations, roles, and responsibilities, accountabilities, financials, safety/OSHA standards, operations/quality reporting

Other Best Practices with Warehousing Contracts

KPIs Question 1

Should our client shift to the closed book transaction contracts ($ per unit) or activity based pricing contracts. If so what would be the pros and cons for the same?

3PL Answer 1

“Closed book” suggests a lack of trust for 3PL/Warehouse partnerships. Books should be open and shared. For gain sharing and cost reduction everything should be shared to meet monetary cost reduction goals. Incentives can be used to increase monetary cost reduction.

Suggestion: Perhaps your large client should consider consolidation/re-engineering of 3PLs and warehouses. Go from this complex arrangement to better managed, simpler solution. Keep only the 3PLs closest to your main customers. Less amount of 3PLs? This will minimize transportation services; Less amount of Warehouses? Using Lean to eliminate all wastes including excess inventory, excess transportation, excess FTEs, excess space, excess obsolete/non-moving/slow-moving SKUs?

Implement slotting and re-slotting? Flatten the table of organization to eliminate FTEs. Use Pareto’s 80/20 priority principle to set the organization, so it is at its optimum best? Also, your client is an asset company owning his warehouse. You can also be an NON-ASSET where you DO NOT OWN
 your warehouses. This is less expensive. CH Robinson, a very large 3PL (Top three (3) 3PL) is ALL non-asset.

I can help your client accomplish this consolidation project, only if they wish, of course.

Suggestion only: Millions of dollars can be saved with these re-engineering suggestions: Implementing Lean initiatives, Re-engineering 3PL operations, consolidating 3PLs to be more manageable, closer to your major customers, and effective and re-engineering the table of an organization using less FTEs/flatten the table of organization. Use metrics on each person, so they all know what is expected of them.

Clarify the person(s) accountable/responsible for this overall re-engineering project and give them milestones to meet.

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