Ideal duration for contracts with services provider
AS consumers, we are used to one-year contracts such as health insurance, club memberships and other subscriptions. Most of these contracts are automatically renewed after a year. Should this be any different with regards to your contract with your logistics services provider (LSP)?
Most manufacturers and traders (shippers) outsource their transportation, warehousing, value added logistics, freight forwarding, and supply chain management to an LSP. Shippers want the contract as short as possible like one or two years, whereas the LSP prefers the duration as long as possible like five to 10 years. As competition is fierce in the logistics industry, many contracts with LSPs today are just two or three years. But what is the most optimal contract period?
Shippers are traditionally hesitant to engage in a long-term outsourcing engagement for the reason that they become overly dependent on the LSP. Furthermore, shippers may be concerned with the continuity of operations and LSP commitment in case of big organisation (like merger or acquisition) or market changes during the contract period, demanding major adjustments in the supply chain.
LSPs, on the other hand, need to optimise logistics operations and supply chains for their customers, requiring significant investments in specialised buildings, racking systems, conveyor systems, automation, trucks and people. This becomes a big risk when the payback period is longer than the contract duration.
Basic transportation and freight forwarding contracts can be two years. There should be of course a cost escalation clause in case of significant petrol price changes, which are outside the control of the logistics service provider. In this way the transportation rates can be adjusted accordingly to maintain a win-win business relationship.
However, transportation contracts where the logistics service provider is expected to invest in a specialised fleet like refrigerated trucks, double-decker trucks, contract terms should be longer. In these cases, I would suggest a contract period of five years.
Warehouses used to be basically sheds: a storage space under a roof. Unless you are dealing with bulky construction materials, these times are gone. Warehouses today need tailored mechanised and automated operations, meeting high environmental standards through investments in solar energy and water catchment, and specialised equipment and training of manpower.
Many warehouses also require various licences and certificates like food safety and halal that are facility-specific. Obtaining licences and certificates for the best location of the warehouse takes time.
Warehouse contracts of two years are absurd, making it impossible for logistics service providers to seriously invest. Warehousing and value-added logistic contracts should be in the range of five to 10 years.
In supply chain management outsourcing engagements, also called the fourth-party logistics, the LSP controls and optimises client supply chains. However, the biggest cost reductions and synergy advantages are only generated through intensive vertical within your own chain and horizontal with similar chains collaborations. Contracts up to three years will not allow an LSP to embark on these advanced collaboration models, leaving the biggest savings potentials on the shelf. Supply chain contracts should be preferably five years.
In short, a more mature logistics and supply chain management operations require a relook at contract terms with your LSP.
Warehouse contracts of two years are absurd, making it impossible for logistics service providers to seriously invest. Warehousing and value-added logistic contracts should be in the range of five to 10 years.