Executive Briefings

Logistics Services Contracts, and How to Negotiate Them

Matching shippers' needs and providers' capabilities during the selection process may be as important as the agreement spelling out the parties' rights and responsibilities.

A contract is a lot like insurance. If everything's going fine, you don't need either one, and you don't really think about them. On the other hand, if things go sour, contracts and insurance might be nice to have around.

There is a crucial difference between the two, however. Insurance clearly is useful only when a problem occurs, while a contract that spells out the rights and responsibilities of the parties can be proactive in the battle against problems, designed from the outset to ward them off. That seems to be true in virtually any industry, and the experts say that it's certainly the case when it comes to negotiating agreements for logistics services.

Your lawyer may be able to beat up the other guy's in court one day, but most logistics professionals feel that having to resort to litigation is a loss in itself regardless of how sound your legal position is. Business opportunities lost due to a ruptured relationship is much too serious to entrust to legal eagles, some logistics professionals say. The idea of a contract is not to hammer the other guy, it's to ensure that everything works, for both sides.

It's tempting to say then that the contract negotiation for logistics services is the most critical time in a shipper-provider relationship. After all, it's where the roles of the parties-as well as compensation, insurance, performance metrics, incentives, penalties and a host of other matters-are delineated with such specificity that no one should be in any doubt about what they should and should not do.

But some feel that the most important phase of the shipper-provider relationship actually starts before the parties meet to draw up a contract. The "design phase" of the relationship begins when shippers first decide to contract for certain logistics services and begin winnowing the providers eager for their business. That is when the shipper's expectations and the provider's capabilities should be matched up with precision and care.

"We spend a lot of time on the upfront engineering of the request for proposal so people can see what we're trying to do," says Brooks Bentz, senior executive in Accenture's Supply Chain Management practice. Services being outsourced by his clients can be quite broad. They might include transportation, warehouse management, customs brokerage, rate negotiation, fleet management, freight payment or forwarding, shipment consolidation, carrier selection, reverse logistics, or any number of other things. No matter, says Bentz. The time and energy that go into the RFP process pay off regardless of the menu of services sought. "We use that process as a way of telling the story of what we want."

And it's vital that the shipper knows exactly what he or she wants, so that can be made known to 3PL candidates. "You've got to ensure that people who cross the finish line in the selection process know what they are expected to do," says Bentz. "There must be as much information as possible about facilities, hours of operations, freight flows, specific requirements about certain services-whatever it is-so that when the provider steps in, they know as much as they can."

A successful match often turns on compatible definitions of value, according to Ron Cain, president of TMSi, a 3PL with corporate headquarters in Fernandina, Fla. A provider may feel it's ill-advised to go with a prospect whose sole idea of value is cost-out. "We like to go with clients who value continuous improvement," Cain says. "So, initially, we need to identify if what they are looking for is what we want to provide. Once we know what the objectives of the relationship are, then we can considering launching into the actual contract negotiation."

Successful relationships rest on clearly defining needs, says Anna Hummel, logistics director for A. Duie Pyle, an LTL, truckload and third-party logistics services provider in West Chester, Pa. "You can't constantly keep hitting a moving target. I think it's OK to have initial conversations in which the shipper says, 'These are the problems I have.' But at the end of the initial investigation, you have to agree on certain criteria and on the specific things you are going to fix. Too many initiatives have derailed because the parties weren't clear on what they were working on."

 

Provider Plethora

Even when a shipper knows precisely what it needs to outsource and what a provider must deliver, selection of a 3PL is no easy task given the staggering number of providers out there. David Fox, CEO of Agistix, a Redwood City, Calif.-based logistics management solutions provider, says the competition is a good place to start. Which provider-or providers-is it using, and why? After developing a roster of 3PL candidates, a shipper can then scrutinize their customer base, history and past performance. "I would also look at some of the customers that a 3PL has," Fox says. "Do they fit into the vertical that we fit into? How long has the provider serviced that vertical? What does its management team look like?"

Bentz says that in the end, the final selection of a provider is as much about fit and relationship management as it is about the money. "The design phase is critical to getting the right result."

At some point, when the shipper and provider have married up, the relationship has to be formalized. But what does a typical agreement for logistics services look like, and is there even such a thing as a typical logistics contract?

How much is boilerplate, and how much needs to be tailored to this unique relationship?

Specificity of language can be a challenge. You need to outline with great care both the obligations and the limitations on everyone, but you don't want the "four corners" of the contract to become a straitjacket. So how do you balance the need for precision with the need for flexibility if circumstances change? And they are fluid. Everyone can point to emergencies, especially those weather-related, that have bedeviled deliveries. After all, transportation takes place in a hostile environment. It wouldn't hurt to know how a prospective provider would deal with such exigencies.

And who is to draw up this agreement anyway? Do you really want lawyers to be involved? Cain says the logistics services industry is largely built on relationships, and trust is important. "It's all in who you pick as a partner." If trust is the cornerstone, can't the parties draft their own agreement?

 

In the Mix

So if there's no model contract that fits every occasion, surely there must be some ingredients that most such contracts need to have. What are they?

"What we try to do is engineer these things so they are acceptable to everybody rather than put somebody in an untenable position," Bentz says.

He feels that boilerplate should be short and simple. The real guts of the contract come in three addenda describing the services to be provided, the compensation schedule, and the rules of engagement.

Take a contract for trucking services, for example. "If I'm the shipper," Bentz says, "I would be as specific as I can about what I want to buy, where the facilities are, where the vendor origins are, what are my service requirements, the volumes I have--basically explaining what it is that I want to buy.

"I want to introduce the KPIs, so that I will expect that you will pick up freight when it's tendered to you and you'll guarantee to do that. We'll specify and define on-time performance. I'll expect that data is to be transmitted once a shipment is picked up from the vendor so we can feed that into our WMS system and be able work the trailer when it arrives.

"The second part is compensation, what I'm paying for that."

A major component in any transportation contract now, Bentz says, relates to capacity commitment. "In the last couple of years we've found that even though we negotiated good rates for service, during periods of tight capacity the truck or airplane or ship was off chasing higher-paying freight. We had good rates, but we still couldn't move the freight. So we add in now, when you commit to the rates, you also commit to the capacity."

Change can be good or it can be bad, and contracts should allow for that. That's why allowing for rate adjustments, for instance, should be included. Adjustments can come about because of negative factors, such as fuel spikes, or because of exemplary performance, Cain notes.

"We typically negotiate incentive clauses," he says, "so if we perform X percent better than originally agreed, the margin increases. Penalties are the other side of that. That's why we create a baseline of the client's productivity before we take over. That way we can demonstrate improvement going forward, and we typically put that in the contract."

Rather than KPIs, Hummel speaks of pilot phases, and says they are indispensable to successful contracts and relationships. "I think the contract should include a pilot phase or start-up phase and then a fully implemented phase," Hummel says. "The contract really needs to address these two steps and say what the pilot and then the full operation will look like. And a full-operation contract should not be executed until the pilot has been analyzed."

Many observers say a major purpose of a formal logistics contract is to guarantee that there will be no surprises for the parties. Hummel agrees and says that's why contracting first for a pilot phase is so important. "It's where you're going to flush out those surprises. It doesn't do any good to have a two-year or five-year contract signed and then have something happen."

Most of those interviewed here say that either they or another company executive negotiate the contracts for logistics services rather than call in the legal department. The latter is good for drafting shell agreements or pointing out the boundaries and "absolute no-no's." Otherwise, most professionals seemed to know what they want to include. And most seemed to think specificity is a good thing.

"The more gray areas you have, the more susceptible you are to risk," says Fox. "If you spell out everything as best you can, you're offering your company more protection."

Fox recalls a client that went against Agistix advice to have every shipment insured. That decision was detailed in the subsequent contract. When a small box of semiconductor wafers, valued at about $2m, was hijacked from a truck in Malaysia, the client insisted on reimbursement from Agistix. Fox says his company was able to point to the precise language in the contract that spelled out who was liable-and who was not. He says the client deferred to Agistix in matters of insurance from that time on.

"I err on the side of specifics," Fox says. "I believe the more specific you get, the more it drives out ambiguity."

But can the wordage be too tight? By their nature, contracts have an air of rigidity about them, Bentz says. What you want is a working agreement. Flexibility is important. "What you say in effect in these negotiations is, 'This is our view of the world. If you guys come up with any ideas that make this better, we'll make changes if it's warranted.' You have to be able to make adjustments without throwing the agreement in the trash."

No industry can exist totally outside the society in which it operates, and the litigious nature of the United States today can hardly be denied. So, logistics contracts wind up in court a lot, right? Apparently not. There have been some famous cases, of course, but most disputes seem to get resolved without the need for court intervention. There are two very good reasons for that. One, a well-crafted  logistics services contract has a dispute resolution mechanism written into it. Second, nobody wants to go to court. Litigation is often counter-productive.

'By and large," says Cain, "our industry is dependent on relationships. You create both personal and professional partnerships. So you can resolve disputes by talking to each other and not resorting to lawsuits."

Still, TMSi writes dispute resolution language into its contracts. "You'll either have an arbitrator or some organization named for dispute resolution," says Cain. "But I've never used it. At that point, our relationship would be broken and it wouldn't work for them or for us."

Hummel agrees that court is seldom seriously contemplated. Yes, she knows of some agreements that fell apart. Compensation may have been paid, she says, but things didn't get so bad that lawyers had to be called in.

Even if lawsuits are the exception rather than the rule, parties in essence can "fire" each other from time to time. True, but churn gets expensive. If there were an industry theme it probably would be, how can you structure an agreement that you can keep in place for a long time? If a shipper gets rid of a provider today, the capacity crunch may make finding a replacement a very tall order. 

Disagreements concerning overcharges and special charges on a shipment are not uncommon, Fox notes, because there are a lot of hiccups in moving freight. But these hassles usually get worked out at the director level, he says. The executives can make those problems go away.

So, is there any one thing that is absolutely indispensable to a logistics service contract? "You know, you have to have the right price point, and a good rate that works for your company," Fox says. "But it's really the working relationship with that other party that becomes the most critical component of that contract."

If you get that part right up front, the rest will probably just take care of itself.

A contract is a lot like insurance. If everything's going fine, you don't need either one, and you don't really think about them. On the other hand, if things go sour, contracts and insurance might be nice to have around.

There is a crucial difference between the two, however. Insurance clearly is useful only when a problem occurs, while a contract that spells out the rights and responsibilities of the parties can be proactive in the battle against problems, designed from the outset to ward them off. That seems to be true in virtually any industry, and the experts say that it's certainly the case when it comes to negotiating agreements for logistics services.

Your lawyer may be able to beat up the other guy's in court one day, but most logistics professionals feel that having to resort to litigation is a loss in itself regardless of how sound your legal position is. Business opportunities lost due to a ruptured relationship is much too serious to entrust to legal eagles, some logistics professionals say. The idea of a contract is not to hammer the other guy, it's to ensure that everything works, for both sides.

It's tempting to say then that the contract negotiation for logistics services is the most critical time in a shipper-provider relationship. After all, it's where the roles of the parties-as well as compensation, insurance, performance metrics, incentives, penalties and a host of other matters-are delineated with such specificity that no one should be in any doubt about what they should and should not do.

But some feel that the most important phase of the shipper-provider relationship actually starts before the parties meet to draw up a contract. The "design phase" of the relationship begins when shippers first decide to contract for certain logistics services and begin winnowing the providers eager for their business. That is when the shipper's expectations and the provider's capabilities should be matched up with precision and care.

"We spend a lot of time on the upfront engineering of the request for proposal so people can see what we're trying to do," says Brooks Bentz, senior executive in Accenture's Supply Chain Management practice. Services being outsourced by his clients can be quite broad. They might include transportation, warehouse management, customs brokerage, rate negotiation, fleet management, freight payment or forwarding, shipment consolidation, carrier selection, reverse logistics, or any number of other things. No matter, says Bentz. The time and energy that go into the RFP process pay off regardless of the menu of services sought. "We use that process as a way of telling the story of what we want."

And it's vital that the shipper knows exactly what he or she wants, so that can be made known to 3PL candidates. "You've got to ensure that people who cross the finish line in the selection process know what they are expected to do," says Bentz. "There must be as much information as possible about facilities, hours of operations, freight flows, specific requirements about certain services-whatever it is-so that when the provider steps in, they know as much as they can."

A successful match often turns on compatible definitions of value, according to Ron Cain, president of TMSi, a 3PL with corporate headquarters in Fernandina, Fla. A provider may feel it's ill-advised to go with a prospect whose sole idea of value is cost-out. "We like to go with clients who value continuous improvement," Cain says. "So, initially, we need to identify if what they are looking for is what we want to provide. Once we know what the objectives of the relationship are, then we can considering launching into the actual contract negotiation."

Successful relationships rest on clearly defining needs, says Anna Hummel, logistics director for A. Duie Pyle, an LTL, truckload and third-party logistics services provider in West Chester, Pa. "You can't constantly keep hitting a moving target. I think it's OK to have initial conversations in which the shipper says, 'These are the problems I have.' But at the end of the initial investigation, you have to agree on certain criteria and on the specific things you are going to fix. Too many initiatives have derailed because the parties weren't clear on what they were working on."

 

Provider Plethora

Even when a shipper knows precisely what it needs to outsource and what a provider must deliver, selection of a 3PL is no easy task given the staggering number of providers out there. David Fox, CEO of Agistix, a Redwood City, Calif.-based logistics management solutions provider, says the competition is a good place to start. Which provider-or providers-is it using, and why? After developing a roster of 3PL candidates, a shipper can then scrutinize their customer base, history and past performance. "I would also look at some of the customers that a 3PL has," Fox says. "Do they fit into the vertical that we fit into? How long has the provider serviced that vertical? What does its management team look like?"

Bentz says that in the end, the final selection of a provider is as much about fit and relationship management as it is about the money. "The design phase is critical to getting the right result."

At some point, when the shipper and provider have married up, the relationship has to be formalized. But what does a typical agreement for logistics services look like, and is there even such a thing as a typical logistics contract?

How much is boilerplate, and how much needs to be tailored to this unique relationship?

Specificity of language can be a challenge. You need to outline with great care both the obligations and the limitations on everyone, but you don't want the "four corners" of the contract to become a straitjacket. So how do you balance the need for precision with the need for flexibility if circumstances change? And they are fluid. Everyone can point to emergencies, especially those weather-related, that have bedeviled deliveries. After all, transportation takes place in a hostile environment. It wouldn't hurt to know how a prospective provider would deal with such exigencies.

And who is to draw up this agreement anyway? Do you really want lawyers to be involved? Cain says the logistics services industry is largely built on relationships, and trust is important. "It's all in who you pick as a partner." If trust is the cornerstone, can't the parties draft their own agreement?

 

In the Mix

So if there's no model contract that fits every occasion, surely there must be some ingredients that most such contracts need to have. What are they?

"What we try to do is engineer these things so they are acceptable to everybody rather than put somebody in an untenable position," Bentz says.

He feels that boilerplate should be short and simple. The real guts of the contract come in three addenda describing the services to be provided, the compensation schedule, and the rules of engagement.

Take a contract for trucking services, for example. "If I'm the shipper," Bentz says, "I would be as specific as I can about what I want to buy, where the facilities are, where the vendor origins are, what are my service requirements, the volumes I have--basically explaining what it is that I want to buy.

"I want to introduce the KPIs, so that I will expect that you will pick up freight when it's tendered to you and you'll guarantee to do that. We'll specify and define on-time performance. I'll expect that data is to be transmitted once a shipment is picked up from the vendor so we can feed that into our WMS system and be able work the trailer when it arrives.

"The second part is compensation, what I'm paying for that."

A major component in any transportation contract now, Bentz says, relates to capacity commitment. "In the last couple of years we've found that even though we negotiated good rates for service, during periods of tight capacity the truck or airplane or ship was off chasing higher-paying freight. We had good rates, but we still couldn't move the freight. So we add in now, when you commit to the rates, you also commit to the capacity."

Change can be good or it can be bad, and contracts should allow for that. That's why allowing for rate adjustments, for instance, should be included. Adjustments can come about because of negative factors, such as fuel spikes, or because of exemplary performance, Cain notes.

"We typically negotiate incentive clauses," he says, "so if we perform X percent better than originally agreed, the margin increases. Penalties are the other side of that. That's why we create a baseline of the client's productivity before we take over. That way we can demonstrate improvement going forward, and we typically put that in the contract."

Rather than KPIs, Hummel speaks of pilot phases, and says they are indispensable to successful contracts and relationships. "I think the contract should include a pilot phase or start-up phase and then a fully implemented phase," Hummel says. "The contract really needs to address these two steps and say what the pilot and then the full operation will look like. And a full-operation contract should not be executed until the pilot has been analyzed."

Many observers say a major purpose of a formal logistics contract is to guarantee that there will be no surprises for the parties. Hummel agrees and says that's why contracting first for a pilot phase is so important. "It's where you're going to flush out those surprises. It doesn't do any good to have a two-year or five-year contract signed and then have something happen."

Most of those interviewed here say that either they or another company executive negotiate the contracts for logistics services rather than call in the legal department. The latter is good for drafting shell agreements or pointing out the boundaries and "absolute no-no's." Otherwise, most professionals seemed to know what they want to include. And most seemed to think specificity is a good thing.

"The more gray areas you have, the more susceptible you are to risk," says Fox. "If you spell out everything as best you can, you're offering your company more protection."

Fox recalls a client that went against Agistix advice to have every shipment insured. That decision was detailed in the subsequent contract. When a small box of semiconductor wafers, valued at about $2m, was hijacked from a truck in Malaysia, the client insisted on reimbursement from Agistix. Fox says his company was able to point to the precise language in the contract that spelled out who was liable-and who was not. He says the client deferred to Agistix in matters of insurance from that time on.

"I err on the side of specifics," Fox says. "I believe the more specific you get, the more it drives out ambiguity."

But can the wordage be too tight? By their nature, contracts have an air of rigidity about them, Bentz says. What you want is a working agreement. Flexibility is important. "What you say in effect in these negotiations is, 'This is our view of the world. If you guys come up with any ideas that make this better, we'll make changes if it's warranted.' You have to be able to make adjustments without throwing the agreement in the trash."

No industry can exist totally outside the society in which it operates, and the litigious nature of the United States today can hardly be denied. So, logistics contracts wind up in court a lot, right? Apparently not. There have been some famous cases, of course, but most disputes seem to get resolved without the need for court intervention. There are two very good reasons for that. One, a well-crafted  logistics services contract has a dispute resolution mechanism written into it. Second, nobody wants to go to court. Litigation is often counter-productive.

'By and large," says Cain, "our industry is dependent on relationships. You create both personal and professional partnerships. So you can resolve disputes by talking to each other and not resorting to lawsuits."

Still, TMSi writes dispute resolution language into its contracts. "You'll either have an arbitrator or some organization named for dispute resolution," says Cain. "But I've never used it. At that point, our relationship would be broken and it wouldn't work for them or for us."

Hummel agrees that court is seldom seriously contemplated. Yes, she knows of some agreements that fell apart. Compensation may have been paid, she says, but things didn't get so bad that lawyers had to be called in.

Even if lawsuits are the exception rather than the rule, parties in essence can "fire" each other from time to time. True, but churn gets expensive. If there were an industry theme it probably would be, how can you structure an agreement that you can keep in place for a long time? If a shipper gets rid of a provider today, the capacity crunch may make finding a replacement a very tall order. 

Disagreements concerning overcharges and special charges on a shipment are not uncommon, Fox notes, because there are a lot of hiccups in moving freight. But these hassles usually get worked out at the director level, he says. The executives can make those problems go away.

So, is there any one thing that is absolutely indispensable to a logistics service contract? "You know, you have to have the right price point, and a good rate that works for your company," Fox says. "But it's really the working relationship with that other party that becomes the most critical component of that contract."

If you get that part right up front, the rest will probably just take care of itself.