The premise of third-party management or outsourcing makes sense to many customers: stick to your core competencies and outsource non-core activities, such as pallet management, to expert third-party providers that can deliver superior value. Count on them to add specialized expertise and economies of scale to cut costs and stay abreast of industry best practices in their niche.

In spite of this logic, however, third-party does not always ensure a happy outcome. While the rate of success for third-party pallet relationships is not widely known, the reality for third-party logistics relationships in general is that they often fail. If your company is considering third-party offerings or has had third-party deals turn sour, read on.

Problems Are ‘Huge, Huge, Huge’

The problem of third-party failure is "Huge, huge, huge," according to Jim Tompkins, founder and president of Tompkins and Associates. Jim, a prolific author and member of the Modern Materials Handling Hall of Fame, is the lead author of ‘Logistics and Manufacturing Outsourcing: Harness Your Core Competencies.’

According to a recent Warehousing Education and Research Council (WERC) survey, 55% of logistics alliances are terminated after 3-5 years.
In some cases the relationship ended even before completion of the first year of operation.

Such failures can result in serious problems, Jim noted. For example, third-party logistics typically provide the last link before the customer. "When the arrangement doesn’t work out, it takes place right in front of the customer,"
he said.

In addition, third-party logistics deals often come with high expectations of cost savings and high visibility. "Oftentimes when they don’t work they can end up in court," Jim said, "and then everybody is a loser. It can be an ugly situation."

The underwhelming success rate so far has not diminished the appetite for third-party logistics solutions, though. Referring to a phenomenon he has coined, ‘organizational acceleration,’ Jim has observed that executives have more and more on their plate than ever before. So in spite of the failures, customers continue to seek third-party solutions for non-core activities.

Executives naively assume that a failure is just a provider issue, Jim noted, so they look for a new provider, saying to themselves, ‘How hard can this be? It should be easy.’

Rarely, however, is one side solely to blame when the relationship fails. "There hasn’t been a single time when both vendor and customer shouldn’t have been taken out back of the shed," Jim quipped.

He noted a litany of common mistakes. For example, communications may be inadequate, although he indicated that the provider must ultimately take a lead role in this role. Another challenge: a customer may view the third-party deal as an opportunity to throw a problem over the wall instead of building a true relationship. The customer may put the wrong person in charge, usually the functional expert for the activity being outsourced; this is the executive who will be most likely to resist change and to interfere with daily operations.

One thing that has given a bad name to the third-party logistics providers is a legacy of ‘over-commit and under-perform’ of services. Client companies, on the other hand, often treat third-party logistics providers more as vendors than logistics partners, withholding valuable information that could help maximize the value of the arrangement.

Thorough Core Competency Process

The path to success, according to Jim, involves both service provider and customer alike developing a core competency for outsourcing (see accompanying explanation). Successful relationships can be achieved by both seller and buyer creating a thorough joint framework for initiating and sustaining third-party relationships.

It is not as easy as just listing ‘third-party pallet management’ on your
business card or business brochure, however. The weight of the challenge can
be measured by the size of the book — the information-packed volume is over
200 pages.

There are several steps involved in the outsourcing process, such as activity definition, vendor selection, multi-functional dialogue, contractual agreement, implementation and ongoing partnership. These are summarized in the accompanying information box. "If you don’t do these things right the initiative won’t be successful," Jim emphasized.

There are two ways to develop a core competency in outsourcing, according to Jim. "You either grow it or buy it," he said. Some companies hire someone who knows how to do it or look to a consulting company, such as Tompkins Associates. The worst thing is a trial and error approach, said Jim, with so much often on the line.

For some pallet companies, experience in third-party relationships has evolved from the gradual expansion
of services to their best customers.
Without a formal collaborative process that clearly spells out such issues
as performance metrics, payment
requirements, and problem resolution procedures, however, that high level of trust may be difficult to replicate with other customers.

"Both (service provider and customer) need to have the core competency
for outsourcing," Jim stated. "It’s like
a marriage. You can’t have a successful relationship if both sides aren’t committed to it."

Watch for Red Flags

As for a pallet company looking to negotiate a third-party contract, Jim cautioned that one of the red flags is simply paying attention to the person doing the negotiating. "If the only person you are dealing with is the purchasing agent, you might want to run," he said. "The purchasing agent should be involved, yes, but others should also be included in the process." Other participants
from the customer’s side should also be of an appropriate level of responsibility. If only junior people are sent to meet with the service provider, it is a signal that the customer may not be taking the proposal seriously.

Another potential sign of trouble, Jim noted, is if the customer has a lack of interest in the details. For example, if the customer is not particularly interested in such variables as lumber grade specification, fastener type, or delivery requirements, he is leaving the door open for the service provider to be pressured by competitors offering a lesser product.

And if the three most important issues the customer wants to discuss are "…price, price, and oh, by the way, price," Jim mused, then this could constitute another signal that a successful long term relationship might not be in the making.

Written Contract

Since third-party pallet relationships will often be less complex than a major third-party logistics arrangement, the document may be shorter. "You definitely need the same methodology," Jim explained, "but probably not the same rigor. While a third-party logistics provider deal may be 150 pages, it might only take four pages with some drawings for a simple pallet management agreement. The challenge is to cover the same ground." The size of the document should be proportionate to the complexity of the service being proposed.

"When you do a good contract, you don’t need it," Jim said. "When you do a poor contract, then you do really need it. A gap in expectations is the result of not creating a good contract, and it can often end up in court."

A contract should specify such things as performance metrics, basis for payment, conflict resolution, and how changes will be addressed. For example, a contract may require the delivery of
an average of 1,000 pallets per week,
but perhaps in experience the customer
only needs 300 per week during some period and 3,000 during others. "That’s
a substantially different requirement," Jim noted.

Another key issue to write into a contract is how to terminate the relationship. "How do we get divorced?" Jim asked. Such issues as inventory, facility or equipment leases, confidential information and transition planning must all be addressed. "Eighty percent of third-party logistics do end, so not having an agreement on termination is problematic."

Start Gradually

Implementations can be plagued by incomplete transfer of information and unrealistic expectations. Jim stressed the need for a logical, gradual implementation. "If you have zero percent of the business on Friday and 100 percent of it on Monday, there may be a major blow up," he said. He suggested a better approach might be to assume 20% of the business initially and gradually increase to 100% over a one-month period.

A good project schedule and good communications links are critical. One important objective is to avoid unpredicted problems that can lead to ‘he said, she said’ scenarios. "All surprises are bad," Jim noted. "Good surprises are bad. Bad surprises are worse."

Swim with the Whales

Ultimately, the success of a third-party management or outsourcing relationship rests on moving from a vendor-customer relationship to a true partnership. Regular reporting of metrics, ongoing cost control, open lines of communication, flexibility, innovation and a high level of trust are qualities that help build an enduring relationship. And in spite of the size differences between a modest pallet company and a Fortune 500 customer, true partnership is still achievable between a pallet ‘minnow’ and a customer ‘whale.’

"If the whale is a quality player and doesn’t try to bully the minnow, then there shouldn’t be an issue," Jim offered. The pallet is critical, he emphasized. The importance of a provider should not be based on the expenditure for a particular service but on the importance of the service. "The whale should be excited because the minnow is really focused on doing a good job. If the minnow is bullied, it should swim away."

"If you step on your right foot with your left foot to prove it is stronger, you are still going to end up with a sore foot," Jim reiterated. True value is created when the goals of the provider and the goals of the customer are both aligned.

In summary, successful third-party programs require a core competency in outsourcing by both provider and customer. By proceeding with the proper framework, providers will avoid the pitfall of over-promising and underperforming. Customers, likewise, will come into the relationship recognizing that best value will be obtained from a true partnership where close integration will allow the provider to deliver a superior solution and give the customer room on his ever more crowded management plate for whatever drops on it next.