Earlier this year in Procuring Logistics Services is Not the Same as Buying Paper Clips, I wrote about an issue that continues to negatively affect 3PL-customer relationships: Procurement organizations looking to shift more and more risk on third-party logistics providers — while, of course, also demanding lower costs. As I wrote in that post, “Many shippers still don’t get it: there is no incentive for 3PLs to be innovative and creative if your objective is to beat them down on cost, shift all the risk to them, and then put the business out to bid again in 1-3 years. Procuring logistics services is not the same as buying paper clips, yet that’s how many procurement organizations approach it.”
This troubling trend is explored in more detail in a new white paper published by the University of Tennessee Center for Executive Education titled, “Unpacking Risk Shifting: A White Paper Challenging Unreasonable Risk-Shifting in the Transportation and Logistics Industry.” I am a contributing author along with Kate Vitasek, Phil Coughlin, Peter Moore, Karl Manrodt, Emmanuel Cambresy, and Andrew Downard.
Below is an excerpt from the paper where we argue that the 3PL industry is suffering from Gresham’s Law, an economic principle that states bad money will drive good money out of circulation. In this context, good Third Party Logistics (3PL) providers are being driven away as Global Shippers and Consignees (GSCs) seek extreme commoditization of transportation and logistics services and also apply bad contracting practices to them.
I encourage you to download and read the full white paper, which has five main parts:
- How GSCs are changing the landscape for buying 3PL services.
- Identifying emerging trends where GSCs are shifting risk to suppliers.
- Discusses our premise that the 3PL industry is at a tipping point, using the analogy of Grehsam’s Law.
- Proposes a new approach for GSCs to change from a value extraction and risk shifting mindset to one of long term value creation.
- Finally, we summarize our discussion and conclude with a call to action for GSCs and 3PLs to drive proactive and positive changes in the transportation and logistics industry.
After reading the paper, post a comment and share your perspective on this topic! Also, check out these related posts:
- Important Factors to Consider When Evaluating and Selecting a 3PL Partner
- Do Your Business Relationships Suffer from Strategic Drift?
- Develop a Shared Vision Statement with Your 3PL
- Time for a New RFP
- Perverse Incentives in Outsourcing Agreements
We argue the 3PL industry is suffering from Gresham’s Law.
Gresham’s Law is an economic principle stating that good money is always replaced by bad money. However the analogy can be applied in the 3PL industry. Good 3PLs are slowly being replaced with bad 3PLs who are consciously or unconsciously allowing themselves to play a short-term game focused on winning bad deals simply to get revenue and win a key client at the expense of their competitors.
Gresham’s Law is leading to the emergence of four distinct groups of 3PLs:
- Credible 3PLs losing market share – The first group is comprised of the best 3PLs. It is becoming increasingly harder for this group to take contracting seriously with the full intent to honor contractual commitments. A case in point is a CEO of a 3PL who was forced to walk away from a $20 million contract even though they were the incumbent supplier because they refused to sign their customer’s “new standard contract template.” While walking away from one bad deal may not seem significant, think about the impact of walking away from five deals totaling $100 million in revenue. Profit pressures put these “best” 3PLs at an inflection point where CEOs and CFOs are limiting investments as their profitability declines.
- Benign 3PLs — The second group consists of those 3PLs that are unaware of the scope and depth of the risk associated with agreements they are signing. Often benign 3PLs rely heavily on sales reps with commissions to drive revenue. Unfortunately, contracts get signed that lead to a nice short term commission check at the expense of overlooking or undervaluing the risk the firm is taking on.
- Cynical 3PLs – This group of 3PLs take a passive-aggressive approach. They hope for the best as they bury their heads in the sand hoping the risks will not come to fruition. These 3PLs sign contracts with little assets at risk, and little capability or intention of honoring their contractual commitments should the risks exceed their economic return on investment. One cynical 3PL even created a subsidiary to “house” a bad client that had shifted too much risk onto it. The rationale? In the event that risks actually came to fruition, the subsidiary could be shut down, allowing the primary business of the 3PL to remain intact and ensuring the GSC would not be able to collect damages from the 3PL under the contract. The rise of mergers and acquisitions, fueled by private equity investors, is also leading some 3PLs to “unrealistically price their service offerings in order to win the business of high-profile GSC clients and make themselves more attractive to prospective investors,” as one Credible 3PL who walked away from such a bid put it.
- Blind Faith 3PLs — The last segment consists of those 3PLs in the industry that have entered into a “nudge-nudge, wink-wink” scenario with their clients. Often these are 3PLs that have had long-term relationships with clients who are not willing to walk away from an existing customer’s revenue. They often have a key trusted individual who is advocating for the 3PL to go ahead and sign the contract to enable the GSC’s procurement or legal departments to “check the box” to meet internal audit requirements. These trusted individuals often seal the deal with a handshake saying, “We all know the best relationships simply put the contract in the drawer and forget about it.” But, what will happen if unforeseen risks do occur? Surely the 3PL will be held liable for the written word of the contract, especially if the trusted counterpart who nudged and winked at contract signing ever leaves the GSC. So, simply saying you have a good relationship and don’t need the contract only works until a risk happens. Unfortunately, burying your head in the sand with blind faith does not make the risk go away.
Far too many GSCs fail to realize a fundamental flaw in their procurement practices: you can’t convert a fundamentally weak, under-resourced, under-capitalized, unaware, or irresponsible 3PL into a responsible supplier through price concessions and shifting risk. Putting more pressure on a 3PL supplier will simply increase the speed of the death spiral of running good and credible 3PLs out of business.