Is contract warehousing different than 3PL warehousing?

When looking to outsource some or all of your warehouse operations, it may seem a little confusing that there are so many different names for a service that essentially involves someone else storing your goods and managing inbound and outbound activities. And as much as I would like to definitively clarify the differences, it’s just not that simple. There is a lot of overlap, and in many cases it just comes down to what the service provider likes to use to describe his service, or what the person you are talking to thinks is the appropriate term for a specific service.

That said, there are some generalizations that can be made.

Contract Warehouses.

Hmm, let me see? Contract warehouses must have something to do with contracts, right?  

Well, since a public warehouse (as described above) technically works under a contract (an agreement for specific services at specific rates), one could deduce that a public warehouse is a contract warehouse. While that is somewhat true, the term “contract warehouse” implies a more significant contractual agreement. Primarily, the “contract” with a contract warehouse is typically a much longer term contract. Public warehouses are often contracted on a month-by-month basis. Meaning, I can probably pull all my product out of a public warehouse at any time, and not be responsible for any fees beyond that month. However, with a contract warehouse, I may have committed to the service provider for several years.

So why would you sign a three-year contract with a contract warehouse when you could just go month-to-month with a public warehouse? Well, primarily because you need more specialized services that aren’t offered by a public warehouse. Public warehouses tend to follow the very simple pallet-in-pallet-out scenario . With some minor variation, they typically are bringing your product in, storing it, and shipping it out the same way they do with their other customers. The product in public warehouses is typically stored in high-density floor storage (stacked pallets on the floor), though they may have some racking.

If your operation has more specific requirements, the service provider will need to put more time and effort into getting your operation set up. He may also need to purchase additional equipment, and may even need to buy or lease warehouse space for your account. He simply can’t afford to do this on a month-by-month contract basis, so he will require a more significant commitment from you.

How much of a commitment? That often depends on what he needs to do to get your operation up and running. If your needs are relatively simple and fit into processes and space he already has in place, you may get in with a yearly contract, but longer contracts are more common. Three-year contracts are fairly common as a way to balance the amount of time it takes for service providers to recoup their investments with the amount of time a typical client is willing to commit to. Everything is negotiable though. If you require extensive investment but want a shorter contract, the service provider may be able to do that but will need to increase his rates.

What kind of special services do contract warehouses provide?  In my experience, they will do just about anything you ask them to do. It’s the nature of the business that they need to do whatever is required to run your operation.  They are very eager to do more stuff for you because they get paid for doing stuff for you.  To put it another way, they will do whatever you want, but you will need to pay them for it.

That said, common services would include order picking and order packing services, order consolidation, cross-docking services, various packaging services including custom packaging and repackaging, bulk packing, kitting, returns processing, inspection services. Some may even provide light manufacturing services (typically light assembly or simple manufacturing).

Fee structures.

I already covered how public warehouses tend to have fairly simple fee structures. Contract warehouses, however, can potentially have much more complex fee structures.

Activity-based costing.

Activity-based costing (also called transaction-based costing) in a contract warehouse is basically the same approach as the fees we covered in public warehousing.  However, since contract warehouses often handle more complex processing, the fee structure ends up being more complex. With activity-based costing, a fee must be determined for all the key tasks. The reason this gets so complicated in contract warehouse is because every client’s business is unique, so not only are there different cost categories for different clients, but also different costs within each category based on the client. So you may have costs associated with orders processed, line items processed, pallets processed, cases processed, pieces processed, weight processed, materials used (shipping cartons, etc), packaging, kitting,  trucks loaded or unloaded, etc.

These costs need to be estimated by the service provider so he can bid on your business. This is where things can get rather tricky because it’s not always easy to estimate costs for these types of tasks. The time it takes to process an order, line, or piece pick for one client may be very different from the time it takes to process an order, line, or piece pick for another.

I mentioned that fees need to be determined for key tasks. This doesn’t mean all tasks fall under activity-based costing. This would be impractical since there tend to be all kinds of miscellaneous tasks that come up in the day-to-day operation of a warehouse. The miscellaneous tasks are often performed at a pre-defined hourly rate. This means you can call your contract warehouse and have them do something that wasn’t specifically addressed in the contract, and not have to go through a bidding process to get it done.  Things like physical inventory counts, special inspections or product rejections, etc. are often handled this way.

Warehouse space in a contract warehouse is often a fixed fee based on the amount of warehouse space estimated in the contract. So basically you commit to a certain square footage, and they bill you based on that. This can be flexible though depending on the contract. There may be a provision for a fixed amount of space plus a variable rate applied for space used in addition to that fixed amount of space. Or, you may even be able to contract for actual space used on a month-to-month basis similar to the public-warehouse scenario.

3PLs

3PL is short for Third Party Logistics. The term Logistics covers a lot of territory, but when we talk about Third Party Logistics providers, we are usually talking about businesses that provide warehousing and/or transportation services. So 3PL is technically an umbrella term that would cover contract warehouses, public warehouses, as well as other services such as transportation.

You can even have a 3PL service provider provide warehouse services in your warehouse. In this scenario, you already have your own warehouse with your own equipment in it, and hire a third party to operate the facility.

Cost Plus

Another fee structure used by contract warehouses is known as “cost plus”.  In cost plus, the service provider tracks actual costs associated with your account and then simply marks them up by an agreed-upon percentage.  In this scenario, your operation is typically run as a stand-alone warehouse within the service provider’s warehouse. You will have space, equipment, and workers dedicated to your account. All costs associated with them will be applied to your account and marked up. This eliminates the need to have to track and cost each individual activity. It also eliminates the tricky process of estimating and bidding task-specific costs. The obvious problem with this is method is the inherent disincentive for the service provider to keep costs down (the less efficient he is, the more money he makes).

Other fee structures.

Since the nature of contract warehouses is that each contract is unique, the fee structure can be whatever both parties are willing to agree to. So any combination of fixed costs, activity-based costs, and cost-plus options can be incorporated into a contract.

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