Better Contract – Better 3PL Performance

Abstract

Contract design and management are critical for Fast-Moving Consumer Goods (FMCG) companies. Well-designed contracts promote a value-driven relationship between the buyer and the supplier. Under the governance of such contracts, the service provider will proactively lead continuous improvement efforts in the direction that best aligns with the goals of the buyer. Such goals may include cost savings, service level, or context-dependent KPIs. On the other hand, poorly-designed contracts can lead to overspending and compromised performance. In 2017 Acme, a leading North American FMCG, designed a new contract model for managing its Third- Party Logistics (3PL) suppliers. The key differences introduced by the new contract were a stronger emphasis on cost savings, an enhanced review process of unbudgeted spending, and higher levels of risk/reward sharing. Acme is interested in learning whether the new contract created value for itself and the suppliers. To answer this question, we use the econometrics model, Difference-in-Differences (DiD). Our results show that despite the increase in 3PL spending over time, there is no evidence to suggest a causal impact of the new contract on the cost performance of the 3PLs. We then proceed with the discussion of how the new approach to governance provides some benefits to Acme since it promotes better alignment of financial incentives between the parties and protects the buyer against the risks of gross underperformance on the part of the supplier. Additionally, we develop a framework that helps the reader to understand the key structural elements of contracts that define the relationship between an FMCG buyer and a 3PL service provider. Such elements include Performance Measurements, Compensation/Incentive Structure, and Governance Process. We then describe the appropriate functional levers and the trade-offs that apply to each of the three structural elements of value- driven contracts.