What to Look for in a 3PL Warehouse Contract (Service Agreement)

What Are Fulfillment Agreements?

To get your product to market, you need to work with the right people. A fulfillment agreement is a legal contract between a manufacturer and a product distribution company that defines the nature of the relationship, the fees, and numerous other details.

It may sound simple, but these contracts can involve dozens of different factors, and your fulfillment agreement needs to be specifically defined so that each and every detail is laid out in clear, easy-to-understand language. While you may need legal assistance creating and finalizing the document, you shouldn’t need a law degree to understand it. With this guide, you’ll have a basic understanding of fulfillment agreements and the most important elements to protect your interests.

1. Error Rates

This is an important benchmark for working with fulfillment providers, and it’s one of the top ways that these companies gauge their own performance. The accuracy of picking products is essential to client success, so fulfillment providers need to maintain extremely high accuracy if they want to remain in business. According to our latest survey, 87% of companies measure their own performance, and the average picking accuracy is 99.51%, while average inventory shrinkage was 0.65%. If a 3PL warehouse doesn’t track error rates or is unwilling to be held accountable to them within the context of the 3PL agreement, it is a red flag.

2. Contract Length

Each contract will also have various lengths, and you should be able to find a program that specifically meets your needs. According to our survey, over half of the fulfillment providers offer month-to-month agreements, which allow greater flexibility for your shipping contracts. About 38% offer annual agreements, while about a quarter offer agreements on a multi-year basis. Only 10% require no agreement terms whatsoever.

3. Warehousing Fees

Pricing can vary and is dependent on many factors, including volume levels, product types, and location. As an example, pricing in highly populated areas such as New Jersey and California could vary significantly from less popular areas such as Illinois or Florida.

According to our annual Warehousing and Fulfillment Cost & Pricing survey, the average price for pick-and-pack on a single item was $3.18, while the average fee for a business-to-business order was $4.79. Almost three quarters of all warehouses surveyed said they do offer discounts for high-volume orders, and the average discount came into effect when the client has 500-1,000 orders per month. These discounts ranged from 6% to as high as 7.5%.

There are also fees for storage, and you should look for this information in your fulfillment agreement as well. In most cases, warehouses charge by the pallet. Almost 85% based their storage prices on this system, and the average cost was $20.37 per pallet. However, cubic footage is used by 26.67% of providers to calculate the bill, while 20% measure the cost by square footage. Cubic feet averages about $.55, while the cost for storing a bin averages $2.67. As you may have noticed from the percentages, a few companies offer more than one fulfillment pricing structure. However, pallet storage pricing is most common. While the average cost to store a pallet per month is $20.37, fees can range from $10 per month for high volume scenarios (100+ pallets) to $40 per pallet for low volume scenarios (less than 10 pallets).

How shipping price is calculated will also need to be considered. Many companies offer a discount off of published rates, helping to reduce the cost for their clients while increasing volume. It’s also common for warehouses to allow customers to use their own freight account, and some offer cost plus pricing, although a small portion do not apply discounts whatsoever. If discounts off of published rates are offered, you’ll commonly see rates of 19.90% for ground, 23.04% for express, and 22.92% for LTL.

Annual Increases Must Be Defined

Throughout the life of the contract, there will be a need to gradually increase the cost of services. These annual increases should be clearly defined in the fulfillment agreement. When looking for a fulfillment agreement, be sure that these increases are laid out so you can maintain a consistent budget with no surprises. Roughly 72% of respondents say that they increase their prices annually, and the average annual increase is 4.54%, and the price increases range from 2-5%.

4. Minimum Volume Requirements

Many fulfillment houses will require new customers to produce certain volumes, or will require new clients to spend a minimum amount each month. While there are some small business friendly fulfillment centers, most companies do have minimums. The following are 3 of the most common requirements for warehouse contracts.

5. Insurance, Damages, and Liability

A quality fulfillment agreement will also have details for insurance, damages, and liability, which helps protect the manufacturer from ruined product or other issues that are the fault of the distributor. This area of the contract should include a few different aspects, including procedures for handling loss and damage, and the required timing of claims. In many cases, claims for damages will need to be filed within nine months.

Warehouse insurance for the contract should also include various aspects, including workers’ compensation, liability insurance, and cargo liability. All of these should be described in full in the fulfillment agreement.

6. Service Level and Responsibilities

While it can be easy to assume that the service level and specific jobs are a clear and well-understood component of fulfillment agreements, the exact specifics should be defined in the contract. There are simply too many forms of service to leave this area unaddressed.

Essentially, the contract should state, in clear wording, what fulfillment services will be performed. These services can include receiving, storing, and shipping the goods at the facility for the agreed term. It will include who is responsible for selecting the location for storage and whether or not the goods can be moved without the owner’s permission or notice.

There are also complications with operating procedures, so if the client has specific standards, the contract will need to define whether or not these standards will be implemented, and if they will be used, how the provider will implement the standards.

Other aspects of service that need to be defined in the contract include the process for submitting written instructions and the schedule of delivery appointments.

7. Liability for SLA Non-Compliance

It’s essential for parties in a warehouse contract to clearly outline SLAs, including specific metrics, benchmarks, and the corresponding penalties for non-compliance. This ensures a transparent framework for assessing performance and establishes accountability for meeting the agreed-upon service standards. Regular monitoring and communication between the parties help address any issues promptly and mitigate potential liabilities arising from SLA non-compliance.

Non-compliance can result in various liabilities for the parties involved. SLAs define the agreed-upon standards for performance, including metrics such as order fulfillment times, inventory accuracy, and other key performance indicators. If a party fails to meet these defined standards, they may be held liable for breaches of the SLA.

Liabilities for SLA non-compliance often include financial penalties outlined in the SLA itself. Possible penalties may include financial compensation, additional free services, service credits, or options to terminate the contract. These penalties act as a means to compensate the affected party for failing to meet agreed-upon service levels. Repeated or significant SLA breaches can lead to more severe consequences, such as contract termination or legal action.

8. Carrier Liability

The 3PL warehouse is not ultimately responsibility for mistakes made by outside shipping carriers used to deliver packages. The liabilities of a carrier, often referred to as carrier legal liability, encompass responsibilities related to the transportation of goods. These include accountability for potential cargo damage or loss during transit, adherence to agreed-upon delivery schedules, and compliance with safety regulations. Carrier liability involves financial repercussions or legal actions in case of breaches, emphasizing the importance of comprehensive insurance coverage to mitigate risks and ensure compensation for any losses shippers incur. Your 3PL contract should state what actions the 3PL warehouse must take when shipping errors take place.

9. Law and Venue for the Warehouse Contract

The choice of law and venue in a warehouse contract is significant because it outlines the location where disputes will be resolved and will dictate which local laws will come into play. When using a local fulfillment center, travel to the relevant courts is minimized and familiarity with local laws may not be troublesome. However, when the 3PL warehouse resides in another state or country, law and venue may pose significant challenges to conflict resolution. Below are the key legal factors:

• Location of Parties: Determined by the geographic locations of the contracting parties.
• Operational Location of the Warehouse: Often aligned with the jurisdiction where the warehouse operates.
• Industry Standards: Adherence to established norms within the industry.
• Cost and Convenience: Considerations of cost-effectiveness and logistical convenience.
• Enforceability of Judgments: Opting for a jurisdiction with efficient enforcement of judgments.
• Neutral Jurisdiction: Choosing a neutral jurisdiction for parties in different locations.
• Legal Expertise: Selection based on the jurisdiction’s expertise handling warehouse contract legalities.
• Mutual Agreement: Finalized through mutual agreement in the contract terms.

10. KPIs and Performance Reviews

Warehouses should be contractually obligated to provide performance data in the form of KPIs (Key Performance Indicators). KPIs are measurable metrics used to evaluate the effectiveness and efficiency of warehouse operations. These indicators help to gauge performance, monitor service quality, and meet contractual obligations. Common warehouse KPIs include:

• Order Fulfillment Accuracy: Measures the precision of picking and packing orders, ensuring that the correct products are delivered to clients without errors.
• Inventory Accuracy: Reflects the precision of inventory management, indicating how well the actual inventory matches the recorded stock levels.
• On-Time Delivery: Evaluates the punctuality of order deliveries, a critical KPI to ensure that products reach clients within agreed-upon timeframes.
• Cycle Time: Measures the time to complete specific warehouse processes, helping assess operational efficiency.
• Warehouse Space Utilization: Examines how effectively the warehouse utilizes its storage space, optimizing capacity and minimizing unnecessary costs.

Performance reviews in warehouse contracts involve the systematic assessment of these KPIs and other relevant factors. Regular reviews allow both parties to identify strengths, address weaknesses, and make necessary adjustments to improve overall performance. Clear communication, transparency, and a collaborative approach are essential during performance reviews to maintain a strong and mutually beneficial partnership between warehouse operators and clients.

Example Third Party Warehouse Agreement

Want to see what a fulfillment agreement looks like? Download this file to get an example. (This fulfillment agreement was provided by Charles Intrieri, a warehouse consultant experienced Supply Chain, Warehouse, Inventory Management and LEAN consultanting).

3PFL-Third-Party-Logistics-Contract

Now that you fully understand fulfillment agreements, you will be able to select the right contract for your specific needs. Rather than searching lists of fulfillment companies, we can help match you to the best fulfillment centers for your needs. If you have any further questions, we encourage you to contact us today.

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