Tuesday, June 11, 2013

When Selecting a 3PL Ensure Your Goals and Incentives are Aligned

As I travel and speak to industry leaders I am always asked about strategies for shippers to manage their 3PL relationships.  There are many theories from transactional "beat them down" relationships (which I do not advocate) to the "Vested Outsourcing" espoused by Kate Vitasek (Which I believe is a great framework for how to manage any third party relationship).  And, of course, there is everything in between. 

While a great strategy to manage these relationships is a subject too complex for a blog posting, and usually too complex for my short discussion, I do get asked "what is the one thing" they can do.  Well, here it is:

The One Thing: - Align Goals and Incentives

Let me start with my philosophy on human behavior and one which is built into the DNA of a capitalist society. People will always act in their own self interest.  Think about this as you develop your relationships and let me use an example totally outside of our industry -  Financial advising.  There are two broad categories of financial advisers:  Those who work for a fee for which you pay and those who get commissions, 12b-1 fees, rewards etc. from the products they are selling.  The latter looks like a good deal because you do not pay the up front fee.  But is it a good deal?

When we apply my general philosophy of people will always act in their self interest  to this case the answer becomes clear.  The financial planner who is considered "free" has an incentive to sell to you the product which will make them the most amount of money - and they will.  Two products, one of which if sold gives her and her family a free trip to Hawaii v. another which gives her just a few bucks commission are the selection.  Which do you think she will sell to you?  If you picked Hawaii, you are right.  

Now, the former advisor, the one who you pay a fee for has a fiduciary responsibility to work in your best interest. In fact, because you are their sole source of income, they have no incentive to provide anything to you that is not in your best interest.  The only way their income continues is if you are happy and that only comes if they work in your best interest.  In this case the goals and incentives are aligned.

Let's apply my philosophy (again, it is people will always act in their self interest) to the world of the 3PL and specifically to the outsource model of transportation management.  I see many models where both the operations and the procurement of transportation have been outsourced.  The key question here is whether the goals and incentives are aligned when you are in a relationship where the 3PL essentially acts as a broker for you. 

Imagine that the "broker" 3PL relationship comes across a way to lower your overall transportation costs knowing however that it will eat into their margin on the spread they make between what they are selling transportation to you for and what they are buying it for.  In this situation they have a choice to make:  Will they act in your best interest  or will they act in their own self interest?  Both my guiding principle philosophy and my experience is that the answer is clear: The 3PL, when confronted with a conflict between their self interest and the client's, will almost always choose their self interest first. This is especially true if they have shareholders (whether public or private) to report to.  Why would they do anything different.

However, if their goals and incentives are aligned - such as the my recommended solution which is the shipper should always retain the procurement process in house and NEVER outsource this part of it - then the 3PL will never be put in this conflict situation.  You pay them for a service and they execute that service.  

The critical point here is the 3PL should not make money on both sides of the transaction.  As soon as that is the case, they will be in conflict. The only way the 3PL should be able to make money is by acting in the client's best interest.  In other words, they have a sole and singular fiduciary responsibility and that is to you the shipper. 

This is "The one thing".  If you are a shipper who has outsourced your procurement to a 3PL you should think again and ask yourselves what is driving the 3PL thought process (By the way this also applies to "dedicated" fleets who make money leasing equipment to you - are they working in your best interest or in the best interest of the profitability of their leasing operation).

I am not one to quote the Bible much in public but, if you do not believe me about this then listen to what Matthew has to say:
"No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other. You cannot serve both God and money."
In my case change the last sentence to: You cannot serve both sides of the transaction.  

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