Performance based logistics- Changing the way we contract!

Performance based logistics

Abstract:
This discusses what Performance based logistics (PBL) is, how it came into being and how it has brought a paradigm shift in the way companies operate. H ow it mitigates the risk in entire supply chain and creates a win-win business model for all stakeholders. No matter whether these are manufacturing organizations or service providers, PBL, a concept and a practice is very much executable in all kinds of industries, provided organizations are willing to accept their suppliers/ service providers/ customers as their partners.

Problem:
A company Dusing Ltd. has outsourced the fulfillment and call center services of their product to Idetel 3PL and agreed to pay on the following basis:
• $1 per minute for each call
• $3 for each order fulfilled
• $2 for each expedited order
• $15 a month for each pallet of inventory
• $2 to manage each return
• $1 to scrap and destroy damaged goods
Under these terms and conditions, more the Idetal gets paid, worse the supply chain operates.
Puzzled? Startled? Read on…
Let’s see how!
If Dusing Ltd. forecasts too much and unable to sell, then Idetel gets more money due to high inventory and moreover, it gets paid a scrap fee to destroy the product when it becomes obsolete.
Even when its products return from the market, Idetel gets paid more.
What is resulting is a transaction based logistics wherein service provider gets incentives to abide by the contract, and not necessarily by doing well for Dusing Ltd.

Second example: A software giant, just like other software firms, struggled with frequent excess inventories and huge write-offs due to mismatches between supply and demand. It sells its products through retail stores and it is almost impossible to know the demand of a new product in a market. Driven by the philosophy of hitting the shelf in no time compounded with high profit margins, it holds huge inventory.
To minimize the loss, software firm shrinks the profit of the supplier, leading to unhappy supplier and quality problems. But the problem of high inventory persists.
Where did the business model go wrong if at all and is there a way of doing it differently and efficiently?

Another example is about a company which pays it logistics service provider on the basis of number of trips it makes to supply the material to its various site locations. More the trips, more the money/incentives transporter gets.
Does the company want the transporter to make as many trips to the sites as it can? Or it wants the transporter to make as less number of trips as it can? Or it doesn’t matter to the company how many trips it makes as long as it is providing the material at the right time with minimum number of damaged goods?

How PBL helps and who has adopted it?
DoD (United States department of defense) has adopted a creative approach for procuring logistics support for its weapon system christened as performance based logistics which has been a key driver in helping the DoD to deliver higher performance and lower costs in procuring logistics support for its weapon systems.

At its core, PBL is a new collaborative business model designed to align the interests of both the client (e.g., the DoD) and the logistics service provider.

Under a PBL agreement, the client specifies his goals or desired performance outcomes, and the logistics service provider then gets paid according to how well it succeeds in delivering those performance outcomes.

Under this arrangement, the client does not pay for unit transactions of such support services as warehousing, transportation, spare parts, repairs, or hours of technical service.

In the example of software giant which was discussed earlier, PBL contract can contain
• Maximize revenue from its retail sales by ensuring 98% in-stock rates for retail fulfillment with a 48 hour service level.
• Reduce its costs by holding a minimum amount of inventory needed to achieve the high in-stock rates-thereby reducing obsolescence.
• Reduce overall total costs of operations by reducing non-value added activities.

Under the new PBL arrangement, the software company still gives the supplier a forecast. However, the supplier is accountable for production at optimum levels that are just high enough to meet demand. Rather than simply setting production levels to meet the forecast, the supplier is rewarded with incentives for producing less provided that it can hit the targeted stock rates.

For the supplier, the PBL agreement required it to assume a more proactive and accountable role in managing the customer’s supply chain. Toward this end, the supplier had to switch its production model from traditional push-based approach, where production levels were set equal to the customer’s forecast, to a demand-pull system

Similarly in the last example of transporter getting paid based on number of trips, contract should contain clauses such as availability of goods at 98% times with less than 1% damaged goods.

The PBL business model should be considered by any company that out sources services as a way to align supply chain partners to a set of common goals. And in so far as the partners succeed in aligning their performance goals, they will also have reduced risk across the entire supply chain.
Understanding the core competencies, aligning the goals and treating the service provider as a partner, remain the important pillars of PBL.