Reverse logistics is a part of the supply chain that is often outsourced to 3PL’s.  Many companies with large sophisticated logistics departments outsource returns management because they do not have any expertise in processing returns and the return center operation can stand on it’s own, outside of normal supply chain operations.

In addition, companies outsource reverse logistics operations for many other reasons. Some need quick expansion and don’t have the manpower nor the infrastructure in place to expand as needed. Others are looking to cap exposure to worker comp expenses, inventory shrinkage, or hiring costs when starting up a new operation.

All of this can be done by outsourcing to a qualified third party logistics organization (3PL). However, to do this successfully the 3PL agreement must clearly articulate the level of service (LOS) goals, budgets, and the other metrics. LOS goals used by the 3PL must be in alignment and support the company’s goals. The incentive systems and payment terms for performance must parallel and support the same financial impact on the outsourcing company.  In other words, contract terms and conditions must incentivize the 3PL to perform the stated duties in a manner that is in the best interest of the company.

Outsourcing return center management to a 3PL usually goes badly for one of four reasons:

1. The level of service requirements and scope defined in the contract are not in alignment with the financial justifications used to outsource initially.
2. The recovery rates on returned inventory, which justified higher 3PL costs and fees, are below expectations.
3. The volume and timing of the flow of returns is much higher and more condensed than anticipated, causing problems with customer service, space, and escalating processing costs.
4. The contract does not provide the flexibility necessary for a reverse logistics operation.

Many companies new to outsourcing don’t include key metrics in the contract. Often they don’t have good benchmarking data for items such as damage rate, inventory shrinkage, annual inventory turns, and thru put numbers to ensure they are getting what they expected from the 3PL returns operation. These details have to be carefully spelled out along with who will be responsible for the associated costs if the LOS goals are not met.

Reverse logistics operations are much different than distribution operations or transportation.  The contract that governs outsourcing to a 3PL must be specifically designed to ensure these differences are addressed.  Many executives new to outsourcing returns to a 3PL make a big mistake by using “the standard outsourcing agreement” used when outsourcing warehouse operations.  Reverse logistics contracts must provide flexibility to the 3PL and that must be reflected in the financial terms and conditions.

Remember, nobody orders returns.  You don’t know what you will get until it shows up at the door.  It isn’t a good contract unless it is flexible. 3PL outsourcing agreements should include language addressing how costs will be paid based on a wide range of unique returns related metrics, the biggest of which is volume. Many companies use volume bands to calculate variable costs. Some companies use a fixed dollar fee for the provider.  Many 3PL contracts are cost plus with a budget cap. All of these methods can work in the right situation, with the appropriate means of adjusting the T’s & C’s built into the contract.

There are two reasons for signing a contract with a 3PL when outsourcing reverse logistics. The first reason is so there are clear terms and conditions for running the operation and billing.  The second reason is to have a framework to dismantle the operations if it fails.

Many companies that outsource don’t seem to think about the details and what they are going to do if they have to fire the service provider. Make no mistake, terminating a contact with or without cause can cost millions. You need to think about what happens to the inventory, the capital equipment, the building, ongoing worker comp issues, shut down and closing costs and what you are going to do after the 3PL is gone. All of these and many more issues need to be considered and you must spell out who is liable for each issue under each scenario. Once you’ve decided to end the relationship, you could save yourself millions if the contract addresses the shut down process correctly. There are many valid reasons to outsource reverse logistics to a 3PL. The key is to have a good contract that will protect everyone’s interest, achieve the original goals that drove the decision to outsource, and ensure a win/win relationships between the parties.