Finding and evaluating process changes that will improve cost and service levels in your warehouse seems like a fairly straightforward task. In a third-party logistics (3PL) environment, though, it's not as easy as you might think.

Contracts between a company such as yours and a 3PL often are based on a budgeted staffing level that probably varies with the type and level of business activities performed. The 3PL earns a margin on the labor hours actually expended and may be rewarded or penalized for being under or over budget.

Under this type of arrangement, when a labor hour is saved it adds $15-$20 to your bottom line. For the 3PL, though, a couple of dollars comes off its bottom line. The 3PL may get a pat on the back for saving on labor costs, but there's little real incentive for the provider to do much more than stay right on budget.

Because it's expected that each year a 3PL should gain enough experience to do a little better job, some contracts require the budgeted staffing allowance to be reduced by a few percentage points over time. The problem with that approach is that next year's business might have characteristics that require a much different level of effort by the 3PL.

For example, the number of small orders that are shipped directly to consumers or to small retailers may begin to grow without anyone noticing that this should be reflected in the staffing budget. Tracking these factors to determine their impact on operating costs is an integral part of any fair agreement between you and your 3PL partner.

When these hard-to-quantify changes make it difficult to stay on budget, you can work with the 3PL to identify and implement short-term process improvements that can help it be more efficient.

For instance, you can work together to anticipate daily workloads. Look at tomorrow's activities, calculate the expected time to finish the projected workload, and adjust working hours accordingly. Nailing down tomorrow's workload today will let the 3PL avoid bringing in extra labor because of unanticipated demand. As a result, hours of marginal productivity can be replaced by fewer hours of higher productivity. This can have a significant impact, since cutting 30 minutes a day off time on the job reduces direct labor costs by 6 percent.

My good friend Ken Ackerman suggests encouraging 3PLs to be more efficient by writing into the contract a gain-sharing clause that gives the provider a bonus for beating the budget. My partner, Randy Telfer, says that this works well when the budget accurately reflects the required work effort and when workloads can be forecasted with reasonable accuracy. The trick is to make sure that the bonus rewards hard work and skillful management.

The biggest challenge is to try to find a way to give your 3PL partner an incentive to make really big improvements in cost performance. I don't think that it's either sufficient or fair to simply say, "they get to keep the business."

It seems to me that that unless we find a way to share the benefits of a major gain in productivity, 3PLs will receive little more than praise, and inevitably they will continue to protect their margins on labor hours. Ultimately, partnerships will falter because creative juices will never get a chance to flow.