I’ve been tracking the logistics service provider (3PL) market for almost 10 years, and I’ve also talked to a lot of companies that have outsourced their logistics operations to learn why they chose to outsource and what their experience has been (e.g., see “A Deciding Factor in Anna’s Linens’ LSP Selection“).  I’ve also written about how very little has changed over the years in the way 3PLs and their customers work together-i.e. transportation and warehousing are the main operations that companies outsource; very few companies outsource more “strategic” functions like inventory management or establish “4PL” relationships; and 3PL customers are generally unhappy with the IT capabilities of their service providers (see “Is Logistics Outsourcing Still a One-Way Street?“).  In light of the current economic environment, maybe now’s the right time to innovate the way companies and 3PLs work together.

Specifically, I wonder if the time has come for more logistics service providers and their customers to embrace Performance-Based Logistics (PBL).  Now, PBL is not new model, it’s been used for a long time by the Department of Defense and the aerospace industry.  For a good overview of PBL, read “Performance-based Logistics-Next Big Thing?” (ProLogis Supply Chain Review, summer 2007) written by Kate Vitasek and Steve Geary of Supply Chain Visions.  In a nutshell, in a PBL relationship, companies pay for results (e.g., fill rates, in-stock levels) not activities (e.g., cases picked, pallets stored).

A couple of years ago, we did some work with Unipart Logistics and their relationship with Jaguar was the first example I had come across of PBL being used in an industry other than aerospace and the DoD.  Unipart and Jaguar have been working together for more than twenty years, in areas including service parts management, which I believe is a “sweet spot” for PBL contracts.  Unipart is also well-recognized for its corporate culture based on Lean/Six Sigma principles (see “Applying Lean Thinking to Warehouse Operations“-available to ARC clients only), another attribute I believe is critical for PBL-based relationships to work.

But it seems that this “Next Big Thing” is still waiting to catch on in the contract logistics industry.  I spoke to Kate Vitasek a few months ago and she recently completed a research study (with the University of Tennessee) on Performance Based Outsourcing funded by the US Air Force.  The Air Force was interested in uncovering best practices in PBO in the commercial sector.  Kate uncovered PBO case studies in various industries, including facilities management (Microsoft and Grubb & Ellis), but very few in contract logistics.  She shares my opinion that Unipart/Jaguar, which she included in the study, is perhaps the best example out there.  You can listen to Kate’s comments about the study in a podcast conducted by the Council of Supply Chain Management Professionals (CSCMP).

One of the interesting things about “paying for performance, not activities” is that if a PBL contract is structured and executed correctly, revenues may actually decrease for a service provider, but their profits will go up.  And clients will achieve better or the same level of service, but at a lower cost.  So, why isn’t PBL more common in contract logistics? 

I think the biggest reason is that PBL requires logistics service providers and customers to think about their relationship in a completely different way.  My sense is that LSPs are more willing to move in this direction than clients are.  For many companies, outsourcing is still about getting “assets off the books” and reducing labor costs, not about transforming their logistics processes and competing on performance.  But I also believe that many logistics service providers don’t have the right culture and processes in place to execute PBL contracts successfully.  And, of course, not every outsourced service is a good fit for PBL (in my opinion, the model works best in large-scope engagements, not stand-alone services like brokerage).

Nonetheless, I’m betting that 2009 is the year that PBL starts to gain traction in the industry.  As I argued in a recent piece (“Innovating the Way Shippers and Carriers Work Together“), I believe the economic slowdown gives companies a good excuse (business case) to develop and implement innovative processes and solutions.  I plan to research this topic more in the months ahead, so stay tuned.  In the meantime, what do you think?  Should logistics service providers (3PLs) and their clients move towards performance-based contracts, or is this a case of “if it isn’t broken, why fix it?”