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How to Compare Internal Fulfillment Costs to Third Party Fulfillment

Austell, GA November 2018 - We get this question frequently so we are sharing an interesting blog post from Brian Barry of F. Curtis Barry and Company entitled “How to Compare Internal Fulfillment Costs to Third Party Fulfillment.”    

By Brian Barry 

For some e-commerce and multichannel companies, using third party fulfillment (3PL) can be cost effective and provide high customer service as an option to internal fulfillment. As we consult with clients to assess the 3PL option, the burning question is this: “how will 3PL costs compare to my internal fulfillment?”

Each business’ costs and fulfillment environment are different and you have to provide detailed statistics to 3PL vendors by year to gain accurate proposed costs.

In order to get an accurate “apples to apples” comparison, you will have to be sure you have fully loaded costs for both internal fulfillment and 3PL. For example, fulfillment managers, while they approve the expenses for leases, generally don’t incorporate the lease costs into their “cost per order” thinking. This may be 15% to 20% of the fully loaded costs. They rightfully focus on costs they control and can affect, such as direct labor and packing supply costs, etc. They may not include IT costs or allocation of management costs to operations in the cost per order.

In comparison, 3PL providers generally base their invoicing on services and types of transactions (e.g. picked order and line item charge), activities performed and agreed-upon service levels. They are not on a fixed cost per order basis because of the variability of these contracted services (e.g. kitting).

In order to get an accurate comparison, it’s important to account for internal fulfillment services provided by other departments. This is important because the 3PL costs will include all costs like warehouse space and utilities; IT services, communications and equipment; recruiting costs; benefits; management of fulfillment and profit.

Read: 10 Steps to Developing a Successful Third-Party Fulfillment Partnership

Here are six considerations for creating a fully loaded cost per order for these options:

Steps in Analysis

To get an accurate “apples to apples” comparison between internal and 3PL costs, these are the steps in planning and analyses:

  1. Create a business profile of the services required and transaction volumes for your business.
  2. Identify your all costs which will make up the fully loaded cost per order for your internal fulfillment costs.
  3. Send out a Request for Proposal (RFP) to qualified 3PL vendors that meet your high level criteria. Request a three-year projection of all costs by year indicating any factors used to increase services.
  4. Develop an accurate an “apples to apples” comparison between internal fulfillment costs and each individual 3PL providers’ proposed costs.

The details of this analysis is explained below. If this is not done at a low enough level, the planned internal budget and proposed 3PL costs may be understated.

Business Profile

In order for 3PLs to give you an accurate cost proposal, you will need to outline your business in terms of services, their expected usage and the transaction volumes by year. We recommend a three year-by-year time horizon which aligns with typical contract length.

Each vendor has a questionnaire to identify services, transactions and service levels. Here are some measures which directly affect proposed costs:

Number of SKUs – to be warehoused

Number of forward picking and bulk locations by type – pallet, shelf, floor stacked for average and peak

Major transactions by month - such as number of receipts, shipped orders, returns and drop ship orders

Order profile – unique SKUs (lines) and units per order; projected orders projected orders by month; peak and average order weeks; number of single line and multi-line orders annually

Returns and exchange profile – Projected number by month and for peak and average weeks; average units returned; percent of returns which are exchanges (creates shipped order)

Types of value-added services – kitting, personalization

On hand inventory – for peak and average week in units and pallets; inventory turnover; number of physical inventories annually

Expected service levels – for orders (e.g. percent of orders taken and shipped same day); returns goals (e.g. inventory back in stock and credited to customer accounts in 48 hours)

Shipping carriers, by plans (e.g. overnight, 2 day etc.) and total shipped

Shipped orders and weight by state - to determine shipping cost changes for each 3PL versus internal

Inventory accuracy – expected goal

Error rates – for order picking and returns

Keep in mind you’ll need both the marketing department’s projected order counts and the fulfillment department’s shipped orders (cartons shipped). The number of shipped orders (cartons) is always higher than marketing orders because of back orders and ship alone products.

If you’re business to business, the statistics will be somewhat different. For example, you’ll want to compile the number of pallets picked and shipped as well as full case picks and shipped.

Develop your fully loaded cost per order

  • For the internal fulfillment option, what are the expense categories you are responsible for? Typically these include direct and indirect labor, facility costs, packing materials, etc.
  • What other allocations of costs to fulfillment are there?
  • What other departments provide services to operations which would no longer be incurred (e.g. IT, human resources)?

Include these in your internal cost per order.

State in your RFP that you are doing a fully loaded cost per order analysis. Identify that you must have all expected costs that you will be invoiced for. Not all costs are transaction driven so there will need to be costs planned for services planned on an hourly basis. Additionally there may be surcharges for managing supplies and inbound freight, etc.

Incorporate overhead in cost per order

One of the benefits of 3PL in our clients’ businesses is that management can focus their time on marketing and merchandising tasks to grow the business. What part of senior management’s time is spent on managing fulfillment and customer service? Convert that to dollars spent. Include this expense into the fully loaded cost per order.

At the same time, what will be the salary cost for a person to be the liaison to the selected 3PL? Include a travel budget to periodically visit the 3PL.

There are other expenses managed by other departments that need to be incorporated into cost per order. For example, IT costs for operations, programming cost expended, communications, servers used, etc.

Understand future costs

  • How will your budget increase in the next three years (by year) to meet order and service level goals?
  • Will labor costs increase in your market?
  • How will your company benefits increase to remain competitive?
  • As you negotiate with 3PLs, how will their costs increase by year? For example, agreements may factor in future costs with the consumer price index (CPI).

Thinking about your company’s growth and needs, will 3PL allow you to avoid facility expansion or a move to new facility; or eliminate projects requiring capital expenditures for technology and automation? Include this in your comparison.

Calculating cost per order

You can see that getting an accurate proposal from 3PLs and understanding whether you’ll save money is not a quick task. When you have arrived at your best projections for both options, then calculate the cost per order. Divide the total costs for a year by the number of orders to give the fully loaded cost per order for your internal fulfillment operation and individual 3PL proposals. We find this often gives senior and fulfillment management a totally new perspective of costs.

Determining how internal costs compare to 3PL costs requires detailed projection and analyses. Without the detail projection, you will end up understating costs.

If your fulfillment process isn’t quite right and you want to explore improving the process, FSI is here to help.   When you partner with FSI, you are partnering with a company centered on providing fulfillment and distribution programs that exceed industry norms and client expectations.  Our fulfillment management team is experienced in providing unique and customized solutions that address our client's specific fulfillment and distribution needs. From our customized on-line programs, to our near 100% order picking accuracy, the team at FSI is focused on demonstrating excellence at every step of the process.  FSI is a fulfillment company you can depend on to get the job done right each and every time.  Reach us at 800-979-9012 or info@fsifulfillment.com

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