Selecting the right 3PL for gross margin gains

Fulfillment is a broad term, so let’s define that within inbound and outbound fulfillment. Inbound is the receipt of bulk shipments to the warehouse and the subsequent storing and tracking of this inventory using a warehouse management system. Outbound services monitor your order management system for a daily batch of orders and then packs (“packout”) these orders for shipping via your shipping provider that arrives; usually daily, to dock and pick up these orders for processing. An independent non-Amazon DTC business will typically pay a 3PL fulfillment operation explicitly for the square footage in the warehouse(s), per pick variable fees, and management fees.

Let’s look into how to compare these operations based on their pricing structure. Once a DTC operation surpasses a monthly order run rate that requires a certain level of spending on fulfillment services, it will at that point make sense to seek out a third party. Monitoring this intersection of forecasted order counts, AOV and costs should help keep you within a comfortable range of fulfillment costs to revenue on an aggregate and per order basis. Let’s run a quick sketch of that:

When it comes to driving margin leverage against shipping and fulfillment, the key understanding is the split of fixed versus variable costs. When shipping small parcels, there is a certain cost sensitivity to weight that should allow a business to forecast shipping costs per order within a range. The costs of the 3PL partner for fulfillment-specific services will consist of fixed costs for space charges and management fees. Both of these are related to the amount of space your solution requires, let's say 10K square feet. Variable costs come in when measuring inbound deliveries and cost per pick of SKUs & items per order.

Management fees are typically paid monthly, and serve as a general cost for the 3PL’s basic services, sales support, and warehouse management system reporting. This monthly amount will vary based on the core services selected. Space charges are the other (semi) fixed cost that is based on your forecasted monthly order rate. A fulfillment partner will scope out the amount of space they think is a good fit for your solution and charge you based on a per square foot rate. It is very important to get a good feel for what the right amount of space for your business is because if you forecast orders accurately it will minimize storage costs and help avoid signing on for too much space.

Variable costs are what most are already familiar with, as a warehouse associate moves down an aisle picking 20+ orders at a time, each item pick action is priced and charged to the customer. Assuming a cost of fifteen cents per pick, with duplicates of an SKU done for ten cents the initial rate that cost would look like the following:

Add the variable cost of 75 cents to $13.00 in fixed costs at 5K monthly orders to reach the all-in total of $13.75. If this number looks relatively high in comparison to AOV, then the business is probably not in need of the full 10K sq feet.

With this price structure, there is clearly moderate leverage gain in getting customers to order in bulk, especially if you sell mostly lightweight items. Large parcels have significantly more dispersion of pick (and shipping) costs, so expect higher per-item costs if your item is large or heavy. On fixed costs there are significant advantages to pushing more orders through the allotted 10k square feet, work with your 3PL to optimize it for the right use of flow and storage.

Value added services are the other primary variable cost, this consists of how many labor hours you purchase for things like high touch pack service, labeling adjustments, or changing the configuration of items in the package. You’d likely end up paying a flat rate of say $40 an hour for these types of services that are performed just before or during the packout process.

Once we understand how to think about a single location, you can apply the same to multiple FCs with some potential for combined management fees across your multi-facility solution. Most companies have facilities strategically located across the US, offering both B2B and B2C capabilities. Be aware that many 3PLs will outline typical ramp up times of roughly 3 - 6 months and charge service start up and integration costs.

As you work through your pricing quote and select a partner, it is best to know your customer and their needs. Make a smart strategic decision on your location, so the product is in close enough proximity to where most of your customers are. Start your process with an accurate orders outlook so that you will scope the right sized solution and carry less risk of price changes based on weaker/strong order flow. The goal should be to efficiently drive volume through your optimized space layout while carrying a rational amount in storage.