Stop the Risk-Shift Merry-Go-Round

Anyone involved in a contract negotiation has likely heard the “standard” answer from their General Counsel: make sure the terms of the deal are full of protections that shift the risk, limit the liability and indemnify the parties.

But there is a better way? Is there a to get off the risk-shifting merry-go-round?

Many risk-averse organizations—and that’s most companies—do everything they can to transfer risk to their business associates and/or their suppliers. This common practice is particularly prevalent in the supply chain, logistics and procurement sectors.

What I call risk shifting usually occurs during the final stages of a contract negotiation, when the parties are ready to close the deal. One side—usually the one with the most power—will bring up last-minute items to seal the deal, such as 90-day payment terms, unlimited liability clauses, open-ended indemnity provisions, or an extended warranty. Sadly, many buyers view contractual risk shifting as a way to leverage additional value or concessions from a supplier. Suppliers are thus trapped—if they don’t agree the deal might not close.

Does it make long-term sense to shift risk? Actually no, because shifting risk is short-sighted, especially when combined with procurement practices that drive commoditization. Simply put, shifting risk to a supplier is analogous to burying your head in the sand. Just because you have shifted the risk doesn’t mean it goes away. And, if the supplier has been squeezed on profits, they may not be in the best position to mitigate or manage the risk.  

The Catch-22 of Risk Shifting

A white paper published by the University of Tennessee, “Unpacking Risk Shifting,” focuses on risk shifting in logistics and supply chain services, but the concepts apply to virtually all the goods and services that organizations might buy. In the paper—written with the support of the University of Tennessee, Expeditors and Adelante—industry experts contend that power-based procurement practices of shippers in the third party logistics (3PL) industry cause more harm to 3PLs than benefits and/or gains achieved at the negotiating table.

The white paper uses the analogy that outsourced transportation and logistics is a victim of “Gresham’s Law.” Gresham's law is an economic principle that states: “When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.” Simply put, this is commonly known as: “bad money drives out the good.” Thus, good 3PL providers are being driven away as Global Shippers and Consignees (GSCs) seek extreme “commoditization” of and aggressive risk shift when buying 3PL services.

Many shippers assume if they “buy,” they should use “market” forces to ensure they are getting the best possible deal. In doing so the default approach is to use highly competitive bidding approaches that help buyers compare “apples to apples.”  The theory is that if you can standardize and commoditize the work, buyers will be able to compare suppliers and ultimately identify how to squeeze the price down. In the last couple of years, with the Great Recession receding, 3PLs began to fight back on lowering their prices. Savvy procurement professionals have found alternative ways to get a better deal, which often includes shifting risk in contractual terms and conditions to 3PLs.  

The result? The 3PL industry is locked in an “over-commoditization” bubble. Shippers who continue to put more and more pressure on 3PL suppliers will simply pop the bubble and push credible 3PLs to the sidelines, or out of business.

In many cases, shippers have gone too far. 3PLs that compete aggressively to win a bid too often find themselves falling victim to what is referred to as “The Winners Curse,” where the winning supplier is “cursed” because the costs to service the client are much higher than anticipated. This results in poor service, which ultimately comes back to haunt the shipper. When this happens, the shipper is forced to start the cycle again to find a new 3PL. Thus – a real Gresham’s Law in practice.

Adrian Gonzalez, one of the white paper’s co-authors, notes, “Many shippers still don’t get it: there is no incentive for 3PLs to be innovative and creative if your objective is to beat them down on cost, shift all the risk to them, and then put the business out to bid again in one to three years. Procuring logistics services is not the same as buying paper clips, yet that’s how many procurement organizations approach it.”

Procurement professionals are starting to get worried. One procurement professional at a Fortune 50 GSC put the problem into perspective: “We only have five 3PLs that can do what we need. What do we do, go back to the first one we fired?”

3PLs are not helping the matter. In the rush to get a deal done, 3PL sales reps often don’t demand due diligence. The 3PL thus does not fully understand the true costs of the scope of work. This is especially true for larger, more complex, or dedicated 3PL operations. The result? 3PLs often over-commit. Once they realize the true costs of what it means to be a “Strategic Partner,” they face internal pressures to cut costs and, perhaps, even cut corners.

This is a lose-lose proposition for all. Bottom line: there’s a fundamental flaw in shipper procurement practices: you can’t convert a fundamentally weak, under-resourced, under-capitalized, unaware, or irresponsible 3PL into a high-performing, innovative supplier through price concessions and shifting risk.

A Better Way

Is there a better way? Progressive players in the logistics procurement arena are focusing on innovative ways to create value through collaboration. This means a clear shift away from commoditization to that of a mindset where 3PLs work in unison with shippers to develop solutions that help their supply chain reduce risk and drive innovation to become a competitive differentiator.

The concept of creating highly collaborative win-win relationships was coined by University of Tennessee researchers as “Vested Outsourcing” – or Vested for short. Vested is a sourcing business model and methodology that enables win-win relationships in which parties are invested in each other’s success. Vested fosters a highly collaborative environment that sparks innovation, resulting in transformation, improved service and reduced costs.  

The Vested sourcing business model helps buyers and suppliers shift their focus to collaboratively mitigating and reducing risk – not simply shifting risk. The book Vested: How P&G, McDonald’s and Microsoft are Redefining Winning in Business Relationships shares the success stories of eight different organizations and how they are using highly collaborative win-win approaches to achieve remarkable success.  

Is “Procurement” plus “Collaboration” an Oxymoron?

According to Dr. Karl Manrodt and Dr. Mary Holcomb, the answer is clear.  Procurement professionals can be collaborative. In fact, in a recent “Annual Trends and Issues in Logistics and Transportation” they share some insights about trends in organizations that buy 3PL services showing that GSCs are starting to shift to more collaborative procurement approaches.

The report delves into what the researchers call the “New Masters” concept. Holcomb explains, “While procurement is assuming control and responsibility for transportation in many companies, a critical mass of companies is moving in the opposite direction. They have developed strategic partnerships with carriers that enable them to keep costs low while providing innovative service to their customers. This value-added perspective is leading to performance that is significantly better than their competitors.”

What makes these new high-performing shippers different? Manrodt and Holcomb identified five key factors:

·       They choose strategic partners that make them better

·       They work with their strategic partners to develop a plan for achieving their respective goals

·       They identify the gaps between current and desired future practices for both parties

·       They develop shared solutions with their strategic partners to close the gaps

·       As a team, they leverage the results of the previous efforts to create a shared competitive advantage

That’s the better way: one where the winners are redefining the definition of winning to that of focusing on mitigating, managing and reducing risk through collaboration – not just simply shifting risk hoping that it goes away.