Episode 3: The Ultimate Guide to Working With 3PLs

The Ultimate Guide to Working With 3PLs

Over the past few days, I’ve had several conversations with people about their 3PLs. It got me thinking about the dozen or so 3PLs I’ve worked with over the course of my eCommerce career, and the mixed experiences I’ve had with them. 

I want to share what I’ve learned. In particular, I want to go over (i) what a 3PL is, (ii) how they screw you, (iii) how to defend against it, and (iv) how to select a 3PL. This newsletter ended up getting really long, so apologies in advance.

What is a 3PL?

If you’re not in eCommerce, you may not know what a 3PL is, so let me explain it. It’s basically your warehouse. It’s rare in eCommerce to actually own your own warehouse and do your own shipping. Nearly everyone in the eCommerce community works with 3PLs instead. They are the guys who own the warehouse where you leave your inventory, and when you get a sale, they pack up the order on your behalf and ship it directly to the customer. This means they end up shipping stuff both to consumers (who order through your DTC site), and often to other businesses such as Amazon, Target, or Walmart. 

Ultimately, 3PLs are responsible for (i) receiving inventory from your manufacturer, (ii) packing it up into boxes, and (iii) shipping that inventory out to the appropriate party.

Why are 3PLs important? 

Save for marketing costs, your 3PL may be (and possibly should be) the most expensive line item on your P&L. That means for most eCommerce businesses, you end up paying more to your 3PL than you do to your manufacturer for the actual goods you are selling, or to your employees for their time. 

In addition, your 3PL is the one who actually gets your product into your customer’s hands. If they are slow in shipping out products, that damages the relationship you have with your customer. If they mispack or poorly pack your items, that damages the relationship too. Ultimately, your 3PL controls the end experience with your customer.

The Harsh Truth 

Let me start by saying something harsh but true. There are three axioms in life: you will pay taxes, you will die, and your 3PL will overcharge you. In my life, I’ve worked with about a dozen 3PLs and have audited several dozen more. Some are run as honorable operations where they make mistakes and overcharge you, and others intentionally overcharge you because it is their business model to overcharge you. About two years ago, I spoke to the head of a 3PL and asked him point blank: “Do you have meetings where you write ‘Ways we can scam Moiz’ on the whiteboard and then brainstorm with your team ways you can overcharge me, or does this happen at happy hour over drinks?” 

Almost all 3PL contracts are set up so that they are billing you for two types of expenses:

• Pick & Pack Fee: typically this is something like $1.50 per item + $0.20 for each additional item shipped in the same package. This is pretty straightforward, clearly covering their labor expenses and adding some margin. Imagine you sell one stick of deodorant to John Doe. You’re going to get charged $1.50 for the expense of the 3PL making the box in which your deodorant will ship, putting the deodorant in there, and then sealing the box and putting the shipping label on it. If you sell two sticks of deodorant, you’ll get charged $1.75. That’s part of the reason that increasing units in an order results in such outsized profit, since your shipping costs just went from $1.50 per unit to $0.875 cents per unit.
  
  

• Postage Fee + Surcharges: This is the cost of actually shipping an item from the warehouse to the customer. This is the fucking postage stamp. And this is the place where dishonorable 3PLs thrive. 

1. Postage Fees

When it comes to the postage fee, your 3PL will try to talk you into using their own rate card (the fee that UPS/FedEx/DHL will charge for the stamp). They’ll act as if they’re doing you a favor, arguing that as a result of their scale, they have better postage rates than you could negotiate with UPS/FedEx/DHL, etc. yourself.  “We ship 500,000 packages daily with UPS, Moiz. You only ship 50,000. We’re going to get better rates from UPS than you, and we’ll pass along those savings.” 

But almost always, they’re inflating the postage rates they charge you above what they are being charged themselves. Fair enough. Some 3PLs are even transparent about this and they will say: “We’re going to get better rates from the carrier than you, and we’ll pass along a portion of those savings.” There’s some truth in what they say: you may not be able to negotiate rates below what the 3PL is actually paying. But, you can probably negotiate your own rates with UPS below what the 3PL is charging you.

2. Surcharges

Well, Moiz, you might be thinking, the rate card I got from my 3PL is cheaper than the rate I was able to negotiate with UPS, so you’re wrong. I’m going to use my 3PL’s rate card. 

Fine, but watch out for the other place you will get screwed: surcharges. Surcharges were invented by the devil to cheat you. And your 3PL is a sinner. Delivery, fuel, and peak surcharges are all valid surcharges. But they can easily be manipulated such that while your rate card looks good, the rate you actually pay is far more than you realize. 

(i) Residential Delivery Surcharge. Let me tell you about an example of  an instance where I agreed to use the rate card of my 3PL. I didn’t know better, and so I agreed to their rates (which looked really low) and those rates included surcharges. When I was auditing a 3PL invoice - literally spot checking the charges on individual orders - I found that my 3PL was passing through a $0.75 “Residential Delivery Surcharge.” Some carriers do charge this surcharge, depending on the method of shipment and the address of the destination. But the carrier we used on this package didn’t do that! While my 3PL had promised me low rates, they were inflating the bill through this fake surcharge. 

When we dug in, it wasn’t just an isolated incident. It was all over the invoice on hundreds of orders. Some even had an “Extended Residential Delivery Surcharge” of $1.25 - also fake! That meant I was paying $2.00 more per order than the rate card we agreed to because of these fake surcharges. When challenged, my 3PL at the time was forced to correct it. But the problem was, they’d only correct the ones you challenged them on. You’d have to audit every single zipcode on every single order to see if the surcharge was valid, and at some point, it just wasn’t worth the 75 cents. And that was their business model. 

(ii) Peak Surcharge. Another surcharge you have to watch is the peak surcharge. This is the one that occurs (in some years) when UPS and FedEx charge more for delivery during their “peak” periods: October to December. That’s a fair surcharge and I expect to pay that when the carrier is charging my 3PL for it. But I found my 3PL charging this after the peak period ended, and when challenged, they finally relented and refunded me this cost. But so many of their other customers didn’t realize this.  

(iii) Fuel Surcharge. Fuel surcharges are real surcharges too. They can vary from week to week based on what the price of fuel is. But while the fuel surcharge may only be 6% this week, you might be getting billed 8 or 9% from your 3PL. So while that rate card looked good originally, it now is meaningless because you are paying 3% more than you agreed to pay. 

(iv) Overweight Surcharge. Okay, this isn’t technically a surcharge. Let me explain what I mean here. If you negotiate your own rates with UPS and your 3PL bills your UPS account postage, your 2 pound packages will end up costing you the rate it should for 2 pounds. Why? Well, first, your 3PL will not have an incentive to overweigh them. Second, UPS will weigh the item while it is being transported, and charge you for the actual weight. So even if your 3PL said it weighed 1 or 3 pounds to UPS, UPS will reweigh the item and correct the weight. 

But if you use your 3PLs rate card, that same package will suddenly weigh 4 pounds! Why? Well, now your 3PL does have an incentive to over-weigh your package. They will charge you for the 4 pounds, but UPS will still charge them just for two pounds. 

When I used to work at a gas station, someone from the local government would come out and make sure that when we said we sold you one gallon of fuel, we actually put one gallon in your fuel tank. That is, our pumps were calibrated correctly. That doesn’t happen at 3PLs. Their scales can be rigged. I’ve got photographic proof that it happens. 

(v) Dragging Feet Surcharge. Unfortunately, misaligned incentives also mean they will drag their feet in resolving contested invoices. I would contest June’s invoice in July and dutifully remind them about it in August, September, October, November, and December. June’s invoice wouldn’t get fully resolved until January, and in the meantime that same overcharge would be incurred on August through December’s invoices, which now we had to harass the 3PL into correcting as well. It all can feel like a sisyphean task, because it is!

3. Solution

I always bring in my own rates and have them charge my own UPS/FedEx/DHL account directly. Why? 

First, I think I can negotiate a rate better than the one my 3PL is offering me. 

Second, if I bring in my own rates, I can switch carriers if I feel like I’m not getting good service from the carrier I selected. For instance, if I’m working with UPS but the service and delivery times aren’t great, I can just drop them and move to FedEx or DHL. If your 3PL profits handsomely off of the postage they charge you, they won’t let you switch carriers even if the service is bad. There is too much money in it for them.

Third, I feel like (and have reason to believe) that 3PLs may give you a lower rate card, but will build in so many extra fees and surcharges that are difficult to discover that in reality, your postage costs will be more than if you had just brought my own card in. Frankly, I’d rather just work with a carrier that bills me more honestly - even if the bill is higher - than go to bed feeling like I’m getting screwed. 

Fourth, this allows you to charge your postage to your credit card. You can pay your Stamps.com account or your UPS bill with your credit card. That means you’ll earn cashback/rewards points on your postage, which is a huge line item. I just got a 2% discount on all your postage!

What to look for in a 3PL?

All the issues I just described can happen accidentally even with an honest 3PL, so you can imagine what a dishonest 3PL might do. Picking the right one is critical for your business and your own sanity, so here’s what to look for:

1. No VC-backed startups. Ideally you’re able to go with a mom & pop shop. The conventional wisdom holds here: a smaller business will care about making each client happy, because it hurts them much more if you leave vs. a 3PL with 100 other clients. A high-growth VC-backed startup 3PL may have glossy marketing, but will nickel and dime you out of everything. Their teams are too big, they have too many clients…it’s like fighting Delta for your lost luggage. You’re a very small fish in a very big pond fighting for attention, even if they’re the ones in the wrong.

2. Bring in Your Own Rates. If your 3PL really doesn’t profit off of postage rates, they will let you bring in your own rate card which you negotiated with the carriers without issue. If they do profit off the rates, you can pay a bit more in Pick & Pack Fees to balance this out. But better that than having to audit every invoice for months on end. 

3. Reference Checks. Don’t just go to the references they give you. Those guys will all be super positive. Instead, ask around to see what the reputation of the 3PL is like. 

4. Watch for contract renewal terms. The renewal terms on 3PL contracts can be a huge trap. Some 3PLs won’t even ask you to sign a commitment of more than 3-6 months. Other 3PLs will lock you into a full year contract that automatically renews again for a full year if you don’t cancel on the right day. And of course the 3PL will never, ever mention to you when your cancellation window is open. Arduous lock-in periods are probably a sign that this 3PL isn’t the right one for you. 

5. How they let people leave. Every relationship will end at some point, and it can be a real nightmare extricating yourself from a 3PL who doesn’t value doing it fairly. Some will charge you massive fees to leave and make you sign an NDA on the way out (or even a non-defamation agreement). They may even try to charge you a $1.50 Pick & Pack Fee for each item you’re shipping to the new warehouse, even though they are shipping pallets and not individual items. Some will just destroy your merchandise on the way out. 

   Remember - the leverage lies with them because they have your product and they own the delivery of the product to your customer. Imagine if they don’t ship out your orders for two weeks? You can’t exactly tell your customers that you are fighting your warehouse. 

   What to do before & after hiring your 3PL

My must-dos are a pretty short list:

1. Narrow down your options using the above criteria of “what to look for”.

2. Meet in person. Fly out! It’s 100% worth it to really understand who you’re dealing with and how they run their facility. 

3. Understand them. Do you get to meet the owner? How many clients do they have? Are you a big client or a small one? Can you text with the CEO if you need to? Does everything have to be a scheduled call? 

4. Routinely audit your invoices. This is key, no matter how good of a job you do in selecting your 3PL. Investigate your suspicions down to the package level, because your intuition is usually right and it will save you a lot of money.

5. Order your own packages from them at least quarterly. You can audit overcharges on the invoice, but the best way to audit the quality of how they’re packing your product is to have them send you a package like you’re a customer. Make sure to use a different pseudonym every time.

6. For god’s sake, put a reminder on your own calendar for when your cancellation window opens.

Leaving your 3PL

If you are trying to leave your 3PL, try to store as little inventory there as possible while you’re on the way out. This will give them less leverage over you. That is, if you’re staying for another 30 days, try to only have 30 days of inventory in stock at the 3PL so they can’t charge you to take it out. Second, I’ve even heard stories of founders resorting to bribing the shipping manager to get their product out of the warehouse in a clean/honest manner. One founder I know Venmo’d the warehouse manager $500 to pack it up nicely and $500 after it arrived to ensure they did it properly. It just reached a point where sending $1k under the table via Venmo was preferable to ending up with $10k in damaged inventory.

Empathy for 3PLs

I’ve been pretty tough on 3PLs here, but it’s fair to take a moment to appreciate that it’s not so easy for the 3PLs either. If it was easy to do, then you’d be doing it yourself. 

Running a 3PL is a pretty thankless job, and I recognize that. Beyond needing to eek out a relatively slim profit margin on a commoditized task, 3PLs have a lot of overhead in managing a labor force that just isn’t very reliable. Warehouse workers will switch jobs for $0.50 an hour - and, understandably so! Nobody is faulting them for it. But, that unpredictability is still hard to deal with as their employer.

It’s really hard to hire for 3PLs. In addition, extreme seasonality in their business further complicates this, as they need to hire aggressively leading into the holidays. You can’t hire a huge crew just to work on Black Friday - they need to be trained first. So you have to hire them at the beginning of November for one week of work at the end of November, and that isn’t easy. If you hire too late or too slow, you’re paying overtime to still miss your SLAs and field angry calls from clients. Both cost you money. 

Does it sound like you want to be dealing with all this?

This is exactly why despite all the pitfalls, nearly all eCommerce businesses use a 3PL. Simply put, you don’t want to deal with the staffing issues. You don’t want to deal with the roof being torn off during a hurricane. You don’t want to deal with the toilets at your own internal warehouse not working. In the end, it’s worth it to deal with 3PLs unless you’re at a massive scale such that it might make sense to move this internally. 

If you only take one thing from this really long email, it should be this: your 3PL has your products (and therefore, your money) literally locked in their warehouse. They have you by the balls from the moment you sign the contract to the moment your last unit leaves their warehouse. That’s why you have to be careful who you choose, and you have to prioritize the relationship. Diligence will save you from some of the biggest headaches, but at the end of the day, you need to find a 3PL owner who can’t sleep when the packages haven’t shipped out because he cares so much. 

If you’re looking for a 3PL, email me at [email protected] with your volume of packages per month and your store name. For the first time in my life, I actually think I have a great one I can recommend!

Finally, if you enjoyed this newsletter, please let me know what you liked! If you hated it, tell me that and why too! You can do so by responding here, or tweeting at me (@moizali). This is a pretty new thing for me, and while I have a few thousand readers, I get virtually no feedback. Please give me some!