When should my Ecommerce business use a 3PL?

Congratulations. You’re once little Ecommerce business is growing to the next level.

In just a few short years, you evolved from selling stuff from your garage to now managing a full-fledged warehouse operation.

Send me this article

An operation complete with a team of packer and warehouse managers.

But you’re growing so quickly that even your current warehouse operation is starting to show cracks.

Products are going to the wrong customers.

You’re running out of space when stocking up for Black Friday and Xmas crazy season.

You’re hiring staff like crazy to keep up with demand  – and that payroll bill is eating into your profit margins.

Furthermore, you have little visibility on your inventory, and it’s creating stock outages and unhappy customers.

Things are getting out of control…

Cue Third Party Logistics

You didn’t start your Ecommerce business to be an expert at logistics, warehousing and fulfilment. 

Accordingly, many businesses outsource this non-core function of their business to specialised logistic providers – referred to as ‘Third Party Logistics’, or 3PL for short.

By taking care of the often tedious and ‘boring’ warehousing and fulfilment function of the business, 3PL providers are a solution to high-growth online retailers to help them scale.

This allows founders like you to focus resources and bandwidth to the core competencies of your business – product innovation, sales and customer happiness.

The Cost-Benefit Analysis of using 3PL

From a financial perspective, the primary benefit of using a 3PL is that you convert fixed costs into variable costs.

Consider all of the fixed expenses you incur in your current logistics setup. Warehouse rent, wages for your packaging and fulfilment staff. Perhaps some capital investment in forklifts and other equipment.

By using a 3PL, all of these fixed costs are now outsourced to a provider who charge a rate per product, instead of a fixed overhead cost.

Of course, 3PLs need to make money too – so they charge a premium for their efforts. Sometimes, the cost of outsourcing to a 3PL can outweigh the benefit of outsourcing the function in the first place.

Due to scale and the specialisation on core competencies, every high-growth retailer will reach an inflexion point where it’s more economical to use 3PL rather than insource the function yourself.

In this blog – I will help you identify your company’s inflexion point, using your numbers.

The steps are as followed. 

There’s also a free Google sheet template you can download at the end.

Step 1: Quantify the fixed costs of your current warehouse and fulfilment operation

Pull up a monthly profit and loss statement for the last 12 months and calculate all of the costs associated with your current fulfilment operation. This typically includes:

  • Shipping/postage to customers
  • Wages for your warehouse/packing/delivery staff
  • On costs associated with your staff (training, bonuses, provision for sick leave)
  • Warehouse rent
  • Oncosts associated with the warehouse operation – electricity, insurance
  • Depreciation expenses on any equipment for the warehouse

Step 2: Calculate the average fixed cost per sales unit

Export a unit sales report from your Merchant sales platform – i.e Shopify/WooCommerce/Sales CRM which shows the total units sold per month for the last 12 months.

Now calculate the total fixed logistics cost per sale per month by taking the total fixed costs and dividing it by the total units sold for each month.

The value you have now is the fixed unit cost per sale of your current operation.

Now, let’s calculate the cost of using a 3PL.

Step 3: Calculate the cost of using a 3PL

3PL providers will provide you with what is termed a rate card. 

A rate card is essentially a menu of all the unit costs you need to consider when exploring the use of a 3PL.

Using the unit sales data that you pulled in Step 2, enter this information into the rate card provided by the 3PL.

If you are comparing multiple 3PL providers, be warned that there is sometimes little consistency amongst how 3PLs structure their rate cards. Some examples include whether the provider charges a set rate for handling returns or picking particular items of stock.

Keep this in mind if you’re assessing multiple providers so you’re comparing apples with apples.

Step 4: Compare the total costs under each scenario!

Now, compare the total unit costs under each scenario.

Forecasting when to make the switch

As your company grows, there will be an inflexion point when it makes sense to utilise a 3PL versus absorbing all the fixed costs yourself with hiring more staff and getting a bigger warehouse.

The art of ‘forecasting’ requires a bit of art and science. The best part is that you’ve already done the hard work of understanding the throughput of how many units your current operation can manage – i.e the number of orders per employee. This sets a benchmark to help you forecast how many more staff you need as your unit sales grow too.

The non-financial benefits

Of course, the financial aspects are just one consideration in any strategic decisions. The other issues that you need to consider if shifting to a 3PL include:

  • Committing to a lease for a warehouse
  • Making warehouse staff redundant from your business
  • Finding the 3PL right provider
  • Less quality control measures 
  • Less flexibility to personalise/tailor orders for specific repeat customers (with personal notes, random gifts etc.) 

Overall, deciding to move to a 3PL is a big, strategic decision that shouldn’t be done half-heartedly. Like every strategic decision in your business, it’s important to understand the true costs and risks associated.

Do you want to conduct a cost-benefit analysis of using a 3PL provider for your business?

Download our free cost-benefit analysis template here.

I recommend watching the 6-minute video tutorial below before you start playing around with it.

If you have any problems or general questions, don’t hesitate to reach out to me at jason@sbo.financial.