The motors whirred as a robotic trolley sped down the long warehouse alleyway. As it went it rose ever higher in the ten-story tower, lifted by cables and pulleys. The trolley’s mechanical arm picked a box from the rack suspended fifty feet above the warehouse floor and deposited it in a bin on its back. Within a minute the trolley returned to its starting point with its precious cargo.

This automated, robot-driven warehouse facility was a technological wonder 25 years ago when it was built by a multinational pharmaceuticals company. It stood on the company’s main U.S. campus as a showcase and was a favorite stop for visitors on campus tours. Tour guides explained that almost all of the company’s U.S. inventory spent time on these shelves before being shipped to destinations throughout the country.

That was then. Today, the robotic vertical warehouse is gone. In its place are green fields, a gleaming new research building, and a new logistics model that relies on a third-party logistics provider (or “3PL” in the language of the industry) for managing the flow of goods from the factory to the market. How and why did this happen? Four factors tell the story.

Expense. During the many years that the company ran its own logistics operation using company employees, the quality of the operation was high. The numbers of inaccurate picks, spoiled products and out-of-stock events were small. But this good performance came at a steep price. The company had overinvested in capital equipment and real property, having built facilities that were expensive to maintain on prime real estate on a campus that lacked good access to interstate highways and other transportation corridors. Despite the automation of key elements of the operation, the department had substantial personnel expenses that were hard to manage.

The company asked us to assist it in assessing alternatives, including engaging a 3PL to take over the warehousing and transportation of its inventory. A vigorous proposal process followed. It revealed that substantial savings could be found by moving the inventory to the 3PL’s warehouses and allowing its personnel to manage the inventory.

Expertise. Actually, cost savings weren’t the primary driver in the company’s drive to restructure its logistics and fulfillment operations. The company knew that it had not kept up with the state of the art over the previous 25 years and wanted to be sure it was using best practices in an effort to fulfill its mission of continuous quality improvement in all elements of  its business. But the company’s core competence was drug development, not warehousing. So it sought business partners with core competence in that arena who could commit to applying current and future best practices to drive more quality, accuracy and speed into the process. Of particular concern to the company was the 3PL’s ability to handle the many regulatory requirements applicable to the handling of pharmaceuticals.

As part of the vendor downselect and contract negotiation process, we helped the company assess the experience and capabilities of the bidders in the pharmaceutical field. It was key to work with experts inside the company and with industry consultants to draft statements of work that describe in detail the current best practices to be used in the logistics operation while also incentivizing the implementation of newer, more efficient processes as they became available over time.

Efficiency. Despite the company’s expertise, developed over many decades, in managing pharmaceutical product inventory, the company acknowledged that it did not possess the domain expertise and breadth of facilities, systems and personnel that dedicated logistics providers could offer. In making their pitches to the company, the providers emphasized the efficiencies that they could bring to bear. The key in negotiating the deal was to make sure these discussions would not be forgotten as sales talk, but would be woven into the fabric of the agreement.

We advised the company on ways to enforce and encourage efficiency, using outcomes-based language in the contract and in statements of work, and measuring success using service level agreements (SLAs) and key performance indicators (KPIs) that would affect the payment of fees to the provider. Additional tools, including putting a part of the management fee at risk and offering to share newly found cost savings with the service provider, were made part of the agreement as well.

Risk. Whether we are counseling product companies in highly regulated industries such as pharmaceuticals or in less regulated industries such as consumer electronics, we still view our chief role as assisting our clients in assessing, allocating and minimizing risk – risk of product loss, risk of personal injury, risk to revenue, risk to reputation. All of these risks are elevated when a company entrusts the handling of its economic lifeblood – its inventory – to a service provider.

The old “warehouseman’s” model, which limited liability based on “bailor-bailee” concepts known to all who have read the back of a parking garage claim ticket, has fortunately been overtaken at the top end of the industry by an increasingly sophisticated group of service providers that willingly assumes risk and liability for ever larger parts of the supply chain. These assumptions of risk and liability are not normally offered voluntarily. Instead, they are won by the demands of sophisticated customers, and by hard negotiation. It’s worth noting that, in addition to negotiating favorable contractual terms, there are other ways to reduce business risk. One is to require that inventory be stored in multiple locations so that the catastrophic loss of one facility will not result in the loss of all inventory. Another is to strictly monitor the facilities to ensure that there is no undue risk of loss due to fire, flood, temperature excursions, pests or insufficient security. Substantial issues can arise when more than one company’s products will be stored in the same facility.

Happily Ever After. The flying robots are gone. They’ve been replaced by sophisticated inventory management software, handheld scanners and, the flying robots’ cousins, autonomous forklifts, all under the control of logistics experts who have dedicated their careers to the art and are willing to take responsibility for their work.

The story in this case study ends well. Although no relationship or business process is ever perfect, the company and the logistics service provider in this story are happy with their partnership and have just completed (with our help) negotiations to renew it. The provider takes pride in the efficiency of its services and its ability to deliver high quality services to a maker of vital medicines. The company is happy to have been brought to the leading edge of best practices while experiencing meaningful cost savings.