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Pallet User Education Series: Negotiating the Pitfalls of Rental Pallet Contracts
Andrew Mosqueda, industry veteran, identifies major pitfalls in negotiating rental pallet contracts and provides advice on how to save money by negotiating the little details.
By Andrew Mosqueda
Date Posted: 9/1/2009
Mahatma Gandhi once said; “It is difficult, but not impossible, to conduct strictly honest business.” To that end, how you negotiate your contract with a Pallet Rental Company (PRC) can save your company thousands of dollars while keeping the pallet company honest. The intricate details of the contract should not be overlooked. A PRC uses several strategies that give it an upper hand in contract negotiations. The purpose of this column is to explore the variables in a typical rental contract and suggest a game plan that can give you a fighting chance.
A basic pallet rental contract typically is comprised of several sections. This usually includes: issue fees, transfer fees, transportation rates, daily rental rates, lost equipment fees, emergency load fees, and restocking fees. In each of these areas you may be able to negotiate lower charges.
Just When You Thought You Were Out…
A quote made famous by Al Pacino in Godfather III is, “just when I thought I was out, they pull me back in.” Much like the famous fictional mob boss, rental companies use a strategy designed to “pull” a customer on to the rental pallet program. The way it works is a PRC will go to a retail customer, like Wal-Mart, and ask it to request that vendors join a rental program. Product manufacturers will then be notified by the retailer that they must use an authorized rental pallet program or face certain penalties or fees. Retailers may back such a program due to incentives provided by the PRC or other reasons, such as the promise of a higher quality pallet. Essentially, this tactic pulls product manufacturers onto a rental program due to customer pressure. Although this does put the pallet user on a weakened bargaining position since it has to approach the rental company versus the other way around, there are ways to even the negotiations.
Besides from the pull through strategy, CHEP which has around 100 million pallets in its U.S. pool, may use size to keep business. PECO pallets, a much smaller pallet rental company, may try to gain a foothold by trying to take one or two lanes at a time. All CHEP contracts are based on volume. As a result, CHEP may go back to the customer and notify them of an increase in the issue fee due to the decrease in volume. Another potential reaction by CHEP would be to cancel the contract and let PECO pallets supply 100% of the business. The problem is that PECO generally does not have the inventory in many regions to handle 100% of a large customer. This makes CHEP the only viable option for pallet rental in come cases. Thus, many customers stick with CHEP to avoid higher operational costs. Potential customers need to be aware of the tactics as they consider contract negotiations. It may be easier to switch to pallet rental than to maneuver among various suppliers.
The first thing to understand is how both pallet recyclers and rental pallet companies determine their basic fee structure. Most companies base success on two factors; the earnings before interest, taxes, depreciation and amortization (EBITDA); and the return on capital investment (ROCI) models. As a pallet user, your goal would be to determine what ROCI model looks like for a particular PRC. For argument sake, let’s say a PRC is required to maintain a 35% ROCI on any contract. This is a reasonable rate and one that many companies would find acceptable. The base fee for pallet rental contracts is the issue fee. You have to keep in mind these questions, “How does an issue fee relate to the ROCI for a particular PRC and how is it figured?”
The issue fee will vary based on volume, which does put smaller companies at a slight disadvantage. Begin by identifying what expenses are covered in the issue fee. Remember that PRCs did not create the pallet business; they just made it a little more complicated. PRCs have the same type of expenses as any used pallet dealer, with the exception of calculating depreciation on assets, which the pallet is considered. See sidebar on page 46 for a complete breakdown of costs.
After these factors are figured into the model, a PRC could have expenses upwards of $2-4 per pallet. The question is can you open any of these elements to negotiation? These are costs that all pallet recyclers and PRCs must consider when pricing pallets – simply the cost of doing business. These costs are factored in before your contract is even considered.
One place you can negotiate is fees related to shipments outside of the rental system. Let’s say that the PRC adds .25 cents on every pallet issued to cover non-participating transfers.. You can request a .15 cents discount in those areas where you are only shipping to receivers who are in the network. The goal is to get them to disclose how your issue fee was figured. You want specific information to figure out what goes into it and what can be negotiated.
Who Says Leaving Doesn’t Hurt
When a rental pallet changes hands from a product manufacturer to a receiver, PRCs usually charge a transfer fee. These fees can significantly increase the overall cost of a pallet rental program. This might be a good place to negotiate lower fees. The PRC might have several location types it will charge in your contract. Here are a few examples and estimated transfer fees:
• Participating Distributors located in the U.S. $0-$1.17
• Non-Participating Distributors (NPD) in the U.S. $1.17-$12.00
• Participating Puerto Rico Distributors $0-$4.00
• Participating Alaska, Mexico, Canada $1.17- $15.00
Amounts will vary depending on volume to each of those locations. Be aware of all domestic and international shipments prior to signing the contract. Also, keep in mind that most brokers are considered non-participating distributors. Because international business is increasing between U.S., Mexico, Puerto Rico, and Canada, companies should be careful not to accept high transfer fees based on current business. However, if you are shipping 80% domestic you are in a position to ask for a lower transfer fee to U.S. distributors, possibly even no transfer fee. If you do ship into non-participating distributors (NPDs), you may be able to negotiate a percentage of your shipments be permitted to ship into those locations without high transfer fees. A current common trend is 80/20, 80% being domestic participating distributors.
High Rent District
Daily pallet rent is a variable in the contract that is directly tied to inventory management and can literally cost a company hundreds of dollars per week. In my July Pallet Enterprise column, I covered a really good example of how CHEP calculates its rental fee. Weekly rental is figured using the formula (pallet balance x product days x daily hire fee). For example, 940 pallets x 7 days= 6580 product days x .03 rental fee = $197. Because the CHEP invoice period is from Sunday to Saturday, have your stock as low as you can by close of business on Saturday to cut costs.
I would bring your buffer down to 300 pallets. Your rent for the week would be: 300 pallets x 7 days= 2100 product days x .03 rental fee = $63. This would save you $134 just on your buffer stock. However, if you negotiated your rent to be .025 per pallet, per day your rent based on 300 pallets would be: 300 pallets x 7 days = 2100 product days x .025 = $52.50, saving an additional $10.50. If you had the original 940 pallets the difference would be $32.50 for the same amount of stock, during the same time period. This is a case where every half cent makes a difference to your bottom line.
The Devil Is in the Details
There is no doubt that if your operation is a fit for rental pallets you can benefit from a well-run rental pallet program. The key is what your contract covers. You need to know what you can and cannot do. Asking the right questions can make sure that you don’t miss a critical detail that will end up costing you a lot in the end. Make sure to ask, “What is the responsibility of the rental company?”
This should include the following:
1.) Will ensure that the pallet is of merchantable quality except for defects which a reasonable examination by the customer prior to the use of the pallet ought to reveal. (This will put quality assurance directly on the customer not the PRC. If quality is in question, it is up to the customer to inspect, sort and return any pallet that is not up to the specification specified in the contract. This is a fairly standard practice and must be considered when comparing rental with used or new pallets.)
2.) Manage the effective operation of the rental pallet activity.
3.) Provide account management services.
4.) Provide consulting services if requested.
5.) Will deliver truckload quantities. For LTL shipments additional fees apply. The rates depend on quantity but typically the break down as follows:
a. 81 – 150 pallets = $1.60 per pallet
b. 151 – 250 pallets = $.80 per pallet
c. 251 – 459 pallets = $.40 per pallet
6.) Provide invoices in a timely manner.
The agreement for the PRC is clear, short and to the point.
The rental customer has a list of responsibilities it must perform to stay within the contract guidelines. A few areas to examine in order not to break your contract are:
1.) Take good care of pallet and prevent contamination of any kind. While the PRC usually does not require indoor storage, it usually would prefer it, which can add to the cost of a rental system.
2.) Inspect equipment upon receipt for defects and to ensure it is fit for use. Immediately return to the PRC any pallet that is not fit for use for whatever reason.
3.) Accept transfers of pallets from other rental company customers.
4.) Promptly and accurately notify the PRC of all returns and transfers of pallets including name, rental pallet account number, quantity, date, invoice number, PO number, and any other identifiers.
5.) Conduct annual inventory and allow the rental pallet company to participate.
6.) Comply with all the rental pallet company’s standard procedures.
7.) Transfer equipment only to rental the PRC’s authorized locations with approved account numbers.
8.) Supply annual and monthly forecast of pallets needed by location.
9.) If a customer ships to a third party (anyone other than end user or service center) the customer will remain responsible for that pallet. Customer will reimburse the PRC for any marks on that pallet that tamper or cover up ownership.
10.) A charge will apply for any pallet lost, destroyed, stolen or damaged. Payment of the lost pallet does not transfer ownership.
In order to do your due diligence, the program administrator needs to perform a minimum of the ten contract elements mentioned above. Of course, this is just a segment of a contract, other areas cover contract termination, liability and indemnity and other general stipulations. More often than not the administrator has never seen the contract and only does as much as he has been trained to do. These ten areas are not negotiable even for big customers although the PRC may write off for high volume accounts any penalties for lack of performance in the contract. Failure to follow these key actions can result in severe mismanagement of the program, thereby resulting in significant lost equipment fees.
Knowledge is Power
Information flow often plays a critical role in the derailment of a rental program at many companies. Understanding what is expected and passing the importance of that information to all who will be involved in the management of the rental pallet program will determine failure or success. For example, if you take step #4 above, “Promptly and accurately notify the PRC of all returns and transfers of pallets including name, rental pallet account number, quantity, date, invoice number, PO number, and any other identifiers”, pallets are shipped to an end user and all data is transmitted accurately. The program administrator should then reconcile by matching what was sent compared to what was received by your customer. That should not be the end of the reconciliation process. The administrator needs to make sure that shipments are made only to approved receivers. If you did ship to non-participants, transfer fees could apply.
The transfer fees are where your contract negotiations will directly affect your overall costs. The above scenario is one example of how mismanagement of a pallet rental program can result in high transfer fees. If a receiver is not a participant on the rental program, it is easier to ship on a new GMA pallet.
Here are a few other areas to consider negotiating into a rental contract. My recommendation would be to insert an acceptable damage ratio on all loads. For example, adding each load cannot exceed 5% of damaged pallets. So on a load of 570 pallets, no more than 29 pallets can be defective. In many cases contracts are negotiated at a discounted rate, to be evaluated six months to one year after the contract is signed. If sales are not at the expected volume, issue fee increases or changes in the NPD transfer fee will be modified. If your volume is only 70% of expected issues and your NPD rate is higher than 20%, your prices will rise to be in line with EBITA and ROCI requirements.
We have discussed several areas where your contract negotiations with a rental pallet company can cost or save you thousands. The lesson here is twofold. Read the contract and fight to negotiate beneficial terms from the beginning. Don’t believe the line that the contract is standard language that everybody signs. Some parts are negotiable. Second, make sure your program administrator is familiar with what is expected and the consequences if the program is not administrated correctly. Know that you do have negotiating power if you know what to look for before you sign a contract.
Andrew Mosqueda is a former Inventory Project Manager and Customer Service Rep for CHEP USA. He has extensive experience with pallet rental and recycling programs for major shippers. Now he works for SCS Logistics in Bakersfield, Calif. Andrew can be reached at email@example.com.
Here is how the issue fee breaks down for all pallet dealers:
• Retrieving Pallets from Non-Participating Companies
• Inspection & Sorting
• Overhead and losses