How to successfully outsource contract packing and fulfilment services

Outsourcing contract packing and fulfilment services can be a great way for a brand to scale. However, a high degree of trust is needed, since the packer forms a crucial part of the brand’s supply chain.

In this article, our Commercial Contracts partner Lucy Pringle outlines the conversations the parties should have at the outset to ensure quality control and reliability for the brand, and to ensure expectations are appropriately managed by the packer. The tips take into account the interests of both parties. This balanced approach helps both parties strike a fair deal to set up a long-term successful relationship.

1. Volumes

The brand will want flexibility regarding the volume of support needed from time to time, and comfort that the packer has the bandwidth to expand volumes as the brand grows. If the packer is investing in equipment, systems or additional staff to service the brand’s business, it will want some volume guarantees to recoup that investment. The packer needs to manage its capacity and resources across its full customer base.

Consider:

• Is the packer required to reserve capacity for this customer or make any investment to service the bespoke needs of this brand? If so, will the customer commit to minimum volumes? If the minimum volumes are missed, will the customer be required to make a shortfall payment for the deficit?
• Will the customer’s orders be binding on the packer? If so, the packer should impose minimum lead times and maximum order volumes so it can manage its order book. If the packer can decline orders, the customer should be released from any exclusivity commitments so that they can get replacement services elsewhere.
• Does the customer have a right to amend volumes, change delivery dates or cancel orders? Usually this will only be allowed with the packer’s consent, but some flexibility is crucial for a successful relationship.

2. Free issue materials

The customer is likely to be supplying the product to be packed, and possibly also the packaging materials. The nature, quantities and inbound delivery of the goods should be agreed.

Consider:

• Are the products to be packed dangerous or do they require any special handling or storage?
• Is it the customer or the packer who determines whether the packaging materials are suitable for use in relation to the products to be packed? If the customer supplies the packaging materials, the customer should give warranties about their quality and the packer should be released from liability if quality problems arise from the customer-supplied packaging.
• What conversion efficiencies are expected in relation to the free issue materials? What happens if the wastage exceeds the permitted tolerance?
• Who insures the products and packaging materials whilst they are on the packer’s site? Packers should note that their insurance may not cover goods which remain owned by the customer.
• When will the products and packaging materials be delivered to the packer? Just-in-time delivery may be preferable to avoid the packer being required to store large quantities. The packer should be released from liability if the products and/or packaging materials are not delivered to the packer in time to meet the customer’s orders.

3. Warranties, remedies and liability

Quality is key and is usually dealt with via warranties in the contract terms. The customer should have upfront discussions about what the remedies will be for any contract breaches. For the packer, limitations and exclusions of liability are essential protections.

Consider:

• What warranties does the packer give about quality and on-time performance? This is important to get right as it is a key area where disputes can arise. A sensible compromise position can be to agree tolerances for packaged goods (e.g. 99% quality compliance) and service levels for timely delivery (e.g. 95% of orders will be completed on time in full).
• The usual remedies for breach are to reperform the defective services or resupply defective goods, but the packer should also ensure they have a right to give a refund instead in case it is uneconomical to fix the problem. The customer will want to know how quickly these remedies will be available, and whether they can bring a breach of contract claim on top for any losses suffered.
• The customer should also consider their own quality processes – are they going to check that the packer has done the job correctly before the goods are distributed onwards? If not, it may be necessary to impose more stringent quality control procedures on the packer. It is in both parties’ interests to identify quality issues before the items reach the end-customer.
• The packer should have limitations on its liability which apply on a per-claim basis (i.e. for each incident) and on its total liability under the contract. It is also standard for the packer to exclude liability for indirect loss and loss of profit, amongst other things. The packer’s insurers should be consulted on these limits and exclusions, and they need to be drafted carefully from a legal perspective. If you try to exclude too much liability in the contract terms, there is a risk that they will be legally unenforceable.

4. Intellectual property (IP)

Ownership of IP can be complicated where the customer supplies the designs, but the packer produces packaging using its own processes and know-how. Both parties should retain ownership of whatever IP they bring to the arrangement. Any new IP developed which is bespoke to the customer will generally be assigned to the customer and should not be used by the packer in relation to other customers.

If the customer supplies designs or process instructions to the packer, the customer should indemnify the packer for any IP infringement claims.

5. Termination

Contracts usually include termination rights for material breach by either party, and for insolvency. If the contract contains ongoing obligations (i.e. minimum purchase volumes on the customer or an obligation on the packer to accept orders), then a notice period for termination will also be needed.

Consider:

• How long will the customer need to transfer its packing and fulfilment operations to a new provider?
• Has the packer made any investment for this particular customer which needs to be recouped over a minimum period?
• If notice to terminate is served, are outstanding orders to be fulfilled or cancelled?
• What happens to materials in the packer’s possession at the end of the relationship? The costs of returning them to the customer or disposing of them should be covered by the customer.

Outsourcing contract packing and fulfilment services can be an effective way for businesses to achieve lean operations. It is essential to document the agreed position in a well-drafted contract that adequately protects the interests of both parties.

If you have questions about outsourcing contracts, or commercial contracts in general, please contact Lucy Pringle.