August 28, 2008, 12:00 AM

Exit Strategy

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Along the way, Kelly has learned some lessons that could come in handy for any web merchant looking to outsource fulfillment and to prepare at the same time for the possible end of that relationship. One is to avoid warehouse liens. Under a warehouse lien, provided for in some state laws, the warehouse operator can hold onto inventory on its premises owned by the merchant in resolution of a monetary dispute; for instance, a disagreement over a final bill. “It’s important to have a lawyer who really understands outsourced fulfillment,” Kelly says.

Based on her experience with multiple moves to new fulfillment vendors, Kelly also advises retailers to find vendors that are on the same software and systems that the retailer uses, as Junonia does now. “It softens the pain of moving considerably,” she says. “The order management software is key because we remotely mange our inventory, enter purchase orders and pull sales reports. Not having to do a complicated systems integration makes it all a lot easier.”

No time for questions

Becky Simon, CEO of Bra Smyth, one of the retailers forced to find a quick alternative when AB&C; closed its doors, also encourages retailers moving to a new fulfillment provider to pay close attention to the prospective vendor’s systems, particularly if the systems are proprietary. Bra Smyth moved its fulfillment operation to another provider successfully with the help of consultants F. Curtis Barry. But on the very compressed time frame involved, Simon wasn’t able to delve into the new vendor as deeply as she might have otherwise.

“When we found we were moving to a new vendor on a proprietary system, I didn’t ask any questions about that system. Now I would,” she says. “We took them at their word that they have sufficient IT staff to support it. But if they have 15 people, and people leave or are fired, they could suddenly have five. It’s not something you can anticipate, but when someone tells you they have a proprietary system, explore that very carefully. Look at how purchase orders are received, and put it through its paces.”

While it’s tough to anticipate and plan for every contingency, a well-written contract can provide at least some protection for the retailer suddenly having to separate from its fulfillment vendor. Contracts typically spell out the metrics that constitute acceptable performance, for example, that orders will be filled within a designated time and that the vendor will record inventory status at a specified level of accuracy. They also spell out the basis of pricing for service. But contracts also provide an a opportunity to build in additional terms that could ease an unexpected move.

Kelly, for example, says many retailers don’t understand the need to write into a contract provisions that relieve the retailer of the warehouse lien in the event of an end to the relationship, and it may not appear in the provider’s contract boilerplate because vendors want the assurance on their side that if the retailer goes out of business, they can cover their costs by liquidating that inventory.

Making ownership clear

Junonia always structures contracts with outsourced fulfillment vendors to state that no matter what happens, even if the retailer still owes payment on the final bill, the warehouse operator is not entitled to the inventory. It’s an extra measure of assurance against the possibility of contention at the sudden end of the relationship.

“We might still owe them for the last bill and they could come after us as any vendor would for an unpaid bill, but they can’t keep our goods to reconcile a billing,” Kelly explains.

But what if it’s the fulfillment vendor, not the retailer, that suddenly closes its doors with inventory owned by the retailer inside? If a fulfillment house suddenly shuts down under circumstances such as a bankruptcy, for example, does the inventory in that third-party warehouse go into the asset pool targeted by the third party’s creditors?

“Normally, no,” says Moore. “Your contract should clearly state if the retailer owns that inventory, and that the third party is liable for any damage to the inventory. In the case of a business failure, the third party has to provide for the retailer to have access to get its inventory out of there.”

But getting access solves only part of the problem. Another challenge for retailers is that they have to know exactly what they’ve got at the warehouse, including the quantity of each item. With retailers receiving periodic updates to their own systems from the third party’s systems, recorded inventory levels may be out of synch to a degree but should provide a rough idea of what inventory the retailer has at the warehouse.

Because neither party plans to fail, most contracts don’t go as far as setting out a fully-developed exit plan. But it pays to lay out at least some aspects of how a separation would be accomplished, beyond just specifying the performance levels that would justify contract termination, according to Betke. For example, the contract might include specific language about what happens to the retailer’s inventory and to the retailer’s data that resides on the third party’s system in the event the third party suddenly ceases to operate.

Buyout option

Some contracts address ownership of software, if the partnership has customized packaged software. “They spell out whether you can negotiate to license that software if you leave,” Betke says. That also goes for buying back shelving or other equipment the fulfillment provider may have acquired to support the retailer’s business, particularly useful if the retailer intends to take fulfillment in-house.

Kelly takes that approach one step further. Currently, Junonia has what she calls “a gentleman’s agreement” with its outsource fulfillment provider, a local company new to the business, for first option to buy the warehouse and equipment if the provider ever decides to exit the business, but Kelly says that language will go into her next contract with the vendor. “That would put us in the business of operating it directly, but I think that might be less painful than moving again,” she says.

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