Over the last 20-25 years, outsourcing of logistics activities to third-party logistics service providers has become increasingly popular.
Key findings of the 2016 Third-Party Logistics Study: The State of Logistics Outsourcing (J Langley and Cap Gemini) indicate the following:
- Although economic conditions vary significantly among countries and regions of the world, modest improvements have been experienced in many key areas. Armstrong & Associates reported aggregate global revenues for the 3PL sector growing by 9.9% from 2011 to 2012, 2.7% from 2012 to 2013, and by 6.5% from 2013 to 2014.
- Users of 3PL services report an average of 50% of their total logistics expenditures are related to outsourcing compared to an average of 36% reported last year. This increase helps explain how improving economic conditions have impacted aggregate shipper spending on 3PL services as a percentage of total logistics expenditures.
- This year’s Annual Third-Party Logistics Study reports that 73% of the shippers surveyed are increasing their use of outsourced logistics services, while 35% report a return to insourcing many of their logistics activities.
With an expanding sector, and increased expenditure on third-party logistics, why is that 35% are returning to insourcing? What have they discovered, or struggled with, to the extent that its driven them back to insourcing?
“Warehouses and vehicles are expensive to purchase or lease and can tie up millions of dollars that could otherwise be invested in the core business of the firm.”
In this article I will outline, firstly, the reasons why organisations outsource logistics activities, and secondly, what the key drivers are for outsourcing success.
Why do organisations outsource logistics operations?
There are many apparent motives why companies outsource, but from my experience there are four principal reasons:
- Warehousing and distribution management is not a ‘core’ skill.
Peters and Waterman in their best seller In Search for Excellence identify one of the eight factors of organisational success as ‘sticking to the knitting’. They warn that companies that stray from their core business risk their employees’ attention being diverted from that business to the point where they lose focus.
Many enterprises have taken heed and determined that inbound and outbound transport and warehousing are ‘consequential’ processes of their business, rather than ‘fundamental’ or ‘core’ processes. This has fuelled growth of the third-party outsourcing industry and expansion of scores of logistics service providers.
While many logistics service providers commenced as transport companies, they have diversified to engage in contract warehousing logistics, freight forwarding plus many other value adding services. On a world scale there are thousands of providers offering third-party services, yet there are only a handful of very large ones with the ability, network, systems and infrastructure needed for multinational customers. The top ten are:
|DHL Supply Chain||17,748|
|Kuehne + Nagel||4,047|
|UPS Supply Chain Services||2,990|
|DB Schenker Logistics||2,338|
Source: Transport Intelligence
Choosing the right provider to use typically depends on the local and/or international scale of the customers, and alignment with the size and geographic spread of the logistic service provider.
- Performance is sub-optimal
Related to the ‘core skill’ issue, often organisations that have a strategic focus, other than in transport or warehousing, cannot attain the desired performance levels and key performance indicators (KPI) required by their customers. For example, companies that have their own in-house vehicle fleets often struggle to deliver products on time.
For instance, a service ratio of less than 98% of deliveries delivered on time is a major issue for modern consumers as they have become far more demanding. Merely dealing with the complexity of transport networks, contractors, inventories, industrial unions, and cost control is tough enough for many enterprises, so achieving 98% on-time performance is, for some, just a dream.
On the warehousing front, checking performance against just a few industry KPI can quickly help managers determine how effective their operations are. Telling signs are low levels of inventory accuracy, low stock turns and low order output ratios per labour hour, high levels of unexplainable losses or damage to goods, high operating costs, customer performance complaints and high employee turnover. When these signs are evident firms often choose to outsource rather than waste time developing their own remedies.
- Reduction in asset capital
Warehouses and vehicles are expensive to purchase or lease and can tie up millions of dollars that could otherwise be invested in the core business of the firm. Consequently, there is a trend for firms to remove warehouse assets from the balance sheet and redirect capital gained from the sale of assets to working capital and/or core asset investments. In choosing to outsource, firms can therefore transfer all the costs of distribution to their profit and loss account. This is a blessing for third-party logistics providers that have won large amounts of new business for this reason alone.
- Flexibility and scalability
With the advent of e-commerce, increasing globalisation and rationalisation of industries, today’s Australian market place demands fast, flexible and efficient supply chains. Coupled with shorter strategic planning horizons, the use of logistics service providers gives organisations flexibility to expand or change their method to market and volumes handled with almost immediate effect. Enterprises will typically negotiate one- to two-year agreements with Termination for Convenience exit clauses in case they wish to change their short- to medium-term strategy to market. It is simply not possible to respond quickly to market changes if there is a fully owned or leased network of warehouse and transport assets in place.
But what about cost of service?
Surprisingly cost of service, although important, is seldom a deciding factor, or driver for outsourcing decisions.
Why? Very rarely do companies save money through merely ‘outsourcing’ warehousing and transport. They may attain savings over a period e.g. 3-5 years, but not simply from the ‘act’ of outsourcing. The reason is elementary. Third-party logistics companies must pay almost the same operating costs as other organisations (sometimes more). While they do develop purchasing power and discount rates with transport sub-contractors and other vendors, there is often little disparity between the costs of a logistics service provider and would be customers. Why? The provider must add a margin to their costs to be profitable. In my experience the profit margin can range from 7-15%. This means that if a firm is seeking to bank savings after outsourcing they may well be disappointed. As a rule of thumb, companies can expect to pay from 10-20% more than current costs for outsourcing. You will recall the four reasons for outsourcing, to which cost is subservient. However, cost is a critical factor in judging the value proposition of potential providers who are quoting to do the work and in their ultimate appointment. So, to be clear, cost is not a reason to outsource, but a means to assist the decision as to whom to outsource.
“As a rule of thumb, no more than six KPI should be used. But make sure you choose the ones that are most meaningful to your business.”
What are the key drivers for success in establishing a good customer and 3PL relationship?
- Strategic alignment
The outsourcing decision must align with the company’s strategic direction. This is a ‘common-sense’ statement, but unfortunately not well practiced. Amazingly, many companies have suffered after outsourcing decisions were made at an operational level, without due regard to the board’s supply chain strategy.
Alas, in some cases, there is no supply chain strategy to speak of. This can cause organisational stress and is a nightmare to remedy after contracts are established. These days, third-party providers are aware that their clients may be deficient in strategy formulation, so they include clauses in contracts that enable them to change pricing and performance mechanisms if a change in company strategy or method to market occurs.
- Attention to detail
When seeking third-party quotations and contracts, there is no room for intuition, or best guesses on order velocities, volumes, processes and service requirements. Very detailed specifications must be prepared by enterprises with full disclosure of all available data before a quotation from service providers is attained. There is rarely too much information that you can gather. But where there is an absence of sensible interpretation of data, this can cause major issues in the outsourcing relationship.
Surprisingly, some companies agree to pricing mechanisms that are based on Customer Cost of Goods Sold, Volume Sold or Percent of Revenue. On the surface these appear to be simple pricing gauges, but often they force one party, either the customer or logistics service provider to prosper or lose unfairly. The supply chain interactions of physical movement and electronic information is complex and overly simple charging mechanisms deserve scrutiny as they can lead to disputes if one or the other party decides that they are being ripped off.
- Resource wisely
Both during implementation and the ongoing partnership a competent team is essential. Both the customer and the third-party logistics company must create an open and trusting working relationship. Each company’s team should include senior relationship managers from across the organisations, who meet regularly to discuss and monitor progress and performance.
Too often, once an agreement is signed implementation is left under the stewardship of the logistics service provider. This is a mistake. It must be a joint exercise. The best implementations are those that have a key member of the customer on the team to lead, organise and develop the relationship to full implementation with the provider. Such implementations are usually augmented by robust project management methods to ensure that all milestones are achieved.
- Raise potential issues early
From my experience, issues that are not dealt with proactively and in good time can fester into ‘relationship breakers’ and end in disaster. Therefore both parties should take a long-term perspective and be mature in their outlook and approach, always avoiding disrespectful behaviour to the other party. It never helps if one party is kicking the other. During implementation planning phases representatives from each company should meet weekly to discuss implementation tasks. Some may argue that this is too often, but in my experience the regularity maintains momentum and full attention to successful outcomes.
- Use KPI to manage
The contract and agreement should be subject to regular reviews of KPI. Data speaks volumes in terms of performance. For both warehousing and transport, KPI should be agreed at the outset. Typical measures include delivery in full on time, goods lost in transit, stock damage, ullage (unexplained loss or damage), inventory accuracy, time to receive goods, and time to dispatch goods.
As a rule of thumb, no more than six KPI should be used. But make sure you choose the ones that are most meaningful to your business. In this way, a focus on the ‘facts’ can help remove ‘emotionally charged’ opinions or feelings by either party.
Whether you are an organisation seeking to outsource, or a third-party logistics provider, by following these tips you will be equipped to enter into an outsourcing agreement that is ‘fertile for growth, and well placed to build into a mature and successful partnership.
In my next article I will be covering the different types of outsourcing relationships and issues to be aware of when entering contracts.
Mal Walker is manager, consulting with Logistics Bureau where he works with local and international organisations to guide them in specification preparation, establishment and review of outsourcing contracts. For more information contact Mal on 0412 271 503 or email [email protected].