What is Outsourcing in Logistics?

Over the last 10 to 15 years, outsourcing of logistics activities to third party logistics companies or 3PL’s has become increasingly popular. And research indicates that up to 75% of businesses report positive impacts from outsourcing logistics – but what of the balance? Why did they struggle to obtain the results that they were hoping for? I

’m going to define what outsourcing is, firstly, then go through the reasons why organisations outsource logistics activities and highlight the key drivers for outsourcing success.

What is Outsourcing?

Outsourcing is using an external supplier for services to a company that cannot provide them for itself, or cannot provide them in an efficient way.

If you look at the situation a few decades ago, there were many companies that manufactured products, stored the products in their own warehouses, ran their own transport fleet and sought to distribute those products, all under their own “umbrella” and their own management.

In the 1970s, 80s and 90s, it became increasingly expensive and complex for these companies to handle the warehousing and the transport themselves. The outsourcing industry grew up in parallel with this and the decision of many companies to be supplied externally for such “non-core” or non-strategic activities.

Good Reasons to Outsource to a 3PL

Perhaps surprisingly, cost savings should not necessarily be the primary factor in a logistics outsourcing decision. In fact, it’s relatively rare for a company to enjoy lower supply chain costs for some time after partnering with a 3PL.

However, there are a number of other very compelling reasons to outsource a logistics operation. There are many apparent motives why companies outsource but for my experience there are four principle reasons:

1. Warehousing and Distribution Management is Not a ‘Core Skill’

The trend to outsource non-core activities continues particularly in the area of logistics. Well, I have to say that for some companies who do outsource, I would have thought that logistics should have been a core skill.

2. Existing Performance is Sub Optimal

Related to the core skill issue, often organizations which have a strategic focus other than in transport or warehousing, can’t seem to reach the desired performance levels required by their customers.

3. Reduction in Asset Capital

Warehouses and vehicles are expensive to purchase or lease it can tie up millions of dollars that could otherwise be invested in a core business. Consequently, there’s a trend to remove warehouse assets from the balance sheet and redirect capital gain from sale of assets to working capital and core asset investments.

4. Flexibility and Scalability

Business is becoming increasingly fluid in terms of market focus, structure, mergers and acquisitions and the like. Sometimes it simply not possible to respond quickly to market changes if there is a fully owned or lease network of warehouses and transportation assets in a place. So degree of flexibility, at least, can be very beneficial.

5. Cost of Service

Surprisingly, cost of service although important, is not always a deciding factor or driver for outsourcing decisions. Why? Well very rarely do companies save money through merely outsourcing warehousing and transport.

They may attain savings over period of time through process improvement or synergies with other 3PL customers but not simple from the act of outsourcing.

The reason is simple, 3PL’s have to pay almost the same operating cosst as other organizations. Well they do develop purchasing power and discount rates with transport sub-contractors and other vendors, there’s often little disparity between the costs of a 3PL and their would be customers. Why? Well the 3PL has to add a margin to their cost to be profitable. So if an organization is seeking to bank savings after outsourcing, they will may be disappointed.

The Key Drivers for Success in Establishing a Good Customer and 3PL relationship?

Business Alignment is vital

It’s really important to select 3PL’s that are aligned with your business needs. Look for 3PLs that are experience in your industry sector and that have a good track record.

There’s always scope to include some new or emerging players in your tender process but make sure you have a core of 3PL’s that you can be confident or propose solid commercially realistic solutions to you.

Attention to detail

When seeking 3PL quotations and contracts, there’s no room for intuition or best guesses on order velocities, volumes, processes and service requirements. Very detailed specifications have to be prepared with full disclosure of all available data before a quotation from 3PLs is attained.

There is really too much information that you can gather, but where there’s an absence of sensible interpretation of data this can cause major issues in the outsourcing relationship.

On a number of occasions, I’ve been asked to sort out problems with pricing mechanisms which are based on customer cost of goods sold, volume sold or percent of revenue.

On the surface, this appear to be simple pricing methods, but often they force one party, either the customer or 3PL, to prosper or loss on fairly. I have another video on pricing structures that you may want to look at.

Resource Wisely

Both during implementation and the on-going partnership a competent team as essential. But the customer and the 3PL company must create an open and trusting working relationship. Each company’s team should include senior relationship managers from across the organizations 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 3PL. 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, organize and develop the solution to full implementation with the 3PL. 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 hidden disaster. So both parties should take a long term perspective and be mature in their outlook and approach. During implementation planning, representatives in each company meet regularly to discuss implementation tasks.

Use KPI’s to manage the contract

The contract and service agreement should be subject to regular review of KPI’s. Data speaks volumes in terms of performance. For both warehousing and transport, KPI should be agreed at the outset.

Typical measures will include delivery in full on time, goods lost in transit, stoke damage, alleged which is unexplained loss or damage, inventory accuracy, time to receive goods and time to dispatch goods.

As a rule of thumb, no more than 6 to 10 KPIs should be used to manage the contract. 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 and feelings by either party.

Logistics Outsourcing Trends and Statistics

Depending on which statistics you look at, it’s not unreasonable to consider that more than 75% of companies now outsource warehousing and transport.

In fact, more than 90% of Fortune 500 companies in the United States alone are working with third-party logistics providers, according to a released report from Armstrong & Associates.

Of course some companies may try outsourcing for a period of time and then decide, for various reasons, to move those services back in-house. However, for many shippers—especially those exploiting the ecommerce explosion—outsourcing has become the only sensible logistics solution.

The 3PL market has grown strongly and consolidation is a continuing trend. Key mergers taking place over the last five years have included Exel with DHL, BAX with Schenker, and DSV with UTi, while XPO has expanded massively after acquiring French logistics giant Norbert Dentressangle and the US-based Con-way group.

Outsourcing should be a Strategic Decision, but not a Strategy

The decision to outsource logistics is not one to take lightly, especially for larger companies that currently have an in-house warehousing/distribution operation. There are pitfalls for the unwary, and shippers have been known to make mistakes and regret the decision to outsource.

The biggest mistake of all is to consider logistics outsourcing as a strategy in itself. At the same time, commitment to a strategic, rather than transactional relationship with a 3PL will be more likely to yield the desired results.