The Rise of Outsourcing

Outsourcing has moved from a backroom secret to a boardroom strategy.

When Penton Media, parent of Outsourced Logistics, partnered with the University of Tennessee and PriceWaterhouseCoopers to study supply chain management trends, part of the discussion centered on what to call the practice of contracting logistics services to a third party. Outsourcing was being bashed in the general media in association with manufacturing job losses and production moved offshore.

The mood among logistics professionals wasn’t much different. What we elected to call contract logistics in 1998 often spelled the elimination of mid-level positions at traditional manufacturing companies. (Many of those roles resurfaced at the logistics service providers contracted to perform the former in-house function.)

A slightly larger number of respondents to the 1998 survey said they bought third party logistics (3PL) services to replace in-house functions. Others used 3PLs for tactical purposes— about 20% each for entering new markets or new product introduction.

That was then. Ten years later, logistics outsourcing is a critical enabler for strategic sourcing and global marketing strategies that provide companies with the agility to adjust to rapidly changing market conditions. True, there are still tactical reasons for outsourcing, but the boardroom understanding of the role of logistics in supply chains has improved, and that recognition helps elevate the outsourcing decision to a more strategic level.

In the 12th Annual State of Logistics Outsourcing study, Dr. C. John Langley Jr., Georgia Institute of Technology, notes that 82% of the respondents (a total of 1,287 individuals) identified their organizations as users of 3PL services. The study was about evenly split among four major regions of the world, North America (29%), Europe (27%), Asia Pacific (23%) and Latin America (21%). Clearly, the adoption curve—on a global scale—is on the rise for logistics outsourcing.

And, while many organizations may base part of their decision to outsource on a tactical need for “hands and feet,” the study, jointly sponsored by Cap Gemini, DHL, SAP and the Georgia Institute of Technology, indicated 3PLs play a critical role in providing new and innovative ways to improve logistics effectiveness.

Respondents said 3PLs had a positive impact on customer service, a positive impact on business process efficiency, and provided a measurable return on investment for users.

Despite an ongoing freight recession, says Richard Armstrong, Armstrong Associates Inc., third party logistics service provider revenues in the US grew to $122 billion in 2007. Revenue growth for 3PLs was highest in non-asset transportation management, says Armstrong. This is supported by the results Langley highlights from the global 3PL study. The most frequently outsourced functions are domestic transportation, international transportation and warehousing (with some regional variation in the order).

With US outsourced logistics spending up nearly 8% over 2006, Armstrong projects a further 7% growth in 2008, reaching an estimated $131 billion. Spending on outsourced logistics has been growing at roughly three times the growth of the US gross domestic product and continues, driven by companies outsourcing to concentrate on core competencies, the need for sophisticated supply chain information technology solutions and globalization, says Armstrong. By 2010, US spending for outsourced logstics services should top $150 billion, adds Armstrong.

Outsourcing has penetrated all segments of the economy. The global Fortune 500 3PL market is $162 billion, says Armstong. (That’s out of a $487 billion world 3PL revenue estimate.) The automotive sector, says Armstrong, spent an estimated $39.1 billion with 3PLs. Major companies like General Motors, Wal-Mart, DaimlerChrysler and Ford Motor each use 31 or more 3PLs, says Armstrong.

What’s driving all of this growth? Clearly, cost always plays in the decision, but how much of a driver it is depends on the organization and market conditions. Recessions tend to cause people to outsource more, says Armstrong. And some of the fastest growth areas for outsourcing are in value-added warehousing and distribution, he notes. Since 1995, compound annual growth rates in value-added warehousing have been a little over 18%. But more recently, since about 2003, “the real pace setter has been international transportation management.”

“Transportation is still 70 to 80% of the solution,” Armstrong points out. “And you know so often the guys who are on the buyer’s side of the fence get so enamored of how the warehouse works and saving 2% in the warehouse that they forget that the big money is in how you manage transportation.”

That said, there is still plenty of opportunity in the area of warehousing, distribution and facilities. According to Bob Lilja, vice president of Weber Distribution, “Outsourcing logistics operations is at least as valuable a tool in a down or uncertain economy as in a rising one. Companies with lower demand may reduce asset-based infrastructure and build a logistics spend that more closely matches activity levels.” Among the areas where manufacturing companies have benefited from outsourcing logistics operations, Lilja points to the fact that facilities that are underutilized may choose to outsource the warehouse and shipping process, and either close the facility or avoid the required capital expenditure that could be difficult to approve in uncertain times.

Companies are cutting costs by rationalizing and consolidating multiple locations into single—often outsourced —distribution center (DC) operation, Lilja continues. Among the benefits of consolidating smaller warehouses into larger more centralized distribution centers, the process can provide better utilization and control of inventory as well as strengthening inventory position for a greater mass of customers, says Lilja.

This consolidation also can Improve service through more efficient replenishment to the forward DC’s by enabling inventory planning to position inventory based on forecast demand with less volatility due to customer sourcing, forecast deviations and poor service levels at multiple smaller DC’s.

Users often cite opportunities to improve their technology base or push process improvements through outsourcing. Lilja agrees that adhering to common operations practices across distribution centers provides benefits—among them, more focused operations as a user becomes a key partner for the 3PL. This increases the mutual efficiencies and overall value of the relationship, he says.

In addition to efficiencies of higher volume throughput, users often gain purchasing leverage through a 3PL. The user’s business becomes more carrier friendly as there is more volume out of each DC, explains Lilja, and thus the user can become a more important player for key transportation companies in the area.

A strong majority of companies feel their outsourcing has been successful. The highest satisfaction was in Asia, where 88% agreed outsourcing was successful, reported Langley in the annual State of Logistics Outsourcing survey. Further, 31% of non-users said their future plans included outsourcing. Other regions exhibited similar results. North American respondents were satisfied (87%) and 45% of non-users said they planned to outsource logistics. For Europeans, 86% said outsourcing was successful and 42% of non-users planned to adopt logistics outsourcing. Latin Americans, arguably the later adopters of outsourcing, were only slightly less satisfied, 76% reporting successful outsourcing. But, they were among the strongest adopters with 53% saying they had plans to outsource logistics.

Relationships continue to be vitally important to logistics success, acknowledges Langley in the report. That said, the 2007 report concludes, “with ever-growing trade volumes and increasing logistics costs, managing those activities will remain a daunting task, but the best managers are proving that global collaboration is now the key to improved efficiency.”

Users and their 3PLs will need to work towards common goals, what Langley describes as more than “vauge expressions of partnership and aligned interest.” He continues, “The 3PL and the customer [user] must leverage each other on a strategic and operational basis so that when working together, they perform better than they would separately.”

Leading companies embracing collaboration in outsourced logistics relationships will exhibit organizational and strategic alignment from the executive down to the operational level. The user, the 3PL, and all trading partners will work together to optimize processes across the extended supply chain, sharing key performance indicators (KPIs), focusing on continuous process improvement.

Aligning organizations to achieve common goals, sharing economic and business risks and benefits and creating a transparency between user and supplier are not tactical- transactional-level functions. They don’t focus on driving another penny out of a rate. And that’s why logistics outsourcing has moved from the backroom to the boardroom.

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