Focus on Value

Jan. 1, 2009
The shift in focus is too significant to ignore but too subtle to label as a trend. We're moving from a cost-based to a value-based model in outsourcing,

The shift in focus is too significant to ignore but too subtle to label as a trend. We're moving from a cost-based to a value-based model in outsourcing, and the impact will have far-reaching consequences.

Central to this view is the perception of logistics as a service. That takes some of the emphasis off the assets and places it on results. One major logistics provider recently described a tangle of relationships that would have given a genealogist pause. First, they buy services from other divisions of their own company. Second, they sell services to those divisions. Third, they buy services from other logistics providers, including companies which directly compete with some their own service offerings. And fourth, they sell services to companies they compete with on some accounts or in certain markets. This in addition to the traditional manufacturing and retail users of logistics services.

From the user's perspective, the tangle is nearly as complex. A long-standing bias against shared facilities or shared capacity is slowly breaking down. Logistics providers are creating shared-use facilities to serve specific market segments with common sources, common customers, or both. An example is the Exel Optical Village. The 3.5-million-sq-ft facility provides manufacturing, packaging, storage and distribution capabilities for lens and eyewear companies.

The evolving logistics service sector is, at times, moving faster than our ability to coin descriptions for the hybrids. “When we described ourselves to clients,” says Bob Shellman, CEO & president of Odyssey Logistics & Technology, “one of them jumped up and said, ‘Wait a minute, you're a 4PL and a 3PL; you're a 7PL.’” While he chuckles when he retells the story, Shellman is serious about the company's role as a 4PL, managing other 3PLs for its clients. He says Odyssey is also a 3PL and “does the work.” “We manage over 100,000 origins and destinations on a global basis,” he points out.

“The whole area of logistics is predominantly service driven,” agrees Anand Cherian, VP of technology, NIIT Technologies. As such, continues Cherian, you cannot deliver and keep your customers happy unless you have a well-engaged, well-educated motivated work force. That's not something that shows directly on a bottom-line cost analysis, leading Cherian to observe, “It's gone from a cost-based model to a value-based model.”

It may be true that users are looking for value, but other factors are also shaping the attitude shift away from price and discounts. Shrinking credit markets were having an effect on pricing of long-term outsourcing deals, according to a study by Compass Management Consulting. Analysis of 125 outsourcing deals over the last two years was showing that discounts in the initial years are no longer available as outsource service providers are now unwilling, or unable, to fund losses in the early years of their contracts said the Compass report.

“Outsourcing providers have typically made long term deals attractive by offering pricing structures that deliver significant discounts on the cost of the in-house operation it replaces in the first year of the contract. This initial discount is recovered in the later years of a contract, when charges can be 30% or more above a comparable internal market rate,” said Compass. “Fewer outsourcing providers are entering into contracts that have negative cash flow in year one in order to fund a short term discount for their clients.”

The Compass report continued, “The economics of outsourcing and the way deals are managed is going to change radically in the months to come.” Compass predicts that with the attraction of short- term discounts removed from outsourcing deals, providers and purchasers will need to adopt a more precise and co-operative approach to the way contracts are put together, priced and managed. Specifically, companies are seeking reassurance that the price they are paying remains competitive throughout the contract lifecycle and clarity on the areas where they and the provider could collaborate to achieve sustainable cost reduction.”

Back on the logistics front, Odyssey's Shellman describes how he executes on all modes globally as well as managing 3PLs. “Our business model allows for complete transparency to the underlying cost of all of the global transportation, and if we're paying 50 cents a mile, our customer pay 50 cents a mile.” The same is true in other modes, says Shellman. Whatever the containership freight cost is, that's what the customer pays. One reason that may work for Odyssey is, as Shellman explains, the company handles movement from origin to destination, including clearing customs, processing international documentation and effecting foreign payments in hard currencies.

Another major 3PL describes its relationship with a customer where the 3PL manages the full range of global transportation planning and execution except freight bill payment. Those arrangements ensure the company sees its actual freight costs and is able to budget based on those costs and negotiate fees for additional services provided as part of the transportation management contract. On the one hand, this may speak to a discomfort with what some providers may be charging in mark ups, but on the other hand, it puts the focus on the service aspect of the contract and the value that is delivered there.

“We don't do gain share and never will,” continues Shellman. “The reason we don't do it is, it doesn't work. It doesn't lend itself to a partnership. It ends up in a contest between the organizations as to who can prove there's great savings and who can prove there weren't great savings so that the fees are lower.” That doesn't stop users from asking for gain share, or savings share as Shellman calls it. Shellman turns the discussion to thinking more in terms of strategic solutions. The first question is, does the outsourcing improve service? Second, is the question of whether the deployment of a 3PL or 4PL saves money. And third is the issue of whether the fees for the service will provide a return on investment above the savings.

Reinforcing the sense of partnership, Shellman says Odyssey's minimum contract is three years. That said, Shellman doesn't like to go over seven years. The six-year-old company, specializing in bulk and chemical logistics, has had every contract renewed when it reached the end if its term and, says Shellman, more clients are asking to change from a three-year period to a five-year term.

Starting up in a time when users expected their 3PL to issue them a check for savings, Odyssey was able to avoid that and charge fees because of its approach to logistics on a strategic level and its leverage with asset-based suppliers. The service argument may resonate more with users now than it did six years ago, but the ability to deliver lower costs is still important. “We have over $200 million of spend in bulk truck alone,” says Shellman, and he sees that growing. A single customer can look at its total transportation spend and see a big number like $50 million, but, notes Shellman, “that's all they're ever going to have.” The 3PL makes them bigger on day one, and bigger with all modes. That's one reason Odyssey passes through actual freight costs with no mark up. The savings should be visible and the fees for services should also be clear.

In a very true sense, most of what a 3PL does may be straightforward transportation management, but Shellman pauses for a moment to reflect on why US companies specifically find it difficult to achieve similar results. “It was a very ugly business event that's been occurring over the last 15 years called right sizing and down sizing,” he says. Companies eliminated as much of the cost in non-core areas as they could and invested in core areas. They weren't putting the money in personnel or technology for transportation management. (By contrast, Shellman claims, Odyssey bought one of the largest transportation management systems suppliers and continues to invest in its technology to serve its 3PL customers.) So, while many transportation departments were struggling to “maintain” the 3PL was constantly upgrading skills and technology and adding volumes.

NIIT Technologies' Cherian adds another slight twist on the evolution. NITT is a software services organization and Cherian's experience with companies outsourcing tech services may have led trends with logistics outsourcing. Initially, in the 1980s, customers wanted to maintain complete control, he notes. They didn't want to become dependent on their service provider. Then, the attitude changed 180 degrees and companies wanted to push everything out to a service provider. Neither approach worked very well to move services or technology forward.

We've matured, he says, and now realize that total dependence or total independence don't work. There's always finger pointing. Today, and going into the future, the services are decided upon by both sides. The user and the service provider sit together and plan for the next quarter and the next half-year and the next year, he continues. And each side then says, “OK, I'm good at doing this and you're good at doing that.” “Because of this approach, organizations are now more comfortable moving away from that monolithic logistics outsourcing to best-of-breed logistics outsourcing,” says Cherian.

This collaborative approach allows both the user and the service provider to advance their practice, according to Cherian. It's not a case of buying a product or service in the market and tuning your business to meet the product's demands or the service provider's structure. The basic questions are changing from, “What does this technology do?” or “What service do you provide?” to “How is this service or this framework you have helping me accomplish my business goals?”

The way you define your business goals matters, continues Cherian. He points to one company with the approach, “How can I pay the least to get the maximum amount of work?” Another company in that same industry takes the approach, “How can I increase the quality of the interaction my employees have with my customers and I have with my employees, thereby motivating and boosting their morale and desire to produce more?” Both approaches have a goal or controlling or reducing costs, but the tools (including outsource service providers) used for each will be different. One will focus on the low-cost provider, the other on the partner who can help increase business value.

Service level agreements that spell out operational details and cost goals, among other things, are tools to achieve a larger, more strategic goal in Cherian's view. A successful approach to outsourcing for both Shellman and Cherian is one that shifts responsibility to an outside provider for functions that don't help differentiate a user's brand or directly enhance the customer experience or relationship. The responsibility for granular detail and doing the root-cause analysis to fix problems or improve performance levels must be spelled out, but it is shifting to the service provider to allow the user of outsourcing to focus on business goals and supporting a value proposition with will, Cherian feels, ultimately gain and keep the best customers and best employees.

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