Growth spurt

Shippers' use of 3PLs is greater than ever, an annual study confirms. Both users and providers see new opportunities on the horizon.

By -- Logistics Management, 11/1/2000

The third-party logistics industry in the United States is young and the picture of its future prospects is still developing. Yet thanks to a pair of pioneering surveys of both users and providers of third-party logistics (3PL) services, important information about past, current, and future trends in logistics outsourcing continues to be available to shippers.

Since 1991, Dr. Robert C. Lieb of Northeastern University in Boston has been examining shippers' usage of third-party logistics services. For the last seven years, Lieb has conducted a companion survey of CEOs of third-party logistics service providers, in which executives describe their companies' current status and predict future developments. This year, Lieb was joined by John Miller, a partner with Andersen Consulting in Boston. In September, the two researchers presented the results of those surveys at the annual Council of Logistics Management conference in New Orleans.

Shippers Use More 3PLs More Often

For the shipper portion of their research, Lieb and Miller sent surveys to the top logistics executives of the Fortune 500 companies, garnering 82 usable responses-a respectable 17-percent response rate. Their questions focused on four specific areas:

• The extent to which the companies surveyed used 3PLs in their operations;

• The specific 3PL services they used;

• The impact of using 3PLs on such areas as costs, customer satisfaction, and employee morale; and

• Future plans regarding use of 3PLs.

This year, 77 percent of the respondents said that their companies used 3PL services, the highest rate since the survey began. Fifty percent said that they had worked with third-party providers for more than five years, and on average, they spent 19 percent of their total logistics budgets on 3PL services. Increased expenditures seem to be assured, as respondents predicted that on average, they would be spending 31 percent of their budgets on 3PL services three years from now.

Nearly three-fourths (73 percent) of the respondents said they were using more than one provider. This is a significant change, given that the percentage of companies using multiple providers had steadily declined between 1991 and 1998, from 79 to just 40 percent. "That may be because the scale of many contracts today is so large that a single 3PL can't fulfill all the requirements," Lieb suggested in his presentation. This tendency to use more than one provider could make the European practice of designating a "lead logistics provider" (LLP) to manage relationships with other providers more common in the United States, he added.

Another recent development is the globalization of 3PL services. This year, 69 percent of users reported that they were using third-party services in their international operations. In particular, a high percentage of users said they relied on third parties for freight forwarding (44 percent) and customs brokerage (43 percent). The study had not previously tracked those services because freight forwarders and customs brokers do not fit the researchers' definition of a 3PL. But many of the major third-party providers have acquired forwarders and brokers, while the largest freight forwarders have expanded into 3PL operations. The resulting integration of those functions into a "package" of services made it necessary to include them in the survey.

Still, users continue to rely most heavily on third parties for warehousing management (56 percent), transportation services (49 percent), and shipment consolidation (43 percent). Use of 3PLs for these "traditional" logistics functions has remained relatively stable in recent years, but the use of third parties for a number of manufacturing-related functions has generally declined. (See Figure 1.)

The study also looked at contracts between users and providers. Some of the results were encouraging, while others remained troubling. On the plus side, 83 percent of the respondents reported that there was clear agreement concerning both parties' expectations in their current contracts. More problematic was that just 59 percent of the respondents said they had incorporated performance metrics into their contracts. Even fewer (41 percent) had included penalties for non-performance. "That is a problem because such agreements lack an effective control mechanism to guide future actions," said Lieb.

A new finding this year is that 25 percent of respondents have included gain-sharing provisions in their 3PL contracts. About half of those respondents said that these provisions had promoted cost and service improvements. Most of those agreements focused on cost reductions, but some respondents cautioned that service improvements should also be rewarded lest cost cutting be promoted at the expense of service.

One measure of the success of users' relationships with third-party providers is their contract renewal rate. Lieb noted that the average renewal rate reported by providers was 93 percent. When asked to evaluate the impact of using 3PL services on their companies, 72 percent of users-the highest number ever-reported that using 3PLs had a "positive" or "very positive" impact on service levels. Sixty-four percent said the same for customer satisfaction and 75 percent reported positive results in the area of logistics costs. (Only a few respondents, however, were willing to quantify those savings. They reported an average cost reduction of 10 percent and an average capital asset reduction of 18 percent.)

A substantial percentage, however, said that using 3PLs had "no impact" or a "negative" effect on various corporate issues. (See Figure 2.) Lieb points out that a likely reason is that outsourcing may not provide benefits in every area; a program designed to improve customer service, for example, may well increase logistics costs.

Given their apparent overall satisfaction with logistics outsourcing, it's no surprise that 75 percent of the users said they would increase their use of third parties at least moderately if they had complete responsibility for that decision. That's a big jump over the 57 percent who said they would do so in 1999. About 11 percent said they would make no change, and 14 percent said they would decrease their use of 3PLs. None said they would eliminate the use of third parties.

Providers Focus on e-Commerce

The second part of the research surveyed CEOs of 19 major providers of third-party logistics services. (See the list on Page 77.) These companies reported average annual operating revenues of $1.052 billion, almost double the $545 million reported just three years ago. Respondents said that an average of 65 percent of their revenue growth in the past year had come from increased business from existing clients and 35 percent from new accounts. They predicted that in the next three years, those percentages would be 58 percent and 42 percent, respectively. The primary sources of those revenues will continue to be transportation management services, warehousing, and integrated logistics services.

This year's results indicated that a significant shift was taking place in the relationship between 3PLs and their customers. The percentage of their clients reporting annual revenues in excess of $500 million has increased from 52 percent in 1993 to 83 percent today. One reason for that increase, says Lieb, is that CEOs of all of the 3PLs surveyed said they were being more selective about the accounts they served.

CEOs reported that they were taking a number of steps to ensure a higher quality of client. These included exercising more due diligence, such as evaluating potential customers' financial positions and cultural "fit" more thoroughly; focusing more attention on specific business sectors to minimize startup risks; selling more aggressively to existing customers; evaluating requests for proposals more stringently; and improving and solidifying relationships with desirable customers.

Globalization is a big issue for all of the 3PLs, as customers push them to offer both domestic and international logistics solutions. All of the respondents' companies have operations outside of the United States (three are subsidiaries of European-based providers), but none are truly global in scope, depending instead on alliances to provide such coverage. "There is nobody out there that can span the globe," said Lieb, "and you're not likely to see anyone doing that soon."

As expected, the major source of international revenues is Western Europe, with 15 percent. Next in line is Canada, with 5 percent of annual revenues. Asia and Mexico follow, with just 3 percent each, and the rest of Latin America represents 2 percent of total corporate revenues. Surprisingly, the CEOs don't expect that to change much. They predict that in three years, the percentage of total revenues represented by these regions will increase by no more than four points.

Outstripping globalization in importance is the growth of electronic commerce. For the last two years, the CEOs identified e-commerce as the most significant growth opportunity available to 3PLs. (Others included further supply chain integration, globalization, and mergers.) Seventeen of the 19 respondents said their companies served customers that had e-commerce distribution channels. A number of the 3PLs have gone so far as to establish separate subsidiaries or special internal organizations to serve e-commerce clients. (See Figure 3.)

On average, 45 percent of the 3PLs' revenues from e-commerce services came from business-to-business activities, the CEOs reported, while the rest came from business-to-consumer transactions. One-third of the respondents said that they had encountered problems in serving e-commerce customers, including insufficient scale of business to support the necessary infrastructure, lack of client expertise in logistics, unpredictable sales volumes, and concerns about business risk and clients' viability. Nevertheless, most of the CEOs indicated that they planned to continue expanding in this arena.

At the same time that they are looking toward electronic commerce as a source of growth, 3PLs are grappling with business issues that could seriously constrain that growth. As is true for most U.S. industries today, they are having a hard time finding and retaining top talent. They also cited inadequate pricing and profitability as well as difficulties and costs associated with IT system development as serious industry problems. These issues, said Lieb, "collectively pose a threat to the long-term viability of the industry."

In addition to these worries, the 3PL executives said they were concerned about a number of current industry dynamics. (See Figure 4.) Continued pressure from shippers to cut prices topped their list, although greater selectivity about clients may relieve that situation, Lieb said. "Companies that have historically behaved that way are going to find providers walking away," he predicted. Other industry dynamics named included shippers' increased interest in outsourcing more functions, greater demand for one-stop shopping, and the growth in e-commerce.

Hanging over all of these issues is the wave of mergers, acquisitions, and bankruptcies that has swept the industry in the last year. Both Skyway Freight System and Burnham have shut down, and GeoLogistics is believed to be in serious financial trouble. Circle International, MSAS Global Logistics, Redwood Systems, and Mark VII were all bought out earlier this year, to name just a few examples. And there's more to come, predicted Lieb. "The merger and consolidation movement is fundamentally changing the structure of the industry, not only domestically but also in the international arena. As a result, the next several years are likely to be challenging as companies work to integrate the newly acquired or merged enterprises."

Third-Party Logistics Companies Included in the CEO Survey

Cardinal Logistics

Caterpillar Logistics Services Inc.

C.H. Robinson Co.

Customized Transportation Inc.

DSC Logistics

Exel Logistics

Fritz Cos. Inc.

GATX Logistics

GeoLogistics

Menlo Logistics

Penske Logistics

Pittsburgh Logistics Systems

Ryder Integrated Logistics

Tibbett and Britten Group, North America

TNT Logistics

Transplace.com

UPS Worldwide Logistics

USF Logistics Inc.

USCO Distribution Services Inc.

Figure 1 Most Frequently Used 3PL Services, 1997-2000

Figure 2 Impact of Using 3PL Services on Various Corporate Issues

Figure 3 Separate e-Commerce Business Units Established by 3PLs

Figure 4 CEOs' Perceptions of Three Most Important Industry Dynamics, 1997-2000

Figure 5 Degree of Reliance on 3PL for Specific IT Support

TWO ROADS DIVERGED.

Third-party logistics companies and their customers usually see eye to eye on most topics. But the Northeastern University/Andersen Consulting surveys of users and providers of third-party logistics services uncovered differences of opinion between vendors and customers on the following topics:

• Information technology. The 3PLs have invested significant resources in developing logistics information systems, which they see as a major selling point. Most of the CEOs in the provider survey listed "design of IT systems," "selection of software," and "operation of IT systems" as services they provided to e-commerce clients. And they named costs and problems associated with IT system development for customers as one of the three most important problems facing the industry.

Yet shipper respondents said they relied very little on their providers for information systems. Only a handful said they relied "very extensively" or "extensively" on 3PLs for information, redesign, implementation, or operation of software and systems. The majority said they relied "not at all" on third parties for those services. (See Figure 5.) Nevertheless, more than half (56 percent) said they outsourced freight payment and accounting, transportation planning/optimization (40 percent), operation of warehouse management systems (38 percent), shipment tracking (38 percent), and international documentation (37 percent).

Dr. Robert C. Lieb of Northeastern University, who conducted the survey with John Miller of Andersen Consulting, suggested that users may not recognize the extent to which their companies rely on outsourced information technology. In fact, 61 percent reported that integrating 3PLs' software and systems with their own had caused no problems, indicating that IT services may have become "transparent" over the course of their relationships.

• Most significant industry developments. Both users and providers were asked what they thought were the most significant industry developments of the past year. Respondents to the CEO survey most often named industry consolidation, followed by the expansion of e-commerce"-related business opportunities and rapidly changing information technology.

Shippers, on the other hand, most often cited the expansion of Internet-based logistics services, followed by industry consolidation, improvements in logistics software and systems, increased service offerings by 3PLs, and global expansion by major providers. Their answers, necessarily colored by their own priorities and the direct impact those developments would have on their companies, show how the views of buyers and suppliers often represent different sides of the same coin.

• Electronic commerce opportunities. Most (79 percent) of the shipper respondents said their companies were involved in e-commerce in some way, either by selling or purchasing products online. Only 35 percent, however, said they currently used third parties to support e-commerce initiatives.

Nevertheless, all but two of the third-party CEOs said they were providing customers with e-commerce services. When asked which services 3PLs provided in support of e-commerce initiatives, users and vendors gave similar answers, but users specifically mentioned use of the 3PLs' Web-based systems and Web-site support, while the providers themselves did not specifically name that function. Users also mentioned EDI linkages to order-entry and order-management systems as well as inventory ownership, but providers did not mention either one of those activities.

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