3 PLs serve up supply chain innovation

A small but growing number of third-party logistics providers are expanding beyond traditional transportation and logistics-management services. But shippers have been slow to take advantage of these opportunities.

By Thomas A. Foster -- Logistics Management, 11/1/1999

Logistics outsourcing has long been hailed as a creative solution for companies that are seeking to restructure their distribution networks to gain a competitive advantage. But creativity doesn't appear to be a top priority among shippers.

Few seem to be taking advantage of the full menu of services third-party logistics service providers (3PLs) can offer, which range from cost reduction to supply chain re-engineering. The majority of agreements between shippers and logistics-service providers, in fact, are intentionally limited to very basic logistics tasks.

A recent survey of third-party usage by major manufacturing companies, for example, shows that two-thirds of the services 3PLs provide to Fortune 500 companies are basic transportation services, and nearly one-half are warehousing services. Respondents to the survey, conducted annually by Boston's Northeastern University in conjunction with Mercer Management Consulting of Lexington, Mass., reported that less than 20 percent of the contracts covered activities further down the supply chain, such as inventory replenishment and product assembly.

Shippers that limit themselves in their dealings with 3PLs may be missing an opportunity to gain significant competitive advantages, believes David Bovet, a vice president with Mercer Management Consulting. "Shippers need to adopt a much more adventurous and aggressive attitude toward outsourcing if they are to uncover real value," he says. He recommends that shippers move beyond the traditional focus on asset reduction and logistics cost savings. "The key value-added benefit shippers should expect from 3PLs is supply chain innovation," Bovet says. "That innovation must lead to increased competitiveness and profitability."

What is preventing shippers from achieving that goal? The shippers themselves often bear responsibility for the lack of innovation in outsourcing agreements, Bovet says. "Because logistics is still considered a cost center at most companies, the focus of most shippers is totally on cost reduction to the exclusion of more important goals, such as improving service and competitiveness," he observes.

Results of a study by the New York City-based Outsourcing Institute support Bovet's assessment. Thirty-five percent of the CEOs who responded to a survey on third-party logistics reported that the main reason their customers outsourced was to reduce operating costs. Another third of the respondents said their clients used outsourcing to avoid investing in non-core assets and activities. Only 17 percent of the CEOs said their customers' primary reason for outsourcing was to improve service. (See the accompanying graph.)

But third parties also share some of the blame for the lack of creativity in outsourcing agreements, Bovet believes. They often come into less-sophisticated companies with basic load-planning and networking technology, and thus are able to score a quick win by doing a one-time optimization, he says. Although most companies can gain some benefit in those circumstances, the 3PL really isn't doing its job. "Where is the ongoing value added? Unless this customer needs optimizations run every week or every day," he says, "the 3PL has not accomplished ongoing value."

There are third parties out there that can provide the kind of continuous value improvements that Bovet believes shippers should be seeking. Yet even when shippers do find such potential partners, they often are unwilling to develop the kind of intimate relationship that will allow them to achieve their goal, he says. "[Shippers] first have to break down the self-imposed barriers that keep them from sharing goals, risks, and rewards with 3PLs."

Tried It, Liked It

Some pioneering shippers that have entered into true risk-sharing partnerships with third parties report that they have achieved benefits they never could have attained on their own. One such shipper is Santa Cruz, Calif.-based R.S.V.P. Inc., which manufactures "fragility" packaging--packaging that is specially designed for delicate, high-tech items--from recycled materials in Wheaton, Ill., and Reno, Nev.

R.S.V.P. wanted to export its packaging to Asian manufacturers of computer components and other high-value products. The problem, according to R.S.V.P. President David Roberts, was that the company had no international sales presence or distribution infrastructure in Asia.

R.S.V.P.'s solution was to hire Circle Trade Services, a division of San Francisco-based 3PL Circle International. Although its parent company has its origins in international freight forwarding, Circle Trade Services offers supply chain management services that extend well beyond freight transportation. Under the arrangement with the packaging manufacturer, Circle Trade purchases product from R.S.V.P. in the United States, actually taking ownership of the goods. Circle's freight-forwarding arm manages the transportation of the product to Thailand, where it clears customs and is delivered to Circle's warehouses in Bangkok. There, the shipments are deconsolidated, sorted, and inventoried. When R.S.V.P.'s customer in Bangkok needs packaging, it issues "pull orders" to Circle's warehouses. Specific packaging products then are pulled, packed, and delivered to the customer within four hours.

Circle not only handles the logistics of shipping and storage, but it also provides sales support and local administration. R.S.V.P.'s customer, which receives a consolidated invoice incorporating the cost of the product, transportation, logistics services, customs duties, and service fees from Circle Trade, pays the 3PL, not the manufacturer.

This arrangement offers financial and service benefits for R.S.V.P. and its customers. "By selling to Circle Trade, R.S.V.P. improves its cash flow considerably," says Roberts. "We do not need any production facilities in Asia or even a direct sales presence. We are paid more quickly," he says, "and the customer receives the direct sales contact it wants in its home market."

According to Kim Wertheimer, Circle's executive vice president-logistics, Circle Trade Services' operations demonstrate how a 3PL can expand beyond the traditional confines of logistics to the benefit of its customers. In this case, trade facilitation and procurement have become an integral part of the 3PL's services. "Our customers are able to respond more effectively to the needs of their clients," he says. "Circle Trade leverages our single-source network, so companies that might not normally be able to participate in a global market can do so profitably."

Taking on More Risk

Circle Trade Services is hardly alone in providing innovative services. Another 3PL on the front lines of this movement is Jacksonville, Fla.-based Customized Transportation Inc. (CTI), the 3PL subsidiary of CSX Corp. CTI does more than just manage the logistics for its client General Motors; it also takes on the role of a manufacturing supplier.

Under this unusual arrangement, CTI provides General Motors' plant in Kansas City, Mo., with automobile interior door-panel modules at the exact moment they are needed on the production line. Although GM selects the materials vendors, CTI issues the purchase orders and buys the material from those vendors. The 3PL then receives the material, assembles the modules, puts them in racks, and delivers them to the production line. GM receives an invoice from CTI that includes all operating costs, the cost of goods sold, and a profit margin. "We wrap this all into a comprehensive unit price," says David G. Kulik, CTI's president and CEO.

To make this system work, GM shares vital production data with CTI. The 3PL is linked to GM's real-time production system, so it knows where specific autos are in the production process. As soon as CTI's personnel have been notified electronically that a car is out of the paint shop, they start to build the panels for that specific vehicle. "We have four hours to put a module together that includes panel, handles, and carpeting," says Kulik.

Though its role also includes logistics and transportation, CTI goes well beyond traditional 3PL responsibilities by financing the inventory, taking on the risk of obsolescence and damage, and performing the assembly. That helps General Motors achieve its own financial targets, Kulik explains. "We meet a key need of GM, which is to reduce its inventory and the need to manage assets," he says. Importantly, CTI and other suppliers only own the inventory until the car is finished. Vehicles are sold to a dealer the minute they come off the assembly line, Kulik reports, so suppliers are paid as soon as the parts are in the car.

Kulik sees a growing trend among users of third-party services to outsource entire processes, not just logistics. That allows CTI and other qualified 3PLs to help customers reduce their investments in fixed assets and speed up inventory turns. Compaq Computers, for example, has a vendor-managed inventory arrangement with 80 suppliers. Those suppliers reduce their investment by using CTI to perform key processes such as testing, quality assurance, and inventory management, as well as providing logistics services.

That move toward process management is one reason why more shippers are basing compensation on unit pricing. Under this system, the 3PL is paid a set amount on each unit the customer produces. This model presents both risks and opportunities for the 3PL, which must be sure its compensation covers its fixed and variable costs--just as the manufacturer did before it chose to outsource.

"If the manufacturer forecasts 250,000 units, we will base our fixed costs on a range of production from 220,000 to 250,000 units," says Kulik. "If production exceeds 250,000 units, our fixed costs disappear and we make more profit. If the production is less than 220,000, that means our costs are not covered, so we share the pain with the manufacturer." Fortunately, he adds, that doesn't happen very often.

Needed: More Management Skills

Opportunities abound for imaginative and profitable applications of 3PL services, according to Mercer Management's Bovet. "The key is to have people in charge of outsourcing who have management skills, not necessarily a great deal of logistics experience," he says. "The core skills needed are the ability to see business needs, set goals, coordinate teams, and focus on customers. By focusing too much on logistics, the goals may be too limited."

When 3PLs share risks with their clients, they have much more to lose than under a typical logistics-only contract, so those business-management skills become even more critical. "We are being asked to take the same business risks that our customers face," CTI's Kulik says. "We are taking on all of the risks that are part of production or sales activity. That is how the customer makes a profit, so we must make our profit the same way."

Of course, the shipper also is taking a risk when it outsources individual functions or even entire processes to a third party. Many questions are bound to arise: Will service or product quality be the same or better? Will cash flow improve and inventory investments fall? Will the changes being considered benefit both shipper and customer? As both General Motors and R.S.V.P. Inc. have found out, with careful planning, the right logistics partner, and some creative thinking, the answer to all of those questions can be yes.