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Shippers lean on 3PLs to secure capacity, gain agility

Freight pricing impacts some outsourcing strategies

David Hannon, Senior Editor -- Purchasing, 4/21/2005 6:00:00 AM

Third-party logistics (3PL) providers are seeing strong growth as shippers look for help with mounting challenges: Demand for transportation services is high, capacity is tight, rates are booming and carrier costs are through the roof. Many manufacturers are seeing business pick up and increasing their global scope, but are having difficulty gaining the adequate freight capacity to get materials into manufacturing sites at a reasonable cost (ocean freight rates in some Asian lanes have skyrocketed almost 100% in the past year).

More and more, outsourcing part or all of the logistics management function is looking good to overburdened, underfunded logistics and supply chain organizations.

The 3PL industry in the past decade has grown an average of 14.2% in the U.S., according to industry analysts Armstrong & Associates. But revenues for 2004 grew a robust 16.3% for the industry. "Overall, outsourcing in logistics is going to continue like crazy," says Dick Armstrong, principal at Armstrong & Associates in Stoughton, Wis. "And as outsourcing for production and manufacturing increases and buyers get more materials from overseas, supply chains are getting more complicated and demand for 3PLs will increase to help companies manage part or all of those global supply chains."

Brooks Bentz, an associate partner in the Accenture Supply Chain service, says in the current environment of tight transportation capacity, shippers are increasingly looking to 3PLs for help in securing capacity, even restructuring the way they contract with logistics service providers.

"Instead of giving volume in exchange for rate discounts, shippers will begin to give volume and ask for capacity guarantees in their contracts with logistics providers," says Bentz. "The inbound logistics managers have to try to stabilize the supply chain and lock in capacity and that might mean increasing rates—paying more for guaranteed capacity. And company executives may not like to hear that from their freight buyers. After highlighting their ability to reduce freight rates for years, now freight buyers may have to tell execs that rates will go up 5% in exchange for more capacity, and that is good because their competitors' rates are up 8%."

Expanded services

The 3PL community has seen the need for shippers to reduce costs and is focusing more on services that reduce overall supply chain costs. Bentz points out that without excess capacity 3PLs can no longer tell carriers to do things cheaper and shippers cannot negotiate lower rates very easily.

"3PLs are trying to differentiate themselves and solidify their place with the shipper/client," Bentz says. "The client likes the 3PL to be exchangeable so if their service levels drop, they can just swap out another 3PL. But the 3PL wants to get so interwoven with the client's business, they're indispensable. Inbound freight managers have a particular challenge to keep the supply chain reliable and keep inventory under control but not go broke by air freighting or expediting everything when needed."

The most important step to evaluating the need for an outsourced logistics partner, Bentz says, is to accurately understand the costs within the shipper's network and only then evaluate where a 3PL can improve the network.

Bringing in a 3PL almost always increases the cost-consciousness of a network because it's in the 3PL's best interest to function as cost-effectively as possible because that's where the margins come from, Armstrong points out. An internal logistics operation is typically not as well motivated to reduce costs because it's a budget item, whereas for a 3PL, it's a profit or loss issue. Fat 3PL contracts are extremely rare, Armstrong points out, adding that some 3PLs have to give up huge contracts because they just cannot make money at the levels that their customers want.

"I expect 3PLs to be creative about the cost vs. price equation," says James Lamb, director of global logistics for Illinois-based telecom equipment maker Andrew Corp. "They may not be able to change the carrier rates, but they can remove cost by gearing down from next-day to second-day air where possible." Another example came when Andrew's 3PL converted a couple major truckload lanes to intermodal for substantial cost reductions. "Their optimization process will take shipments that can automate that analysis for us."

Lamb says using a 3PL can help insulate shippers and freight buyers when transportation rates spike. A 3PL may report that rates are increasing in one mode, and a shipper can ask the 3PL to make up for it in another area to ensure the bottom line stays the same, which is much more difficult for shippers to do if they are working with carriers directly.

Bentz points out that 3PL rates tend not to fluctuate as much as carrier rates because the contracts are based on long-term plans, not short-term functions. Benchmarking 3PL rates is very difficult, he says, because 3PLs do such a wide variety of things for customers. "Even if you could get an apples-to-apples comparison on similar networks, keeping the cost and rate information fresh enough in such a fluid market is exceedingly difficult."

Lamb says benchmarking 3PL service levels and pricing is possible, but agrees it is trickier than benchmarking many other types of suppliers or service providers. Lamb has recently challenged one of Andrew's 3PL partners to do a price benchmarking project and hired a small consulting firm to benchmark its 3PL service levels.

Simon Powell, director of global logistics and compliance at integrated circuit maker Agere Systems in Allentown, Pa., agrees benchmarking for 3PL services or costs is difficult, because of the range of services 3PLs offer and customize for shippers. Powell says instead of comparing to other shippers' 3PL use or rates, the shipper's primary goal should be to ensure the 3PL is helping the shipper meet its key performance indicators and, if so, then how much it is costing vs. other shippers that are meeting similar KPIs.

Agere's strategy

Agere's logistics network spans the globe, but is concentrated in Asia. About 75% of its 500 inbound and 650 outbound shipments per day are within Asia. Agere was originally part of AT&T and later part of Lucent Technologies and, as part of those larger companies, relied more on its own transportation equipment, personnel and management than 3PLs. Today, the company is nearly 100% outsourced in its logistics, choosing to focus instead on its core competency of manufacturing integrated circuits.

Agere has divided its logistics operation into four functions: transportation (movement of materials), distribution/warehousing, information technology, and compliance (adhering to government programs, etc.). For each of those segments, Agere has defined key performance indicators based on customer requirements—what levels it needs to hit to meet its goals in areas like on-time delivery and inventory accuracy.

"From there, it's a question of how do we achieve that performance level at the lowest possible cost," says Powell. "We ask if there are areas where a third-party could get us to that level of performance at a better cost and outsource when the function can be improved by an outside source or if the same service can be provided at a lower cost."

Agere has outsourced 100% of its transportation requirements, the majority of which goes to FedEx, one of the few providers that could match Agere's demands for delivery time and cost in a global, Asia-heavy environment. "We've also been able to expand the services we ask them to provide as needed including labeling and on-dock activities," Powell notes. "This was clearly an area where to meet our defined performance needs, we had to bring in a third-party. Trying to do it alone with our own assets and [establishing] a huge internal organization simply didn't make sense."

But it was a different story when it came to Agere's warehousing needs. The company's typically small products do not require much space and the inventory can be placed close to manufacturing sites for more rapid deployment.

Powell says the current capacity trends do not change the way Agere approaches its logistics outsourcing strategy. "We try to take a long-term view with our strategy and not react as much to short-term market trends," he says. At the same time, that does not mean passing the function off to a third-party and never looking at it again. Every quarter Agere has a formal review with FedEx on its transportation and asks for FedEx's plans to add capacity, specifically in the Asia region. "While we have not adjusted our overall outsourcing strategy based on capacity trends, we make changes as needed," Powell says. "We feel the best strategy is to outsource to a 3PL, but keep an eye on them and evaluate their performance closely."

Agere is not replacing discounts with capacity concerns in contracts, but is increasing the severity of ramifications for lack of capacity, including language specifically addressing capacity now.

Andrew's perspective

As a survivor of the telecom industry fallout, Andrew Corp. made some major changes in its organizational structure. In the past, its distinct business units functioned independently but as the company grew, it realized the need for a centralized logistics organization. Lamb heads up that lean organization which sits above the business units and sets overall logistics strategy. "We focus on setting the strategic direction, policy, processes and improvement, best practices, internal consulting and training, regional and global tracing, purchasing leverage and management of strategic global supplier relationships. Our strategy is to automate or outsource all of the operational or transactional/executional activity in our logistics operations."

Andrew has outsourced three major portions of its logistics operation to date. First it outsourced international air/ocean/customs globally to its long-time 3PL partner, Exel, including shipments from one overseas region to another. Andrew has also outsourced its North American transportation management to Schneider Logistics. In both of those cases, the 3PLs do the carrier selection, negotiation, qualification, routing optimization, etc. "They manage the carriers and we manage them," says Lamb.

The third function outsourced was freight payment in North America to Schneider's payment service. Lamb says the strategy going forward is to evaluate the use of a 3PL in intra-Asia and European operations. "Our business is exploding in China right now. We've got three manufacturing sites and dozens of suppliers. There's a lot of opportunity to do something holistically there."

Lamb points out that a 3PL partner can be a huge help when moving to new markets with no assets on the ground. Company executives often want to see a fast return on investment in such a move and establishing a full logistics operation on the ground in a new country is simply not realistic. A 3PL can typically adapt to change much more easily than an internal logistics operation in a far-off region.

In addition to managing existing costs, Lamb puts a high value on cost-avoidance in logistics operations. For example, his organization recently installed a compliance manager that implemented a NAFTA compliance program which helped Andrew avoid more than $20 million in violation fines. While it's not the kind of cost the CFO will see pulled off the books, it is the kind the CFO would notice when it comes onto the books.

One area Lamb sees 3PLs adding value in is the logistics technology space. Rather than seeking out software and technology to support its logistics operations, Andrew is getting the majority of its logistics technology from its 3PL partners for both operational and cost-management reasons. "For one, technology changes so fast, that if you get a package every three or four months you have to roll out a new release. In the 3PL model, they deal with that," he says.

The biggest recommendation Lamb would make to a shipper looking to outsource more of its logistics operation is to make sure that operational requirements and performance metrics are clearly documented and understood by both shipper and 3PL provider.

"I highly recommend a shipper and a 3PL do a process map because there are always some glitches in starting out. Sometimes, a shipper's processes can surprise a 3PL. But sometimes that helps identify those clumsy processes. A 3PL's outside perspective can provide a new voice on those kinds of issues. Also, by outsourcing we don't have to manage a staff. I manage a $70 million global freight operation with three guys under me. If we did it all internal, we'd need something like 70 people here."

3PLs increasing market
Third-party logistics providers had a great year in 2004, according to market analyst Armstrong & Associates. Total revenues for the U.S. 3PL market rose to $89.4 billion, an increase of 16.3% and the compound annual growth rate for U.S. third-party logistics is 14.2% since 1996.

Who's Who in 3PL
A guide to third-party logistics providers

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