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Thursday, 16 October 2014

Is outsourcing logistics worth it?

Time was when outsourcing one's logistics operations to a third party logistics (3PL) contractor was thought to be more costly than an efficiently run in-house operation. After all, there is the contractor's profit margin to add to all the usual running costs which did not exist before outsourcing. So why, then, did outsourcing catch on or was even tried in the fist place? In Britain, one key driver was the turbulent record in transport labour relations which left companies a hostage to fortune and so they were only too willing to break that mould by outsourcing. It worked in the sense that labour relations became much calmer. It caught on because most companies using their own in-house logistics solutions were not particularly super efficient in that function partly, perhaps, because they saw it as a side show distraction from their main function of manufacturing products.

Most 3PL contracts are for a minimum of five years and it is possible that costs within the first year could be higher than when the operation was run in-house. But as when choosing or renting new forklifts, the focus of attention should be on the life cycle costs over the five years, not the initial cost, but how does one know what those costs may be four or five years hence and how flexible will the 3PL be to meet wide fluctuations in demand for the clients' products?

The problems of costs and uncertain product demands can be eased at the contract negotiating stage, which admittedly is a highly complex business that demands great care. A key element in success is the degree of trust -- in the form of confidential information -- that customers must extend towards the contractor, which is immense. Without that gesture the contractor will not be able to provide an effective service. Secondly, the partnership should involve pro-active suggestions, agreeing and implementing efficiency savings which are tracked throughout the contract's life and the monetary benefits shared with the client on a fair basis. This is where probing of potential 3PL contractors is critically important. The winner of the contract should have a long-term track record of not only reliability but also be able to prove how good they are at making big savings for their existing clients. It would also be comforting to the client to know if the 3PL has a wide spread of warehouses strategically located nationwide as this would enhance the flexibility it could offer, partly through shared user facilities, which is so important to cope with seasonal fluctuations in demand or long-term changes caused by adverse moves in the economy.

A third caution which every outsourcer must never neglect is the financial stability of the potential 3PL contractor. Size is no guarantee of solidity. Back in the 1980s, the high-flying logistics operator, Rockwood Distribution, collapsed, leaving its clients with embarrassingly empty shop shelves and frantically having to find alternatives. Financial investigations into prospective 3PLs should never be left to just bankers' references. There are various formulae which can predict bankruptcy up to two years ahead, one of which, the Lis formula, named after its creator, Roman Lis of the Manchester Business School, is said to be 90% accurate, and that is close enough for Government work. It takes four key ratios from a company's annual accounts, each of which is multiplied by a certain coefficient and the sum of their products is then compared with a cut off point of 0.037. The more a company's result is above that cut-off point the sounder it is. Below, the amber lights start flashing.

If the choice of 3PL has been wise just what benefits can be expected? A good example among many is how the 60-year old British, family-owned business of Howard Tenens (HT) transformed the logistics of Costa Proud, which supplies its entire ingredients supply chain. During the initial 12 months of a five-year contract HT achieved a smooth implementation of both a new IT system and 3PL provider with no loss of service. Stock was centralised from nine locations to one. Stock availability reached 99.9% and there was a 50% cut in stock holding at partner sites. Delivery refusals fell by half and annual logistics costs by 30%. There were also considerable CO2 savings which is a key attraction to blue chip clients keen to establish their 'green' credentials. HT, in fact, leads the 3PL industry in having 88% of its heavy goods fleet over 18 tonnes with dual fuel capacity. It has invested in re-fuelling stations for both CNG and biomethane which are all open to third parties.

So, to the question is outsourcing worth it? the answer is a resounding yes, provided the partnership is truly pro-active and the choice has not been made on price alone as the dominant factor in an industry where competition has always been intense and so likely to see a 3PL's margins under extreme pressure.
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