Why Outsource? By Clifford F

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Why Outsource?

By Clifford F. Lynch

There are many good reasons to outsource logistics and supply chain activities. But outsourcing is not necessarily the best answer for every situation. The key to making the right decision about whether to perform an activity in house or turn it over to an outside provider is to carefully assess the pros and cons of both options--and then make the choice that's best for you.

There are as many reasons for outsourcing as there are firms that do it. Many of these are unique to specific firms and industries, but in a broad sense, there are several readily identifiable advantages to subcontracting logistics services. No priority has been assigned to these advantages, which are discussed below, as the relative importance will vary by firm and circumstance.

Return on Assets

First of all, outsourcing allows the user firm to improve its return on assets. By reducing the not-insignificant investments in ware house facilities, materials handling, order picking, transportation equipment, and information technology, returns can be enhanced significantly through outsourcing. While it is true that most firms capitalize leases, the fact of the matter is that the majority of logistics contracts are relatively short-term and allow reasonable termination arrangements. Most importantly, the user firm does not have to make the capital outlay.

This capital, in turn, can be invested in those ventures that fall into the core competencies or basic businesses of the user firms-whether they be manufacturing, marketing, or distribution.

Personnel Productivity

Personnel utilization can be more effective. By emphasizing the core business, firms can greatly improve the productivity of their employees. Often there will be fewer people to train in fewer skills, thereby increasing the level of expertise.

Take, for example, the case of a major grocery manufacturer that a few years ago operated a large manufacturing and distribution facility on the same site. For new employees, the entry-level route was through the distribution center as an order picker or forklift operator. All job openings in the facility were posted, and every time a higher paying production position would become available, those at the lower levels would apply for it--often successfully. The end result was a warehouse that functioned more as a school for forklift operators than as a distribution center. Because the company never achieved true warehouse operations efficiency, the center was a prime candidate for outsourcing.

The personnel productivity advantage often is difficult to measure but can be real nonetheless.

Flexibility

Flexibility is another key outsourcing driver for most firms. As new markets and new products are developed, it is often impossible to predict future logistics needs accurately. Likewise, as existing market and product characteristics change, logistics needs change as well. New customer service requirements, ordering methods, and competitive offerings and services all influence a firm's logistics practices. In the face of such changes, the use of a contract provider greatly reduces the risk of misplaced or outdated facilities and equipment.

Specialized services in today’s environment are becoming the rule, rather than the exception.

There are a number of empty buildings across the country for services or products that became obsolete. The building boom generated by the Internet bubble is a classic example. Several 500,000-plus square foot, fully automated facilities were left empty after only a few months of operation.

In the case of mergers and acquisitions (M&A), if the firms have out sourced logistics services, it is much easier to combine operations and take full advantage of logistics synergies. Often, logistics cost reductions can be one of the major motivators of the M&A transaction.

This was effectively demonstrated by a major firm that had maintained 12 to 15 distribution centers for a number of years. After two acquisitions in quick succession, the company found itself with almost 200 warehouses - in some cases, two or more in the same city. Because the majority of these were public or contract ware houses, the opportunity for consolidation was greatly enhanced. Within two years, the total number of distribution locations was down to 20.

At the same time, logistics costs were reduced by millions of dollars annually.

If these facilities had been owned and/or operated by the firms themselves, it would have taken years to achieve the same savings – if, in fact, they could even be realized at all.

Labor Considerations

While labor issues can be somewhat delicate depending on the user firm’s own labor environment, these considerations should not be ignored when considering outsourcing, particularly in the warehousing area.

If you are operating in a union climate and your own facilities are organized, the advantages to utilizing a facility that is nonunion, or even one that has a different union, sometimes are obvious. The key word here is caution. All appropriate labor agreements should be evaluated by a competent legal authority. Labor unions are well aware of the outsourcing advantages and, in some cases, have taken measures to protect their members.

With the outsourcing of hundreds of thousands of technology and service jobs to India and other foreign countries, the term "outsourcing" has taken on a negative connotation for many. And while this type of outsourcing is quite different from logistics outsourcing, the very mention of the word can raise a red flag. This caution is not meant as a deterrent but as a reminder that thorough research will minimize the risks and protect the projected benefits.

Cost

To many firms considering outsourcing, operating costs will be the most important consideration. Surveys conducted on the reasons for outsourcing almost always find it to be in the top three determinants.1

In addition to capital savings, the outsourcer will expect the outside facilities to operate at a lower cost or achieve savings that could not be generated internally. Obviously, this is important and is often the case, but sometimes the sophisticated Firm will not find this to be true. If a company has an efficient, well-managed distribution system, outsourcing it may not reduce operating costs.

Outsourcing, however, may add to the value of the distribution system, and this should be the primary cost consideration. While the absolute dollars spent may be more, the value received often can more than offset the premium. (A Mercedes-Benz costs more than a Ford Taurus but that does not necessarily make the Taurus a bad investment.) Most important of all, when comparing the cost of your Firm's performance of a logistics function to that of a provider's, be sure to capture your total costs. The results may be surprising.

Management and Political Considerations

In the modern business environment, managing any function is difficult, particularly at the middle management level. More often than not, there is ongoing pressure to reduce costs and improve productivity with fewer resources. ln addition, people are more difficult to manage today, and some have work ethics that me not compatible with the goals of the organization. ln short, logistics and personnel issues require significant amounts of attention and resources.

Outsourcing facilitates managing the basic business and leaving the solution of distribution problems to others. It is fa1· easier to manage one, or a limited number of providers than it is to manage the individual functions internally. This is not intended to be a text on corporate politics, but one would be naive to ignore them. All too often, managers see their primary survival technique to be that of recommending how others could manage their function better or, in some cases, how they themselves could manage the function better than the incumbent. Outsourcing removes the logistics Function from the corporate political spotlight and enables the logistics executive to manage it in a more orderly, less political, and more productive fashion.

Customer Service and Specialized Services

In today's environment of error-free, prompt deliveries and unique business and service requirements, customer service has to be the most important consideration for any firm. This focus in both the business-to-business and business-to-consumer markets has resulted in many changes in logistics practices and service approaches. These changes are likely to continue and must be addressed in a timely fashion if the firm expects to remain competitive.

Specialized services in this environment arc becoming the rule, rather than the exception. Although some logistics services providers have been able to serve the needs of various industries efficiently, a number of firms have gradually evolved into businesses that offer specialized services for specific industries. This, of course, shortens the learning curve, encourages expertise, and removes the inefficiencies from the system. Described below are some of the main specialized services being offered today.

Just-in-Time. The automotive industry provides a good example of the potential of specialized outsourcing. Specifically, "just-in-time" (JIT) techniques have been utilized in this industry for a number of years, with many of the associated functions being performed by outside providers.

One carrier-based contract logistics firm, for example, handles warehousing, transportation, and assembly for several major automobile manufacturers. This provider has the ability to acquire parts from hundreds of vendors in myriad geographic locations, move them into one warehouse, process the orders, and deliver to destination plants within two-hour windows.

Another warehouse-based provider has a similar arrangement. Through an electronic data interchange (EDI) network, trucks are dispatched to parts suppliers. The parts are then collected and delivered to a cross dock where they arc consolidated and shipped to 12 different assembly plants in North America. The parts arc never warehoused or inventoried at the plants. The JIT delivery system schedules next-day arrival l S to 30 minutes prior to the time that the parts arc needed for manufacturing. While the parts are en route, a sophisticated system monitors each part and its expected arrival time.

Order Consolidation. Efficient consumer response (ECR)--sometimes called quick response (QR) or continuous replenishment process (CRP)--is designed to link all segments in the product pipeline into a smooth, flowing steam of products. Vendor-managed inventory (VMI) is another variation of the same theme, utilizing a "pull" rather than a "push" inventory system. ln the grocery industry, collaborative planning, forecasting, and replenishment, or CPFR, links customer demand with replenishment scheduling. This joint planning, if successful, can lead to a smooth flow of products through the entire length or the pipeline.

All designed to reduce inventories in the system, these techniques result in smaller, more frequent shipments. Rather than handle these small shipments from their own facilities, grocery manufacturers have turned to the contract logistics companies. With their multiple client base and sophisticated systems, the providers are able to combine these shipments into truckloads, reducing Freight and handling costs-and even further enhancing the cost reductions in the efficient- consumer-response process. One food manufacturer, for example, eliminated its network of privately owned and operated distribution centers and outsourced the entire system to firms with sophisticated consolidation programs.

Although consolidation has been a factor in the food business since the 1960s, the early programs were very simplistic manual operations. Today, the leading logistics Firms have systems that combine orders into truck or container loads by customer and requested arrival date, route the shipments, and electronically tender them to the appropriate carriers.

One major logistics provider ships SOO to 1,000 trailers of consolidated product daily. Such consolidation programs, in addition to providing superior service, have produced consistent reductions in transportation costs from 30 to SO percent. Specialized programs of this type would be virtually impossible without the logistics services providers.

 

Packaging. Outsourcing also has facilitated the changing landscape of consumer-goods retailing. Buying one of anything can be almost impossible in many of the club stores. In a high-volume manufacturing plant, the combining of two or three packages of the same item by banding or shrink wrapping causes tremendous inefficiencies. Manufacturers are tooled up to put 12, 24, or 48 packages in a case, seal it, palletize it, and move it to storage or the dock--untouched by human hands.

If the customer packaging requirements were all the same, the issue could he dealt with. The difficulty arises when Walmart wants three tubes of toothpaste wrapped together, Costco wants two tubes, and Target wants a toothbrush thrown in. Much of this labor-intensive work can be outsourced.

Outsourcing removes the logistics function from the corporate political spotlight and enables the logistics executive to manage it in a more orderly, less political, and more productive fashion.

At the provider's facility, the original cases are opened, and inner packages are grouped together according to customer demands, using small shrink-wrap tunnels or other combining techniques. They then are placed back in the original case, or some other form of display module, and shipped. While this is tedious, it is considerably less disruptive and

less expensive that attempting to customize packages at the manufacturing plant.

Order Fulfillment and Electronic Commerce. It is an irrefutable fact that the Internet and electronic commerce have had an enormous impact on logistics service requirements.

While the concept of order fulfillment is not new (our grandmothers' Sears Roebuck catalogs would effectively demonstrate that), the direct consumer contact with manufacturers through the Internet has resulted in more precise and critical communications, information, and customer service requirements. And more often than not, residential deliveries are required, presenting an entirely new set of challenges.

Many manufacturing firms simply do not have the expertise to establish and manage these delivery and communications systems as well as a dedicated outside firm docs. In addition, an efficient order-picking facility is expensive to equip and maintain, and sales volumes can fluctuate wildly--a classic case for outsourcing. The result: firms are turning to outside providers for the necessary customer-focused services.

Here, selection of the best-qualified provider will be critical. Sophisticated order fulfillment is not for the faint-hearted. Be sure that the providers arc in the business for the long haul. There have been several conspicuous examples of those that were not.

The most important thing to remember in electronic commerce is that there is a direct exposure to the ultimate consumer at a number of stages in the process and that good rapport must be protected at all costs. The selected provider must be one that will focus on and nurture customer relationships for its clients.

Information Technology

For firms engaged in electronic commerce, and even those th,1t arc not, the increasing demands for new information sys- terns and resources often can be met more efficiently and

economically through outsourcing.

When resources within the firm arc scarce or logistics systems development has a low priority, there can be significant advantages to utilizing a provider that has the necessary systems in place--or the ability to develop them. Additionally, there are literally hundreds of firms that offer warehouse and transportation management systems as well as other supply chain management technology. Such firms can be included in outsourcing arrangements with transportation or warehousing specialists, assuming that they add some value to the process. The technology available is quite impressive; the outsourcing firm can acquire such capabilities as carrier selection, route optimization, order/shipment visibility, freight payment, load planning, and asset tracking, to name a few.

Caution must be exercised, however. Again, care should be taken to ensure that the provider is well-capitalized and has the resources and expertise to maintain existing systems and enhance them when needed. The important thing to remember is that, in and of itself, it has no value. The real value is in the information and decision-making tools it enables. It must enable reporting metrics, operational efficiencies, visibility, and the integration of processes. Peter Drucker said, “The computer can handle only things to which the answer is 'yes' or 'no.' It cannot handle 'maybe.' It's not the computerization that's important then; it's the discipline you have to bring to your proccsses."2

Global Capability

As Firms seek to expand into worldwide markets, outsourcing can be an extremely effective method of establishing foreign distribution centers and/or arranging for and making international shipments. There are a number of excellent freight forwarders, for example, that can provide sophisticated logistics services throughout the global pipeline. Many U.S.-based logistics managers simply do not have the expertise necessary to be effective in the international logistics arena and will find outsourcing a valuable tool. Managing a domestic logistics network can be challenging enough. Combine that with customs, security, terrorism, foreign cultures, currency, and language issues, and the task become formidable indeed.

Maturity of the Service Providers

Another important reason for outsourcing is the increasing maturity of the logistics companies themselves. No longer is the industry characterized by smaller, unsophisticated companies. Today's successful integrated logistics service provider is a dynamic firm, utilizing a combination of systems, facilities, transportation, and materials-handling techniques. It is managed and staffed by logistics professionals and, in many cases, has true global capabilities.

Quite often, the provider is better qualified than its clients to perform the product distribution function and can contribute knowledge to the process that many logistics managers simply do not have. The McKinsey Quarterly aptly referred to outsourcing as having moved from "economics of scale to economics of skill."3

Four Key Questions

There are, of course, some inhibitors to outsourcing. Some logistics managers have reservations about outsourcing, particularly in the areas of confidentiality, control, and security. Others do not have the confidence that providers can be trusted with important customer contracts and relationships.

Every firm that considers outsourcing will have its own unique reasons for doing so. [Following some basic rules of outsourcing can help ensure success. See the “Ten Rules of Outsourcing” on the final page.] They need to be able to qualify the advantages and disadvantages of the outsourcing option for their particular operation. Whatever these advantages or disadvantages may be, these

they should he analyzed and researched as thoroughly and realistically as possible by managers who know the industry.

A company considering outsourcing should ask itself four questions:

1. Is logistics a core competency of our firm?

2. If not, are we exceptionally good at it?

3. Will outsourcing add true value to our logistics process?

4. Can we become comfortable with the risk of turning over control and customer relationships to an outside firm?

If the answer to the first two questions is yes, serious considerations should be given to retaining the function in house. Conversely, if the answer to three and four are yes, outsourcing can be a viable option. Implemented and managed confidently and properly, outsourcing can be a powerful logistics tool.

Ten Rules of Outsourcing

Adherence to these ten basic rules will go a long way toward ensuring a successful

and mutually beneficial outsourcing relationship.

1. Develop a strategy for outsourcing. Outsourcing should always be carefully thought out and measured against an in-house solution. This will help identify relative strengths and weaknesses for each alternative.

2. Establish a rigorous provider-selection process. Check industry sources, existing clients, and financial health. Carefully analyze management depth, strategic direction, information technology capability, labor relations, and personal chemistry and compatibility.

3. Clearly define your expectations. A number of outsourcing relationships have been unsuccessful because of unrealistic expectations. Providers are often asked to submit bids based on inadequate information about volume size and frequency of shipments, which results in them developing costing for and committing to arrangements that don't reflect reality.

4. Develop a good contract. Provide incentives to improve operations and productivity with both parties sharing in the benefits. Clearly spell out obligations, expectations, and remedies in the contract.

5. Establish sound policies and procedures. Give the service provider an operating manual. Ideally, the manual will be developed jointly and contain all policies, procedures, and other information necessary for the efficient operation of the outsourcing arrangement.

6. Identify and avoid potential friction points. Both parties are usually aware of friction points that may arise. Identify them in advance and develop a procedure for dealing with them.

7. Communicate effectively with your logistics partner. Poor communication is second only to poor planning as a cause for a failed outsourcing relationship. Communications on all aspects of the operation must be frequent and two-way.

8. Measure performance, communicate results. When setting up the relationship, clearly identify, agree upon, and communicate standards of performance.

9. Motivate and reward providers. Reward good performance; don't take it for granted.

10. Be a good partner. Good partnerships are mutually beneficial. Bad ones are not. Your logistics provider's ability to serve you and your customers often can hinge on your own performance, or lack thereof.