Deciding to outsource a company’s logistics is not easy—an effective outsourcing strategy can reduce costs and increase speed to market, but outsourcing does not fit every organization. The decision to outsource should be grounded in an organization’s overall strategic direction, supported with detailed operational analysis.

Kurt Salmon has found the questions outlined in Exhibit 1 helpful in the decision to outsource. Answering “Yes” to any of these questions can help the decision process of whether distribution needs are best met through internal assets, or outsourced partnerships.

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In the context of increasing shareholder value, choosing to outsource to a third party is a play to incur additional operating expense while reducing capital expense. This is often a great alternative for a new market entrant or a player expecting rapid or unpredictable growth in the next three to five years. Add in the cost of capital and the total cost of investment is drastically different between “own” and “contract.”

New Market Entrant

Kurt Salmon recently worked with a discount retailer and determined that the best strategy for supporting a westward store expansion was to temporarily outsource distribution using 3PL assets, then reassess whether to bring distribution in-house two to three years after piloting the strategy. With many moving parts and potential changes to their store growth plan, going with a 3PL supported the expansion without investing in assets that may be incorrectly positioned to support future growth. Many times, inaccuracy in forecasted sales and high revenue growth projections dictates choosing a 3PL to minimize unnecessary investments in assets.

Unpredictable Growth

In a differing example, Kurt Salmon advised a new entrant to the U.S. market that wanted to launch a Web store. They are expected to sell X million units their first year, 2X million units their second and 3X million their third. They had no idea how the U.S. market would react to their site or how their business would react to the pull of the U.S. direct market. Getting an owned facility up and running that could handle their projected second-year unit volume could have easily cost $120M just to construct and equip. Add in operating expenses for labor and this was a steep investment for them to make without having the slightest clue what their business will look like three to five years from now. Choosing a third party with existing infrastructure to handle their volume provided service guarantees—nothing is guaranteed if they opened their own building—and offered greater flexibility to adapt their distribution model as they learned the market. Further, this choice deferred significant capital expenditures and likely maintained operating expenditures as compared to a start-up facility.

The answer isn’t always to outsource or not. Each supply chain may have unique conditions and situations that could lend themselves to a hybrid approach. But regardless of the level of outsourcing, the organization must maintain control of its supply chain and value chain even if it doesn’t own each outright.

Evaluating Different Outsourcing Models

If you’ve decided that outsourcing is a good fit for your organization, picking a model with the right characteristics is critical. There are three general forms of outsourcing: a non-asset-based 3PL, an asset-based 3PL and a hybrid approach that combines internal assets with a 3PL. Guidelines used to evaluate your supply chain effectiveness apply here too. Keep in mind cost to serve customers, quality and partnership to determine the best model for your organization.

Making Outsourcing Successful

Regardless of the model, following these five guidelines will help ensure your outsourcing strategy is successful.

1. Build in plenty of time. Transitioning distribution operations to 3PL providers can be extremely complex and resource-intensive endeavors. It typically requires six to nine months from the time the decision is made to outsource until the 3PL is fully operational and ready to support the business. Longer timelines may be needed for extensive systems integrations or more complex implementations.

2. Don’t skimp on planning. Significant effort will be required to develop the business requirements that will serve as the basis of the request for proposal (RFP), developing the RFP, performing the necessary due diligence to select a provider and ultimately transitioning to the new provider(s). This process will require the full support and alignment of key components of the organization—particularly in the transition phase.

3. Plan for increased expenses. Kurt Salmon has found that the costs of outsourcing will generally equal the true cost of running a well-run facility, plus a 15% to 40% margin, depending on scope and scale. (See Exhibit 3.) Capital expenses incurred by the 3PL will typically be amortized and passed along to the 3PL’s customer, with a markup, over the contract term. Any capital expense items not fully depreciated by the end of the contract term will either be assumed by the 3PL or the 3PL’s customer, depending on the contract terms.

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4. Don’t underestimate system integrations. Significant integration efforts will likely be required to integrate with a 3PL’s systems. Do not underestimate the cost and resource commitment of the IT effort required. This can make, or break, any partnership. If the transition is not executed effectively, your organization may suffer business disruptions and lost revenues.

5. Document service expectations. During the initial ramp- up of 3PL operations, customer service may suffer as the 3PL learns your operations and improves its overall operating performance. While this is often overcome after the initial start-up, it is important to have an on-site team at the 3PL to help ensure start-up success. Defining clear objectives, roles and responsibilities, and well-understood metrics
and timelines is essential to making outsourcing successful. Documenting these expectations with an outsourcing partner is a must.

Ultimately there is always the potential that the transition to the new provider(s) will not result in significant improvement over the status quo. While there are many reasons for this— such as cultural dissimilarities, loss of control and more competitive options—multiple studies have shown that the top two reasons for failed partnerships, by far, include failed expectations and poor customer service. Documenting,
defining, and making clear what customer service means to you and how you want to measure performance are as critical as the strategy itself. Defining these elements after the fact can increase your costs 100 fold.

Case Study: Outsourcing Strategy for $3B Multichannel Specialty Retailer

Background

  • The new management team of a multibrand specialty retailer wanted to develop and implement a plan to refocus the business and set up the organization for future growth.
  • One critical component of the transformation was to align their physical network to meet the needs of a new vertical operating model and speed-to-market vision.

Challenge

  • Put an agile and responsive supply chain into place and improve speed to market and inventory flow to the customer and reduce operating costs

Solution

  • Physical network configuration to support speed-to-market, inventory flow and multichannel retailing strategies
  • Multidimensional space planning models, accounting for future changes in product types, store structures and inventory holding requirements
  • Detailed review and analysis of space, labor, facility and product flow network components
  • Transportation network analysis, including centroid scenario modeling, detailed mode and node evaluation, and product-centric transportation flows
  • Integrated implementation and transition planning

Results

  • 33% to 55% improvement in speed-to-market calendar
  • 40% increase in DC facility throughput capacity
  • 20+% reduction in transportation costs
  • $5M reduction in annual DC operational cost

15 November 2011