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Principles and Advantages of Logistics Outsourcing

chillibreeze writer — Abhijit Banerjee

In the face of increasingly intensified competition in the emerging global economy, manufacturing and retail firms are progressively turning to outsourcing of their logistics functions.

Outsourcing is a viable business strategy because turning non-core functions over to external suppliers enables companies to leverage their resources, spread risks and concentrate on issues critical to survival and future growth. One way of extending the logistics organization beyond the boundaries of the company is through the use of a third party supplier, or contract logistics services.

One of the most important reasons why companies outsource their logistics functions is the need to decrease the number of warehouses, vehicles and excess inventories and to reduce shrinkage, and labor costs. Such moves bring down fixed and working capital investment., Companies can therefore focus on their core business activities and share the risks.

Most firms direction considerable attention to working more closely with their channel partners, including customers and suppliers, and with various types of logistics suppliers. This has resulted in the development of meaningful relationships among the companies involved in the overall supply chain activity.

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Third Party Logistics (3PL)

A third-party logistics (3PL) firm is an external supplier that performs all or part of the company’s logistics functions. The definition encompasses providers of services such as transportation, warehousing, distribution, financial services and so on.

The use of third party logistics providers has grown dramatically over the last several years and has increasingly become an effective way to reduce costs and spread risks for traditional, vertically integrated firms.

The economic advantages of using 3PL suppliers are:

Elimination of infrastructure investments
Access to world-class processes, products, services or technologies
Improved ability to react quickly to changes in business environments
Risk sharing
Better cash-flow
Reduction of operating costs
Exchange of fixed costs with variable costs
Access to resources not available in one’s own organization

As customers grow accustomed to using the services of a 3-PL provider for certain activities such as transportation and warehousing, they become better candidates for a broader range of service offerings, or value-added services. Examples of value-added services provided by 3PL providers are:

Pick and pack
Marking, tagging, and labeling
Product returns and reverse distribution
Packaging and repackaging
Salvage and scrap disposal
Telemarketing

3PL is an extension of trucking, warehousing, and distribution. It is the provision of these products under one roof, with the aim of taking over some of the associated functions such as stock keeping and documentation. 3PL services also include basic functions comprising physical activities such as transportation, warehousing, line haul and the rental of material handling equipment.

However, the task of providing a full outsource solution comprising different services from one service provider is difficult. It is, therefore, not surprising that opportunities are created for 4PL service providers to assist companies in coordinating all the different 3PL activities, which are provided by different service providers.

4PL Service Providers

4PLs represent the next stage of development in logistics service providers. Consequently, while the traditional activities of warehousing, inventory management and transportation may be given out to one 3PL, other processes like HRD, security and product development are done by other 3PLs. In effect, the activities done by a set of internal departments are now being carried out by a set of 3PLs. As a result the companies now have to deal with a whole set of 3PLs and each needs to be coordinated with and linked via personnel and IT. The number of transactions and the costs reduced are thus offset to a great extent by the cost and time of transacting with all these 3PLs.

Today more and more business processes are being outsourced. In the West, processes like bill payment, credit tracking, invoice generation, HRD, transport and warehousing are all being outsourced. Outsourcing of these activities may indeed add considerable value to the product, but on the flip side, even in a developed economy like the US, there are no 3PLs that offer every process with equal competence or reach.

The 4PL is an integrator that assembles the capital, technology and resources of its own organization and other organizations to design, build and run supply chains. The typical 4PL would eliminate complexity, share benefits of scale and capital and can drive innovation due to its overall view. In other words, a 4PL manages other 3PLs.

The primary role of the 4PL is the management of complexity and time. Two key distinctions make the concept of 4PL unique and set it apart from other supply chain outsourcing options available in the market today:

A 4PL delivers a comprehensive supply chain solution
A 4PL delivers value through the ability to have an impact on the entire supply chain.

In both these concepts, 4PLs have evolved because of constraints faced by the 3PLs. In other words, 4PL is the evolution of supply chain outsourcing. The convergence of technology and the rapid acceleration of e-capabilities have heightened the need for an over-arching integrator for supply of chain spanning activities. 4PL is a non-asset based logistics operator which has chosen to become an outsourcing specialist – assessing the entire supply chain and contracting those best able to provide the required services, all in order to reduce the customer’s investment in inventory.

4PL operators handle the client’s entire logistics function for optimum results. It is not just about reducing costs of warehousing and transport, but rather about managing the logistics functions and achieving optimization. 4PL consultants are being used to analyze certain areas and recommend solutions where processes can be optimized.

It follows naturally that 4PL service providers must become long-term partners, as they are directly involved in the business processes and strategies.

The 4PL service provider manages and coordinates the relationship between all the different activities of the consumer. It must be able to strategize and manage all the different assets that are dedicated to a customer and, where possible, coordinate break-bulk distribution by co-loading different customers’ products on the same vehicle. This can be done when a 3PL service provider has a great number of customers, thus providing the critical mass to allow break-bulk distribution.

The 4PL planning in such a scenario plays a great role in reducing costs. In essence, the 4PL logistics provider is a supply chain integrator and assembles and manages the resources, capabilities and technology of its own organization with those of complimentary service providers to deliver a comprehensive supply chain solution.

The development of 4PL solutions leverages the capabilities of 3PL providers, technology service providers and business process managers to deliver a comprehensive supply chain solution through a centralized point of contact. The 4PL will integrate the client’s supply chain activities and supporting technologies across these “best of breed” service providers with the capabilities of its own organization.

3PL + 4PL = 7PL

The phrase 7PL was coined by the Value Logistics Group and is a concept describing the developing trend of 3PL and 4PL combined. Through this service, the client has one service provider that oversees the entire logistics chain.

The 7PL concept

7PL is the combination of 3PL and 4PL into one (3PL + 4PL = 7PL). One service provider can now provide a client with both 3PL and 4PL services with a complete 7PL solution to clients and can undertake turnkey projects for its clients where all services and activities are provided for under one roof.

One contract, one bill

7PL is a turnkey solution where instead of dealing with several people for various services like inbound, outbound and warehousing, clients now are required to deal with one person under the ‘one contract, one bill’ concept.

7PL companies will be prime candidates for takeover by bigger players and play the role of service providers within the larger offer. Such consolidation will be seen in all areas from shipping, trucking, air cargo to couriers, ground handlers and IT services. Many others will drop out.

The future of Logistics Outsourcing in India is dependent on these criteria:

a. Use of IT: The use and spread of IT, including ERP, warehouse management system (WMS), tracking systems and net-based data exchange – will be inevitable and rapid. India already has a leading edge in IT, which will be leveraged for logistics.

b. Alliances: Scale and reach are the vital ingredients for success in 3PL. Indian companies will increasingly look to alliances, joint ventures and mergers with multinationals or larger Indian logistics providers to attain critical mass. These alliances will be dynamic: as and when required, companies will form alliances and break away when no longer required.

c. Investment: A sustainable 7PL model will need money – money for infrastructure, IT, people, fulfilling of liabilities arising from failure to honor commitments and insurance claims. Financial institutions and banks will play a key role in this aspect. Logistics and supply chain today offer returns of 15-20%, which very few investments give, and this is what should draw Foreign Institutional Investors and banks.

d. Regulation: India’s current labor laws, laws of customs, excise, port formalities, service tax provisions etc prevent businesses from realizing a lot of value across the chain. Cheap and easy availability of labor also hampers the development of people on a long-term basis. There’s not enough time given to develop skills. Current labor laws bar layoffs, making it difficult to infuse fresh blood. However, all these will change as regulations are relaxed and enterprises hire people purely on the basis of need and not any social obligation. Logistics providers’ services will improve in all aspects of business in India, as awareness of their benefits spreads.

Consumer Relationship Management

For logistics outsourcing arrangements to be successful they must include a strong emphasis on customer relationship management (CRM). This is different from what we typically think of as customer service. Customer service actions are ‘passive’ and are initiated after customers present their requirements, whereas CRM is ‘active’. It not only solves problems but also maintains close contacts. CRM relies on the integration of marketing and logistics customer service, and regards customer service as another marketing mode. Therefore, customer relationship management is sometimes referred to as “backstage marketing.”

Links between the components

As services are customer-centered, the strategy, systems and people in the operations of service should also focus on the customer. Customers’ expectations are central to the design of service strategy of the firm. The line linking customer to people (service providers) signifies that people are extremely important in producing and delivering services to the customer.

The customer to systems link shows that the service operations/delivery system should also be designed with the customer in mind.

The strategy to system link means that the systems and procedures should follow from the service strategy. The systems should support the strategy.

The strategy to people link means that all the service providers (people in the service organization) should be well aware of the organization’s strategy.

The system to people link means that the service operations system and procedures should be people-friendly.

The only criterion that counts in evaluating a service quality is defined by the customers. Only customers can judge quality. All other judgments are essentially irrelevant.

Chillibreeze's disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect the views of Chillibreeze as a company. Chillibreeze has a strict anti-plagiarism policy. Please contact us to report any copyright issues related to this article.

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—About our writer:

Abhijit says, "Studying English literature for my graduation opened up a very broad horizon, enabling me to probe and assimilate varied and unconnected subjects - covering the entire gamut from philosophy to IT."

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