Best Practices for Middle-Market Companies Outsourcing to Third-Party Logistics Providers

Best Practices for Middle-Market Companies Outsourcing to Third-Party Logistics Providers

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Middle-market companies face a myriad of logistical challenges ranging from globalizing supply chains and changing customer requirements to inadequate technologies and skyrocketing carrier costs. Yet until recently, they had few options for help. Third Party Logistics (3PL) firms, which have long provided outsourced logistical services ranging from freight forwarding to supply-chain management to large companies, have started to target the middle-market aggressively. This trend presents a tremendous opportunity for middle-market companies that want to reap the benefits of lower costs, expanded capabilities and enhanced responsiveness to customers.

Opportunity for Middle Market

Middle-market industrial companies are in particular need of 3PL services because they have:

• high transportation and warehousing expenses
• limited logistics competencies
• inadequate technologies
• fragmented and global supply chains
• changing customer requirements that demand greater supply chain efficiency.

3PL providers help companies become more competitive by addressing these challenges. Successful 3PL implementations can reduce logistics-related costs including capital spending, working capital, labor, warehousing and transportation by 15-20 percent. Increasingly, 3PL providers also help companies innovate their supply-chain capability, access advanced technologies and be more responsive to customers. Examples include enabling market expansion, expanding service offerings, improving operational capabilities and tapping new vendor networks.

3PLs Outsourcing Challenges

However, the switch to outsourced logistics comes with serious challenges. According to an annual logistics survey conducted by global consulting firm Accenture, in conjunction with Northeastern University, approximately 40 percent of all 3PL customers give neutral or negative ratings to their 3PL providers for customer service. Logistics industry analyst Eyefortransport estimates that approximately 50 percent of all 3PL contracts are cancelled within three years. The reasons 3PL relationships fail or under perform fall into three categories:

Careless 3PL selection. Companies rush the process and choose providers before defining their objectives and business requirements. As a result, they do not have a framework with which to evaluate a 3PL's fit. Companies also underestimate the importance of providing transaction and performance data, resulting in contract mispricing and misaligned expectations.

Poor 3PL implementation. Companies underestimate the work required to successfully transition functions, the change management involved and the impact on customers. Miscalculating the required effort results in longer implementation times, strained customer relationships and internal organizational confusion. Successful implementations require up-front communication about expectations and information sharing, both of which are often overlooked.

Ineffective relationship management and performance evaluation. Some companies ignore the importance of managing the 3PL provider's performance after the initial integration. Other companies regard the 3PL provider as merely a vendor and miss out on the synergies of strategic collaboration. For example, companies that treat their 3PL provider as just a vendor may achieve only short-sighted gains such as cost reduction. Many failed relationships can also be attributed to performance metrics that were vague or never even established.

Best Practices for Outsourcing to 3PL Providers

3PL outsourcing challenges can be substantially reduced if companies apply a structured approach to selection, implementation and relationship management (see Figure 1).

Phase 1—Selection Process

Know objectives and define business requirements. Knowing what you want and need is a condition of creating a successful partnership. Solid objectives lead to selection criteria in evaluating which 3PL provider will provide the best fit. Similarly, defining requirements is necessary for a 3PL provider to determine whether it can serve you efficiently. Business requirements are generally grouped by broad functions such as warehousing and transportation. Other typical selection criteria include services provided within a function, cost, quality and performance.

Take due diligence seriously. Many 3PL providers are savvy marketers that have poorly integrated service offerings because they are the consolidated entities resulting from multiple acquisitions. They lack a unifying operational platform and standard business processes. It's important to carefully vet dimensions that many companies dismiss perfunctorily but that result in preventable downside risks. Key dimensions include level of service and process standardization, financial profile and strategic direction of the 3PL, information technology capability; management depth, history of performance and not promised results, and fit with corporate culture.

Phase 2—Implementation Process

Ensure support from senior management. Unlike simple outsourcing initiatives such as moving payroll to ADP, a 3PL migration touches fundamental business processes that impact employees across the organization. As a result, senior management support is critical to achieving business alignment and program traction. This can be accomplished by assigning a "C" level executive to champion the effort.

Establish clear service and performance expectations. Appraising 3PL performance has been one of the most arduous tasks and relationship strains in the 3PL industry. To counter the risk of a provider failing to meet expectations, it is critical that your company do three things. First, establish up-front goals on short- and long-term savings. Baseline costs should be calculated up front because savings can be difficult to compare once the 3PL operation starts. Second, establish a performance assessment index that spans dimensions of cost, productivity, quality, service and customer service. Metrics must be measurable, achievable and indicative of the few critical value-driving operations (see Figure 2). Third, set up a monitoring process that includes periodic reviews with the 3PL provider.

Create a detailed implementation roadmap. A 3PL outsourcing project is a major change management initiative affecting customers and many business processes. Among the many moving parts are headcount reduction, IT integration, process redesign and adapting to newly defined service and performance measures. A detailed implementation plan is necessary to keep the transition on schedule and within scope. The implementation team should have core members from both the 3PL provider and representatives from functions across the company.

Incorporate an exit strategy. Companies must plan for the contingency that the contract may need to be cancelled. Negotiations can break down with the 3PL midway through the implementation, or service promises can be disrupted by external shocks such as an acquisition of the 3PL provider. The best hedging strategy is to maintain relationships with several 3PL companies. Consider runners-up from the selection process as potential back-ups.

Phase 3—Relationship Management Process

Treat your 3PL as a long-term business partner. A successful 3PL relationship is a business partnership. The 3PL provider should be treated as an extension of the company's own business, not as just another vendor. As in a successful marriage, open and frequent communication is a key ingredient. High-performing companies often co-locate 3PL partners at their facilities and have 3PL providers participate in joint strategic planning sessions. Gain-sharing arrangements are another means of showing commitment to sharing risks and rewards of a 50-50 partnership.

Employ an evaluation framework to consistently monitor 3PL performance. A company must use the performance assessment index developed during the implementation phase to monitor 3PL performance. Regular performance evaluation meetings should be conducted. Practices such as "score carding" allow continuous improvements and longer-term strategic objectives to be achieved beyond one-time gains. A formal and frequent performance evaluation process also reveals under-performance before it can undermine the relationship.


3PL providers can offer real competitive advantages in cost efficiency, technology innovation, supply chain integration and market expansion. By understanding 3PL relationship dynamics and applying the best practices to selection, implementation and relationship management, midsized customers will be one step ahead of their competition.

Journal Date: 
Friday, December 1, 2006