5 Steps to Improving Your 3PL Relationships
A recent article published by the University of Tennessee’s Center of Executive Education had some interesting tips on managing 3PL relationships. While the tips are standard fare for anybody studying outsourcing, they are well worth revising when thinking about setting up a new agreement or renegotiating/renewing an agreement due for extension or revision.
The article cites a case study concerning Armstrong World Industries published in Logistics Management October 2010 edition, who had brought a 3PL contract back in-house after the original outsourced contract proved unsatisfactory. As we read the case study we were actually disheartened to learn that the reason they brought the work back in house was due to a failed third-party logistics services provider (3PL) relationship.
Yes, there are some bad service providers out there. But my experience is that there are always two sides to every story. I’m sure that the service provider Armstrong parted ways with would have their own story to tell from which we could all learn a lesson or two. However, this article is not about assigning blame, but pointing out practical steps, tips, and advice on how to improve a 3PL relationship and prevent one from becoming a failure.
As experts and outsourcing coaches, members of the University of Tennessee’s Center for Executive Education have created five steps to improve your outsourcing relationship from the start and help maintain that partnership once it gets rolling. The next few paragraphs will outline each of these five steps and provide some tips and advice to help you improve your 3PL relationships.
Many of the problems companies experience stem from jumping into the contract prematurely without a solid understanding of the ramifications. With this in mind, our first tip is to slow down and take the steps to get outsourcing right before you start any work.
To do this properly, we recommend a five-step implementation approach that companies and service providers can take to create a successful 3PL relationship:
- lay the foundation
- understand the business
- align interests
- establish the agreement or contract
- manage performance
When taken individually, these steps can offer shippers and service providers valuable insight into current operations. However, they tend to work best when implemented as a process for outsourcing by allowing companies to implement a true collaborative 3PL relationship where the company outsourcing and the service provider have a vested interest in the other’s success.
All too often, companies dust off an existing Statement of Work, rush to competitive bid, and give the service provider three months or less to transition the work—we’ve seen many that only allow for a four-week transition.
The great thing about the five-step framework is that it can be used during a request for proposal (RFP) or with an existing supplier to improve a relationship. Skipping steps usually results in a poorly conceived business outsourcing agreement or worse—a total disconnect in what the service provider is doing versus what the customer actually needs.
Step 1: Lay the foundation
The first thing a company should do before ever lifting a finger to outsource is to thoroughly understand if outsourcing is right for their operations. Management consultant Peter Drucker famously stated: “Do what you do best and outsource the rest.”
The problem is that far too many companies jumped on to the outsourcing bandwagon without realizing if outsourcing was right for them.
The case study on Armstrong raised a red flag on reading the statement: “Managing transportation was once a core competency of Armstrong.” If managing transportation was a core competency, why did Armstrong outsource in the first place? This leads to a second tip: Don’t outsource what is core. A company should only outsource when a service provider can do the work better, faster, or cheaper.
When Armstrong’s 3PL relationship began failing early on they decided to move the work back in house. Because they brought the work back in house, we believe that Armstrong did not follow our second tip.
Step 2: Understand the business
Once a company has properly decided that outsourcing is the right choice and has done its homework associated with laying the foundation, it should take the time to establish a baseline that both benchmark the potential cost, service, or other opportunities.
Which leads us to the third tip: understand your baseline and benchmarks before you outsource. In the Armstrong case study, one of the key decision makers said: “When we priced it out we were shocked to learn that we were less than half of what everyone else was charging.”
The article explains that the Armstrong team discovered this after they realized that their 3PL was failing. If Armstrong had done sound baseline and benchmarked cost and service they would have realized that they had an outstanding team that would not have benefited from outsourcing; in turn, they would have prevented themselves the pain of transitioning the work only to bring it back in house.
Armstrong also pointed out that “there was a failure by the 3PL to understand Armstrong’s customer requirements” and “the biggest flaw was that our 3PL took a one-size-fits-all approach…We have specialized needs, and they did not appreciate the complexity of our business.”
That sets up the fourth tip: Ensure potential suppliers understand the business. Our research and experience says that many companies are poor at stating their requirements. In fact, we often see service providers forced to “understand the business” based on a poorly written RFP and incomplete and inaccurate data.
One way to overcome this is for companies to open their doors and let service providers in to look around and explore the details of business. Let them ask for data—after all they’ll need this to run your business effectively.
Once service providers have had a chance to thoroughly understand the business, the companies and the service providers should mutually agree on cost and service goals. We call these desired outcomes. If the service provider understands the baseline costs and service levels clearly then they can feel more comfortable about signing up to achieve your desired outcomes.
And this takes us to the fifth tip: Develop clearly defined and measurable desired outcomes. You are outsourcing because you have gaps in where you are today and where you want to go (your desired outcomes). It is important to make sure the service providers understand those gaps and knows what success is (your desired outcomes).
The Armstrong case study pointed out that the arrangement was not meeting Armstrong’s established costs and service goals. As researchers and educators, we love to review RFPs and poke holes in how poorly requirements are often stated and how few clearly state their desired outcomes.
Our experience is that service providers do not sign up to take on a client’s business with the intent to fail. As such, we strongly recommend that all companies take the time to work with service providers to ensure they understand the business and communicate the desired outcomes and gaps.
Step 3: Align interests
This step entails designing and documenting how a company and the service provider will work together to achieve the desired outcomes.
In basic terms, this is the part of the process where both companies should document, with as much precision as possible, how the outsourcing company and the service provider will work together to achieve the desired outcomes. It’s the first pass at the future vision for how the two companies will communicate, collaborate, and innovate together to achieve the best results.
This brings us to our sixth tip: Identify risks before you transition the work. While it’s not clear if the parties took the time to align interest, we have to assume that the parties—at least the service provider—likely did not do a proper risk assessment.
We hypothesize that if interests were aligned and a proper risk assessment was performed in the relationship, Armstrong would not have stated “it was evident pretty much from the start that it wasn’t going to work.” Obviously the parties got out of the gate on the wrong foot.
Step 4: Establish the agreement
Vested Outsourcing is based on reducing the total cost of ownership (TCO) versus simply the costs of the transactions performed by the service provider. As such, 3PL pricing models should include incentives that will be used to reward the outsource provider when they achieve the desired outcomes and TCO targets.
This brings us to the seventh tip: Establish a pricing model with incentives that encourage service providers to put skin in the game and invest in your business to close the gaps. As mentioned before, the Armstrong case study cited that “the arrangement was not meeting Armstrong’s established costs and service goals.”
One approach they could have taken was what is called a “fee at risk” pricing model. This is when a service provider charges below market rates for service—but then is rewarded with incentives for delivering results against the desired outcomes. The more successful both parties are, the more profit the service provider makes, often two to three times market rates. A true win-win because the companies become vested in each other’s success. The more successful the company is, the more success the service provider is.
Step 5: Manage performance
This is a most crucial step around which the other steps revolve. Outsourcing is not a “throw it over the fence” business process. Neither should it be an exercise in micromanagement.
The eighth tip helps to make this clear: Develop a governance structure based on insight versus oversight. A sound governance structure outlines how the business will be managed, not just the service provider. The service provider is in essence an extension of the firm with regards to the work they provide.
If you have picked a service provider you trust and it is aligned with your interests, we find it’s often futile to micromanage the service provider. We often refer to this as a “junkyard dog” syndrome because the company outsources and then leaves in place employees who watch over and guard the old processes that have been in place for years. We hypothesize that this may have been the case in the Armstrong relationship, as the case study notes that they kept four people in place to manage the service provider’s 10 employees.
Coming full circle
The lines of demarcation between doing outsourcing effectively and doing it ineffectively can get a little blurry. As such, instead of drawing a line in the sand we promote an integrated “full circle” approach that includes the five steps we have outlined above.
We believe that even though Armstrong World Industries was the winner of the Shipper of the Year award, we’d have to give both Armstrong and their service provider a failing grade on their ability to outsource effectively. Even if the service provider was 100 percent at fault, we believe an outsourcing failure is a failure.
New Dimensions In Supply Chain Management
Many suppliers, whether they are manufacturers, distributors, wholesalers or any other form of transformation activity, simply adopt a single, one-size fits all approach to their supply chain or distribution network. What all organisations need – no matter their size – is to understand what is best for their unique situation: owned or outsourced warehousing; owned or outsourced transport; facility locations; inventory holding and/or ownership; distribution channels; etc.
Going further than this, managers must keep abreast of the changes occurring within the field of supply chain. Some 25 years ago, the noted marketing and logistics visionary, Professor Martin Christopher posed the following rhetorical question at a conference: “could it be possible that if I went to a supermarket and took an item from the shelf and it could be replaced instantaneously along the way back up the supply chain at each distribution level?” Most people at the conference laughed and thought it would never happen. It may not be happening yet in supermarkets, but this concept is certainly coming. But if you were to visit a pharmacy today, you would almost see this happening today. Take an item off the shelf and it will be replaced throughout the supply chain all the way back to the wholesaler within hours.
So what is the next big thing? While there may not be one single item, there are a number of ways by which organisations can stay up to date or ahead of the competition. Looking through a number of whitepapers and magazine articles, I have distilled these to a few relatively simple ideas that are applicable in Australia. Briefly, these include:
Supply Chain Flexibility Most companies simply adopt a distribution network, or inherit it, and leave it unchanged year after year. But conditions in the marketplace change, and sometimes rapidly or without warning. Companies must regularly re-evaluate their supply chain or distribution network to take account of changes in the marketplace, new competitors, changes to their own product, new technologies in transport and warehousing etc. It is imperative that companies undertake an evaluation at least every other year, if not annually as part of their budget cycle to determine whether their systems, process and structures are at least abreast, or better still ahead, of the market. You need to ask the question about your warehouse and/or transport provider: are you able to change the scale of your operation to suit our needs? One contract that I was involved with required an additional charge when we increased our storage, not on the equivalent pallet storage charge, but an additional charge, which doubled the storage cost. The reason was because the 3PL could not accommodate the items in the existing warehouse and had to lease additional space at a higher rate.
Supply Chain Visibility These days knowing where every item in the supply chain is essential both for your own internal needs (for example when are my raw materials arriving) and to satisfy the needs of our customers, who wish to know the exact date and time of delivery for their own production plans. To assist in this regard, many transport companies will provide proof of delivery only after you request them to find a lost delivery, and then only the next day or so. Would it not be so much better to be able to tell a customer before the goods arrive late of a likely delay and how you intend to correct the problem? Transport companies that are on the ball can do it – but is finding one a part of your selection criteria? Or are you simply looking for the cheapest price of a delivery point to point?
Take a global view of demand Companies should be looking outside their own immediate market to determine whether there are additional opportunities to expand. Whether this is going from local to national; from national to regional; or regional to global is activity that should be evaluated and researched on a regular basis. Generally speaking, this is a task undertaken by the business development of marketing team, but within supply chain there is a need to stay alongside these teams to provide advice on likely opportunities. Corporate history is replete with war stories of sales people that have made exaggerated promises about delivery capabilities, without first checking whether it is actually possible to deliver to a location or achieve a promised delivery date. The reaction from the supply chain people is usually along the lines of “why didn’t you ask me”? But this is the wrong approach; supply chain managers need to put themselves in such a position, through building trust in the organisation, that these decisions won’t even be contemplated without their involvement. At the very last supply chain personnel should ensure they are represented at sales planning and strategy meetings, workshops and conferences.
Work the supply network This involves making strategic decisions on issues such as make or buy, local or global, insource or outsource. Each company has a unique set of circumstances that warrant strategic considerations at the senior levels of the business. However, in doing so, the supply chain considerations need to be considered. For example do I need a warehouse in each of the capital cities, or can I make deliveries that achieve the customers’ targets from a single central point? Likewise when we look at supplies we often look to the cheapest supplier, but how is their reliability, delivery performance etc.? Maybe we can buy an item more cheaply from overseas, but when factor in all of the additional costs and the variability maybe it is cheaper to buy from a local distributor, even at a significantly higher price, when they are bearing the risk and stockholding, which in turn reduces our lead time from months to days. And don’t forget, when we are undertaking our analysis, our potential customers are probably undertaking a similar analysis on us.
Maximise Interaction With Customers This seems to be an obvious statement, but it’s surprising how many companies only undertake a dialogue through the sales or marketing people. In some companies talking to customers is expressly forbidden unless sanctioned or in the presence of sales personnel. But when we look at who actually interacts with the customers, we see that there are likely to be many others that are required to discuss issues, problems or normal day to day events. For example, the delivery driver when dropping off a consignment talks to receiving personnel; quality staff will talk directly to manufacturing, finance staff will collaborate on accounts payments; customer service with the purchasing staff. Preventing dialogue without sales personnel presence is neither desirable nor possible. So what we must do is ensure all of these people are trained and look capable of representing the company to its customers in a manner that management wishes to be viewed. There’s no point in only selecting and training sales staff who look great and can “talk the talk” if we have a delivery driver who is scruffy and fails to represent the ideals of your business. As in the foregoing point, are you selecting transport companies based on the lowest point to point rate or someone that has trucks and drivers that represent your desired image?
Facility Location - Is This The Site For A Warehouse?
For many organisations in Australia the choice of warehouse or distribution centre location is a simple one, more often than not driven by two overriding factors: attach it to the production facility for convenience and place one in each state capital alongside the state branch office. Both of these make some sense:
- if we’re leasing land or buildings then the incremental cost of additional adjacent land and/or buildings may not add significantly to the cost
- the facility is alongside production and/or sales staff and thus provides ready access for inspections, sales demonstrations, samples etc.
- the size of our presence is expanded to make it seem that we are a major player in a given location or industry sales staff can make rush deliveries if needed
What’s more, many developers are constructing facilities that tailor directly to this approach – there are a multitude of buildings in commercial and industrial parks that have any amount of office space attached to any sized warehouse. A call to any reputable property manager will reveal a plethora of facilities that will meet an organisation’s needs with very little tailoring, further saving costs in developing a bespoke facility. Selection in this case almost becomes one of push button solutions: just select the button for the size of the office, production facility and warehouse and out pops a recommended facility. Couple this with the cost you are prepared to pay, and there you have your answer. How difficult is that?
However, too often this last point becomes the overriding factor in the selection: the decision is handed to the General Manager or Finance Manager who then makes a ‘real estate’ based decision. This approach can have poor or even disastrous consequences. A real life example is outlined in the Case Studies on the right.
But you think this won’t happen to you? Just think of the numerous companies in Australia that have a head office in one capital city and branch offices in three or four other capitals. Each of these may have a warehouse located out the back of the office, ostensibly to provide maximum customer service to the surrounding customer base. But has anyone actually seriously looked at the customer fulfilment targets required by the customers? If it’s, say, next day delivery (which is often standard in Australia), then one needs to question why a warehouse is required each capital city. More than likely a product that is ordered by midday, can be picked, packed and despatched in the afternoon, moved to a local depot and transported overnight for delivery next day – without incurring any additional priority charges. Usually this is the same timeframe for a locally based warehouse, which will invariably arrive the next morning – the same time as an interstate delivery.
Looking at more local deliveries (i.e. intra-city), many warehousing and production facilities have grown around historically based suburbs in the larger cities. These were traditionally sited alongside transport routes – rail – so that workers could get to and from work. Now, all deliveries are by road, and many workers get to and from work each day by road. Doesn’t it make sense now to locate the warehousing facility near major access points to better enable smooth, faster and lower cost deliveries. As in the case study, it often matters little if the head office is alongside the warehouse, so locating the head office near the centre of the city or closer to the workers might take priority, while locating the distribution facility may be better sited near transport hubs and highways.
Accordingly, the location of warehousing facilities should take into account all of the considerations necessary to maximise service to customers while lowering the cost to serve. (Traditionally, these were seen to be mutually exclusive: increasing customer service meant more and closer facilities at a higher cost to serve, but today through more sophisticated logistic management techniques we can do both.
Without going into the many factors that might influence a location decision, just a couple are discussed below:
- Main Road Entry/Traverse In many cases, deliveries are scheduled to depart from a warehouse/transport depot at the start of the working day. This usually coincides with peak hour traffic with the resultant slow crawl through the traffic (and usually commences just prior to office staff arriving for work). But worse than that, many warehouses or facilities are located in positions where they may spend 15 minutes or more simply getting onto a main road while waiting for passenger cars (usually with a single driver) travelling on the same roads around the facility delivering office or other staff to work. All of this adds up to lost productivity.
- Ease of Access/Loading & Unloading Many older facilities (or newer ones of poor design) are simply not equipped to handle loading and unloading of trucks and containers on site; so this occurs on the roadway. While some councils don’t seem to mind, it could be important to you if you are constantly being held up by the next door neighbour(s) while their trucks block the roadway. Likewise if they haven’t allowed sufficient off-street parking for employees or visitors, your access to your site may be hampered.
Solving both these issues is relatively straightforward, but surprisingly rarely considered. Rather than a single visit to the new site, an extended inspection is warranted: stationing an employee at the proposed site for an extended period covering a number of days and most hours of a given day will soon tell whether the site has issues regarding traffic access and congestion. It should be noted that these issues above are only two of potentially dozens of considerations, strategic and tactical, that management must consider before taking the costly decision to locate a warehousing or distribution centre.
Supply Chain – It’s More Than Moving Boxes
Supply chain management is an ever evolving discipline: it’s only in the last 20 years that it’s become a recognised field within the corporate world. In the past, and depending where in the world you are located, there are a number of different definitions for what each component or the overall discipline represents. But before getting into that level of detail, it’s worth clarifying what is the difference between supply chain and logistics. In the past – basically until 20 years ago, logistics was the all-encompassing discipline of what we today term supply chain.
For ease of understanding I will use a definition, that is one of many, but I like because of its simplicity, and that it encompasses most of the elements I believe are relevant. Supply Chain is the science of moving materials, services and information from suppliers to value adding organisations (manufacturers and/or wholesalers) and on to customers, linking together successive vertically integrated stages of value adding from raw material to end consumer. In this context, we usually think of a typical manufacturing environment, but it may be water supply, for example, moving from a catchment area, through a dam, to water purification on to the eventual consumer through the household tap. If we wish, we can also expand this to include the reverse elements, being returns of goods and the flow of funds back up the supply chain.
In former times this was basically the definition of logistics, but in the past 20 years, logistics has come to mean more the downstream side of supply chain, that is the fulfilment or distribution elements (such as warehousing, transport, deliveries, customer service etc.). The more upstream side, that is the movement into the organisation, is sometimes referred to as materials management. Materials management may or may not include purchasing, which often is considered to be the domain of Finance.
Just to confuse the issue a little further, some regions of the world have slightly differing views. Thus for example, if we are in the United States, or within the confines of a US corporation, logistics is purely in the realm of the delivery side. However, in the context of Europe, or within a European company, we may well be referring to logistics as the all-encompassing supply chain, without purchasing or manufacturing. This latter function – manufacturing – may be included or not depending on the country or company, and if it is the wider term – operations may be in vogue.
In short, it is important for the manager evaluating a supply chain or logistic solution, system or contract to understand what is meant by the term being employed and to also understand what level of authority that a particular person holds when they present you with a business card with a particular title on it. It may be helpful to research the background of the person or company so that you understand their context). I normally ask the person to explain to me what their responsibilities are when they tell me their title, particularly so that I understand what authority and/or responsibility within the business they possess or even what functions they are talking about.