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Outsourcing 2002

By Clifford F. Lynch

Logistics Management, June 2002

In Europe, a number of logistics service providers can trace their origins back to the Middle Ages. The first commercial warehouse operations were built in Venice, Italy in the 14th century. Merchants from all across Europe used them as collection and distribution points.

In the United States in the 1930’s, Al Capone, in an effort to keep his associates out of harm’s way, outsourced the smuggling of liquor from Canada to Chicago. Since most shipments were subject to hijacking and other unpleasantness, Capone minimized his risk through strategic alliances with fledgling ambitious and aggressive service providers.

During the 1950’s and 60’s, the outsourcing of transportation and warehousing was common. The relationships were, for the most part, transactional and almost always short-term in nature. 

The decade of the 70’s emphasized improved logistics productivity and cost reduction. CLM, then NCPDM, commissioned a study to research productivity, or lack thereof, in the logistics industry; and as firms made progress in this area, we began to see longer-term outsourced relationships, particularly in the warehousing area. 

In the early 1980’s, the services offered by the outside firms expanded rapidly; and so-called value-added activities such as packaging, blending, systems support, and inventory management became commonplace. The growth of the club stores, with their special packaging requirements, resulted in particular emphasis on this “value added” area.

By 1990, outsourcing had picked up a significant amount of momentum, which continued throughout the decade.

According to Bob Delaney and Dick Armstrong, our industry statistical gurus, the logistics service market increased from $10 billion to $25 billion between 1992 and 1996. Much of this growth was because firms were placing more emphasis on outsourcing; but one of the major reasons for the increased activity was the increased sophistication of the logistics service providers themselves. Today’s logistics service provider is a sophisticated firm, offering the latest in information technology, facilities, transportation equipment, order and inventory management, and materials handling techniques. Some of these firms, such as Schneider Logistics, have moved far beyond their core origins and are offering state-of-the-art technology and visibility of activity throughout the supply chain.

By the year 2000, we were just starting to get a little comfortable. The outsourcing activity continued to expand; and according to Dick Armstrong, by 2000, the market size had more than doubled again to $56 billion. But like a bolt from the blue, internet retailing was upon us. Almost overnight, it seemed that internet retailing firms were taking millions of orders with, in many cases, non-existing distribution systems. A large number of these companies turned to third parties, and there was a significant growth in the so-called order fulfillment sector of the provider industry.

Brian Ferrin, who at that time was Chief Imagineer for Walt Disney said:

“Trying to assess the true importance and function of the Net now is like asking the Wright brothers at Kitty Hawk if they were aware of the potential of American Airlines Advantage Miles.”

So where are we now? Or more importantly, where are we going?

The predictions are mixed. Accenture, in a recent survey conducted with Northeastern University, concluded that outsourcing would continue to expand. 

J. P. Morgan, in another recent survey, concluded that the percentage of supply chain activities outsourced is expected to remain stable over the next five years, suggesting at least slower growth than we have seen previously. The annual Cap Gemini/Ernst & Young survey confirmed stability, but with limited growth.

Finally, Dick Armstrong suggests that at least for 2002 growth will be flat, compared to the 15 to 20 percent increases we have seen during the past ten years.

I think these results tell us that while there will not be a downturn, nevertheless, there are some concerns. The indications are that now is not the time for a provider to become complacent.

Clients want their providers to take on more meaningful strategic roles. Most large corporations have strategic plans. Most providers do not. Part of this, of course, is due to the nature of the business, but many firms have a planning horizon of one afternoon. I would suggest that it probably is more important that providers have a strategic direction than it is for their clients. Prospective clients want providers to have a well-grounded knowledge of their particular industry and a strategy for maintaining and expanding on it. They must have commitment and direction.

As firms have more significant global needs, they are looking to providers to be responsive to those needs and provide global supply chain services. This will require the providers to do one of two things. Either they must expand their own offerings, which some of them simply are not capable of doing, or they must form responsible alliances with firms who do have global capabilities.

Many potential clients do not believe that the third party industry is providing leadership in the area of information technology. At the same time, they have high expectations. The providers who have the resources and expertise to provide this leadership will be the most successful.

Another important concern is financial stability. Many of today’s contracts are quite large, and outsourcing firms are finding, sometimes the hard way, that some providers don’t have sufficient financial resources. There have been too many recent examples of logistics service providers seeking bankruptcy protection and leaving clients in critical situations.

In spite of this, the industry is, for the most part, financially responsible. As protective measures, however, some user companies have placed minimum limits on financial assets, and others have adopted a policy of awarding contracts only if the total value is below a certain percentage of the provider’s total revenue.

These examples do not indicate a serious, ongoing problem, but they do demonstrate that increased due diligence will be critical.

I do not think that any of these concerns are significant enough to cause a decline in outsourcing. I do believe that prospective clients are going to be more cautious and thorough in their investigation of outsourcing in general, as well as specific providers.

To me, the major concern about the future is our seeming lack of ability to manage these relationships effectively. While outsourcing successes have been numerous, there are far too many less-publicized failures. I firmly believe that the major cause of failure in third-party relationships is the client outsourcing functions it does not totally understand to providers who agree to accept responsibilities they don’t totally understand – with no emphasis on the ongoing relationships.

Notwithstanding all this, logistics outsourcing will continue to play a very important role in our supply chain management activities. It will, however, be approached more cautiously and with more thorough due diligence than possibly it has been.

The success of individual firm outsourcing efforts will hinge on the ability to select the right provider, and most of all, manage the relationship so that it maximizes the benefits to all.

 

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