C. F. Lynch & Associates

Practice Financial Responsibility in Outsourcing Logistics Needs

By Clifford F. Lynch

Memphis Business Journal, April 4 - 10, 2003

A continuing, successful trend in the supply chain industry is the practice of outsourcing various logistics functions to qualified logistics service providers.

Logistics outsourcing is growing at the rate of 15 % annually. But with the slowdown in the economy and the recent bankruptcies and fiscal irresponsibility of several large U.S. firms, companies contemplating outsourcing are becoming more concerned about the health of logistics service providers.

While not as widely publicized as the Enron, Tyco and World Com problems, the third party industry has seen its share of financial difficulties. Many of todayís outsourcing contracts are quite large, and firms are finding, sometimes the hard way, that some providers simply to not have adequate financial resources.

A recent example is the recent bankruptcy of Computrex, a large freight bill audit and payment firm, which left its clients liable for as much as $25 million in unpaid freight bills. Shippers had already paid many of those bills, but they may have to pay them again because freight payment companies are agents of the shipper, and the payment obligation is not met until the carriers receive the funds.

I believe that the industry is, for the most part, financially stable. Such isolated failures should not taint the industry any more than the problems of Kmart should spell doom for all retailers. But these occurrences do demonstrate the importance of conducting thorough financial due diligence when selecting a third-party provider.

This can be a relatively straightforward matter if you need to investigate a provider that is publicly held, such as FedEx or UPS. But most providers are privately held and there is a reluctance, if not absolute refusal, on the part of many owners to reveal financial information.

The cost of an outsourcing start-up can be quite high, particularly in the information technology area. The value of many of the products being handled is quite high as well, and an undercapitalized provider can find itself in trouble very quickly.

It is absolutely critical that the outsourcing firm satisfy itself of the providerís financial stability before a contract is signed. Some providers will furnish serious prospects with audited financial statements before the final agreement and every year thereafter. Others provide banking information, which sometimes can be helpful but is not always an absolute indicator of financial health.

While there will always be some risk in outsourcing, there are a number of steps that can be taken to minimize an outsourcing firmís financial exposure.

Insist on inspecting audited financial statements.

Make sure the statements are examined by qualified financial personnel of the prospective client.

Investigate the reputation of the auditing firm used by the provider.

If funds are to be advanced, such as in the freight payment business, be sure that funds are not co-mingled. Also find out what types of investments are made (with your money) by the provider.

Determine if bond coverage is available. If so, make sure that bonds adequately cover the risks. Some coverage, for instance, applies only in the event of theft or conversion.

Explore the possibility of establishing minimum limits on financial assets. In other words, an outsourcing firm may decide it will not enter into a relationship with a provider that does not meet a certain net worth threshold.

Consider awarding contracts only if the total value of the contract is below a certain percentage of the providerís total revenue. An LSP should not be too reliant on one or two clients.

Whatever methods are used, thorough financial due diligence must be at the top of the list when qualifying potential providers. Todayís supply chain initiatives are complex and expensive and should be considered with the same care as any other large financial transaction of a firm.




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