Making Outsourcing Worth its While

Outsourcing has become an integral part
of how logistics businesses operate in today’scompetitive environment. Effective relationship management lies at the root
of the operation and is essential if outsourcing is to be successful, writes
Dan DeSoto, Managing Director and Executive Vice President, Contract Logistics – North America, Kuehne + Nagel

The growth of logistics outsourcing continues. Some estimates put the
total outsourcing logistics market at nearly 10 per cent of the US$1.3 trillion spent on logistics related activities annually in the United States. The largest logistics service providers at present enjoy annual revenue growth rates of 10 per cent, as shippers continue to focus on their core businesses while engaging outside experts to achieve a competitive advantage. Consider this surprising statistic, however. According to the Warehousing Education and Research Council (WERC), despite the apparent win-win opportunity for service providers and shippers, more than half of all outsourced logistics contracts end within five years.

Why? We’re not exactly sure because, like many industries, we tend not to talk about failures. Perhaps we fear such notoriety might slow the outsourcing growth trend. Perhaps, it’s because failures often are perceived to typically be the fault of the third party. Outsourcers, too, are reluctant to discuss the potential lessons learned from these failed marriages and how those lessons might be brought to bear on today’s logistics environment. Make no mistake.

The rewards of a successful logistics outsourcing partnership are enormous. In the telecommunications industry, for instance, the total logistics costs for companies regarded as having ‘best-in-class’ logistics practices equal 7.3 per cent of revenues, the median being 14.3 per cent, according to PRTM management consultants. For a US$1 billion company using a third party to drive best practice performance, that difference equates to nearly US$70 million annually. A poorly managed partnership can result in a downside that is just as enormous, based on poor performance, lost sales and shattered customer confidence.

There is a proven model for successful relationship management. It involves the creation of a structured dialogue, where both shipper and service provider invest in the relationship and take a more collaborative approach throughout the process.

COURTING STAGE What happens before the search for a third-party logistics partner is the most important period in the entire outsourcing chronology. Most activity occurs in the planning stages, well before outsourcing. It’s imperative that the outsourcing company does two things: (1) clearly define its strategic reasons for outsourcing logistics and (2) gain executive sponsorship for the decision. Executive support is critical since the company actually may need to initially invest additional resources to maximise outsourcing benefits. Next, the company must clearly define specific objectives and expected benefits.

It isn’t surprising that most companies cite ‘unclear expectations’ as the main reason why logistics outsourcing deals fail. The two partners must mutually agree on the outcomes at the start of the relationship. These outcomes should not be defined solely in cost-reduction terms. Too often, outsourcing companies fail to assess the total value and revenue growth opportunities linked to an agile logistics infrastructure that drives consistent, superior customer service. In the larger picture, that may be where the most value can be found.

OUTSOURCING PROCESS Why don’t outsourcing companies invest the necessary time planning for success? Some equate ‘outsourcing’ with ‘out of my company and out of my hair’. In fact, the number one reason outsourcing relationships of any kind fail, according to the Outsourcing World Summit, is a lack of resources deployed to manage the relationship.

Companies may be outsourcing logistics to focus on their core businesses but they must develop a new core competency – relationship management.

It’s no coincidence that leaders in the area of managing logistics service providers, such as Sun Microsystems and Nortel Networks, have dedicated staff to manage their relationships with third-party providers. This staff actively monitors the relationship to ensure that the company is maximising outsourcing benefits.

Once the outsourcing company finishes the tough up-front work, the next step is choosing the right partner. Unfortunately, both parties frequently enter the dialogue in ‘buyer vs. seller’ modes. The potential pitfalls are obvious. On the one hand, companies often fail to share all the data available with their prospective partner. Third parties, on the other hand, faced with circumstances they know may lead to less than-optimum results (e.g., poor or no data), fail to push back and actively manage the data-sharing process.

GETTING HITCHED The sense of mutual ownership must extend beyond the third-party selection point. The partnership period begins in earnest during the critical 60-days-before through 90-days-after the transition point. This is a period when clear and frequent communication is essential.

Some service providers make the mistake of using a ‘SWAT’ team approach to transition management. In these instances, a special team comes in to get the operation rolling before moving on to another project after a brief transition phase. While a short-term transition team may keep all the balls in the air during this critical period, a new team cannot be expected to sustain this juggling
act.

A better model is a third-party dedicated team that works with the customer during – and beyond – the initial transition to assure successful long-term integration and sustained operational excellence. The model should be an integration team rather than a transition team.

This integration team must use documented process steps in establishing clear timelines and metrics. It must invest time to communicate clearly and often about progress, particularly in areas where objectives may slip. Good partners over-communicate rather than under-communicate.

Realistic outsourcing companies don’t expect perfection from the start. In fact, they anticipate minor hiccups as new staff are trained to understand their business’ nuances. They also invest appropriate resources to aid in the transition.

AFTER THE HONEYMOON Assuming that the shipper has taken a careful, planned approach to outsourcing part or all of its logistics functions and there is a strategic imperative to outsource, objectives are clear and the company has developed a good collaborative working relationship with its service partner, the challenge is how to manage the relationship to continue to drive superior value and results.

Most logistics service providers, asked how they manage quality assurance, can provide stacks of procedure manuals and flowcharts to assuage the most sceptical quality assurance manager. Ask the same service providers, however, how they assure quality in relationship management and you will hear words like ‘trust’, ‘communication’, ‘partnership’, and ‘honesty’. Encouraging words – but in the absence of strict disciplines, they may not translate into action and benefits. The secret is to get beyond talk and to institutionalise relationship management. Third parties must have the processes in place to manage dynamic relationships that require constant monitoring to adapt to clients’ changing needs.

Here are several specific ways both the shipper and service provider can formalise the critical process of relationship management.

• Appoint a business manager. This is the ‘relationship manager’ with overall responsibility for directing client-related activities, from strategic planning to day-today operations to customer service. They are the single access point to the third party. They must be allowed to invest the necessary time to understand the customer’s business and make proactive suggestions based on the provider’s experience. Customers want and expect this level of support from third parties.
• Drive ownership of the customer’s objectives to the operations level. Associates who handle the product must have visibility to, and understanding of, the customer objectives that drive logistics success.
  Too often the service provider does not effectively communicate objectives to the people who do the work and have the most influence on whether or not operational metrics are met.
• Assess customer confidence at different levels of the organisation. It’s important for the service provider to periodically review perceived customer value by asking, ‘How are we doing’? This review, occurring outside the day-to-day operational context, should pose these questions to both strategic-level upper management contacts and daily contacts. The service provider will often be surprised to discover that, at different levels, the customer’s perceptions of delivered value vary widely.
• Structure the relationship’s economics to drive continuous improvement. While a ‘cost plus’ pricing model is common, it does not provide incentive to the provider to continue to drive out process inefficiencies. Outsourcers and their service providers should consider a unit rate structure that rewards the provider who constantly asks, ‘How can I improve the process to do more with less’? It may be difficult to establish unit rates at the onset of a relationship but mutually agreeable rates can be determined after the business dynamics are well understood.

Contractual gain-sharing agreements are another way to drive accountability to a bottom-line level. For example, if a service provider suggests a new packing method that eliminates waste and annually saves US$100,000 in packaging costs, the provider may receive 25 per cent of first-year savings, after which all savings accrue to the customer. A word of caution: gain-sharing agreements are difficult to monitor and manage and should only be developed where there is a strong, trusting relationship between the two organisations. The biggest misperception about the longevity of third-party outsourcing arrangements is that the relationship will continue if the provider continues to meet and exceed customer service requirements. In fact, service consistency is merely the price of entry in today’s logistics environment. Customers expect their provider to consistently deliver high service quality while being agile and innovative.

ANTICIPATING NEEDS At the apex of the model, third parties not only respond to customer requirements, but also, based on an in-depth understanding of their customer’s business, anticipate needs and offer proactive
solutions. This level of strategic interaction requires a service provider equipped with the necessary orientation and commitment to this level of value. It also demands a shipper willing to embrace its service provider as a true strategic partner who is given access to strategic plans and other data.

Logistics outsourcing relationships may exist at one of three levels:

1. The third party implements one or more logistics functions, such as warehousing or transportation. Cost drives this tactical solution; the provider is viewed as a commodity.

2. The third party executes logistics functions but also adds value by designing solutions. Shippers pay more for this value-added service.

3. In its ultimate state, the company and its third-party service provider are fully integrated: at the strategic level with joint planning teams; at the operational level with cross-functional improvement teams; and at the systems level with integrated information systems that interact in real time. Here the third party designs, as well as executes, logistics strategy, becoming part of the shipper’s extended enterprise and part of its business family.

It’s at Level Three where maximum value can be derived. Of course, not all companies desire this level of integration with their logistics provider. But even purely tactical relationships can be enhanced when there is a strategic rationale for outsourcing; where expectations between shipper and provider are clear; and there are adequate resources invested and a structure in place to proactively manage the relationship. Regardless of specifics, in the end, effective relationship management is at the root of all successful outsourcing.