Outsourcing of logistics functions_a literature su

Outsourcing of logistics functions 89Outsourcing of logistics functions: a literature surveyMohammed Abdur RazzaqueDepartment of Marketing, National University of Singapore, Singaporeand Chang Chen Sheng YCH Group of Companies, SingaporeIntroductionManagement of logistics functions in modern organizations involves decision making for the complete distribution of goods and services in the marketing function (Watson and Pitt, 1989) with a view to maximize value and minimize cost. A growing awareness that competitive advantage comes from the delivery process as much as from the product (Muller, 1991a) has been instrumental in upgrading logistics from its traditional back-room function to a strategic boardroom function (Foster, 1994). The following reasons have been proposed to explain this trend:•There is a growing need to be more responsive to customer service and market demand (Horne, 1989). As an integrative concept that cuts across the traditional functions of the business (Christopher, 1993), logistics can deliver better customer service.•Logistics activities involve a large commitment of capital.•The logistics function can be the key facilitator in the cross-functional effort towards supply chain integration (Harrington, 1995a). Hence it is not surprising that concepts such as supply-chain management have now assumed strategic importance.In order to handle its logistics activities effectively and efficiently, a company may consider the following options.(1)It can provide the function in-house by making the service.(2)It can own logistics subsidiaries through setting up or buying a logistics firm (Candler, 1994).(3)It can outsource the function and buy the service.Currently, a growing interest in the third option, i.e., outsourcing has been indicated by the volume of writings on the subject in scholarly journals, trade publications and popular magazines. Although its evolution is “one of the most widely discussed contemporary topics in the field of business logistics” (Lieb,1992, p. 29), efforts to organize them in an integrated broad-based body of knowledge have so far been rather limited. With the exception of a very recent International Journal of Physical Distribution &Logistics Management, Vol. 28 No. 2, 1998,pp. 89-107. © MCB UniversityPress, 0960-0035Received June 1997Revised April 1998IJPDLM 28,290publication by Sink and Langley (1997), most other publications in the area either focus on specific aspects of third-party logistics, or are narrow in their scope and objectives. This paper makes an attempt to bridge the gap and aims at developing a comprehensive literature on outsourcing.Outsourcing: definition and evaluationOutsourcing, third-party logistics and contract logistics generally mean the same thing (Lieb et al., 1993). Jon Africk of consultants A.T. Kearney has defined them as multiple logistics services provided by a single vendor on a contractual basis. They offer “at least two services that are bundled and combined, with a single point of accountability using distinct information systems that are dedicated to and integral to the logistics process” (Bradley, 1994c). It should, however, be noted that outsourcing “may be narrow in scope”and limited to one type of service (e.g., warehouse) only (Lieb et al., 1993). According to Bradley (1994a) there is no difference between outsourcing logistical functions and any other procurement process. He asserts that like a reliable supplier of materials and parts, contract logisticians should also provide a high level of customer satisfaction so that their clients can become a tougher competitor.Traditionally handled by the firms internally as support functions, logistics activities such as transportation, distribution, warehousing, inventory management, order processing, and material handling have been given low priority compared with the other business functions. However, the need for developing sustainable competitive advantage, the growing emphasis on providing good customer service effectively and efficiently, and the strategic value of focusing on core businesses and re-engineering (Hill, 1994; Lieb, 1992; Sheffi, 1990) resulted in the evolution of contract logistics which is very different from traditional logistics (see Table I).Service considerations and outsourcingQuality of a logistics system has often been equated with service quality (TM Staff, 1991). As part of its strategic positioning process, a company must choose its customer service strategy; and developing logistics excellence is an important option through which customer satisfaction can be achieved (Kearney, 1994; Schary, 1992). Consistent service at the appropriate level is the natural output of a strategically focused, well-designed and well-run logistics system. Such a system has extraordinary power in achieving goals such as high-quality service despite some cost constraints or low cost despite some service constraints. The logistics system of the company can be differentiated to produce its target service level (Byrnes et al., 1987). The close relationship between logistics and customer service, and its effects on a firm’s competitiveness dictate that companies handle their logistics function prudently so as to achieve its full potential as a source of competitive advantage. Outsourcing the function appears to be an important mechanism to realize that objective.Outsourcing of logistics functions 91Drivers of outsourcingOf the many factors that may act as driving forces behind outsourcing,globalization of business has been viewed by many (Byrne, 1993; Foster and Muller, 1990; Rao et al., 1993; Sheffi, 1990; Trunick, 1989) as the most prominent.The continued growth in global markets and foreign sourcing has placed increasing demands on the logistics function (Bovet, 1991; Cooper, 1993;Fawcett et al., 1993; McCabe, 1990; Whybark, 1990). Consequently, it has led to more complex supply chains (Bradley, 1994a) and has involved more transportation and distribution managers in international logistics. Lack of specific knowledge of customs and infrastructure of destination countries forces firms to acquire the expertise of third-party logistics vendors.The increasing popularity of just-in-time (JIT) principles is another major factor promoting outsourcing (Goldberg, 1990; Sheffi, 1990; Trunick, 1989).With the shift to JIT delivery, inventory and logistics control have become even more crucial to manufacturing and distribution operations. The complexities and costs of operating in a JIT environment are prompting many of its potential adopters to supplement their own resources and expertise by using sources outside their corporate structure.Trunick (1989) suggests emerging technology and versatility of third parties as two other important drivers of outsourcing. Since it would be time consuming and expensive to develop and implement new technologies in-house,firms can easily employ those of a third-party. On the other hand, versatility of the third parties enable them to provide an improvement in control, technology,and location, turning fixed costs into variable costs. They have the ability to reconfigure the distribution system to adjust to changing markets or technological advances. Small companies tend to be more interested in third-party use (Maltz, 1994) since they are in greater need for expertise and assistance in the area of technology (Harrington, 1995b). The KPMG PeatTraditional servicesContract services Not tailoredTailored Usually one-dimensional – trucking orAre multi-dimensional, linking transportation, warehousing for examplewarehousing, inventory management, systems and others Shippers aim to lower transportation costGoal is to lower total cost while providing through a contractbetter service and more flexibility Contracts tend to run for a year or two Contracts are more likely to be of longerduration, multi-year arrangements negotiatedat a higher management levelRequire expertise in, say, transportation ofRequires broad logistics and analytical skills packaged materialsContracts generally take less time to negotiate Contracts generally take more time to negotiate Simpler arrangement and relatively low Complexity of arrangements leads to higher switching costs switching costsSource:Adapted from Jon Africk of A.T. Kearney consultants, quoted in Bradley (1994c)Table I.Differences between traditional and contract transport serviceIJPDLM 28,292Marwick’s third annual logistics benchmarking study shows that cost control, followed by information technology and inventory management are the major logistics concerns in respondent companies, and as such, have resulted in further emphasis in outsourcing (Bradley, 1995a). Many other logisticians have suggested various other reasons for outsourcing. A representative list of these reasons is presented in Table II.Importance of outsourcingA recent survey by Lieb and Randall (1996) found that the CEOs of third-party logistics companies perceived growing customer interest in outsourcing as the top industry dynamics. This awareness of contract logistics’ role has been instrumental in compelling the logisticians to learn to adapt to this new intrusion into their territory (Gooley, 1994b). Since firms can often replicate or improve on a competitor’s offering with relatively little difficulty, gaining sustainable advantage through product differentiation is rare. Also, it is harder to compete on manufacturing excellence alone. Outsourcing can contribute to profits by enabling users to gain competitive advantage, adding measurable value to products, enhancing customer service, assisting in opening new markets, and providing dedicated resources (Foster and Muller, 1990). Third party logistics providers can enhance value creation for customers leading them to become more competitive and profitable through speedy and superior Drivers of outsourcing Identified by Improved productivity measurementsIncrease in cost-efficient foreign competitionManagement demand for a financial contribution from all sectors of thecompanyMergers and acquisitions that require keeping assets off the booksNeed to move inventory fasterNeed for flexible productionRetrenchment to core business Muller (1992)A company’s need to assess present and future market prospects for itsproductCompany restructuringDevelopment of supply chain partnershipsIncreasing customer demands andIncreasing environmental awarenessTo determine the products’ competitive advantage in the marketplace Byrne (1993) Change in managementExisting facilities and/or systemsExpanding into unfamiliar markets andTaking on new product lines Maltz (1995) The success of firms using contract logistics Bradley (1994a) The focus on temporal aspects of logistics management Cooke (1994b) Trend towards centralized distribution systems Bence (1995)Table II.Some reasons for outsourcingOutsourcing of logistics functions 93customer service (Daugherty and Pittman, 1995). Value creation involves the understanding of the dynamic interaction within the customer’s supply chain.One of the most important reasons for employing third-party logistics providers is their ability to provide their clients with expertise and experience that otherwise would be difficult to acquire, or costly to have in-house (Byrne,1993; Dillon, 1989; Goldberg, 1990; Richardson, 1990; 1992; 1993a; 1993b;Sheehan, 1989; Trunick, 1989). Their expertise gained from working with other clients allows users to benchmark against other companies and may lead to opportunities to lower costs and improve customer service. It is believed that a contract logistics company with national and regional expertise can even provide a customer a local image even though that company may have no local presence in assets and logistics employees (Bradley, 1994b; 1994c). With the contract logistics firms as their advisors and innovators, companies can gain since the former “add value that translates to profit” (Wood, 1993).At the strategic or management level, companies lacking sophisticated information systems might look to outside sources for database management techniques used in forecasting or for handling the information flow loop (Richardson, 1990). Use of contract logistics enables firms to spend more time to pursue strategic planning and management issues, and focus on their core business competency, rather than on logistics (Africk and Markeset, 1996;Foster and Muller, 1990; Lynch et al., 1994; Richardson, 1992; Saw, 1995;Sheehan, 1989; Trunick, 1989).Types of contract logistics vendorsAccording to Goldsmith (1989), public warehousing may be the oldest form of outsourcing in logistics. Later, Richardson (1992) added marketing, packaging,transportation, distribution, import and export to this list. This is justifiable since third parties do have some role in determining where goods are stored,how they are packaged for shipment, and in choosing the best mode for transporting them to the customer (Hill, 1994). Since the third-party providers are also increasingly being utilized for value-added activities such as assembly and quality control (Fawcett et al., 1993) the list is, however, expanding. Some companies are not involved in moving goods at all: they sell software and consulting services that help their customers develop their own efficient transportation networks. Others handle chores such as paying bills and tracking costs of transportation for their customers. Many third-party logistics companies have been found to offer services such as logistics information systems, shipment consolidation, warehouse management/operation, carrier selection, rate negotiations, fleet management/operations, product returns,order fulfillment, customer spare parts, vendor selection and purchasing (Lieb and Randall, 1996).Muller (1993b) appears to be the first to propose two basic types of contract logistics service providers, i.e., operations-based and information-based third-party logistics vendors. Later, Muller (1993a) himself modified this classification scheme by suggesting the following four types of vendors:IJPDLM 28,294(1)Asset-based vendors. Companies which offer dedicated physical logisticsservices primarily through the use of their own assets, typically a truck fleet or group of warehouses or both.(2)Management-based vendors. Involved in offering logistics managementservices through systems databases and consulting services, often acting as a subcontracted traffic department, either for part, or all, of a client’s business segments. These firms do not own transportation or warehouse assets.(3)Integrated vendors. These companies own assets, typically trucks,warehouses or a combination of both. They are not, however, limited to using those assets, and will contract with other vendors on an as-needed basis.(4)Administration-based vendors. Firms which mainly provideadministrative management services such as freight payment.This classification scheme is similar to a more recent one proposed by Africk and Calkins (1994) endorsing that asset-based and non-asset-based providers are the two main types of third-party logistics service providers along with a third type providing hybrid services. The asset-based providers could either be capacity-dedicated or assets-dedicated. In the capacity-dedicated situations, the provider commits to meeting certain volume and service levels specified by the buyer, but will use its assets to serve multiple customers. In the assets-dedicated situations, the equipment or facilities service only one customer. The buyer makes a trade-off between a lower price for the capacity-dedicated project, and greater assurance of meeting service requirements with assets-dedicated undertakings. In contrast, the non-asset-based providers generally do not own or lease physical assets but provide human resources and systems to manage the buyer’s logistics function. The hybrid services providers are subsidiaries of asset-based contract logistics companies generally specializing in project-based services with some of the physical services offered by the parent company. In terms of their service offerings and relationships with buyers, the hybrids lie somewhere between the asset-based and non-asset-based competitors.There are many benefits of choosing asset-based service providers (Africk and Calkins, 1994). They:•have the knowledge and experience in handling and maintaining equipment, facilities, and physical operations;•can pass on savings to users; and•help to reconfigure operations to improve efficiency, reduce costs and/or improve service.On the other hand, many of the management companies generally tend to focus on a niche, such as international or domestic in-bound logistics. They are a logical alternative when value addition results from co-ordination and integration of flows rather than from a core service such as transportation orOutsourcing of logistics functions 95warehousing (Bradley, 1994c). It should be noted that no one category of the logistics vendors is inherently superior to another. Buyers should have knowledge about the various providers and make a selection based on their own goals and needs (Muller, 1993b; Sink and Langley, 1997). It has been advocated that instead of focusing on the service providers’ assets, firms should consider their skills, and see how those skills compliment what the firms have in-house (Minahan, 1995).Advantages of outsourcingOutsourcing offers many advantages to those using it. It reduces capital investment in facilities (Foster and Muller, 1990; Richardson, 1992; 1995),equipment (Fantasia, 1993; Foster and Muller, 1990; Richardson, 1995),information technology (Fantasia, 1993; Goldberg, 1990; Lacity et al., 1995;Richardson, 1995; Sheffi, 1990; Trunick, 1992) and manpower (Foster and Muller, 1990; Richardson, 1992; 1995). This allows the using firm greater flexibility in adapting to changes in the market and access to leading edge technology (Lieb, 1992; Sheffi, 1990). Firms only need to contract for the necessary level of service to meet current demand. When demand surges beyond the capability of a firm to fulfill, a third-party may be called in to help the firm. Thus, the contract logisticians convert a fixed cost to a variable cost for users (Bradley, 1994b; 1994c; Richardson, 1993a).By coordinating production and shipping schedules, outsourcing reduces inventory and improves inventory turnover rate (Richardson, 1990; 1995)resulting in faster transit times, less damage, and less paper work. Contract logistics also enables firms to respond quickly to marketing, manufacturing,and distribution changes (Byrne, 1993) and helps to improve on-time delivery (Richardson, 1995).Third-party logistics users generally agree that it costs less to use such firms than to carry out the same functions in-house (Candler, 1994; Lieb, 1992).Logistics being their core business, these firms can lower costs by being more efficient than a manufacturer (Bradley, 1994c; Lieb, 1992). Since the use of an outside multiple service provider reduces the needed multiple service contacts for the firm to a single point of contact (Richardson, 1990), coordination costs are also reduced. In a recent Purchasing Magazine survey, more than 50 percent of the participating contract logistics users cited cutting transportation/distribution costs, freeing up or reducing staff, focusing on the core business and cutting internal administrative costs as major reasons for using third-party logistics. Other reasons cited included acquiring outside expertise,consolidating services, improving service to the company, improving customer service and satisfaction, simplifying the logistics process, avoiding capital expenditures, using provider’s logistics information systems, increasing productivity and reducing number of service suppliers (Bradley, 1995a). This study reveals that reasons for outsourcing have not varied much over the years.IJPDLM 28,296Obstacles and problems in outsourcingJust as there are many reasons that favor outsourcing, there are many others that discourage its use. Loss of control to third-party provider(s) appears to be the most commonly cited reservation that inhibits firms from using contract logistics (Bardi and Tracey, 1991; Bowman, 1995; Byrne, 1993; Cooke, 1994b; Lynch et al., 1994; Richardson, 1993a). However, in reality firms do not totally relinquish their control as outsourcing does not absolve firms of the need to monitor their vendors (Bowman, 1994). The two sides need to meet frequently to map strategy and resolve problems as they arise. Byrne (1993) adds that the lack of advanced information technology linking manufacturer, carrier, warehouse, and customer operations has often caused hindrance to contract logistics management.Besides losing control, losing touch with important information, failure to select or manage providers properly, unreliable promises of the providers, their inability to respond to changing requirements, their lack of understanding of the buyer’s business goals and difficulty of changing providers have also been cited as potential problems by their users (Bradley, 1995a).A major obstacle to outsourcing is the difficulty of obtaining organizational support (Bowman, 1995). Management’s lack of confidence in an outside company to deliver service at as high a level as the company employees is a major issue: the third party may be inadequate in its capabilities to meet users’requirements (Cooke, 1994b; Maltz, 1995). Difficulty of assessing the savings to be gained through outsourcing creates additional problems. Also, the use of an outside firm may make the firm’s logistics people apprehensive about their job-security: they may develop a fear of being retrenched (Cooke, 1988; Muller, 1991b).Companies planning to outsource their logistics function must address each of these issues carefully, so that contract logistics can be a catalyst for improvement, rather than another problem to handle. By considering various aspects of the outsourcing process cautiously, firms can expect to achieve greater success with third-party logistics.Considerations in the outsourcing processThe outsourcing decision is a variant of the classical make/buy decision (Maltz and Ellram, 1997): companies can either invest in building a logistics organization, or they can contract this function out (Sheffi, 1990). Heinritz et al. (1991, pp. 161-6) consider factors related to quality, capacity, labor, scheduling and skill to be important in a make-or-buy decision. The firm also needs to determine the benefits of outsourcing according to some criteria, such as, return on assets (Trunick, 1989) and include the risk factor in the sourcing decision (Bradley, 1994c). Other considerations include fit with corporate objectives; strengths and strategy; social, political and environmental concerns; secrecy and market conditions (Leenders and Nollet, 1984).To make use of external logistical services to their greatest benefits, firms must first understand the various types of logistics functions that may beOutsourcing of logistics functions 97outsourced. The next step involves the evaluation of these functions to choose the specific ones for outsourcing (Dobler et al., 1984, p. 95). Decision-makers need to know how their product and the organization can be affected by outsourcing the logistics function. They need to gain insight into key issues relating to the acquisition of these services (Sink and Langley, 1997). Goldsmith (1989) believes that the best way for a firm to begin to assess its current logistics capabilities and needs is by posing a series of questions. Some of the key questions are:•What are our company’s most significant logistics considerations:Competitive position? Bottom-line cost? Inventory control of finished goods?•Do we have adequate manpower for these functions? Do we have aknowledgeable logistics staff, enough support, and third-party help?•Have we made a current cost-benefit analysis of internal staffing versusoutsourcing to accomplish our goals?The answers, or even the process of reviewing these questions, should provide top management with an understanding of the strengths, weaknesses and future needs of its logistics operations. Companies should choose third-party logistics providers by matching up the needs of their companies with the essential competencies of the potential logistics service providers (Buxbaum,1994).Copacino (1994a; 1994b) presents a comprehensive framework to help managers in assessing how their logistics decisions will affect their companies’operations at the strategic, structural, functional, and implementational levels.It addresses customer service issues at the strategic level; channel design and network strategy issues at the structural level; warehouse design and operations, transportation management, and materials management issues at the functional level; information systems, policies and procedures, facilities and equipment, and organization and change management issues at the implementational level. Use of this framework helps companies to decide whether to make or buy logistics services. It should, however, be noted that the factors critical to the design of a logistics structure include:•an accurate definition of customer service;•some inside knowledge on competitors; and•flexibility of the structure to incorporate a speedy response to futureneeds of the existing or new customers (Bingham, 1994).Modeling, a more objective and systematic method to determine make-or-buy,has also become an integral part of logistics analysis and decision making.Optimization (Powers, 1989), heuristics (Ballou, 1989) and simulation models (Bowersox, 1989) may be instrumental at this juncture. A buy decision prompts the firm to determine, explicitly, its reason(s), measurable objective(s) and requirement(s) for outsourcing (Bowman, 1995; Maltz, 1995; TrafficIJPDLM 28,298Management, 1992; Trunick, 1989). It is essential to take into consideration whether the firm plans to be a service leader or compete on costs. The firm must ask whether it needs someone merely to take over discrete functions, such as warehousing or transportation, or to revamp a distribution operation. More specifically, a thorough evaluation of how the functions that have been selected to be outsourced have been performing in-house is a must. It is crucial to match a third-party’s strength to the firm’s weaknesses. The firm needs to determine how well these services can be integrated into its operations (Trunick, 1989). Achievement of a high level of customer service demands a match between a firm’s logistics requirements and the offerings of the logistics providers.After choosing the logistics function to be outsourced, the firm is required to select from among the prospective vendors. Following this would be the negotiation stage (Heinritz et al., 1991, pp. 150-59). Some key ingredients in a logistics contract are competitive rates, equipment needs, service standards, extraordinary items, e.g. special handling for products, escape clause to terminate contract, provision for performance reviews, provision for reports, options to extend the length of the contract term or increased pricing and insurance requirements (Richardson, 1993d).Selection of third-party logistics providersOne of purchasing’s paramount responsibilities is to select a capable group of suppliers (Dobler et al., 1984, pp. 95-112; Soukup, 1987). According to Maltz (1995), a proper supplier selection procedure is critical for two reasons:(1)Good procedures will maximize a firm’s chances of picking the thirdparty most suited to its needs.(2)Correct procedures will insure that all the stakeholders can contribute tothe selection and as a result, accept the final choice.Hence, understanding the characteristics and capabilities of third-party logistics providers, appears to be a logical first step in this selection process. An effective selection process uses cross-functional teams to evaluate and review third parties. There should be a constant effort in measuring the performance of the service providers and the firm’s entire logistics operations (Foster, 1994). Some important criteria that are commonly used in the evaluation of third parties include:•Ability to provide highly detailed logistics data preceding, during and following shipments (Bradley, 1994b; Cuthbertson, 1995; Maltz, 1995).•Business arrangements, e.g. incentives for performance, replacement of equipment, etc. (Bradley, 1994a).•Business development, e.g. accounts gained and lost (Bradley, 1994a).•Business experience, e.g. how long in the third-party business, depth of management experience, the strength of operating management, the quality of the work force, etc. (Bradley, 1994a; Harrington, 1994).。