Getting Outsourcing to Work in the Supply Chain

Popularity of Supply Chain Outsourcing
Outsourcing of supply chain functions and ultimately the supply chain in its entirety are popular now and inevitable for many companies in the future. Several critical business factors lead to this conclusion. First, the very name 'supply chain' implies linkage; initially between internal functions, and, more importantly, to suppliers and customers. Outsourcing, is an inevitable result of the supply chain.

Further, as a matter of course, the management of corporations focuses on core capabilities, eliminating from direct control those activities which can be done effectively elsewhere. And for most organizations, supply chain functions fall into that category. Certainly, from the point of view of 3PL, the range of skilled suppliers is substantial.

Due to the ever-increasing emphasis on short-term profitability, asset-based activities are of the highest priority for outsourcing. Expanding on this situation is the recognition that the asset turnover, as measured by return on assets, equity, or investment, grows substantially when facilities and equipment are removed from the equation, and when significant investments in hardware and software can be avoided.

In addition, outsourcing benefits from the recognition that a third party is more likely to keep abreast of technology, whether in information, material handling, or operating equipment.

Finally, recognizing the rapid changes in industry standards, to say nothing of virtual overnight shifts in distribution channels, it is appropriate to deal with organizations whose entire focus is on supply chain operations. Agility in these organizations, whether it is obtained through the flexibility of one supplier or access to others who could quickly replace it, can allow a company to respond far more rapidly than if it were tied to its own locked-in infrastructure.

Statistics bear out the success of supply chain outsourcing, popularly called 3PL. According to research conducted by Mercer Management Consulting, Northeastern University and Cranfield University, some 65 percent of logistics managers interviewed state that their company uses some form of 3PL. Although the number flattened in 1998, it has grown dramatically since the survey began in 1991.

Plenty of problems
Outsourcing both the fully integrated supply chain and the individual supply chain functions have been extremely problematic. By its nature, the activity of outsourcing includes at least two separate organizations that traditionally have their own dictionaries of terms, information capabilities, charts of accounts, operating philosophies, priorities, work paces and cultures. In addition, although outsourcing relationships are intended to be long lasting, they are subject to countless partner changes in priority, levels of urgency, and strategic direction.

As a result, outsourcing relationships often start poorly, and a poor start leads to an ineffective relationship. According to the Mercer/Northeastern/Cranfield survey, CEOs of 3PL providers state that implementation is their number one problem. They highlight the lack of agreement on requirements and expectations, often borne out of inconsistent definitions and measurements. They also mention the difficulty in overcoming client resistance to change. These problems, coupled with a consistent complaint of poor data, and the re-occurring problem of staff turnover, leads to serious implementation difficulties.

To make things worse, executives representing both sides of the relationship complain about a poor match in systems, often as a result of different technologies or poorly communicated technology changes at one partner. In short, both sides claim that the other is not living up to expectations, and both sides usually are correct.

3PL Relationships are not Long-Lasting
Once a 3PL relationship has been established, it usually erodes rather than ends suddenly. Quite often the situations upon which the 3PL partnership was based change significantly. For example, either side could be affected by an acquisition or merger, generally causing a refocus or at least a disruption in continuity. In addition, successful relationships often are affected by management change. Generally, leaders of successful 3PL relationships are recognized by their organizations and are promoted. Although good news for the individual, quite often these promotions lead to awkward adjustments as new managers are introduced. Further, the partners rarely are exempt from outside changes that are caused by new marketing strategies, new channels, different systems, and a different emphasis on measurement metrics.

From the financial community, there is constant pressure for management to focus on the short-term. Because the nature of a 3PL arrangement is long-term from the point of view of assets, but often short-term regarding the one-time effect on the profit and loss statement, 3PL managers are often faced with the question, "What have you done for me lately?". Rarely is an outsourced supply chain relationship compatible with this issue.

Undermining outsourced supply chain relationships are the technology and processes that often lead to them in the first place. For example, many relationships are justified on the basis of new operational technology, yet the very asset life of that technology may limit the supplier in terms of rolling to newer technologies when they become available. In many cases, suppliers of outsourced services find that aluminum trailers, larger rail cars, workforce seniority, or other points of original advantage become disadvantages with the passage of time and the introduction of new technologies. Unfortunately, in the supply chain outsourcing arena, there always is a competitor waiting in the wings to offer a better deal.

Successful management of an outsourced supply chain relationship requires a special level of care in dealing with these issues.

Inconsistent Objectives
It is no surprise to recognize that the CEOs of 3PL suppliers are under huge pressure to secure more growth in earnings. In the Mercer/Northeastern/Cranfield survey, the CEOs of 3PL's state that they are under far more performance pressure each year. From 1997 to 1998, performance pressures from their parent companies were up 140 percent, while new 3PL competitors increased by 83 percent. Further, growth projections are lower than they have been in the past.

The response of the suppliers of outsourced supply chain services is to focus on revenue growth from value-added services, and they have regularly stated that this is their area of primary marketing focus. On the other hand, users of outsourced supply chain services state that their direction is toward focusing on more basic or commodity services. Their objective is to greatly reduce the use of value-added services. Finally, since most growth in outsourced supply chain services will be outside of North America, and since global growth overwhelmingly focuses on basic services, the mismatch in the beliefs of suppliers and users of outsourced supply chain services will accelerate.

What can be Done?
The challenge facing both providers and users of supply chain services is massive. Nonetheless, the direction toward outsourcing is inevitable. Actions necessary to overcome these difficulties should be of the highest priority for every organization involved in the supply chain.

An agenda for successfully outsourcing supply chain relationships can and will work effectively if some golden rules are followed, as is illustrated in Figure 1. The challenge to management is to balance the informational, organizational, people and directional issues, with the inherent need for flexibility.

Design for Flexibility
An outsourcing relationship must exist within the world of change; new technologies, revised channels, new players, different objectives, new products, redefined services, changes among competitors, new management -- all are likely to happen before the contract comes to its conclusion.

Figure 1.	Solving the Inherent Conflicts in Supply Chain Outsourcing

From the beginning of the relationship, the process must be established for conducting regular, routine meetings to maintain clarity and direction as circumstances change ­ throughout the life of the relationship. World-class outsourcing relationships start with the basics: definitions and terminology, outline of measurement techniques, description of special relationships (internal and external) and establishment of means to review and adjust activities and expectations.

Use the Same Language
Both parties should share a dictionary of definitions so that their limited communications can mean exactly the same to each. Such is the situation in outsourced relationships, especially in the supply chain, where the third party often is interfacing with customers and suppliers, both of which are accustomed to a clear glossary of terms with the third party client.

Double Total Transition Cost Estimates
Adopting a third party supply chain relationship is fraught with costs and efforts that go way beyond initial plans. Rarely does data contain the nuggets of information that are expected by either party. Timeliness, accuracy, thoroughness, and level of detail rarely meet expectations. Further, the duplication of activities -- to validate, to check, and to correct difficulties early in the relationship -- rarely is included in the staffing estimate or schedule. In addition, although the relationship is designed to deal with the overwhelming majority of situations, even a small proportion of exceptions (very common in supply chain activities) will overwhelm the transition. Finally, those individuals who have not been involved in the negotiations and other steps leading to the transition will not have the knowledge that the participants have gained. Typically, several months are necessary to help those people transition.

Focus on People Commitments and Transitions
Change, by itself, is difficult; change which involves new people in new roles from a new organization often is overwhelming. It is no surprise that in the Mercer/Northeastern/Cranfield survey, staffing problems were ranked first among the industry's biggest problems by third party CEOs.

Such is the situation when a new third party is introduced into the supply chain. Internal managers whose very job depended on their own tight control of materials and information now are being asked to begin an arms-length relationship with 'strangers' from another company. Or, as is often the case, these individuals find themselves as employees of company, after working for their former employer for quite some time.

Involving managers and supervisors in the steps that lead up to the transition process, and making them an integral part of the regular updating and review process, will provide the opportunity for them to integrate into environment.

Be Realistic
In outsourcing relationships, the expectations at the outset tend to be unreasonably high, caused by both sides trying to secure a relationship. The supplier of services often over promises, blaming competition for forcing the situation. Often, internally, commitments are made that after time has passed, the relationship will become more profitable because of shifts in staffing, improvements in information and processes, and addition of new services offered at higher margins.

The customers for outsourcing have justified their own position on the basis of inflated savings estimates and assumptions that processes will suddenly become world-class. Unfortunately, linking into a third party supply chain relationship does little by itself to improve effectiveness, accuracy or quality of services.

Both parties, working very closely together, must lead the process to improvement. That effort costs money and will take time, and, although the benefit may be substantial, it is not going to come without significant effort.

Don't Expect IT Miracles
According to the Mercer/ Northeastern/ Cranfield survey, IT issues are described by third-party CEOs as the industry's second biggest problem. Often, customers and 3PL suppliers alike exaggerate their technology capabilities and then assume that the other organization will carry the IT burden. The reality is that most 3PL relationships start at the technology level of the weakest partner, and improvements come slowly as the data and capabilities of each partner are exposed.

Beginning with realistic technology self-descriptions and then investing the needed time and effort before transition are critically important for getting the relationship going effectively.

Be Tested, not Beta Tested
Obviously, there must be a first customer for every new service. It is advisable, however, that another company besides yours should be that first customer. The biggest disappointments in using outsourced supply chain services have come from the sale of unproven and even undeveloped capabilities. Successful relationships grow from using tested applications. During the reference checking process, it is imperative that similar applications and similar industry/channel experience has tested the approaches being recommended.

Be Sure That They Have 'been there, done that'
Generic solutions sound exciting in the early sales process, but they rarely have relevance to the specific situation being encountered in your organization. Because of competitive issues, it may be difficult to find a partner with exactly appropriate industry, channel and issue experience. Nonetheless, reviewing processes at an extreme detail level, and talking through all of the unique attributes of your company's situation are critical introductory steps which should lead to testing processes within your own environment. Working through realistic examples, step-by-step, and testing every type of exception are absolutely required before even testing process within an operating environment.

Commit to Make the Relationship Successful
In advance of any negotiation, it is critical to secure the commitment of top and middle management toward recognizing that their role is likely to continue beyond the initial arrangement. They must recognize that change in the relationship and its expectations will be inevitable, and that their role in supporting the change process when it ultimately happens will be basic to the continued success of the outsourcing relationship. Further, it is important at this critical time to secure management recognition that short-term cost reduction is primarily a one-time event. Longer-term value comes from participation and visibility of the process, and third party supplier justification will provide considerably higher value to both parties if managed for the long term.

Keep Objectives Current and Compatible

The goals that lead to the initial relationship are interpreted by the participants into a set of objectives. Unfortunately, as time passes, the objectives usually become rigid, and sight is lost of the goals. Typical relationships will encounter changes in channels, customers, competition, management, technology, and people. Successful partners regularly review their objectives and measures used to test them, recognizing that evolutionary change leads to successful results.

Review and Rebuild as a Regular Part of the Process
If both parties are insensitive to the changes in capability, technology and objectives of the other, no benefit will accrue as time passes. Rather, organizations that continually share their technologies and update accordingly can provide exceptional value in a 3PL relationship.

Don't Give Up Your Basic Skills
As companies move toward outsourcing, customary business thought has it that the outsourced skills should migrate away from the company. Obviously, the expense of maintaining the skills should be avoided by any company outsourcing its supply chain. On the other hand, loss of these skills prevents long-term re-evaluation, should it be necessary to recapture them or rethink the entire process.

Great care must be taken to maintain a management level supply chain perspective. This challenging responsibility can be handled in one of three ways:

• maintain the capability of staff
• use management consultants, academicians or recognized authorities, as required
• contract with the 3PL supplier to return staff and management in the event of the contract cancellation

Don't do it Because it's a Fad; do it Because it Works
Supply chain outsourcing is generally expected to be the single strongest direction within the supply chain community during the next ten years. That reason alone, however, is insufficient to justify having your organization move to outsourcing. Still, outsourcing may be the perfect solution for you. The decision to outsource and the process to make it successful are what should provide the impetus and the value. That decision and that process should, like every other important business decision, be based on the investment, the effort, the return, and the likelihood of success.

CONCLUSION
If outsourcing is the right direction for your organization, then setting the processes for each activity and recognizing where to provide flexibility and where to provide structure could be the difference between exceptional results and failure. Investing the time and capital at the outset and throughout the relationship is the ante for success. It's a price worth paying.

Acknowledgement
The author wishes to acknowledge and thank Hugh Randall of Mercer Management Consulting Inc. (Washington office) for providing information used in this analysis. The source is the annual survey of North American and European Third Party Logistics Service Companies conducted by Mercer Management Consulting, Northeastern University and Cranfield University, and presented annually at major transportation and supply chain conferences. A research summary and further insights into this information can be secured from Mr. Randall (202 778-7312). A summary of the survey findings is contained in Logistics, November, 1998 edition; "Third Party Logistics Grows Up", by James Aaron Cooke, Senior Technology Editor.

About the Author
Robert Sabath
(847) 475 3963
bigbobcons@aol.com

Robert Sabath is Chairman of Sabath Supply Chain Consultants, a firm focused on breakthrough excellence in supply chain effectiveness. During his 30-year career, which included long-term leadership of the supply chain practice of A.T. Kearney and of Mercer Management Consulting, Bob has gained a reputation for both creativity and skepticism in dealing with supply chain issues. His practice currently serves manufacturers and channel partners in consumer goods, food and grocery products and building products.