Distribution Outsourcing: Creating and Executing an Effective Supply Chain Partnership

WHITE PAPER Distribution Outsourcing: Creating and Executing an Effective Supply Chain Partnership By Mike Edie, Chief Operating Officer, and Joe Brady, Senior Partner, Supply Chain Edge Today s world presents a host of significant challenges that can affect companies long-term strategies and operations. Whether scarcer resources, softer demand, or hungrier competitors or all of the above myriad obstacles are challenging organizations to renew their focus on what truly differentiates them in the marketplace and drives their growth. For many companies, distribution is not such a differentiating factor but, rather, a necessary and often expensive part of doing business that can create greater value when shifted to a third-party provider. The potential benefits of such a move can include lower costs, better customer service, and greater scalability. At the same time, distribution outsourcing carries its share of risks: systems integration challenges, disruptions to customer relationships, and resistance among in-house employees, to name a few. In most instances, the benefits of distribution outsourcing outweigh the risks. But organizations still must proceed with caution. In this paper, we explore some of the key issues companies should address to prepare for and implement a distribution outsourcing relationship that can unlock a new source of sustainable business value. Distribution outsourcing: an important source of value As companies navigate an uncertain economy, success increasingly hinges on focusing talent and resources on the essential capabilities that boost market differentiation and accelerate growth. Depending on the organization, these capabilities might include R&D, customer service, finance, product management, or any other area that sets the company apart from the competition and in which it possesses deep skills. It is relatively uncommon, however, for an organization to have market-leading skills in distribution, or for that function to be a true source of differentiation. There are exceptions, of course Amazon and Wal-Mart come to mind but for many companies, distribution is simply a necessary step in the process of getting products to customers. However, it can be an expensive, labor-intensive step, especially for companies that own multiple distribution centers and a complex distribution infrastructure. For large-scale organizations, in fact, distribution typically involves a complicated array of buildings, warehouse management and picking systems, conveyor equipment, and full-time and seasonal staff. Companies for which distribution is a key point of differentiation generally have the resources and focus necessary to build the kind of mature distribution capabilities necessary to help drive differentiation. These companies tend to be very adept at measuring their distribution performance against industry benchmarks and making the appropriate investments to continually improve the efficiency, quality and technological sophistication of their distribution function. But what about other companies that tie their longterm success to strengths other than distribution? For these enterprises, outsourcing the function can deliver significant benefits (Figure 1). For instance, in nearly all outsourcing deals, one of the primary considerations if not the most important is cost. This is true of distribution outsourcing as well. In fact, according to the 2010 15th Annual Third-Party Logistics Study, reducing logistics costs is the single most important reason for companies to work with a 3PL. 1 More specifically, the study found users of 3PL services can realize substantial cost reductions in fixed assets and inventory. 2 1

Figure 1. Benefits versus risks of distribution outsourcing Lower Costs Improved Service Scalability of Operations Access to Leading Technologies Benefits Fear of Loss of Control Difficulty Integrating Systems Employee Resistance Failure of 3PL to Meet SLAs Risks Improved service is another benefit companies typically enjoy by outsourcing distribution. By replacing outdated or inefficient operations with state-of-theart capabilities offered by third parties that specialize in distribution, companies can experience improvements in service levels of as much as 20 percent to 40 percent largely driven by shorter average order cycle length and improved order fill rates and accuracy. 3 At the same time, companies that outsource distribution can gain access to cutting-edge skills and technology that often provide an instant yet lasting performance boost. Third-party logistics providers (3PLs) can spread the costs of new technologies and top talent across multiple clients, and their own market differentiation and growth depend upon their staying ahead of the capability curve. Companies that work with such providers gain access to these leading capabilities and benefit from the ongoing upgrades in which leading 3PLs invest. Conversely, companies that choose not to pair up with these companies yet have competitors that do work with such 3PLs may end up several steps behind industry benchmarks. Outsourcing distribution also boosts the scalability of a company s distribution capabilities, which is especially valuable for companies that face a high degree of seasonality. For such organizations, a 3PL can ramp its services up or down depending on the client s demand, and bill accordingly. And because 3PLs aggregate demand for multiple clients, they often enjoy scale advantages in terms of temporary labor, which further improves the bottom line for their clients. Companies that decide to outsource distribution will have many good choices when it comes to vendors. Many of today s 3PLs are adept at distribution outsourcing and can quickly and smoothly take responsibility for the function. Furthermore, while in the past many companies shared concerns that 3PLs would treat them and their customers as just another client, in our experience today s 3PLs are more devoted to service than ever. In short, by shedding capabilities that are not truly core to the business, companies can focus time, talent, and investments on what truly differentiates them in the marketplace. Consider the experience of Anchor Blue, a fashion retail chain. The company found that it lacked control over its supply chain operations, had poor visibility into the location of goods at a given point in time, and took three and a half days to move products through its distribution center all of which had a negative affect on customer service. And because stores lacked visibility into what inventory was available, they often ordered more product than necessary, inflating costs. According to Richard Space, the company s senior vice president for logistics and sourcing, In reviewing all of these issues, we decided it made the most sense to outsource the DC to a third-party logistics provider. It was clearly not this company s core competency and it was costing us a lot. 4 After successfully outsourcing distribution to a leading 3PL, Anchor Blue cut its processing costs by 42 percent while increasing its annual distribution capacity by 37 percent. At the same time, the retailer improved store delivery and, with better visibility and control, has been able to boost the speed and agility with which it can gauge customer reaction to assortments and adjust orders accordingly. 5 Given these benefits, it s not surprising that several studies show distribution outsourcing gaining respect among shippers and, in fact, becoming more integral to shippers operations. In one study, nine in 10 shippers rated their relationships with 3PLs as successful and 68 percent said 3PLs had provided them with new and innovative ways to improve logistics effectiveness. 6 In a second study, 76 percent of logistics professionals perceived their logistics pro- 2

vider as either a supply chain partner or as a trusted provider (a 15-point increase since 2008), 7 while in a third study, 65 percent said their use of 3PL services is increasing. 8 Considering the risks Despite the obvious benefits, a company should not take lightly the decision to outsource distribution. A company can face considerable challenges and obstacles when shedding its own capabilities in favor of those of a third party (Figure 1). According to the 2010 15th Annual Third-Party Logistics Study, the top reasons respondents cited for not working with 3PLs included systems integration challenges, the perceived superiority of in-house talent, feared loss of control over outsourced activities, and failure of 3PLs to meet service-level commitments. 9 In SCE s experience, resistance from current distribution function employees, as well as from senior leaders averse to making the change, is perhaps one of the most difficult challenges to overcome. Control often is at the heart of this dynamic: Retained employees naturally want control over their jobs both in the long term and from day to day, while some senior leaders believe they can derive more value from distribution by maintaining internal control over it. Yet while these sentiments may be natural, they also can hold a company back from gaining the advantages of a 3PL s greater scale and ongoing investments in new systems and capabilities. Furthermore, as the aforementioned study found, potential difficulties in integrating legacy systems with the typically newer 3PL platforms often can be a major obstacle to getting a distribution outsourcing relationship off the ground. This challenge stems from the fact that companies working with 3PLs often maintain ownership of and control over the processes and systems that support customer service, order management, and fulfillment. Although the 3PL typically conducts significant testing early in the transition to ensure smooth integration of these systems with its warehouse and transportation management systems, problems can arise when a company s internal IT capabilities are not fully equipped to support this testing and ensure that it is both timely and accurate. This can lead to serious integration issues at later stages of the implementation. Figure 2. Key steps to successful distribution outsourcing Assessment Determining if outsourcing distribution is the right choice Selection Implementation Creating the RFP and choosing the vendor Making the transition to the new outsourcing provider Inadequate pre-integration testing is just one potential cause of unforeseen issues during the transition to outsourced distribution. Problems also can arise from inaccurate, non-representative data being used to scope the relationship during the RFP process, or from fundamental changes occurring to the business before the implementation is completed, whether in terms of volumes, service requirements from the company s customers, or technical capabilities. Any such changes can affect the scope of services required from the 3PL dramatically, and consequently, alter the business case of outsourcing. Key steps to successful distribution outsourcing To minimize the risks and enhance the value a company derives from outsourcing distribution, it should follow a rigorous approach to making and implementing the outsourcing decision. Such an approach generally includes three key steps (Figure 2): determining upfront how much improvement the company stands to make by outsourcing (and, consequently, whether outsourcing would be worth it); choosing the right outsourcing provider; and making the transition to the new provider. There is much groundwork a company must do before it ultimately turns over the keys to a 3PL and begins to derive maximum value from the relationship. 3 Assessment: determining if distribution outsourcing is the right choice Before companies embark upon outsourcing distribution, they should perform a comprehensive internal aswww.supplychainedge.com

sessment to highlight specific improvement opportunities and quantify the potential benefits of outsourcing. This assessment also can serve as a useful guide during the preparation of requests for proposals (RFPs), and during the implementation itself as benefits are measured. While this process can take a variety of forms, SCE has found that a highly effective assessment utilizes input from a wide range of stakeholders, including employees, suppliers, and customers. A company can capture such input via a Web-based survey tool that gathers and compares perceptions from customers, suppliers and employees on the importance of, and the company s performance against, supply chain competencies. For each competency such as customer responsiveness, demand planning, performance measurement or employee development each group of stakeholders is asked to assess the effectiveness with which the company currently performs the activity, and how critical the activity is. The results of this survey enable companies to uncover opportunity gaps and differences in perceived supply chain performance across the organization, thereby laying the groundwork for actionable improvement plans. By exploring these survey results via in-depth group discussions and one-on-one executive interviews, a company can identify the specific supply chain improvements that will generate the greatest benefits, and help illustrate if and where outsourcing could help accelerate the attainment of those benefits. (For more details on this assessment process, see the SCE white paper From Insight to Improvement: A Powerful Approach to Supply Chain Alignment and Assessment. ) Before companies outsource distribution, they should perform an assessment to find improvement opportunities and quantify the potential benefits. One of the factors that can have a major influence on the actual value delivered by outsourcing is directly related to the current economic situation: the sluggish commercial real estate market. Part of the value proposition of outsourcing distribution is the chance to divest expensive distribution centers and the fixed costs they entail, and shift operations to facilities owned by the 3PL. However, as companies increasingly adopt this strategy, the already glutted real estate market must absorb an increasing number of such facilities, driving down their value and stretching the time required to sell them. One way to address this concern is for the company to retain its existing distribution centers and have the 3PL manage them. However, by choosing this path, the company will forgo some portion of the scale economies promised by the 3PL s multi-client facilities, and it may encounter higher start-up costs. The results of this first step should demonstrate clearly how much a company could save by outsourcing. In SCE s experience, under most circumstances a distribution outsourcing arrangement should reduce a company s base-level costs (in key areas such as IT, labor, inventory and asset carrying, and capital improvement) to operate the function. If it can t, the company should reconsider whether the risks and effort of shifting its distribution operations to a third party are worth the value they will gain in return. Selection: creating an RFP and choosing the vendor Companies seeking to outsource distribution to a 3PL must take the time to create a comprehensive, wellstructured RFP that solicits all the information they will need to choose the right partner. The RFP should enable each 3PL under consideration to understand the company s business model, goals, constraints, and requirements, and tailor their proposals accordingly. Ultimately, this leads not only to better proposals, but also to a contract and relationship that delivers optimal business value. What, specifically, should the RFP contain? There are two types of information that should be included: information on the business of the company considering outsourcing and guidelines for the vendors on the type of information on their businesses the prospective client desires (Figure 3). In both cases, the more detail and specificity provided, the better. When considering the information about itself, a company should ensure the RFP helps potential vendors understand its business model, operations, and technology. For instance, a company should use the RFP to describe what differentiates it from its competitors 4

Figure 3. Typical information an outsourcing RFP should contain Information on the Business That Is Outsourcing Principal competitive differentiators Overall strategic objectives Important attributes of the business Key performance metrics Operational details and idiosyncrasies Major IT assets and processes Guidelines for Desired Information on the Vendors Operational and financial performance Relevant industry experience Principal capabilities and assets Planned approach to implementation Pricing and fee structure Several alternative scenarios and drives its success, which will allow 3PLs to adjust their proposals in support of these factors. This often means including insights on the company s preferred management style (for instance, collaborative versus top-down), the relative importance of key tradeoffs such as growth versus cost savings, and any other important attributes of the business that would affect the way the 3PL structures its proposal. Similarly, the company should clarify what is expected of the chosen 3PL with regard to specific responsibilities and roles, and the anticipated results of the partnership in terms of key metrics such as cost savings, efficiency improvements, and customer service. The company s current operations also are vital to delineate in the RFP, particularly as they relate to distribution. For example, potential vendors should be made aware of the extent seasonality affects the business (including detailed data on shipments from each distribution center over time). The company also should include information on the number of SKUs it manages, how many units are picked in a given period of time, how many picks there are in each order on average, and any other key metrics that will help 3PLs create better proposals. Perhaps most importantly, the company should explain where its customers are located and what service levels must be delivered to each. Companies should provide details on their order management process as well, including the systems involved, key process steps, and the degree of involvement of each business function. Additionally, they should be sure to reveal any operational idiosyncrasies to which the 3PL must adapt, such as UPC barcode/sku issues, order substitution protocols, batch lot traceability requirements, product return policies, or promotional activities. For most organizations technology plays a vital role in distribution, and 3PLs must understand clearly the IT assets and processes they will need to manage and with which their own systems will need to integrate. While the specific technologies in use will vary from one company to another, 3PLs typically will need to supply or work with systems related to warehouse management, order management, inventory control, shipping documentation, reporting, communication, and electronic data interchange. And for many companies, sophisticated customer relationship management and enterprise resource planning systems are involved in distribution as well. By providing this rich collection of information, companies can improve dramatically the quality of the proposals they receive from 3PLs. Yet without clear guidelines for what those proposals contain and how they present information, there likely will be great variability between each, making one-to-one comparisons difficult. Thus, it is important for companies to spell out exactly what they expect to receive from each 3PL. To ensure 3PLs will make satisfactory long-term partners, companies should ask for details on such things as their insurance coverage and financial performance, IT and communications capabilities, geographic coverage, the number of active carriers utilized and total dollar volume of freight tendered, and quality assurance practices. Companies also should probe 3PLs on how they will approach the implementation, asking about their training programs, technical support practices, document maintenance and storage capabilities, program management and communications practices, and use of performance metrics. Furthermore, it is important for companies to understand a 3PL s approach for overcoming the challenges of starting up new distribution centers, as well as its industry experience, inventory control processes, and safety initiatives and performance. Of course, the 3PL s pricing and fee structure will be important, and companies must be clear about how they want that information to be presented. In our 5 www.supplychainedge.com

experience, it can be helpful for companies to receive unit-level cost information, as well as several prospective annual operating plans that show high-level costs for each geography the company serves. This leads to the final consideration: Companies should ask 3PLs to not only provide estimates of the cost of business as usual, but also to supply several alternative scenarios in which the company s performance and/or cost levels have been optimized. This allows the company to see the full potential value each 3PL could provide to them, as well as each vendor s capability and willingness to think outside of the box, which will be key to achieving long-term success. Implementation: making the transition to the new provider Once proposals have been received and evaluated and a provider is chosen, it is time for implementation. While each distribution outsourcing implementation is unique, companies generally must manage several key areas to ensure a successful transfer of responsibilities to the 3PL (Figure 4). Which of these areas come into play and how they must be managed depends on many factors, including whether the 3PL brings the client into its own distribution facilities or assumes responsibility for the company s facilities. One of the most important such areas is operations, including operational planning, staffing, and facility readiness. Another is facilities, particularly related to the management of construction permits, facility modifications, and contractors. Material handling equipment (MHE) also commonly must be attended to during the implementation, with special attention paid to rack and storage media, forklifts, and conveyor systems. Transportation is a central aspect of distribution as well and, as we discuss in our white paper Generating Maximum Value from Transportation Outsourcing, there are a host of ways in which companies can optimize the value of shifting responsibility for this area to a 3PL. IT also comes into play during a typical implementation. An IT infrastructure plan must be in place and needed equipment and applications must be procured. Likewise, the company must ensure that the setup, integration, and user acceptance testing of the warehouse management system goes smoothly and that electronic data interchange capabilities are in Figure 4. Major areas of concern during distribution outsourcing implementation Operations Technology People Project Management Operational planning Staffing Facility readiness Material handling equipment Transportation IT infrastructure Warehouse management system EDI capabilities Pre-integration testing Job transitions for affected employees retained and outsourced Communications with customers about the relationship Coordinate work streams Assume responsibility for addressing challenges Manage budget and financial performance Coordinate meetings Control scope and timeline Transfer control of applications and processes place and fully functional. As mentioned earlier, it also is critical that pre-integration testing be as complete and effective as possible, and that it occur well ahead of the implementation. Of course, people are at the center of any major transition, and outsourcing distribution is no different. When the 3PL takes over the company s operations, facilities, and staff, it should work closely with the company s HR department to manage individual job transitions. The company outsourcing the distribution function must carefully manage the way in which it shifts its people to new roles or terminates their employment. Employees are not the only people who must be taken into account. Customers also often have concerns about or even resistance to outsourcing distribution, commonly fearing that service levels will be affected by the switch. SCE has found that these concerns can be allayed by proactively taking steps to ensure that service levels will in fact be maintained, and by communicating the change (and the preemptive steps the company has taken) to customers as far in advance as possible. 6

Finally, considering the scope of what must be addressed during implementation, as well as the significant risks that could be incurred as part of the transition, the company or the 3PL should appoint a qualified and effective implementation manager to coordinate the transition s multiple work streams and take responsibility for managing any challenges that arise. In particular, this individual should be responsible for managing the project s budget and financial performance, providing status updates and coordinating meetings, assembling and managing a team of internal resources for the implementation, and keeping tight control over the scope of the project as it unfolds. As the implementation progresses, these duties tend to shift. For instance, in the early stages, scoping, planning and resource management are key priorities, while in subsequent stages issue resolution, risk management, and budgetary concerns become more important. And as the implementation draws to a close, the project manager should focus on the details of going live, including transferring control of key applications and processes to the 3PL and readying post-implementation quality checks and adjustments. Most importantly, throughout the implementation the project manager will need to function as the fulcrum of a complicated, multi-functional effort involving not only every area of the business but customers and vendors as well. Thus, this individual must be chosen carefully, and he or she will need strong communication skills, attention to detail, a love of structure, the confidence to highlight and address issues, and as much prior and broad related experience as possible. Sometimes, due to the degree of challenge associated with making the transition to outsourcing distribution, companies find their internal teams become overwhelmed. In such instances, not only can the implementation suffer, but the performance of the business itself can be in jeopardy due to employee distraction from their regular jobs. In these cases, companies often hire an external firm to help with the implementation and to provide oversight and guidance until the relationship with the 3PL is established and running A qualified and effective implementation manager should be appointed to coordinate the transition s multiple work streams and manage any challenges that arise. smoothly. While most companies will only outsource distribution once, an experienced third party generally has multiple implementations under its belt, and can use this valuable experience to ensure the transition to an outsourced environment is smooth and incurs minimal risk. Conclusion Outsourcing distribution clearly has significant potential for many companies seeking to re-ignite growth in a global economy still struggling to find its footing. Doing so not only allows them to focus on their most differentiated capabilities, but also gives them access to world-class, lower-cost distribution capabilities on a flexible and scalable basis. No wonder, then, that industry research and Supply Chain Edge s own experience suggest that outsourcing distribution is gaining importance among leading organizations, and generating considerable cost- and performance-related benefits. There certainly are challenges to outsourcing distribution, and companies seeking the rewards of the approach must lay the groundwork before making the transition. In most cases, this means first assessing objectively the potential of outsourcing for their specific situation, then preparing a comprehensive and carefully crafted RFP that gives 3PLs the information they need to make accurate bids for the work. For many organizations, the most difficult step is making the transition itself, which typically spans a wide range of functional areas, systems, and capabilities, and entails its share of challenges and setbacks. In our experience, the key to success is putting a capable and empowered individual in charge who can manage such a large and complex initiative, and who will maintain a focus on smooth integration and lasting business value. In short, by specializing in distribution, many of today s 3PLs allow leading companies to enhance their own differentiation and market positions while reducing costs and improving service levels. By laying the right foundation first, organizations across industries can tap into this increasingly important source of business value. 7 www.supplychainedge.com

1 2010 15 th Annual Third-Party Logistics Study, Capgemini and Georgia Institute of Technology 2 Ibid 3 Ibid 4 Outsourcing Distribution Centers Offers More Flexibility, Less Risk, Ryder Systems Inc., 2008. 5 Ibid 6 Ibid 7 http://www.csfd.co.uk/new_logistics_outsourcing.htm 8 2010 15 th Annual Third-Party Logistics Study, Capgemini and Georgia Institute of Technology 9 Ibid Mike Edie is chief operating officer of Supply Chain Edge. He has more than 25 years of operations leadership and performance experience, and has served as corporate vice president of three multi-billion dollar manufacturing companies. He has significant experience improving and transforming supply chains, including distribution, transportation, planning, sourcing, materials, and customer service organizations, and is knowledgeable and skilled in a wide variety of strategy - and operations - related disciplines. Joe Brady is senior partner and a principal with Supply Chain Edge. He has more than 25 years of sales and marketing experience in the logistics and supply chain solutions marketplace. He has played a pivotal role in the accelerated growth of both start-up and entrepreneurial organizations, as a top-performing business development specialist and a sales executive who defined and crafted the strategic direction of these enterprises. About Supply Chain Edge Supply Chain Edge is a team of seasoned supply chain specialists who are highly skilled in identifying, quantifying, and capitalizing on opportunities that drive performance improvements in key areas such as business growth, earnings per share, return on capital, margins, cash-to-cash cycle times, and customer service. Supply Chain Edge is unique in two important ways: Our extensive experience in numerous supply chain initiatives with dozens of companies enables us to bring best practices used by other enterprises to every project while working collaboratively with a client s existing internal talent. And, we don t simply advise clients what they should do, but instead, help them execute more effectively and efficiently to realize tangible, quantifiable financial gain. p. 440.937.5151 c. 440.653.0352 www.supplychainedge.com Maximize Your Profits and Increase Your Competitive Edge. Supply Chain Edge is a team of experienced supply chain advisors. SCE delivers improvements to key business metrics such as business growth, earnings per share, margins, return on capital, cash-to-cash cycle times, and expanded margins and profits to those clients we serve. 2011, Supply Chain Edge