Importance of Outsourcing of Logistics Function
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Published: Wed, 07 Mar 2018
Outsourcing and 3PL, as important business functions, have drawn attention of business operators as well as academic and scholars. A large number of studies have analyzed these areas from a theoretical perspective and a practical point of view. This section will start with the review of outsourcing regarding its definition and importance as well as motivations and concerns. Then, based on the correlation between outsourcing and 3PL, the section presents the concepts of 3PL and most challenges 3PL providers are facing. Lastly, the section shows what could be the current situation of China’s 3PL industry.
Outsourcing of logistics function
2.1.1 Definition and importance
Razzaque and Sheng (1998) defined outsourcing as multiple logistics services provided by a single vendor on a contractual basis. Outsourcing is becoming more important today. Due to economic and competitive pressures, it is imperative for different enterprises to pay attention to their core competencies and turn to third-parties to undertake responsibility for other secondary corporate functions. Outsourcing can create profits by improving customer service level, providing high added-value to products, benefiting in exploiting new markets, and offering dedicated resources (Foster and Muller, 1990). By means of outsourcing, companies can obtain competitive advantage through cost reduction and increased responsiveness to market change.
Motivation of outsourcing
Several reasons lead private business as well as government agencies to outsource logistics functions:
Avoid Capital expenditures – It reduces capital investment in facilities (Richardson, 1995). This allows the using firm to spending where it can get the best return as in research, manufacturing, marketing, or other functions core to the organization.
Increase flexibility – This can enable firms to focus on the core business, question any function or department that is not producing revenue and adapt to changes in the market and access to leading edge technology. A third-party will be invited to help a company when demand increase dramatically beyond the capability of the company to fulfill (Razzaque and Sheng, 1998). Many 3PL providers specialize in logistics functions such as transportation, warehousing management and information technology.
Cost savings – To save costs is identified by most literature as one of the most popular reasons for why outsourcing occurs. In principle, outsourcing will occur to companies for cost reduction when their suppliers offer a service for a low price which however still can cover added overhead, profit, and transaction costs (Harler, 2000). Those companies which outsource their logistics functions to 3PL service providers usually agree that it is more cost saving than to fulfill the same logistics task in-house (Candler, 1994).
According to Bradley (1995a), there are some other reasons of logistics outsourcing such as improving service level and customer satisfaction, using 3PL provider’s logistics IT systems, acquiring outside sophisticated professionals, combining service and minifying number of suppliers, integrating the process of supply chain, and increasing productivity.
Concerns of outsourcing
Despite the fact that outsourcing is now favored by most organizations, there are still many recognized potential barriers and problems related to outsourcing. Normally the most mentioned reservation which restrains enterprises from employing 3PL service providers is loss of control of 3PLs (Richardson, 1993a). Such tendency can be caused by different objectives and attitudes of the logistics service providers and users towards strategy, profits and service or skills (Axelrod, 2004, p49). The adoption of outsourcing might also lead to a situation in which critical knowledge associated with process and customers would leak to potential competitors (Jennings, 2002). Moreover, unrealized savings with a potential for increased costs, employee moral problems, losing touch with important information, unreliable promises of the providers, their inability to respond to changing requirements have been mentioned as potential risks as well.
Each of these concerns should be recognized carefully by organizations that intend to outsource their logistics function, otherwise contract logistics can be another issue to deal with, rather than a catalyst or improvement (Razzaque and Sheng, 1998).
2.2.1 Concept of 3PL
‘Third party logistics service’ has been described in a few ways, including outsourcing of one single service such as transportation, and outsourcing of a set of complicated processs (Vasiliauskas & Barysiene, 2008). Generally, 3PL provide not only just separate warehouse or transport functions but also multiple, bundled services (Leahy et al., 1995). It is also worth mentioned that freight forwarders and shipping lines are included in broad definitions of the 3PL industry (Rao and Young, 1994). On the basis of above definitions, Leib et al. (1993) used the following definition:
‘Third-party logistics involves the use of external companies to perform logistics functions that have traditionally been performed within an organization. The functions performed by the third party can encompass the entire logistics process or selected activities within that process.’
The authors refer to the 3PL as a new industry and growing business environment has more expectations on 3PL. The usage of 3PL has been considered as logistics alliances at strategic level. Bagchi and Virum (1996, p.193) have developed the following definitions:
‘A logistics alliance indicates a close and long-term, relationship between a customer and a provider encompassing the delivery of a wide array of logistics needs. In a logistics alliance, the parties ideally consider each other as partners. They collaborate in understanding and defining the customer’s logistics need. Both partners participate in designing and developing logistics solutions and measuring performance. The goal of the relationship is to develop a win-win arrangement.’
Compared with the prior definition, which focuses on the logistics functional activities, the final one emphasizes the duration of the relationship between the logistics service provider and user, and also covers an extensive range of promising logistics services (Halldorsson & Larsen, 2004).
Many articles have disclosed that 3PL industry has progressed steadily for ages (Liu, 2008). 3PL providers started as a traditional transportation or warehousing service providers from 1980s. Nowadays, 3PL companies provide a variety services including basis logistics service as well as value added services.
Main challenges to 3PL service providers
As the 3PL industry has continued to evolve, the 3PL provider, sitting in the middle between the manufacturers or suppliers (the buyers of the 3PL service, known as shippers) and the end customers (the consumer of the products), will need to balance the dynamic pulls generated by upstream and downstream entities, and thus faces challenges are unique to its position.
Although 3PL providers should develop skills, improve competencies, and provide more value-added service so as to survive and expand business successfully in this flourishing market, the main challenge for them is how to obtain business and achieve acceptable financial performance.
Maintain profits under price pressures from customers
The economic crisis has caused serious situations for both 3PL users and providers -82 percent of shippers now are implementing cost-cutting strategies and 60 percents are reconsidering their supply chain and relationships with 3PLs accordingly (Capgemini Consulting et al, 2009). As a matter fact, economic factor is a strong motivation for outsourcing, of which cost reduction and cost saving are the main concerns. One of the most significant motivations for outsourcing logistics functions to third parties is their professional knowledge and valuable experience in logistics industry which are costly for their customers to have in-house (Byrne, 1993). However, the decision of employing 3PL providers is usually influenced by the evaluation of cost/service trade-offs (Selviaridis and Spring, 2007).
Hence, no matter what strategic stances the logistics providers take, they have to keep upgrading and improving their operational potentialities in the business environment (Sum & Teo, 1999). Meanwhile, as price competition is inevitable and most customers are also price sensitive at present, 3PL providers still need to be cost conscious to achieve higher margins, and to prevent themselves from being priced out of the market.
Many articles have placed emphasis on financial firmness as a critical essential for logistics providers (Bottani & Rizzi, 2006). Based on the empirical survey conducted by Boyson et al. (1999) financial stability was ranked as the most significant selection criteria for choosing 3PL providers because it reduce the risk in relationship. A 3PL services provider with stable financial standing can not only better satisfy its clients and implement cost reduction through a dedicated resource, but also diminish risks for logistics partners (Bowersox & Daugherty, 1990). Accordingly, Boyson et al. (1999) assert that firms prefer providers demonstrating outstanding customer service level with low price and possessing solid financial stability.
Nevertheless, the financial tsunami which has weighted down the world economy has resulted in steep decreasing in logistics demand with no doubt. On the one hand, according to Li & Fung Research Center (2009), the clients of the logistics enterprises asked for price cut and longer credit term, and it is difficult for them to collect the payments form clients during such hard times. Bad debts and financial losses will be easily incurred by any imprudent credit management. On the other hand, the confidence for the banks to lend had been damaged by the tsunami. Banks are now only willing to provide loans to selected enterprises or projects, which limits the financing options of the logistics enterprises (Li & Fung Research Center, 2009). Clearly, it has always been important for 3PL providers to maintain a sound financial condition to survive in the recession as well as to rise superior to others in the market.
Information technology (IT)
Capability of information technology
IT-based logistics services is considered as significant factor by 88% of shippers, but only less than half (42%) of the shippers are satisfied with the IT capableness of their providers (Capgemini Consulting et al, 2009). Accordingly, such IT capability gap result in a few difficulties for both shippers and 3PLs to collaborate in an adaptive supply chain (Capgemini Consulting et al, 2009).
Information is one of the most important elements in logistics management (Cheong, 2004) and it is definitely essential to assist logistics process with effective IT (LaLonde and Masters, 1994). IT capability can be enhanced by employing advanced software, such as electronic data interchange (EDI) networking, enterprise resource planning environments, simulation software, vehicle routing packages, carrier loading optimization tools, etc. (Qureshi et al, 2008). Hardware also may be utilized to facilitate operations and to increase the production efficiency, including radio frequency devices, servers, bar code printers and scanners, global positioning system (GPS), networking and internet/intranet connections, satellite tracking devices, etc. (Qureshi et al, 2008). 3PL services providers which adopt tracking and tracing devices can grant better services to users with quick responsiveness (Rahman, 2004). According to Byrne (1993), the need of sophisticated information technology is imperative for logistics management to link members like manufacturer, carrier and customer in the supply chain.
Sauvage (2003) proposed that to fully satisfy the variety of customers’ demand, LSPs should continuously employ advanced information technologies in order to enhance their service performance. It is unlikely for a firm which is lagging in a technology to move to a position of leadership (Jennings, 2002).
Security of information systems
The sharing of so much information inevitably leads to security concerns. It can not be denied that logistics service providers usually still lose customers annually due to issues of trust in privacy and security, though they keep attracting new clients (Pattel & Conners, 2008). One possible mentioned security issue is that when a 3PL provider has to serve several direct competitors, the information in relation to all of them should be kept confidential (Grover et al., 1994, p. 38; Lacity and Hirschheim, 1993a, p. 24).
Other than cost, security and privacy are also considered as major concerns by many companies when outsourcing.
Compatibility of information systems
IT compatibility acts an essential role in logistics activities such as forecasting, order purchasing, inventory replenishment and life cycle management (Anand, 2010). According to Arshinder et al. (2007), the information system of the whole supply chain is expected to be compatible.
A compatible information system means comprehensible data are quickly shared among the parties throughout the supply chain (Arshinder et al, 2007) while incompatibility will lead to costly and time consuming process because information, though can be shared as well, is rarely in synchronization.
At present, it is difficult for information to seamlessly flow throughout the network as international logistics often includes some different transportation modes and carriers. Moreover, there are diverse IT systems in the different trading areas. For example, Europe adopts Administration, Commerce and Transportation (EDIFACT) standards for EDI systems while the US follows the standards of the American National Standards Institute (Rao & Young, 1994). These difficulties in global supply chain have challenged 3PLs regarding how to capitalize the gap to provide a distinct competitive advantage.
Reliability of information systems
As one of the major industry focus in the global logistics market, the field of information systems paid special attention to user satisfaction as an important performance measure (Ives and Olson, 1984; Robey and Farrow, 1982). Bailey and Pearson (1983) have pointed out that reliability is one of the critical criteria of customer satisfaction.
There could be many unknown increased reliability risk which result from two major sections of technology. One is that new technology innovations or adoptions of 3PL providers may have an unclear reliability performance. The other is that an existing technology may be applied to a new market with unknown increase failure rates (Collins, 2005). To fulfill the promised logistics service reliably and exactly, 3PL providers must identify and remove uncertainty involved with technology reliability performance.
Human Resource (HR)
Lack of expertise
There is a tendency that firms desire to acquire the expertise from third-party logistics providers who possess particular local knowledge of customs and infrastructure of destination countries in such a growing global market (Razzaque & Sheng, 1999). Although one of the drivers for companies to outsource is to acquire resources and logistics professionals (Selviaridis & Spring, 2007), the results of the research conducted by Georgia Institute of Technology et al. (2009) show that many outsourcing users don’t believe that 3PLs are in the capacity of strategic partners currently, 40% of shippers in the survey expect their 3PL service providers to continue focusing on execution, and a good many of them reckon that 3PL providers lack logistics expertise that would support user’s increasing outsourcing. Often-cited problems range from misunderstanding the demand of customer’s supply chain to inadequate professionals in given products and markets (Selviaridis & Spring, 2007). In fact, customers are looking for 3PL providers that have expertise in multiple phases of the logistics process.
An annual surveys of US 3PL firms indicates that ‘company employee/expertise’ is regarded by CEOs as the most important asset of the company for business success in the competition, however those same CEOs also agree that currently the most critical problem facing 3PL companies as ‘finding qualified people’ (Leib and Randall, 1996b).
Almost all members in the supply chain, including third party, have their own company culture which is definitely different from each other (Babics, 2005). According to Pagell (2004), the capacity of how to harmonize its own internal culture with the external different cultures of its customers is one significant factor that 3PL providers should note in the integration of operational services in supply chains.
Mckeon (1991) states that for both 3PL providers and their customers, understanding each other’s cultures and organizational structure is an essential factor to ensure a win-win outsourcing. Compatibility of culture and values is one of the keys to successful partnership which can result in long-term partnership (Qureshi et al, 2008). Culture conflicts often result in change orders, unexpected costs, and sometimes a negative impact on relationships (Kremic et al, 2006). In general, the ability of 3PL providers to understand the customer organization’s culture is a basis for partnering.
Inadequate education and training
In order to remain competitive in the logistics market, 3PL providers have to be vigilant and agile to their customers’ needs, and continually seek to meet customer expectations as much as possible. Logistics executive should be aware that, due to rapid growth in the logistics industry, there could be a shortage of qualified logistics expertise (Yeung, 2006). Therefore, it is necessary for governments and educational services to allocate more resources, put logistics on formal curriculum, and provide more correlated training programs to fulfill the demand of the whole supply chain.
The development of logistics, otherwise, might be constrained by lack of trained logistics personnel (Sum & Teo, 1999). Ulengin and Uray (1999) indicate that in Turkey, senior management that is void of professional knowledge of logistics is the fundamental factor limiting the progress of logistics industry. Kerr (2005b) describes poor training as a ‘black hole’ in China because neither the central government nor China’s regulatory authorities do much to promote logistics training programs.
Obviously, a firm with higher quality of human resources such as better education or training will have superior core competence in the market. Hence, it is imperative for 3PL service providers to offer more training programs to employees so that they can cope with competition in the future (Wang et al, 2006)
Globalization of 3PL market – delivering service in new geographic regions
The internationalization and globalization of 3PL providers has been boosted by the economies of scale and scope, by the internationalization and globalization of the competitors and by ‘customer following’ i.e. the internationalization of manufacturing firms, which ‘may demand that the service supplier provides a global network and/or global experience’ (Arvidsson, 1997, p.74). 3PL providers that take charge of their customers’ outsourced logistics function normally need to build up a logistics network to deal with the flow of the goods from the customer’s factory to the end customers (Cheong, 2004).
In current global economic environment, manufacturing companies tend to establish partnerships with 3PL service providers and they desire to cooperate with some global freight forwarding companies (Lemoine et al, 2003). 3PL service providers with well-content characteristics, such as far geographical spread and wide range of services are popular among the shippers (Qureshi, 2007). As per Bottani and Rizzi (2006), companies favor the 3PL providers with wide range of advanced services more than those traditional ones which can offer mere single logistics functional service.
However, supply chain requirement keep changing. Customer demand can change in spatial and temporal terms. In response to the shippers’ new requirement, 3PL service providers endeavor to extend service coverage geographically and to expand breadth of service so that they can fulfill the interest of their customers as an integrated logistics provider (Qureshi et al, 2008)
Relationship with customers
3PL service providers are normally very concerned with the relationship with their customers because they attempt to establish a long-term one with the users (Cheong, 2004). Long-term customer relationships can enable 3PLs to provide more sophisticated services, reduce the risk of replacement, achieve more earnings, and avoid expense of developing new customer (Cahill, 2006). In addition, long-term relationship is built on the basis of mutual trust and sharing of risk and reward (Qureshi et al, 2008). Bothe shipper and 3PLs will benefit from such long-term relationship (Qureshi et al, 2008). Most of 3PL services users agree that logistics costs could decrease even more through strategic relationships with 3PL service providers. Langley et al. (2004) point out that the successful relationship with 3PL service providers will assist the users to achieve their major objective.
Customer relationship management is necessary once a 3PL provider first establishes a relationship with a shipper. To keep customers satisfied and coming back, 3PL providers must demonstrate their capabilities and the value these capabilities provider to customers (Wisner et al, 2005).
Third-party logistics service providers in China:
China has become the most attractive country for more and more foreign investments, manufacturers, and retailers from all over the world, which results in the fast growth of the Chinese economy (Liu, 2008). Accordingly, the development of 3PL has been spurred in China and 3PL industry has achieved significant achievement.
Currently, most logistics companies offer extensively various value-added services and have confidence in the continuous development of China’s logistics industry. Many literatures have research the Chinese logistics area from diverse perspectives and some supply chain-related difficulties facing foreign 3PLs are identified.
High transport cost
It is not deniable that Chinese government has invested a lot in the logistics sector to improve traffic in recent years. However, poor transportation is still considered as one significant challenge for logistics industry in China, which may result in the increase in logistics cost and the decrease in company profits (Lau & Zhang, 2006). Li & Fung Research Center (2009) notes that the transportation occupies more than 50 percent of the total logistics cost in China, and undoubtedly the operation costs of 3PL service providers will still be ascending due to the price upswing of commodity and fuel. Another culprit is high local road tolls and other hefty transportation fees (Kerr, 2005b).
Underdeveloped physical infrastructure
Many MNCs find that it is difficult for them to implement coherent strategies in China because underdeveloped transportation system hinders their distribution and sourcing throughout the country (Speece and Yukiko, 1995). Although China’s economy and industrial production have been developing rapidly, the current logistics system is loaded with new challenges as it can barely keep pace with the growth rate of economy (Carter et al, 1997). The undeveloped logistics infrastructure in China, including deficient highways, aged port facilities, and limited runways and airports, can hardly fulfill the growing logistics demand in the progress of new economy (Pollit, 1998).
The insufficiencies of present distribution system have restricted foreign enterprises to immensely exploit the plenty opportunities in China’s market (Goh and Ling, 2003). It is thus imperative that the distribution of products and services be supported by a reliable transportation system.
The need for guanxi
Literally, guanxi means relationship. It is noted that Chinese culture is quite distinct from Western culture in numerous aspects, including the way to conduct business (Jiang and Prater, 2003). Guanxi, which is an important concept for successful business in China, refer to ‘relationship between people’ (Michailova and Worm, 2003). It suggests a conveyable, reciprocal, invisible and useful responsibility to dyadic personal relationships (Luo, 2000). It is not surprising that Chinese prefer to deal with people they know and trust. As Wang et al. (2003) indicated, guanxi which is created on the basis of mutually beneficial can lower risk as well as competition in business circles.
Millington et al. (2006) also state that when looking for satisfying vendors, guanxi is more useful than other information from website, trade market or media. This implies that the knowledge and expertise to understand local circumstance and the communication skill with foreigners are absolutely necessary for establishment of a successful cooperation (Lightfoot and Almeida, 2007).
Kerr (2006) identifies that government regulation is still 3PL providers’ biggest challenge. The development of 3PL in China is obstructed by some barriers such as underdeveloped infrastructure and entrenched regulatory circumstance (Lau & Zhang, 2006). In the meantime, various regulations set up by different provinces forcefully influence business activities so that the founding of national networks is hindered (Kerr, 2005). It also has made it difficult for 3PL providers in China to fully meet the requirements of their clients.
Moreover, there are many regulations and rules for foreign 3PL providers who plan to enter China logistics market. According to Lai and Hsu (2007), foreign 3PL providers must apply for the class ‘A’ license issued by the Ministry of Foreign Trade and Economic Co-operation (MOFTERC) if they plan to establish subsidiaries as international freight forwarders in China.
A survey conducted by Li & Fung Research Center (2009) also identifies that the regulations and policies associated with logistics industry are not unalterable because the government will supervise the execution and analyze the effect of the existing ones and then will formulate new ones accordingly to boost the growth of the industry. It is true that a number of government departments which are involved in policies related to logistics industry have impact on the rhythm of changing regulation (KPMG, 2008).
Local 3PL providers
China’s local logistics providers have been growing rapidly because foreign firms are increasingly looking to source there. To contend with foreign logistics providers, domestic companies have to upgrade facilities and enhance their service level (KPMG, 2008). Jiang and Prata (2002) indicate that in contrast with foreign 3PL entrants, local players are always in the close association with local or central governments. For instance, Sinatrans is a state owned company and is the only 3PL service provider in China who can provide a nationwide logistics service with full license. The authors also mention that a number of local 3PL providers at regional level have their own special strength in specific areas or specific business. Some of them even look for individual connection built directly with government officials – which may be valuable in their daily business.
Literature review summary
This section has reviewed the literature ranging from some fundamental definitions of outsourcing and 3PL, to challenges for 3PL industry globally and especially in China which represents the current situation foreign 3PL providers are facing in China. In table 2.1, we summarize the above referred articles in each of the focus challenges.
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