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  • Patrick de Jong

Typical mistakes when scaling the network - Part 4/4: Outsourcing

Aktualisiert: 6. Aug 2019

"If I start outsourcing all my navigation to a little talking box in my car, I'm sort of screwed. I'm going to lose my car in the parking lot every single time." (Ken Jennings, Jeopardy!-King)

We come to the last part of our article series on scaling logistics networks. After spending the last three weeks on strategy, location and timing aspects of network scaling we will discuss the question of operational responsibility.

„Do we want to hire and train our own logistics staff or will we rely entirely or in part on the resources of an external contractor?“ There are countless providers of third-party logistics (commonly written as „3PL“), among them basically all the big names. Many companies scale their network without actively considering the possibility of outsourcing as a strategic measure. This article will cover the advantages, disadvantages, opportunities and risks of out- as well as insourcing.

How to assess whether outsourcing is an option

Even a brief look at the market will confirm that contracting part of logistics operations to an external service provider is far from being an odd exception. It has rather become a fairly common strategic measure to ensure competitiveness and high quality standards. The usual reasoning behind such setups are avoided investments, better availability of valuable internal resources and concentration on core competences. On top of that it is often claimed that external partners are in the position of specializing processes and equipment for a certain part of one’s operation and can thereby run at higher efficiency and responsiveness. This will then automatically allow the clients to differentiate themselves from their competition.

It is not rare for such setups to involve externalization of all, or even just a few processes into another country, particularly into those that feature lower operating cost (mostly due to lower wage levels), at least for the foreseeable future. The classic case that most of us have probably at least heard of would be German customers’ returns being processed in neighbouring Poland. Since receipt and assessment of returned articles is a process with high manual effort (typical performances, even for trained workers, are at “only” 30 to 40 items an hour) it is profitable to route return parcels to a return centre in Poland, have the items processed there and send them back in bulk to the German fulfilment centre from which they were originally shipped. In reverse logistics you have the advantage of lead time not being as crucial as forward, especially when customers are reimbursed for announced returns even before the goods are checked for damages and completeness. Please note that this article does not represent any kind of standpoint on the oftentimes publicly discussed controversy of moral implications of outsourcing labour to low-wage countries.

To be very precise, in aforementioned case it is not the outsourcing itself that enables a potential client to tap into cost saving potentials by sourcing abroad. A company could obviously open their own returns centre(s) in Poland for that purpose. What makes this outsourcing a welcome addition to such a setup is the effect of risk hedging: setting up own logistics in a previously “uncharted” country is a risky business. Consider a potential construction projects, for which experts in national building permit processes and regulations on fire protection would be required. On top of that you will have to deal with a different wage structure, expectations towards an employer that might differ from what you are used to and potentially even different habits when going on strike. Obviously, these are no deal-breakers for setting up own logistics, but service providers in that region tend to know their way around the country and usually have already acquired a solid picture of the labour market.

Another risk aspect should not go unmentioned: if the setup of local logistics capacities is intended to boost a certain market rather than optimizing the cost structure (take for example a satellite warehouse close to Paris), it is usually not certain how much of an effect this significant effort will yield. In case of excessive optimism, it is easier to roll back externalized operations than to close your own recently set up logistics location.

In the context of processing cost, one would have to assume that in the long term, self-run operations should be more economic, since all service providers will naturally charge you a mark-up on their own cost. There are, however, a couple of factors that enable them to process competitively, despite their margin:

  1. Specialization: If only specific processes or assortments are subject to the externalization, a service provider can specialize operations to specifically fit these needs. Consider for example the previously discussed returns case: logistics staff handling returns typically receives the most extensive training.

  2. Economies of scale: When processing relatively low quantities, the significance of fix cost (building, facilities, overhead, …) is rather high. In a multi-user set-up a service provider can split this block among the several different small-scale clients.

  3. Seasonality smoothing: Granted, warehousing contractors will have to brace themselves for the same November- and December peaks as everyone else in e-commerce. However, they are in a position to at least in parts smoothen the seasonality by including anti-cyclical processes or assortments in their portfolio and thereby improve the average usage of their resources.

Finally, there is also the case that outsourcing will become a measure of last resort. Should a company end up in the tricky situation running short on own logistics capacity, outsourcing part of their operations can mitigate part of the problem. Obviously, it is not quite optimal to take such measure out of an avoidable situation such as this, but once it is too late, externalization is a valuable measure of damage control.

Now, the past paragraphs do read a bit like 3PL marketing. We did indeed look at various advantages and opportunities that arise from that concept. Needless to say, the decision for or against it should be thought-through, and these perks do not come without the respective drawbacks and risks.

For starters one should expect a certain loss of control and transparency. If everything goes well you may hardly notice that, but whenever there is need for detailed clarification (e.g. a customer complaint) the flow of information (from customer to you, to service provider and all the way back) may be somewhat more hindered. Obviously, contractors do their utmost to provide a maximum level of insights and influence, but such a setup will struggle to compete in that regard with a fully incorporated one. Also, it will still require substantial efforts of technical integration, which will, by the way, occur anyhow if an external setup is chosen. Hardly any service provider will work plug-and-play.

Apart from IT integration it is worth mentioning the externalization project itself. It will include tendering documents, contract negotiations, approval gates and ramp-ups, with quite a few potential trapdoors along the way. For e-commerce companies such projects are typically a rarity, if not entirely new and they do rarely have the required experts in-house. In the worst case they may end up stuck in a sub-optimal contract with 3 to 5 years duration.

Lastly, we should re-consider the previously posed statement that “self-run operations should be more economic” in the long run. Having reached a certain scale of operations that is surely the case (maybe except for avoiding the own concessions on wages by actively subcontracting). One should therefore consider whether to master to slightly tricky small to medium size phase in order to acquire know-how and learn so one can afterwards leverage this advantage on a larger scale.

Looking at the larger players of the industry one may even recognize a trend towards insourcing, vertically as well as horizontally. Amazon and Zalando did build up own delivery operations over the past years, in order to become less dependent on the established parcel-networks and to gain more transparency and control over the last mile. They could because their scale allowed them to (vertical insourcing). These same companies do by now offer themselves as fulfilment partners for other companies in their industry and thereby themselves act as 3PL-provider (horizontal insourcing).

One could thereby deduce that outsourcing is an interesting tool for young and small logistics networks, while maturity and size render its benefits less tangible, even if active insourcing will hardly be attractive for anyone but a few blue whales. Is it that simple, or do we need a more elaborate rule of thumb? I’ll gladly discuss this thesis with anyone interested. Contact me, as usual, via LinkedIn / Xing / Contact.

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