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International Journal of Computational Intelligence and Information Security, November 2011 Vol. 2, No.

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OUTSOURCING LOGISTICS SERVICES


Group Captain Sanjiv Aggarwal Research Scholar, Singhania University, Rajasthan, India Email: aggarwal_sanjiv@yahoo.co.in Dr. B. S. Hothi Director, Jaipuria Instiute of Management Email: bshothi@rediffmail.com

Abstract

Logistics management is a complex activity and critical to the performance of any manufacturing or trading organization in a country. The practice of outsourcing logistics function to third party logistics is becoming more prevalent in the industry across the globe. Researchers and industrialists have identified and experienced various factors that make outsourcing of one or multiple services of the supply chain function inevitable. They could be avoiding capital blocking in asset acquisition and or an enhanced focus on their core competencies. Say for India, small and mid size companies depend on a third party for inventory and distribution management for the lack of in house resources. The trend of outsourcing of logistics activity has been so rapid that now, the third party logistics (3PL) service companies have started looking at innovative marketing strategies and excellence in the overall service packaging to acquire new clients while retaining the old and existing accounts. This paper aims to examine the various factors that influence the decision of the third party logistics services users to tie up with a service provider for all or some of its logistics needs. The study is based on informal discussions and a structured questionnaire survey with officials of 3PL companies and procurement and supply chain officers involved in selection and finalization of contracts in India. The paper will also review the related literature available on the subject in India and elsewhere. The non parametric tests and other statistical tools have been applied to analyze the findings. Key words: Outsourcing, Logistics Management, 3PL

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1. Introduction: Outsourcing of logistics services among Indian companies is estimated to the extent of US$ 60 million. Approximately 55% of Indian companies are outsourcing logistic services like supply chain management and warehousing which used to be around 1015% a decade back. 3PL companies handle one or more of supply chain functions of the organizations including the management of information by the third party, relieving the officials of the company from day to day interaction with carriers, and having to oversee hundreds or thousands of shipment. Hence, 3PL refers to the outsourcing of a part or whole of the logistics functions. It could be the use of a transportation carrier, a warehouse, or a third party freight manager hired to perform all or part of a companys production distribution functions. In order to handle its logistics activities effectively and efficiently, a company may consider the following options it can provide the in house function by setting up the service resources, or may own logistics subsidiaries through setting up or acquiring a logistics firm or may outsource the function. In recent times, a growing interest in the third option i.e. outsourcing of logistics functions to third party logistics service providers, is being experienced. (Sahay and Mohan, 2006) Realizing significant cost reductions and several other benefits gained by these companies, the large numbers of small to medium and large companies in all the industries are gearing up to use 3PL services in their logistic functions, resulting in a tremendous potential market for the 3PL market in India. Also, as organizations world over are struggling hard to stay competitive for growth and survival they need to focus on their core activities and outsourcing the support functions. The major factors responsible for this are globalization of businesses and liberalization of economies. The organizations are focusing their resources to reach out to the end consumer at the fastest possible time at the desired location which may also involve partnering with an external agency or company which has an expertise in supply chain functions. The three main reasons to outsource the supply chain activities can be summed up as: Globalization of sourcing, manufacturing and distribution leading to an increase in the complexity of material movement. Competition that has forced companies towards more responsiveness and a reduction in inventories. An increased need for small but frequent shipments with total reliability, requiring core competence in logistics management. Resource constraints that require companies to concentrate only on their core manufacturing or new product development activities.

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Despite of the increasing dependence, globalization has forced the 3PL operators and even the players in the unorganized transportation sector to experience the competition posed by the international and strong local players. Apart from strengthening the assets and gearing up the resources, there is an immediate need for these players to understand their clients and the clients customers. 2. Literature Review: Concept of Outsourcing The very fact that the nature of logistics makes the decision of outsourcing a critical one, it is important that the concept of outsourcing is well understood. It is also essential to understand the view of other researchers and academicians on the topic. The business environment has undergone many changes, particularly in the last few decades, and companies are under pressure to maintain and increase their profitability as well as customer service and market share. Embleton & Wright, (1998) mention that Outsourcing is one more approach that can lead to greater competitiveness. Greaver (1999) asserts that organisations are questioning whether the traditional paradigm of owning factors of production is the best to achieve competitive advantage, but that the outsourcing concept of moving activities out of the organisation to where the experts and their resources exist as opposed to owning all of the resources is in opposition to most tradition and experience. Although when successful outsourcing can be a powerful tool for achieving competitive advantage, when not successful, can lead to sub optimal performance, lack of morale, and loss of possible business opportunities. Many problems arise because of outsourcing, as companies search for short cuts to deal with pressures or weaknesses, and failing to consider the long term implications. In order to streamline the process and to derive the benefit of outsourcing, it should be a well planned and takes up as a strategic decision with meticulous execution. 2.1 Reasons for outsourcing The possible reasons that companies outsource could be because in todays highly competitive scenario, they are under tremendous pressure to cut costs, improve customer service and enhance company profitability. Also companies are aiming to expand their markets and wish to focus on their core competencies thereby gaining a competitive edge. Zhu, et al. (2001) conclude many of the preceding discussions by stating that to use outsourcing strategically to increase the organisational flexibility and the speed of an organisation to react to the changes in the business environment would be the most valuable for top managers in the new economy. They add that outsourcing can be used to enhance the connectivity throughout the value chain, be more efficient in the use of capital, produce value-added services and manage risk. Kakabadse and Kakabadse (2000) assert that perhaps the greatest benefit of outsourcing is the full utilisation of external providers investments, innovations, specialised professional capabilities, that otherwise would have been prohibitively expensive for one organisation to replicate. If the client uses multiple best-in-class providers, each provider can contribute greater depth and sophisticated

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knowledge in specialised areas and thus offer higher quality inputs than any individual provider or client could. As can be seen from the earlier discussions, main reasons for outsourcing are the pressure to reduce costs. According to Lankford and Parsa (1999), most outsourcing contracts target a minimum 15% cost savings, sometimes between 20 and 25%. However any process has a flip side as well. The process of outsourcing is not risk free as it calls for a very well designed collaborative working of the user and the provider. In the following section, we shall review the available literature on risks associated with outsourcing. Various studies have been based on the discussion on why the companies outsource. Since we are limited to the decision with respect to logistics, we have summarized the reasons in the table 2. Table-1: Reasons to outsource and the benefits sought Reasons Identified by Lankford and Parsa (1999), Greaver (1999), Stock and Lambert (2001), Embelton and Wright(1998) Reasons to outsource Pressure to cut costs Financial Benefits of outsourcing

Greaver (1999), Stock and Lambert (2001)

Greaver (1999), Stock and Lambert (2001), Bender and Samuel (2000)

Reduced and controlled costs, savings, profits and shareholder value, cash flow, changing variable costs to fixed, hidden costs, capital requirements, accountability, discipline and efficiency, economies of scale, investment in assets, re-engineering and transformation in the company. Pressure to improve Enhancement and focus on core customer service competencies, expertise and service, (Strategic) quality and effectiveness, delivery and reliability, accountability, profit and shareholder value, value creation, competitive advantage, flexibility to meet demands, downtime. Market expansion Resources freed to focus on core (Strategic) competencies, accessibility to and competitive advantage in markets, specialization and focused production, corporate image and credibility, profit and shareholder value, injection of cash, sales and production capacity, downtime, capacity, processes, systems, networks, global sources of supply and demand, entry barriers in terms of capital and technical requirements overcome.

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of internal Greaver (1999), Stock Lack and Lambert (2001), expertise/capability (Operational) Lankford and Parsa (1999), Fan (2000), Bender and Samuel (2000)

Focus on core competencies and competitive advantage, expertise, capability, innovative ideas, reevaluation of business processes, skill/technology/ equipment availability, independent advice, quality of products and service, technological performance and competence, company performance. Human resource Management control, discipline, Greaver (1999), Stock considerations efficiency, fewer functional areas to be and Lambert (2001) (Operational) managed, less steep learning curves, increased focus on core competencies, quality and effectiveness, control of quality/risk/costs, time management and use of time, career paths and opportunities, commitment and energy, productivity and morale, less excess labour, IR and HR aspects simplified, less strikes and labour dispute problems, flexibility in staffing to meeting changing demand/work fluctuation, existing skills can be exploited commercially.

2.2 The risks of outsourcing or the reasons for not outsourcing The possible reasons why companies decide not to outsource could be : Loss of control, no possibility of service commitment being met, no reduction in costs, availability of adequate resources and expertise in house , activity being to important or complex to be outsourced. Embleton and Wright (1998), list the disadvantages as: 1. Companies implementing outsourcing arrangements usually seek, among other benefits; to achieve cost saving may not do so. For many it is a break-even exercise and in some cases more expensive. It is extremely difficult and costly to reverse the process in house. Handing over of control to the provider. The initial contract may appear to be competitive but not later Loss or damage of manpower morale

2. 3. 4. 5.

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6. 7. 8. 9. 10.

More monitoring required for ensuring the service quality. Provider may not give priority to the business Loss of talented and marketable staff to seek opportunities elsewhere. Loss of flexibility damage to companys image

The pitfalls listed are mainly the ones that are the flipside to their list of advantages or benefits and may arise mainly due to poor outsourcing decisions and management: Lonsdale and Cox (2000) further identify loss of core activities, being leveraged by providers, the loss of strategic flexibility, interruptions to supply, poor quality, fall in employee morale, loss of internal coherence, confidentiality issues and loss of intellectual property rights. Greaver (1999) distinguishes outsourcing problems into four areas: people; process; technology; and other problems. People problems: due to loss of key people to poor performance, to people not getting along well together. Process problems arise due to the improper set up and understanding of operations, decision rights, responsibilities, and authorities are distributed and functions. Technology problems are mainly acquisition, implementation, and maintenance of equipment or systems. He adds that such problems can have their root causes in either party, and addressing the problems is a shared responsibility. He further categorizes the excuses that companies have not to outsource, as excuses of uncertainty; loss of control; conflict; financial; employee unhappiness. Research among companies that have successfully implemented outsourcing strategies, according to Elmuti and Kathawala (2000), also identified the following problems areas: Fear of change, including fear of job loss as the most serious problem. Dealing with these fears through communication and honesty is important in managing this factor. Poor choice of sourcing partners. Outsourcing partners should be selected based on their expertise in the operation being outsourced as well as their cultural fit with the company. Establishing strategic provider alliances and adopting the philosophy that the company is a partner with the provider may help alleviate this problem. Inadequate training and skills needed to manage the outsourcing activities. Providing managers with the necessary skills is thus very important to ensure outsourcing success. Lack of understanding as what the organisation wants to achieve by outsourcing. Unclear expectations and inadequately understood objectives are serious obstacles
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to successful outsourcing. Another serious problem is a lack of comprehensive plans. Companies exploring outsourcing as a means of enhanced business performance must complete a strategic analysis which includes a comprehensive plan of all aspects of their business, to determine the benefits which could be achieved through the outsourcing of selected non-core functions. Lack of support with respect to top management and supporting infrastructure.

To summaries, problem areas generally include inadequate control systems over how certain services are delivered, which in turn may raise the companys liability exposures, hidden costs and risks, lack of managerial support, poor organisational communication, cross functional political issues, vague expectations, uncertainties associated with the stability of providers, confidentiality issues, security, time schedules, lack of flexibility, short term contracts and other priorities taking precedence. Often service level commitments and cost, time and effort reductions are not realized. Non delivery of technology capabilities, diminishing control over the outsourced function, lack of strategic management skills and capabilities, constant price fluctuations and misunderstandings or disagreements with the services provider. Hence, it is important to analyse such problems and outcomes of outsourcing implementation which mainly are due to inherent flaws in the concept, or whether they are the result of poor management practice. Developing a comprehensive plan outlining detailed expectations, requirements, and expected benefits may be the key to successful outsourcing. The plan should outline objectives in details, expectations, requirements and expected benefits of the project and management support for the project before the company begins implementation of the process. It is also managements responsibility to remove the fear associated with change and loss of job. 3PL business mainly striving on the parties that outsource, it was essential for us to understand he basic concept of outsourcing and understand the reasons why some companies outsource their logistics activities and why some of them decide not to. At the end of this section, we will briefly touch upon how to establish a successful outsourcing process. 2.3 Establishing successful outsourcing process Outsourcing can surely add value as we have studied in our preceding sections. It could be of sure advantage if a detailed plan is in place thereby avoiding all possible problems listed in the previous section. This may require a thorough analysis, planning and detailed discussions with various providers before implementing the process. Certain steps that must be taken also include identifying the core competencies of the company; having a clear understanding of what the organisation wants to achieve by outsourcing and then developing comprehensive plans to ensure that outsourcing provides enhanced business performance, choosing the correct outsourcing providers and treating them as
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partners, ensuring communication and honesty throughout the outsourcing process and providing adequate training and skills to facilitate the inevitable changes resulting from the process. There must also be complete support of the process by top management with the commitment of the necessary company infrastructure. Different authors have identified the keys to successful outsourcing as follows: Embelton and Wright (1998), Strategic analysis and planning, Selecting the providers, Managing the relationship. The process has been detailed out as following: a) Strategic Analysis and Planning:

The Strategic analysis and planning process involves determination of functions for outsourcing, cost of providing the service, level of quality of service, impact on corporate culture, quantification the outsourcing goals both long and short term. Lankford and Parsa (2000) mention the importance of investigating the benefits of outsourcing. They say that it may be a lengthy but is an important evaluation process as outsourcing is a major event that a company would want to avoid repeating. Greaver (1999) supports the above by reiterating that companies should take a long term view of the move to outsource. The company must understand its vision, core competencies, structure, transformation tools, value chain and strategies.

Hence the companies should determine which areas are not core and will provide the company with the best return on investment if outsourced. A function that is outsourced should be routine and dwell defined. It should also be measured and be managed at an arms length, providers should be established. b) Provider selection and negotiation on terms

Once a clear understanding is established, it is easy for a company to develop a document that may provide the base for a clear understanding of company objectives and reasons for outsourcing. A thoroughly prepared request for proposal document can be really an aid for defining the above. Bendor & Samuel (2000) mention that some users take a longer time in defining what exactly they expect from the service providers. The interest of the user is not only the quality of service but also would like to analyse the cost of procuring that service or a product. An ideal RFP (Request for Proposal) should carry the scope of work expected from the provider. The scope must define the boundaries and outcome of the activities so that both user and provider are clear on their areas of responsibilities. For example say in the area of logistics, the practice of invoicing, and breakup of transportation and warehousing requirements, differentiation of inbound and outbound logistics is essential.

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It should also be left to the provider to apprise the user of some undefined benefits that they can avail of by outsourcing the activity to the specific provider and later the same could be incorporated in the agreement terms and conditions. Greaver-Samuel also states that both the parties should mutually define the performance evaluation metrics and systems. And the price should be worked out and negotiated as an end process as it encapsulates the discussions on what to be and what not to be outsourced. . C) Managing the relationship. Resource transitioning the relationship management All the literature that has been reviewed for outsourcing so far also asserts the importance of an efficient management relationship established between the user and the provider. Outsourcing can be a rewarding experience if carefully administered .This has been stressed upon by many authors in the preceding and the following paragraphs. Kuglin (1998) developed the following outsourcing strategic decision process, which has five elements: 1. 2. 3. 4. 5. Reviewing the competitive frame of reference and core culture and values Reviewing the mission and vision (also determined in the foundation process methodology), as well as the core competencies. Reviewing the objectives, goals, and operating strategies. Performing a current assessment of internal capabilities. Analyzing the strategic options.

While Greaver presents the following steps to successful outsourcing: Exploring strategic implications, Analyzing Costs/Performance, Planning initiatives; and then selecting providers, Negotiating terms, Transitioning resources, and Managing relationships. It is necessary that these steps are adapted to fit each specific company and outsourcing situation and need, but always should be as thorough as possible. For new initiatives, planning activities, including project management issues, Greaver (1999) suggests that the process should certainly include : risks assessment, announcement of initiative/s, putting a capable project team in place, engaging advisers or consultants, training the team, acquisition of resources, managing project, information and resources and setting of objectives. He further mentions that for assessment of risks and resources, information, and management skills needed to mitigation of those risks cross functional teams should be formed. Team objectives, deliverables and timetables should be set and management support achieved. The company may also need to employ consultants for aiding the team work effectively in the shortest time, lawyers experienced in negotiating and drawing up outsourcing contracts,
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accountants to analyze costs using tools such as activity-based costing, and other specialists, depending on the situation. However they may also be available in house based on the size of the organization. Since employees inevitably learn of the initiative as soon as it is decided, it is better to make an announcement that outsourcing will be explored, otherwise employees will generally assume the worst without having the facts, and morale will be negatively impacted. Employees must also be kept informed about the initiatives progress. (Greaver, 1999) References Bendor-Samuel, P. (2000). Turning Lead into Gold: The Demystification of Outsourcing. Provo, UT: Executive Excellence Publishing. st Bowersox, D.J., Closs, D.J. & Stank, T.P. (1999). 21 Century Logistics Making Supply Chain Integration a Reality. Michigan State University. Oak Brook: Council of Logistics Management. Bradley, P. (1994a). "Cozy up, but stay tough". Purchasing, 47-51. Bradley, P. (1995a). "Third parties gain slow, cautious buyer support". Purchasing, 51-52. Burns, G.E., Warren, C.K., & Cook, B.P. (2001). Industry Update: Transportation Outsourcing Survey: Emerging Trends in Logistics. JP Morgan Securities Inc. Equity Research. Aug. New York. Byrne, P., Deeb, A. (1993). Logistics must meet the Green challenge. Transportation and Distribution. Feb. 33-35. CII - KPMG : Skill Gaps in Indian Logistics Sector (2007): A white paper. Commodity Online. (Dec 2009). Indias third party logistics outsourcing to boom. Retreived 4 Jan 2010 from http://www.commodityonline.com/news/Indias-thirdparty-logistics-outsourcing-to-boom-23489-3-1.html. Cooper James. (1988). Logistics and Distribution Planning: Strategies for Management. Kogan Page. Cooper, J.C. (1993), "Logistics strategies for global businesses", International Journal of Physical Distribution & Logistics Management, Vol. 23 No.4, 12-23. Council of Supply Chain Management Professionals. Retrieved on 23rd Jan 2010 from www.cscmp.org/Downloads/Re-sources/ glossary03.pdf. Embelton, P.R. & Wright, P.C. (1998). A Practical Guide to Successful Outsourcing. Empowerment in Organisations, 6(3), 94-106. Fan, Y. (2000). Strategic Outsourcing: Evidence from British Companies. Marketing Intelligence and Planning, 18(4), 213-219. Foster, T.A. and Muller, E.J. (1990). Third parties: your passport to profits, Distribution, Vol. 89 No. 10, 31-32. Greaver II, M.F. (1999). Strategic Outsourcing. AMA Publications. New York. Konezny, G.P. & Beskow, M.J. (1999). Third-Party Logistics: Improving Global Supply Chain Performance. Piper Jaffray Equity Research: Third-Party Logistics. Jan.
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