Today’s escalating, competitive and demanding environment has forced players in themarketplace to be more efficient, to emphasize on a leaner organization and continuouslyinnovate new procedures to keep ahead of competitors. Adding final consumer value to theproduct or service in the form of lower prices, quality and better service has become anessential requirement in the global marketplace.
Logistics outsourcing has become an attractive option in order to take advantage of globalopportunities, to acquire state of the art logistics capabilities, significantly improve customerservice and to enable focusing on core competencies. The purpose of this study is to present a theoretical framework for outsourcing actions as aguideline for companies on why and how to outsource. It gives a deeper insight on logisticaloutsourcing as a new and promising trend in the global environment while presenting themain logistical areas of outsourcing as well as the advantages and disadvantages. In order to effectively implement outsourcing, commitment from top to down managementand a wide understanding of all the stages and implications of outsourcing are required.
Inorder to achieve these prerequisites and a successful implementation process, a modelintegrating the third- party logistics buying process and relationship improvement process ispresented. It emphasizes the importance of carefully identifying alternatives, the overallanalysis of partner selection with the help of specific criteria, mutual relationship buildingbetween logistics service buyer and provider through joint team building and continuousimprovement and performance measurement. The relationship positioning tool model can beused for the continuous enhancement and improving of the supplier-customer relationship. The results and overall reasons of outsourcing should focus on adding value to the finalconsumer of the product or service.
By achieving lower logistical costs and a higher level ofquality and expertise these results can be used to add value to the consumer. The study points out that there is an increasing need for logistical outsourcing as a way to gaincompetitive advantage and as an instrument to meet the requirements of the company’scomplex environment.
Gaining competitive advantage through outsourcing11.0 INTRODUCTION1.1 Outsourcing todayToday’s escalating, competitive and demanding environment has forced players in themarketplace to be more efficient and to emphasize on a leaner organization. Enterprises mustadapt with increasing speed to market pressure and competitors’ innovations. To survive in the21st century, enterprises are hurrying to:1) search globally for opportunities and resources2) focus on core competencies and mutually beneficial longer term relationships3) outsource those activities that can be performed more quickly and at a lower cost bysubcontractorsOutsourcing seems to be an attractive option to take advantage of global opportunities, toacquire state of the art logistics capabilities (often at lower costs), significantly improvecustomer service and most important to focus on core competencies.
The idea of outsourcing is not new. It has been utilized traditionally, but on menial chores.Now it is currently a very popular strategy, commonly used by many companies. TheInternational Trade Commission reported that the trend is global. It expects the global 12%growth in outsourcing to continue, with revenues reaching US$ 99 billion.1.2 Logistics OutsourcingLogistics outsourcing1 is a significant process. The total costs of logistics in highlyindustrialized countries reach about 18% to 30% of GNP. More than 50% of the final price ofthe product consists of logistical cost.2But this function, for many companies, is not a core competence.
This meaning that logisticsis not the means by which the company differentiates itself. Yet it is a significant operation,because it can show a dramatic return on investment. When there exists an industry segmentsuch as logistics, which is a non-core activity to a large number of companies, there is anopportunity for a marketplace for outsourcing to develop.Logistics outsourcing is an attractive alternative, because it matches the three characteristicscompanies are striving for mentioned above (enhance globalization, gain benefits fromeconomies of scale and specialized process expertise). It has clear and objective metrics thatcan be easily measured by the buyer (inventory costs, inventory levels, the cost ofwarehousing space and transportation etc). The buyer can understand the benefits receivedfrom the outsourcing supplier and so the outsourcing relationships becomes an easy sell intoday’s competitive market place.1 This practice is also known as Third Party Logistics (TPL).2 Storhagen, 1995.Gaining competitive advantage through outsourcing2Another driving factor for the decision to outsource is that specialized skills required forsuccess in supply-chain management are rapidly becoming more advanced and complex, so itbecomes essential to have good expertise at hand.
These specialised skills include having theability to effectively use handling and storage technologies; planning software and supportinginfrastructure; data-communications technologies; decision-support; demand-planning andadvanced transportation planning and control tools.Example: Compaq, the world’s number one producer of personal computers, estimates it haslost around $1 billion in sales in 1994 because its laptops and desktops were not availablewhen and where customers were willing to buy them. Compaq’s chief financial officer arguesthat his company made the most of what needed to be done in order to be more competitive.Compaq changed the developing, manufacturing, marketing and advertising of products. Theonly area that was not addressed was logistics.For most companies products, promotion and price are the competitive ingredients, while timeand place have taken a back seat. This relative neglect is now changing. The increase in thegeographical distances between production and consumption, and the concentration ofproduction to fewer and bigger units in order to be able to enjoy the economies-of-scale inproduction has increased the need to store and to transport. Distribution costs, as a percentageof revenue, are greater for international companies than their domestic counterparts.Complexity, long order lead times, unusual product-service requirements and differing legaland cultural factors in foreign countries have combined to create a more challenging operatingenvironment.
Many companies are now seeking to exploit their logistical competence.Strategic vision calls for a willingness to offer extra value-adding services. Logisticallyspeaking, it means meeting commitments and shipments arriving when and where promised.Companies committed to the strategic use of logistics usually outperform the competition inspeed and consistency of the order cycle. The objective is to be the preferred supplier for keycustomers. Consequently companies are willing to use qualified external support to outsource.2.0 ApproachWe will approach outsourcing from a theoretical framework by describing the processes andpossibilities of outsourcing and finally apply the methods to a practical case.2.1 PurposeOur purpose is to present a theoretical framework for outsourcing actions as a guideline forcompanies on why and how to outsource.
With this work we want to give a deep insight onlogistical outsourcing, as a new and promising trend in the global environment. We willexplain what outsourcing is and which are the opportunities offered in this field anddemonstrate how it can create value for the customer. To better show that it is not a riskyinvestment, but a new opportunity, we will propose a framework for the implementation ofthe outsourcing decisions, describing a possible relationship between a firm that wants to testoutsourcing opportunities and a logistical consultant company. We will also apply this theoryto a small case to give an example of how the consultant company could work in thatGaining competitive advantage through outsourcing3situation. Our purpose is to present the theoretical framework for outsourcing actions as aguideline for companies on why and how to outsource.
2.2 Method
The report has been based on a descriptive approach in strive to describe the reality; howoutsourcing can create value.No primary data was used in this report, as we used a case example for background on ourexample implementation. As such all information is secondary, achieved through studies ofrelevant literature, books and journals that proved useful to the study.3.0 Theoretical FrameworkThis capital will deal with the theoretical framework of outsourcing. Presenting some of thebasic reasons why companies outsource and the advantages and disadvantages of theprocedure. A model for implementing the practical phases of the outsourcing process is alsopresented. Finally four possible areas of outsourcing are explored.
3.1 Logistics Outsourcing DriversAlthough logistics outsourcing can vary from one business enterprise to another the basicreasons and driving factors for outsourcing are:1) Facilitate and accelerate business reengineering: outsourcing allows enterprises torealize quickly the anticipated benefits of reengineering. Not only does outsourcing allowenterprises to accomplish rapidly the anticipated benefits of a structural change, but takeadvantage of already reengineered world-class provider.2) Flexibility and reduced risk: an additional logistics outsourcing driver is risk reduction.Investments of a sizeable amount in a non-core business can have tremendous risks. Whenenterprises outsource they reduce workload fluctuations, improve flexibility and enhancecapabilities to adapt to changing opportunities.3) Investment priority: logistics outsourcing is appealing to business enterprises becausethey can switch a large proportion of fixed costs into variable costs. This will not onlyimprove the enterprise’s balance sheet but also free capital funds for core business areas.4) Reduce or control operating costs: cost reductions and operating cost controls are themost often cited reasons to use third party logistics (TPL). TPL seems to have leaneroverhead structures, more expertise, less excess capacity and better control.5) Concentration on core business: to achieve a competitive advantage throughout thelogistical activities the company should continuously develop outsourcing, upgrading itsresources; but by doing this the company may loose the focus on its core activities. Byapplying third party logistics it can fill in the lack of expertise and technology knowledgewithout loosing the focus on its business:High quality logistics service: TPL enterprises are medium to large businesses.They tend to have extensive logistics expertise, state of the art equipment andGaining competitive advantage through outsourcing4excellent training for their personnel. The acquisition of these capabilities through anoutsourcing arrangement can result in an increase in the quality of logistics service thatthe contracting enterprise receives.Better and newer technology: logistics technology requires more often specialexpertise. A competent logistics provider can relieve the outsourcer of a timeconsuminglogistics function and a non-core business area that requires the latesttechnology to be successful.Figure 1: Driving factors of outsourcing3.1.1. Advantages and disadvantagesBy outsourcing the logistical activities the company can achieve great benefits, but it will haveto cope with some common issues. The following is a list of the most important ones, to givea useful insight on the convenience of undertaking this decision.The advantage that a company could gain through outsourcing can be seen both from theoperational and the strategic point of view. Too often companies look at outsourcing as amean to lower only short-term direct costs (operational impact). However, through strategicoutsourcing, companies can lower also their long-term capital investments and leverage theirkey competencies significantly (strategic impact). The following is a summarization of theoperational and strategic advantages of outsourcing.OPERATIONAL IMPACTS:Cost reduction: the outsourcer can experience lower logistics costs due to theincreased efficiency of the TPL;Improved logistics service: the outsourcer can benefit from the third partylogistics provider’s increased levels of service consistency. This enhancesefficiency and can lead to higher customer satisfaction;Gaining competitive advantage through outsourcing5Reduced inventory costs: access to state of the art physical distribution systemsthrough outsourcing can reduce the amount of inventory required in the system.This results in lower inventory costs for the outsourcer;Capital investment reduction: the outsourcer doesn’t have to face the assetinvestment because it is using the TPL provider’s facilities and equipment;Upgrade logistics system: the outsourcer can gain access to state of the artlogistics capabilities, at a fraction of the cost of upgrading its own system, byoutsourcing its logistics functions;Accommodated seasonal peaks: the problem of seasonal changes shifts from theoutsourcer to the TPL provider, so the former doesn’t have to cope with it andcan achieve great flexibility.STRATEGIC IMPACTS:Access to logistic expertise: a strategic goal of the outsourcer could be to acquireand maintain a state of the art logistics expertise. The TPL provider is likely tobe aware of current developments in the logistics field such as new regulations,innovations and logistics technology. It will therefore pass on the benefits of itsknowledge to the outsourcer as a result of the outsourcing agreement;Easier access to foreign markets: an enterprise can gain access to foreignmarkets much more rapidly with the help of a TPL provider than if it tried to setup its own logistics network. By engaging in outsourcing, the outsourcer gainsaccess to the previously established local contacts of the third party logisticsprovider. It also acquires the ability to resolve local regulatory problems andovercome cultural differences using local expertise with professionalaccreditation.
Possibly most important, however, is the opportunity to enter anew market without the necessary infrastructure costs. This reduced costdiminishes the risk of entering new markets;Concentrate on core competencies : some enterprises have found out that inorder to remain competitive in their field they must reduce the range of functionsthey perform and concentrate on their core competencies. To do this they mustreduce the resources and efforts expended outside their core skills. Manyenterprises have made the strategic decision to minimize their involvement inlogistics functions. Outsourcing offers enterprises the opportunity to reduce theirlogistics efforts while maintaining high standards of logistics service;Economies of scale: for many enterprises logistics economies of scale are notachievable due to the relatively small size of the enterprise.
In some cases, astrategic decision can be made to access these economies of scale, not byexpanding, but by outsourcing the logistics functions to a TPL, which is alreadylarge and efficient enough to achieve the desired economies of scale.Outsourcing complete or partial activities creates great opportunities, but also new types ofrisks. The main disadvantages that the management can face are:Loss of critical skills: if the company doesn’t realize that the logistic function inquestion is a core activity for itself, and it decides to outsource it, it will loosethe specific skills that constitute part of its competence;Gaining competitive advantage through outsourcing6Loss of cross-functional skills: communication among the different functionaldepartments is usually difficult enough in a normal company, especiallyregarding logistics.
It is easy to understand that it will be more difficult if thefunction is taken over by an external company (the outsourcing provider), so oneof the main issues in the implementation of the TPL relationship concerns theinformation system and its interfaces;Loss of control over the supply chain: since the logistics functions are beingoutsourced to another firm, which the parent company has no control over, itmay mean a loss of control over the logistics process and the service levels. Thismay in fact lead to the risk of trusting your partner too much; in fact there are nolegal restrictions on the penalties that can be sentenced on vendors for servicelevels not reached;Human resource issues: the outsourcing usually means a reorganization of thework and may sometimes not be accepted by management and employees, whichcan see the outsourcing provider as an interference. Management should solvethis issue by focusing on commitment and employee education;Lack of global logistics providers: even though the trend is to have a uniquepartner in outsourcing in order to achieve better communication and coordination,and even though we are going towards the globalization of themarkets, the company cannot trust a world-wide logistics network that wouldcompletely cover all of the relevant markets.3.2 The implementation of outsourcingAs with other management strategies the most challenging phase in outsourcing is often theimplementing and realization of the change. Converting the theory and ideas into effectivepractice demands decisive co-operation and synchronizing of efforts. Multiple factors mayprevent the successful implementation of the outsourcing plan. The key factors inimplementation are commitment and understanding. Commitment for the outsourcingdecisions is required throughout the organization from top to floor management. Commitmentis also reflected in the level of trust between the participating parties and mutualunderstanding of the importance of commitment. Company-wide understanding of thepartnership-outsourcing concept and the goals set by management are also critical factors.3.2.1 Model for outsourcingIn order to successfully implement this process, by which outsourcing and partnership isfinally achieved, a solid set of procedures and models are required. Therefore we have chosento present a basic model and framework for the practical actions needed to achieve companygoals. This model is an integrated framework of the buying process model3 and relationshipimprovement process4 model, which we found suitable for implementing outsourcing.This is a presentation of the buying process and relationship improvement model used bycustomers (the party wishing to outsource some or all of its activities) in relation to the thirdpartydecision and consists of 6 different stages.3 Coyle, Bardi, Langley, (1996) The management of business logistics4 Macbeth and Ferguson, (1997) Partnership outsourcingGaining competitive advantage through outsourcing7Phase 1: Diagnose and conceptualize needsThis first stage consists of the company realizing and defining its needs for outsourcinglogistical functions. Some of the decisive factors (outsourcing drivers also mentioned in 3.1),which may compel a company to choose outsourcing activities as an alternative toindependent logistic operations are:Capacity/space constraintsLack of needed expertiseOrganizational changeMergers and acquisitionsChanging markets and customer requirementsNew products and cost pressureThe benefits of outsourcing are also considered at this point. From an overall view theemphasis should be on taking cost out of the entire supply chain – not just on an individualcomponent.
Other benefits deriving from outsourcing, in addition to cost reduction and thefacts mentioned in section 3.1.1., are improvement of customer service, ability to focus moreon core competencies, reduction of employee base and capital cost reductions.Phase 2: Internal commitment and team buildingAs previously mentioned commitment and understanding of the issues involved inoutsourcing are crucial factors to the development of the relationship process. Thusmanagement expertise and commitment are essential prerequisites for success. The processitself requires coordinated effort, which is effectively achieved through the building of across-functional implementation team. This team has the responsibility of carrying out theoutsourcing process, development of collaborative supplier relationships and managing therelationship change program. It should have the following characteristics:Stakeholder representation, including key operational people e.g. salesproduction, engineering and purchasingTechnical expertiseOrganizational expertiseHigh level managersStrong leadershipRight size. Preferably eight to ten members.From this point on the implementation team plays an important part in coordinating effortsand selecting suppliers.
Phase 3: Identify AlternativesThis stage should be devoted to the determining of selection criteria for a third-party supplier.The needs defined in phase one should act as a basis for defining the characteristics andfactors required for the coming relationship between company and third party. The process ofidentifying possible alternatives should also include a request for proposals from interestedGaining competitive advantage through outsourcing8suppliers. A pre-screening based on this list of proposals received should identify the relevantsuppliers according to the company’s specific needs.Phase 4: Selecting partnerThe selecting of a third-party logistics partner is the most critical phase in the outsourcingprocess. Suppliers that offer the lowest prices are not necessarily the most suitable ones fordeveloping long-term mutual relationships. The emphasis should be on the total acquisitionscost including selection process, implementation and estimated future expenses instead ofsupplier quoted unit prices. Crucial selection factors include the following:Technical capability. Does the supplier have access to technology, whichprovides basis for customer service and development.Existing level of business. Experience of supplier and key figures indicatingprofit, turnover and healthy levels of investment.Design capability. Is the supplier experienced in working with customers indesign.Capability for development. Does the supplier have processes, which are fullycapable now and plans to ensure their effectiveness in the future.Organization management. Does the supplier have an organizational structurecapably of managing desired processes and a TQM environment.Personnel capability. How experienced is the staff and how well does thesupplier organize, train and use its people resources.Company strategy. Does the supplier have a strategy compatible with formingcollaborative, long-term relationships with customers.The following up and assessing of these criteria’s involve visits to each supplier’s premises,interviews with key personnel and the building of professional contacts on a personal basis. Itis important to achieve consensus on the final selection and ensure that everyone has aconsistent understanding of the decision and its implications. A win-win relationship objectiveis essential.Phase 5: Supplier commitment and joint team buildingAfter choosing the most suitable supplier, the aim of this phase is to encourage the chosensupplier to buy into the relationship improvement process and the building of a joint teamwith the supplier in order to carry forward the rest of the relationship building process. It isimportant that both parties go through a process to develop full understanding amongstsupplier management of the coming changes and improvements. The basic requirement is thusthe provision of information and education from company to the chosen supplier. This isefficiently achieved through the building of a joint team between the supplier and company,which will direct the rest of the relationship improvement process. The same criteria’s andfactors as in the team building of phase 2 are important. As a result of this phase mutual goalsand commitment should be agreed on as well as sharing of benefits and a statement onexpectations set for both partners.Phase 6: Implementation and continues improvementGaining competitive advantage through outsourcing9This phase covers the actual effort of implementing the goals and commitments identified bythe joint team during phase 5. The whole concept of achieving mutual benefits andcompetitive advantage depend on the successful implementation of agreed plans. Dependingon the complexity of the new third-party relationship the overall time needed forimplementation and success may be relatively short or extended over a more extensive periodof time.It is important to keep up a continuing feeling of progress through identifying critical targetsand time-scales for actions and establishing performance measures to estimate the success inmeeting these goals. Continues improvement of the supplier-company relationship should alsobe considered as a priority. An effective model to measure the relationship is the relationshippositioning tool described below (3.2.2). Encouraging “out-of-the-box” thinking and beingcreative and innovative are important factors affecting the level of success achieved throughthird party outsourcing.3.2.2 Relationship positioning toolIn order to measure and continuously improve the relationship between supplier and companya systematic process of rating key elements included in this process is essential. A usefulmodel here is the Relationship Positioning Tool5, which identifies the effectiveness of therelationship and the critical factors determining it. It is based on a model of customer-supplierrelationship shown in figure 2 below.Figure 2: Structure of the Relationship Improvement Tool modelThe leaves of the tree in the figure represent the overall health of the relationship, which aredivided into four components of performance elements: quality, delivery, cost and innovation.Measured variations from quality, delivery and cost indicate weakness in the performance ofthe relationship. Similarly the effectiveness is measured by ensuring that continues5 SCMG Increasing The Potential for Local Sourcing to OEMs, Report of SERC/ACME grant GR/F68119,Glasgow, 1991Gaining competitive advantage through outsourcing10improvement takes place through innovation of the supplied goods and services. However theoverall health of the tree is dependent on the strength of its root system which is divided intothree major contributing factors between the customer (party buying third-party outsourcing)and supplier (party providing logistical functions). The potential of the relationship is thusdependent on:Customer strategy. How well the customer creates the right conditions for asuccessful relationship with the supplier.Supplier Capability. The suppliers raw capability to deliver products/services ata high level of quality, at the right time and the lowest overall cost.Information flow between customer and supplier. The effectiveness in whichpartners create a flow of information between each other providing basis foreffective sharing of knowledge and ideas.The Relationship Positioning Tool framework can be used to provide the basis ofmeasurements on the effectiveness of the supplier-customer relationship. It measures current,visible performance against the business deliverables of innovation, quality, delivery and costthus acting as an incitement for further and continues improvement. It also examines thefactors below the surface giving insight into tomorrow’s performance.3.3 Areas of outsourcingOutsourcing can be applied to various fields of logistics. The following is a presentation offour core capabilities, which can be considered as important areas for outsourcing. These areasare transportation, warehousing, inventory management and information systems.3.3.1 TransportationTransportation is the linkage process in logistics, permitting the flow of goods to the finalconsumers. Customer satisfaction is achieved through place and time utility; with the physicalmovement of goods to the place and time desired. As the geographical distance betweenconsumption and production increases in today’s global economy, transportation has becomean even more important operation.Transportation issues involve the selection of the transportation mode (air, sea, rail or motor),and then the specific carrier. Company characteristic and philosophy, market structure,product characteristics, customer characteristic and environmental issues are often thestrategic issues influencing transportation mode options. Specific carrier selection begins withidentifying carrier attributes required to achieve customer service, followed by the ranking ofthe importance and ended with the evaluation of the potential carrier against the criteria.Transportation decisions are prominent within the company logistic decision due to the tradeoffpotential existing between alternative transportation modes and carriers.Decision making in transportation offers 3 alternatives; the company can choose to operate itsown transport function, lease the vehicles and manage the service function, or it may opt touse a specialist service company.To make or to buy transportation often revolves around factors such as financial policy,customer service policy, the control the company requires and the intensity of the competitionGaining competitive advantage through outsourcing11in the market. For example, the view of how profit objectives are met will be reflected infinancial structure decision. Many companies are questioning the ownership of non-essentialasset. The decision to lease will eliminate many direct cost items, but increases operating orvariable cost. Risk of poor capacity utilization is reduced with a lower level of investment invehicles, special equipment and service support. Market characteristics and competitive offersinfluence customer service. Order cycle length and reliability are important factors within thescope of transportation decision making.Today, there are many large transportation firms, such as UPS Worldwide Logistic, FedExLogistic Service etc., providing a wide range of logistical solutions. Many companies seek tocreate synergy by concentrating on their competence and exploiting the carrier provider’scompetence. A prime example is Drug Transport, Inc., which has carved out a niche in lessthan-truckload distribution in the pharmaceutical and office supply fields.Some examples of services offered transportation service providers:planning of shipments and determining the best carrier for each needprofessional assistance in negotiating with commercial carriers for enhancedpricingassistance in damage and lost merchandise claims, provision of managementreports which enable effective analysis of transportation costs and monitorcarrier performanceconsolidation and centralization of pre-audit and payment for all intrastate,interstate, and international freight companies.3.3.2 WarehousingWarehousing is defined as the storage (holding) of goods. Warehousing is one possible areafor outsourcing. By the year 2000, private warehousing will decrease to 63% and public andin-transit storage will increase to 22% and 13% respectively. As our question is how to createvalue for the customer through outsourcing, we go directly on to describe what the advantagesand the disadvantages are for this action. By using third party warehousing, companies canconcentrate on their core competencies like marketing or manufacturing. The contract orpublic warehouse can not only provide storage, but also provide the logistics services packagethe user requires to support a firm’s logistic channel. Generally at lower output levels contractwarehousing is the best alternative. When volumes increase so that companies can spread thefixed costs over the larger output volumes, it might be more efficient to use privatewarehousing. The contracted party can offer, not only packaging and light assembly, but alsofreight audits, order entry system operation, inventory management and the picking andpackaging of goods. But several other advantages speak for outsourcing warehousing.First of all the company can compensate for seasonality in products: A contract distributor canhandle the peaks and troughs typical in seasonal industries more effectively than a privatedistributor can. That is to say if the output is not stable the company may have problems todecide over the right output amounts and use its warehouse inefficiently. Nevertheless somecompanies have multiple-product lines and this helps to stabilise the private warehousedecision.Gaining competitive advantage through outsourcing12Additionally with third party warehousing the firm can increase geographical coverage by anetwork of facilities. A company could have warehouse locations in different regions withoutinvesting in numerous private facilities. With a combined private and contract warehousenetwork, a company can remain in direct control of the centralised facilities, while using thecontract warehouses to lower direct labour costs and increase geographical market coverage.Moreover it can gain flexibility in testing new target markets. Contract logistics flexibility canenhance customer service. Firms promoting existing products or introducing new ones can useshort-term contract distribution services to test market demand for the products. Thereforwhen building an own warehouse knowledge on the best market area will already be acquired(closest to vendors or most dense market area). A further rationale for contract warehousingreferring to this is, that when a company builds it establishes a long-term financialcommitment. This assumes that the firm has adequately forecasted and located consumerdemand and concentration and that technological breakthroughs in construction,transportation, or warehouse systems will not make the facility obsolete, in order for the firmto get the necessary pay-off.Another point is the obtaining of management expertise and dedicated resources. Contractingout is a unique opportunity to hand a company’s logistics function over to a team of managerswho are distribution experts. These can provide innovative distribution ideas and costreducingproduct-handling procedures.Permit off-balance-sheet financing is another advantage. Hiring a contract distributor toperform distribution operations can increase a company’s return on investment (ROI),allowing the company to invest only in those assets that support its primary business. Inaddition these assets represent an opportunity cost to invest funds elsewhere. Contracting outthe distribution services takes these assets off the balance sheet, thereby increasing acompany’s ROI.Finally, because the contracted firm handles a high volume of products from different clientaccounts, contract warehouses offer significant freight savings by consolidating freight intofull truckloads.Along with the advantages of outsourcing come some disadvantages.There is the loose of control of the logistics function. The company exerts less control overpersonnel, hiring practices, policies and procedures. Companies with high-value products suchas pharmaceuticals must be very cautious to reduce employee theft as much as possible.Physical control like security, refrigeration and service control for customers and plants willbe lost and certain raw materials and finished goods are highly susceptible to theft, damage orspoilage. Thus hiring an outside company to handle products is more risky than using aprivate facility. Even if contract warehousing usually has a good reputation, the chances ofloss are greater.Contact costs possibly exceed private costs. Also there may be management and unionacceptance problems, lack of product volume, incompatibility with company needs andinsufficient understanding of contract warehousing and its value.Gaining competitive advantage through outsourcing13Finally, in some regions there might be no contract warehousing possible, because of theirhazardous nature or for some other reason, where the loss for the contacted firm would be togreat. In this regions private warehousing is unavoidable.3.3.3 Inventory managementA potential area of outsourcing is the inventory management functions, which are closelyrelated to warehousing. Inventory management is defined as inventory administration throughplanning, stock positioning, monitoring product age and ensuring product availability.A recent trend in logistics has been the reducing of carried inventory in order to reduce theoverall costs in the entire supply chain. This can be achieved through various alternatives, oneof them being outsourcing the inventory management function. Inventory managementfunctions include all the actions between the receiving of each stock-keeping unit until thespecific unit is load for transport. These functions are closely related to warehouse operationsand thus inventory management is often outsourced in combination with warehousing.The reasons for outsourcing inventory management include cost pressure due to new productsor scarcity of assets. Inventory costs represent a significant component of total logistics costsin many companies and the expanding product range increases the need for multiple types ofstock keeping units. Another reason is capacity constraints, which are effectively resolved bybuying extra capacity from outside. A third reason is the changing markets and customerrequirements. The inventory levels that a company holds directly effect the customer servicelevel and ability to reach the market. All of these factors can be resolved by buying third-partylogistical functions from outside which offer a variety of services.The outsourcing of inventory management has a major affect on the company’s inventory costwhich consists of inventory carrying cost, order/setup cost, expected stockout costs and intransitinventory carrying cost. Of the above mentioned, inventory carrying cost is mostimportant. It consists of capital cost, storage space cost, inventory service cost and inventoryrisk cost, which may all be significantly reduced or totally removed through outsourcing. Thusthe inventory cost may also be used as a decision criteria for choosing an external serviceprovider. If the company’s inventory carrying costs, added with other overhead inventorycosts, amount to a higher expenditure than the cost of outsourcing inventory management,then outsourcing should be considered as an effective solution. By calculating the totalamount of inventory cost by unit and comparing these numbers with correspondingoutsourcing unit prices valuable insight into the decision process can be gained.From an overall point of view the major effect of outsourcing inventory management is oninventory costs. Thus an essential decision driver in outsourcing inventory management is thereducing of asset investment in order to improve asset productivity. Third-party suppliers offerasset based facilities such as warehouses, which can be combined with inventory managementfunctions and services. Therefor outsourcing will eventually lead to improved assetproductivity, measured for example with return on investment, inventory turnover and profitmargin. This enables adding additional value to the company’s products and for the finalcustomer in the form of better service and lower pricesGaining competitive advantage through outsourcing143.3.4 Information systemsDriven by information technology’s ability to reduce co-ordination costs, business enterprisesare designing and implementing inter-organisational links to support commerce activities.These links take many forms, such as Integrated Logistics Information Systems (ILIS), Just InTime systems (JIT), Electronic Hierarchies and Markets and Enterprise Integration. Theinformation systems make available all the information for carrier negotiations, carriermanagement, shipment control and consolidation, financial reporting and freight in a faster,smarter, and less expensive way by reducing paperwork and redundant processes. But theconsolidation of different software programs can lead to problems, so outsourcing can be agood solution to have at the company’s disposal resulting in high expertise and a betterintegration.The most outsourced activities in the information systems area are freight payment andauditing, cost accounting and control, and logistics management tools for monitoring,booking, tracking, tracing, and inventory management.To give an exhaustive view of the services usually provided by third-party logistics, wesearched information on the web sites of some of the firms included in this category. Thefollowing are examples of how different companies have resolved information systemprocedures and some of the services they offer in the area.GE INFORMATION SERVICES6Electronic Data Interchange (EDI)Purchasing and supplier managementInternet/Intranet/Extranet (this includes building trading communities of internaland external business partners, streamlining business processes and leveraginginvestments in enterprise-wide systems)Risk managementTrading community management servicesNetwork services (providing local support and customer service in all majorglobal markets)Messaging services ( e-mail, bulletin board and database management )CASS INFORMATION SYSTEMS7Freight invoicing, processing and controllingManagement reportingClient database interface systemsOn-line information retrievalInternet delivery systems (a supply chain management system which handlestransportation transactions, procurement of materials and supplies, maintenanceand reparation of items, utility, and warehousing )ENCOMPASS86 http://www.euro.geis.com/7 http://www.primary.net/sites/cassinfo/products.htmlGaining competitive advantage through outsourcing15Programming servicesLocal area networking (LAN) (design, upgrades/conversions, wide area connecton demand (ISDN), equipment installation, troubleshooting)Telecommuting systemsReal time system and network integration (office automation systems,information/document repositories, license tracking and metering, e-mailsystems)Needs analysis (needs identification, cost/benefit analysis, migration planning,standards and procedures, disaster recovery planning)Training services4.0 Case example4.1 BackgroundOur company is situated in the United States. It supplies medical and diagnostic systems tohospitals, physicians office, clinical laboratories and pharmacies. Since the company has beenrestructuring its line of business to focus exclusively on health care; during this time severalnon-health care businesses were divested. Substantial changes in the company’s environmentdemand for a essential rethinking of the logistics system.The health care system itself is made up of two constituencies: payers (insurers, managed careorganisation and government entities) and providers (physicians, hospitals, long-term care andspecialty organisations). The soaring cost of health care had plunged the health care systemthroughout the industrialised world into turmoil. Efforts to control costs created greaterpressures for efficiency, technological breakthroughs and actions to widen access to healthcare systems and to improve the quality of services. The ability to respond efficiently andinnovatively became an important basis for competition among medical and diagnosticsuppliers. Conflicting pressures of providing quality medical care to all, while controlling thecost of health care products and services challenged the companies.In an attempt to control drug costs, the fastest growing expense in many health plans, healthinsurers began to offer financial incentives to providers who selected a lower-priced or genericdrug when a choice was available. Insurers made similar efforts to influence a patient’s choiceof doctors and hospitals. Intervention by insurers in decisions that had formerly rested solelywith the doctor and patient marked a major shift in the way people accessed the nation’shealth care system. As insurers gained more control over the medical choices of individuals,suppliers to the health care industry began to address the economic needs of their customersand adapted their sales strategies accordingly. Purchasers were now more likely to useeconomic selection criteria in their purchasing decisions. Cost-benefit analyses, considerationof the supplier’s distribution systems and the consolidation of vendors took precedence overtraditional relationship-building and attention to a product’s features and benefits. Grouppurchasing became widespread and customers began to demand new services such as8 http://www.monmouth.com/dpietrowski/Gaining competitive advantage through outsourcing16corporate supply agreements. As hospitals placed greater emphasis on inventory managementand purchasing programs with prime vendors, the ability to bundle products together ordeliver them at specified times and in prescribed ways became a major factor in vendorselection. Suppliers in turn looked for ways to improve their price position and become moreattractive to the hospitals, thus logistics took an important strategic role. Demonstrating valuewas no longer merely a competitive marketing advantage: it was the factor that sold theproduct.The increasing demand by hospitals to centralise and co-ordinate relationships with suppliersto achieve economies that they could pass on to their patients forces our company to react tothe demands through better logistic management, in particular outsourcing. Many studiestoday have argued on the need to focus on core competence. That is, our company shouldfocus on the areas that it can dominate and it consists of elements that are important to thecustomers in the long-run. This can be achieved by outsourcing through external logisticspecialists who can provide a customised solution for the company.4.2 Outsourcing solutionThe following is a description of the practical implementation of outsourcing in the case of thedescribed company with the help of the models and methods presented in this study. Theprocedure is based on the implementation model described in section 3.2.The first phase: Diagnose and conceptualize needsThis requires defining the company’s needs. It has to know what to outsource and what are thebenefits through logistical outsourcing. The possible areas and benefits of outsourcing areidentified in the table as follows:Areas BenefitsWarehousing ;TransportationGeographical coverageHigh flexibilityNo capital investmentOpportunity to hand function over to a team of expertdistribution managersConsolidating freight into full truckloadsGeographical coverageThe company has to be clear with the scope of the project and its ultimate objective. Given theimportance of time and costs in the pharmaceutical industry and the company’s global market,we feel that transportation and warehousing are potential areas for outsourcing. We assumethat the company’s scope in this particular outsourcing project is to focus on domesticoutbound truck transportation and warehousing of medical supplies, thus they will also haveto partly outsource their inventory management. We suggest to not outsource “informationtechnology” as it is vital to the company to keep track with the rapid trace of innovation ofnew medical products and diagnostic systems, thus it contributes significant to its corecompetence. Therefor it will be useful to keep full control over “Information Technology”.Gaining competitive advantage through outsourcing17The main objective is to create value for the customer for example by reducing the costs andbeing more flexible. The company can also benefit from the more general advantages likehanding over the logistic functions to experts or extended market coverage. This will lowercosts and add value to the final consumer in the form of better service and lower prices.There are specific advantages for the firm, which are very important to meet the requirementsgiven by the company’s environment. First the hiring of the contract distributor allows thecompany to invest in the assets that support its primary business, as they want to concentrateon their core competencies. These assets represent an opportunity cost to invest fundselsewhere, which is a big advantage as they can relocate the funds to research anddevelopment functions, which is fundamental to a company in such a highly competitive andinnovative environment.The contracted firm will handle a higher volume of products from different client accounts.The contracted warehouses offer significant freight savings, especially on an internationallevel, by consolidating freight into full truckloads, thus reducing costs which they can pass onto their customers. This also fits the request by customers for the ability to bundle productstogether or deliver them at specified times and in prescribed ways.In addition the increased market coverage along with more flexibility plays an important rolein offering better service to their customers as they began to take the supplier’s distributionsystems into consideration.Nevertheless, we have to weigh these advantages against the possible disadvantages. First ofall the company with its high-value pharmaceuticals must reduce employee theft as much aspossible, which might be greater when contracting logistical services. Physical control in theform of security and necessary refrigeration for the medical products will be reduced andservice control for their customers and plants could be lost. Additionally there is the risk ofdamage to products or spoilage. But contract service providers usually have a good reputation,because they also have to navigate in an increasingly competitive environment.Possibly contact costs will not exceed private costs and there will be no management or unionacceptance problems. Neither will the lack of product volume be a problem in our company’scase. After our consulting work there will also be a sufficient understanding of contractservice and its value.Finally, in some regions contract warehousing may not be possible, because of the productshazardous nature or for some other reason, where the loss for the contracted firm would be toogreat. In this regions private warehousing for our company will be unavoidable.The second phase: Internal commitment and team buildingThis phase calls for a committed project team with people who thoroughly understand theoutsourcing process, objectives, agreed evaluation criteria and resources. The team shouldinclude people involved in the outbound truck transportation and warehousing functions.The third phase: Identify AlternativesGaining competitive advantage through outsourcing18The large number of logistic service providers, offering a wide range of services ranging fromorder processing to customer service, offer many alternatives for the company. Our companyhas to identify the alternative suppliers based on its cost reduction objective in outbound trucktransportation. Selection criteria will revolve around the common transportation issues of cost,transit time, reliability, capability, accessibility and security. Given the cost objective,potential partners are likely to be those who can provide the service at low cost. Cost issues onrates, minimum weights, loading and unloading facilities, packaging, damages in transit andspecial service available from a carrier are important.The fourth phase: Selecting partnerOur company has to reach a decision to choose a partner based on the evaluation of thealternatives. Using the theory of the previous section we suggest evaluating the alternativesmainly on the basis of the specific business requirements. This means finding partners able tohandle the sensitive products and the time, place and cost requirements to create final value tothe customers which is the overall objective of our company.The fifth and the sixth: Supplier commitment, implementation and continues improvementIn these two phases the company should proceed according to the given theory. Mostimportant is that there should be commitment between the company and the supplier. Anongoing improvement process should accomplish this.5.0 ConclusionIn order to effectively implement outsourcing, commitment from top to down managementand a wide understanding of all the stages and implications of outsourcing are required. Inorder to achieve these prerequisites and a successful implementation process, a modelintegrating the third-party logistics buying process and relationship improvement process ispresented. It emphasizes the importance of carefully identifying alternatives, the overallanalysis of partner selection with the help of specific criteria, mutual relationship buildingbetween logistics service buyer and provider through joint team building and continuousimprovement and performance measurement. The relationship positioning tool model can beused for the continuous enhancement and improving of the supplier-customer relationship.As we pointed out there is an increasing need for logistical outsourcing as a way to gaincompetitive advantage and as an instrument to meet the requirements of the company’scomplex environment. Some of the basic advantages are lower short-term direct costs(operational impact). Through strategic outsourcing companies can also lower their long-termcapital investments and leverage their key competencies significantly (strategic impact).The results and overall reasons for outsourcing should focus on adding value to the finalconsumer of the product or service. By achieving lower logistical costs and a higher level ofquality and expertise these results can be used to add value to the consumer in the form oflower prices and better service.Gaining competitive advantage through outsourcing19Our report has presented the possible benefits of outsourcing in four important areas oflogistics. All the advantages and disadvantages have to be carefully taken into account beforetaking the final step in outsourcing. This will help companies to concentrate on their corecompetence and keep ahead of their competitors.6.0 ReferencesLiterature:Andersson, (1997) Third party logistics: outsourcing logistics in partnerships, LinkopingsUniversitetCoyle, Bardi, Langley, (1996) The management of business logistics, West PublishingCompanyMacbeth and Ferguson, (1997) Partnership outsourcingGaining competitive advantage through outsourcing20SCMG Increasing The Potential for Local Sourcing to OEMs, Report of SERC/ACME grantGR/F68119, Glasgow, 1991Internet:http://www.euro.geis.com/http://www.monmouth.com/dpietrowski/http://www.outsorcing-journal.comhttp://www.primary.net/sites/cassinfo/products.html
