3 W’s (What, When, Why) of 3PL

Thanks to Ankit Verma and Chandan Bharambe of IIM Kozhikode.

Have you ever wondered when you walk in big retail stores for shopping, that why the same product is priced at different rates in different retail stores? Why big retail stores are able to provide huge and daily discounts to its consumers? Well, as a consumer you should not really worry about it but yes, as a manager you should!

If you think economies of scale is the sole factor for this then probably you are mistaken! Numerous supply chain strategies are being employed by the firms in a competitive world of free economy. Logistics has been a key part of operation for any firm. For large manufacturers it has been always a source of dilemma whether to outsource the logistics and focus on their core competencies or involve in vertical integration to own the logistics system as well.

Innovation has become necessity in this industry and even shippers are ready to invest in innovation of these outsourced companies. 3PLs could able to demonstrate innovation by introducing process improvements, improving execution, offering new services and adding technology. But shippers do not see these activities as truly innovative, instead they seek disruptive innovation in 3Pl industry like a new product or service idea which when implemented significantly disrupts the market and/or value chain by simplifying, automating, generating value, or reducing costs5. Further, role of these outsourcing companies is increasing day by day. Initially, companies used to only ship the goods but then it further added the value with inventory management, warehouse management, order acceptance and processing, pick-and-pack operations, order fulfilment, assembly, packaging, and other value-added activities, credit card verification, invoicing, credit, and collection, pre-sort capabilities, and returns handling.

Thus, Utility of third party Logistics (3PL) has increased drastically. Global Supply Chain Management is the new trend in big manufacturers which requires sourcing and dispatching from different locations around the world to counter, by using different approaches such as Hub and Spoke, Cross Docking utilise their economies of scale and expertise in moving products efficiently along the global supply chain.

Evolution of 3PL:

  • Pre 1980s, it started with companies with strong logistics and who could store big inventory gave their services to retailers and manufacturers
  • In the early 1990s, Express networks and experience came in picture with the rise of companies such as DHL, TNT, and UPS with the rise of Global Supply Chain
  • In the late 1990s, their value proposition changed from service provider to solutions provider. Many companies emerged with extensive knowledge in information technology, consultancy, and financial services such as Accenture, GE Capital Services, and IBM

With the change in value delivery the 3PL market witnessed phenomenal growth. As a result many organizations spun off their logistics businesses to focus on their core business. Table 1 shows global 3PL market and 3PL as a part of logistics. Growth of revenue in 3PL business for North America is sluggish with compared to Asia Pacific and Latin America which shows maturity stage of 3PL market whereas for Europe growth has been declining which is due to economic challenges faced by Europe.

3PL companies have huge presence in Europe and North America so the logistics costs average 8.9 percent GDP, while the percentage of logistics costs to GDP is higher in the rest of the world

3pl_1

The below figure indicates types of logistics service providers depending upon their functions. This matrix can also be viewed as solutions by these companies from standard services to highly customized services.

3pl_2

  • The service developer offers advanced value-added services such as forming specific packaging, cross-docking, track and trace, and special security systems.
  • The standard 3PL provider supplies typical 3PL services including warehousing, distribution, and pick and pack.
  • The customer adapter handles customer’s existing activities and improves handling efficiency
  • The customer developer is the most advanced form and involves high integration with the customer, taking over its whole logistics operations. This is similar to what is now known as fourth-party logistics (4PL)

 

Then the core question arises how companies should decide whether they should go for 3PL or not? What can be possible criteria to judge the performance of 3PL Company?

Here are some of them. If shipper thinks that any of the following tangible or intangible benefits are associated with adopting 3PL to its operations then it should give deep thought for it.

  • Lead time reduction

If company is able to reduce its Lead time to replenish inventory, by efficient and close coordination goods movement, especially when changing from one mode to another; hassle free official work and clearances in movement of goods.

  • Reduction in Bull- Whip effect.

By proper time management and economies of scale 3PL Company should be able to utilize its big network to minimize interruptions and delays. This Reduction in variability helps in better inventory management and much improved productivity and building of trust between partners

  • More focus on core Business

Airtel-IBM joint venture in management of operations has provided fillip to Airtel to expand in other regions as well because Logistics management in extended supply chains is itself a very complex process which has been reduced and eliminated and Airtel is now focusing on its primary business functions.

  • Increased supply chain flexibility

The customer shall have a better bargaining power over its suppliers. Access to big network of suppliers and leveraging that could be one point of differentiation in business. 3PL facilitates sourcing from different locations just like Apple, Walmart extract majority of revenues and small portion of revenue goes to their suppliers. In this way, supply chain is flexible and adaptable to market forces.

  • Market development and Market entry vehicle

There is certain demand for some products in different locations but due to unavailability of raw materials market is unexplored. 3PL providers can solve this problem through their huge network and help customers explore new market opportunities and assisting with marketing in new territories by triggering demand in those regions by sharing of information, expertise and network.

  • Expertise in Logistics

3PL integrates various supplies from different customers, hence have access to huge information. This information can help to identify potential growth areas and help in introduction of new products, new processes, trends in business climates in foreign countries, trends in transportation modes, and more.

Over the years there are major changes in the reasons for not employing the 3PL strategies for the operations. Figure 2 shows these change in the reasons over the time. Other than IT compatibility all other issues has observed drastic decline. Even those who considered logistics as their core competencies do not think it the same over the years. Decline in cost reductions indicates modern technology has reduced the cost for total logistics for the shippers.

3pl_t1

Challenges in 3PL implementation:

  • Incompetent suppliers with variable supplies:

In global supply chain scenario, a company has its suppliers spread all over the world. It is highly unlikely that all of your suppliers are able to keep the same pace throughout the operation. This poses a great challenge for 3PL implementation.

  • Lack of integrated Solution provider:

There are few players in 3PL industry which offer full range of services needed, and their services might not be suited to the supply chain. Figure 3 shows different kinds of services provided by the 3PL player and use of the services in different regions.

  • Less autonomy:

Any incompetency in supply and logistics can lead to huge amount of shortage costs or non-utilization of assets leading to business failure. In a way, this creates variety and hence uncertainty in supply chain. So competent and qualified human resource is required

  • Thorough tangible and non-tangible value analysis:

Customers shall be able to carry out cost-benefit analysis with outsourcing. The value from outsourcing should offset the value by internal management of logistics

3pl_t2
Checklist for 3PL outsourcing:

  • Compatibility with supply chain
  • Cost, delivery time quality of service
  • Performance measurement Mechanism
  • Hassle free paper work
  • Management of service provider and organization
  • Information sharing and mutual trust
  • Operational performance and use of modern technology
  • Size and quality of fixed assets
  • Experience in specific industry
  • Financial performance, Market share of the company
  • Geographical spread, range of services provided and network
  • Risk management and reduction in variability/uncertainty
  • Quasi rents management and effective remuneration system
  • Cost of delivery and solutions
  • Financial Stability
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Building Competitive Advantage Through Operations

Thanks to Shruti Rastogi and Vaishali Gurjer of NITIE for this amazing article

1.Introduction

Competitive advantage deals with the creation of unique advantage that differentiates a business from its competitors. For competing in this Global village with fast changing markets and technological innovations every moment, one needs to build & exploit upon competitive advantage.

In earlier environment, when market competition was low & customers were less aware & demanding, survival was easier for business. However, with change in the market scenario more and more businesses are racing in and survival is equally difficult. These challenging situations though seen as hurdles have helped businesses evolve and upgrade from time to time and Operations has always backed survival of industries in tough times. Earlier Operation was thought of being restricted to shop floor and Manufacturing activities which is not the case anymore. Operation today is a much wider term to include various methodologies, techniques and tools applicable in both manufacturing and service sector to build competitive advantage. Japanese companies achieved their dominance in various industries owing to strong hold on Operations. Various Operation tools like Poka-Yoke, JIT, SQC, Six sigma and Quality circle evolved were evolved in Japan to address challenges faced by business houses in 70s-80s. These techniques proved out to be a lifeline of industrial development and an elixir in tough times. With the passage of time these techniques are now learnt and implemented by all Business houses.

However, even after the knowledge of these operation methodologies, tools and techniques many industries today are suffering from low profit and decreasing working capital. This is because of the lack of sustenance of applied tools and techniques. Simply applying the tool never works. Proper groundwork should be done before applying any tool and proper support has to come from the higher authorities to support the initiative among employees.

The time is again calling Business to innovate there operations, leverage existing Operations Methodologies, tools and techniques and expand it explicitly to entire supply chain to include by-products of supply chain, to consider the entire life cycle of product and to optimize the product not only from a current cost standpoint but also a total cost standpoint.

2.Building Competitive Advantage

“Operations” is the buzzword defining the health of any business. It is also a part of Value chain given by Porter:

Value Chain

Value Chain

Thus one can leverage on Operations to enhance their values to customers.

This value enhancement generally includes 3 strategies:

  1. Cost
  2. Differentiation
  3. Response

matrix

Fig 2: Strategies for value enhancement

2.1Strategies for Value Enhancement

The strategies mentioned above can be very well leveraged for achieving competitive advantage.

  1. Cost

Cost is an important parameter which can be leveraged to obtain advantage over competitors. Reducing the cost also contributes to increase in margin or adds value to customer. Operations can and should always be leveraged on to attain cost benefit. Reduction in cost can lead to decrease in market price thus increase in value of product or service. This helps to gain an edge over the competitors & can help becoming an order winner. Owing to this cut throat competition we need to lower our cost at the same time increase our profit margins to emerge as a successful organisation. We can achieve cost benefit through operations as below:-

  • Mass production increases the profit margin to a great extent .To achieve this assembly line strategy can be applied with consideration of market demand.
  • Layout design also reduces the cost by reducing the material handling cost which amount for about 20-40% of the production cost.
  • Increasing the productivity implies increasing the profit margin. Through work measurement study and automating the time consuming and monotonous operations we can increase the available time per shift by eliminating the non value adding activities.
  • Standardizing the process or using standardized parts for the product also leads to considerable reduction in cost.
  1. Differentiation

A feature that makes the product standout amidst the competitors is the differentiators. Product or Service differentiation gives customer a sense of royalty. It can be achieved through:

1. Quality:

Good quality helps to differentiate a product from others. Today customers are more concerned about quality and don’t mind paying extra for quality. Improved quality serves as a strong attribute to overcome competition. Operation tools like Statistical process control and Six sigma can be deployed and exploited for quality conformance of a product.

2. Design:

Incorporating new features and functions for creating uniqueness in the category will lead to appealing design. Design also develops the user interface and gives physical satisfaction for owning the product. However, designing should be done considering both manufacturers and the customers. The design should be easy to assemble and simple to manufacture. DFMA is used as the basis for concurrent engineering studies to provide guidance to the design team in simplifying the product structure, to reduce manufacturing and assembly costs, and to quantify improvements. The practice of applying DFMA is to identify, quantify and eliminate waste or inefficiency in a product design.

  1. Response

Response includes the entire range of values related to timely product development and delivery and after sell service. For timely response reliable scheduling and flexible performance is required. A good response requires the facilities to be flexible. This can be achieved in manufacturing process by using cellular layouts. Further, the delivery can speed up if the location of the facilities is decided strategically through use of operation research models. Moreover, using operation tools for quality enhancement would lead to satisfactory user satisfaction and less complaints requiring response.

2.2 Operation Techniques Leading to Competitive Advantage

In the current scenario the companies are dealing with problems of low profit margins and decreasing working capital. There is large amount of money that is stuck in the working capital and requires to be released so that profitable opportunities can be reaped out of it. A solution to both can be a proper management of the inventory which also falls in the gambit of Operation Management.

2.2.1 Inventory management

Inventory is a necessary evil. Inventory should be managed efficiently as on one hand inventory buffer prevents stock outs and improve service level, while on the other hand it blocks large amount of capital in holding inventory, therefore by properly managing the inventory we can release the blocked capital.

We have to ensure that we don’t keep the inventory for longer durations and that it is converted into sales as soon as possible. Metrics like inventory turnover ratio and inventory quality ratio are used to measure inventory performance. Higher the ratios better is the performance of the firm’s inventory and hence lesser is the blocked capital.

The methodology for proper management of the inventory is as shown below:-

arrow

Fig 3: Methodology for inventory management

The spend analysis of the inventories is studied and then classification of the inventories is done. ABC classification is the one very popular method of inventory classification based on PARETO’s Principle. Pareto rule states that the major chunk of the capital is blocked with small percentage of inventory. Further, collecting and analyzing the past demand data post which normalization of the data is done to remove the outliers by defining the Upper Control Limit(UCL) and Lower Control Limit(LCL).

UCL=σ+3µ

LCL= σ-3µ

After normalization the norms are devised. The optimum safety stock is given by:

Z*sqrt((average lead time* σd^2)+((average daily demand )^2* σlt^2)

Where, Z= service level

σd=standard deviation in demand

σlt = standard deviation in the lead time

The reorder point (ROP) =d*l +safety stock

Where

d=demand

l=lead time

Inventory Quality ratio (IQR) to measure inventory performance:

A simple method of measuring inventory performance and managing inventory dollars has been successful in reducing inventories 20% to 40% by increasing the effectiveness of planners and buyers.

Using the data from any MRP/ERP system, the IQR logic divides inventory into three groups:

  1. Items with future requirements,
  2. Items with no future requirements but with recent past usage and
  3. Items with no requirement.

The items in these groups are then stratified into typical ABC classifications based on their future dollar requirements (ABC), their past dollar usage (DEF), or their current dollar balances (GHK), respectively. A target inventory level or rule is set for each item based on its classification. The balance on hand of each item is compared to the rule, and the dollars of each item are categorized as either Active (A1 or A2), Excess (E1, E2 or E3), Slow Moving (SM) or Non Moving (NM). These are called the inventory quality categories.

The Inventory Quality Ratio is the ratio of the active inventory dollars to total inventory dollars.

ratioBenefits of IQR

  • The IQR logic uses both future requirements and past usage
  • Quickly identify good, bad and excess inventories
  • Measure performance by inventory segment (supplier, commodity, etc.)
  • Set realistic reduction objectives and track improvement over time

table                           Figure 4: Algorithm showing inventory categorization

  • Drill down on problem areas and prioritize corrective action
  • Enhances any MRP/ERP/SCM system
  • Gives planners and buyers the information needed to free the working capital

2.2.2 Six Sigma

Six sigma is a quality control tool, focused on conformance to standards. In six sigma the quality of defects is reduced to the extent of 3.4 parts per million. Thus, by reducing the defects we are improving the quality (Differentiation), at the same time the cost is also reduced as the bad parts or the scrap factor is considerably reduced.

The variations in the product is kept within ±6σ, those falling beyond the range are rejected. The quality level obtained is 99.9999998%.

graphs

                                                       Fig 5: Six sigma concept

Six Sigma projects follow two project methodologies, composed of five phases each, bear the acronyms DMAIC and DMADV.

  • DMAIC is used for projects aimed at improving an existing business process
  • DMADV is used for projects aimed at creating new product or process design
  • Make or Buy Decision

The make-or-buy decision is the act of making a strategic choice between producing an item internally (in-house) or buying it externally (from an outside supplier). Make or Buy is also an operation strategy. The buy side of the decision also is referred to as outsourcing. Make-or-buy decisions usually arise when a firm that has developed a product or part—or significantly modified a product or part—is having trouble with current suppliers, or has diminishing capacity or changing demand.

Make-or-buy analysis is conducted at the strategic and operational level. The increased existence of firms that utilize the concept of lean manufacturing has prompted an increase in outsourcing.

It prescribes that a firm outsource all items that do not fit one of the following three categories:
(1) the item is critical to the success of the product, including customer perception of important product attributes;
(2) the item requires specialized design and manufacturing skills or equipment, and the number of capable and reliable suppliers is extremely limited; and
(3) the item fits well within the firm’s core competencies. Items that fit under one of these three categories are considered strategic in nature and should be produced internally if at all possible.

The two most important factors to consider in a make-or-buy decision are cost and the availability of production capacity.

buy

Elements of the “make” analysis include:

  • Incremental inventory-carrying costs
  • Direct labor costs
  • Incremental factory overhead costs
  • Delivered purchased material costs
  • Incremental managerial costs
  • Incremental purchasing and capital costs

Cost considerations for the “buy” analysis include:

  • Purchase price of the part
  • Transportation costs
  • Receiving and inspection costs
  • Incremental purchasing costs
  • Any follow-on costs related to quality or service

3.Future Scope

Customers now are getting more and more aware and responsible. They expect the same from Business houses. Customers are now more concerned about environment and society. Leveraging this, industries are looking forward to project themselves as more environmental friendly and socially responsible. Exploiting this shift in consumer behavior, industries can build sustainable operation strategy. Following scope is identified for future

3.1 Going Green

Industries can design their operations in a way to recycle things, use harmless raw material, adopt process leading to reduced emission of harmful gases. For example Novelis, has targeted to increase the use of recycled aluminium to 80% by 2020 which was at around 30% in 2009, it will significantly bring down the environmental impact. Novelis estimates that recycled aluminium avoids 95% of the green house gas emissions associated with primary aluminium production and every metric ton of recycled aluminium saves around 7.8 metric tons of carbon dioxide equivalents over the total aluminium value chain.

3.2 Corporate Social Responsibility(CSR)Customers also expect the Industries to be more socially responsible. They want Business houses to benefit underprivileged section of society with their Operation strategies.These sustainable operation initiatives would help business houses to build trust among their customers and expand and retain the same.

4.Conclusion

Operation, now having expanded its base from simple Manufacturing to various Business areas, is a great opportunity to leverage for sustainable growth by building competitive advantage.