The benefits and risks of Outsourcing

The benefits and risks of Outsourcing In this chapter, an introduction of research background is given and the objectives and scope of the research are described. In addition, a general overview of research methodology will be introduced. Finally, a brief overview of the dissertation structure is given in order to present an overall picture of the research undertaken. Background of research: Outsourcing is one of the fast growing aspects with a spending of US$ 3.7 trillion worldwide in 2001 (Clott, 2004). The latest survey conducted by Cap Gemini, Georgia institute of technology, SAP and DHL, it is clear that the usage of third party logistics (3pl) services continues to grow in Latin America, North America, Western Europe and Asia-pacific (Cap Gemini, 2006). Due to globalisation and rapid growth in information technology organisations are eager to develop competitiveness and responsiveness to customers (Matteo, 2003). Lieb and Randall (1996) defined 3pl to a more detailed extent; in particular, the term third-party has been explained more clearly. The third party logistics is defined here as: A company which supplies/coordinates logistics functions across multiple links in the logistics supply chain. The company thus acts as a third-party facilitator between the seller/manufacturer (the first-party) and the buyer/user (the second-party)à ¢Ã¢â€š ¬Ã‚ ¦. The functions the functions performed by the third-party can encompass the entire logistics process or selected activities with in that process. (p.51). Today many international logistics providers, including freight forwarders, customhouse brokers, ocean and air carriers, promoting themselves as third party logistics providers as they can provide more services for the movement of international freight. Liebs survey clearly tells that one third of large manufacturing companies in us use third party logistics services and over 60 percent of these firms used these services for above five years (Lieb, 2007). The close relationship between shippers and carriers could be a benefit for third party providers. One thing is confirmed that, nearly all large multinational companies make use of third party logistics providers (Maltz, 2004). Research problem: From many researchers point of view (Lee, 2004), Indian 3pl providers are still in an undeveloped state. So it might be difficult for them to survive in the Indian market competing with the foreign players. This research will review the traditional Indian distribution system and analyze the contemporary situations of both Indian and foreign companies like Pantaloons, Reliance, Subhiksha and Wal-Mart. In 2005, India was forecasted as the greatest consumer market opportunity, receiving highest foreign direct investment (FDI) (Mitra, 2005). The third party logistics in India accounts nearly a quarter of its transportation industry and expected to grow over $ 125 billion by 2015 (Srinath, 2006). Currently India sits atop the global retail opportunity. Indias retail industry, the 9th largest globally and valued at $ 330 billion (Kilgore et al. 2007). Reliance, a $ 12 billion giant enterprise run by Mukesh Ambani, plans to open an additional 4000 stores and hypermarkets with a target of $ 22.3 billion in sales by 2012. Wal-mart currently sources goods of worth over $ 1.5billion from India, yet to gain access to sell those products in India. So Wal-Marts joint ventures with Bharti will open doors for multi brand hypermarkets and shopping villages. One of the best approaches to gain competitiveness and improve customer service levels is the firms logistical capability. To be competitive, the companies have to deliver the products quickly and for lower cost. Logistics service providers gain momentum after the successful and efficient distribution network of Wal-Mart (Maltz, 2004). On the other hand, pantaloon is currently Indias largest retailer with more than 140 stores. Its also planning to spend $ 1 billion to open 100 big bazaar stores country wide. The Tata group, which runs lifestyle stores and star India bazaar, also opened an electronic goods shop in Mumbai last year. Tata group is planning to open 30 stores by the next year (Sahey and Mohan, 2006). Behind this growth, logistics infrastructure is the main backdrop of the countrys growth. Logistics costs in India are 13 percent of GDP compared with 8 percent in the U.S. Indian logistics is combination of road transport companies, railways, air freight companies, ports and shipping companies, as well as 3pl companies. 3pl market in India is least developed and its growth is about 20% per annum. If the logistics costs can be reduced from 13% of GDP to 8% of GDP, then the savings would be approximately $ 20 billion. This change will reduces the prices of Indian goods by 4.3% making them more competitive globally. The 3pl revenue and cargo handling volume registered growth rates of 18.25% and 20.33% respectively in 2003-2004 (Mitra, 2005). Retail opportunity opens the doors to reach Indian customers more effectively. Hindustan lever, a subsidiary of Unilever and the coca cola company are extremely successful penetrating in India. The rural population in India is almost 60%. Deliverin g products to those rural people is most difficult task due to the poor transportation and infrastructure facilities. In this situation both the companies above mentioned are successful with their distribution system through logistics service providers to reach each and every part of the country. So all the issues related to transportation infrastructure have badly affected the logistics network in India specifically in terms of lead time and costs. Anyway, a host of policy changes underway is expected to bring some positive revolution in the Indian transportation environment. In the past few years Indian government focussed on the infrastructure development. The main initiative under this project is the national high way development programme. It will connect all the metros and act as east-west and north-south corridor. So this will boost road transportation in India and good news for the logistics services providers in the country and also for the organisations to reduce costs by using 3pl providers (Mitra, 2005). Aim and objectives: The purpose of the research is to understand how third party logistics service providers can develop competitive advantage and improves the service levels of supply chains in Indian retail industry. The objectives of the study can be summarized as: To understand the current situations of Indian domestic 3pl providers To develop the competitive strategies pursued by the Indian 3pl providers To find out the impact of the use of the 3pl services on costs, customer satisfaction. On the other hand, the following research questions are designed for the achievement of the above research objectives. What kind of distribution systems do the Indian 3pl providers have? What kinds of logistics services are Indian 3pl providers providing? What competitive situation are the Indian 3pl providers facing? What kinds of competitive strategies are the Indian 3pl providers pursuing to achieve competitive advantages? Literature review: The supply chain: The process which integrates coordinates and controls the movement of goods, materials and information from a supplier to the end customer through a series of intermediate customers is called the supply chain. It bridges the gap between core business aspects of supply and demand. So the supply chain management is the management of buying/sourcing, making, moving and selling activities in a timely manner. Supply chains today are very slow, costly and do not deliver particularly good value to the end customer. Todays markets are much more demanding and information driven with small product cycles, more choice for customers and consumers and increased competition. Costs need to be cut down out of the supply chain and efficiencies increased, as business relationships within the chain shift and competitive advantage becomes harder to come by. The process of planning, implementing and controlling the efficient, cost-effective flow and storage of raw materials, in-process inventory, finished goods and related information flow from point of origin to point of consumption for the purpose of conforming to customer requirements. Third party logistics (TPL): The growth of high competition and complex business conditions force organizations to pursue competitive advantages and re-engine their business constantly. Outsourcing logistics to a 3pl provider has been considered as an effective strategy for companies to high service performance and lower operating cost. Lieb and Randall (1996) defined 3pl to a more detailed extent; in particular, the term third-party has been explained more clearly. The third party logistics is defined here as: A company which supplies/coordinates logistics functions across multiple links in the logistics supply chain. The company thus acts as a third-party facilitator between the seller/manufacturer (the first-party) and the buyer/user (the second-party)à ¢Ã¢â€š ¬Ã‚ ¦. The functions the functions performed by the third-party can encompass the entire logistics process or selected activities with in that process. (p.51). The basic characteristics of 3pls are to provide customised services and to handle multiple activities, which involve warehousing, distribution, transportation, inventory control, material handling, packaging and inspection (Bolumole, 2001). Here are some of the services offered by 3pls in the present market, according to Sowinski (2005): Dedicated contract transportation and transportation procurement. Inventory management Logistics management and consulting Freight audit and consulting Shipment tracking and tracing Reverse logistics and value added services TPL providers are nothing but supportive supply chain members. Lambert (1998) defined these supportive members as companies that simply provide resources, knowledge, utilities or assets for the primary members of the supply chain. The new level of usage of 3pl has been defined as logistics alliances. Bagchi and Virum (1998) define logistics alliances as: A long-term formal or informal relationship between shippers and logistics providers to render all or a considerable number of logistics activities for the shipper. (p.193). Under this alliance, 3pl users and providers treat each other as long-term partners. By identifying the characteristics of 3pl providers in various stages, Berglund et al. (1999) suggest that there have been three phases of development of the 3pl participants. The first phase started from 1980s, with the presence of traditional logistics providers, with the activities involved only transportation or warehousing. The second phase started from 1990s, when a number of network players such as DHL, TNT and FedEx started their logistics services. The third phase started from late 1990s, when a number of players from other areas like information technology, started working with the original logistics providers. In recent years with the dynamic changing and development of supply chain management 3pl providers have moved their focus to strategy development (Hertz Alfredson, 2003). 3pl providers have started to support logistics operations through value-added services and supply chain solution service, which creates abundant opportunities for companies to reduce costs and improve customer satisfaction (Knemeyer et al., 2003; Lieb, 2005). In addition to the services mentioned above, other services offered by 3pl providers, are known as value-added services. These are the services that add a lot of additional value to the products being distributed (Rushton et al. 2000). The major value added services has been summarized by the authors as follows. Specialist or niche service, where the operation is specifically designed for a particular products. Time reliable services, which are setup to support the just-in-time (JIT) operations of major manufacturers. Assembly, which is fulfilled by third-party distributor. Repacking, this is another area of value-added development, like a torch together with battery. Refurbishment: in the light if current environmental legislation many manufacturers have endeavoured to re-engineer their products so that parts from some used products can be reused in new products. Packaging return: collect packaging for reuses or disposal. (p.62). A research conducted recently by Hertz and Alfredson presented the strategic development of 3pl providers (Hertz Alfredson, 2003). According to Lai (2004): There are four types of 3pl providers from the resource based view of the firm. Each type of provider exhibiting different service capabilities and service performance. Also different types of logistics service providers adopt different service strategies to respond to different market segments Logistics outsourcing is simply a make-or-buy decision based on cost efficiency by increasing competitiveness and complexity (Christopher, 2005). A company may pursue logistics outsourcing for the following reasons, Own lack of logistics experience Desire to focus on core competency Difficulty in maintaining communication and information technology up to date Sahay and Mohan (2006). Outsourcing can give a company proper access to resources, equipment and management expertise which may count a worth of billion dollars (Clott, 2004). Outsourcing not only allows an organisation to achieve goals like cutting delivery times and ensuring accurate shipments, but also promotes competition among service providers and motivating them to continue renewing their services. Currently a growing interest on outsourcing has been mentioned by massive writings in scholarly journals and popular magazines. The terms outsourcing, third party logistics and contract logistics sounds the same. Traditional logistics activities such as transportation, distribution, warehousing, inventory management, order processing and material handling have been given less importance (Mitra, 2005). There is a need to develop competitive advantage and providing better customer service effectively and efficiently. This can be possible only through contract logistics (Razzaque and Sheng, 1998, updated reference). Third party logistics and customer service: Sadler (2007) defined logistics customer service as: the process of providing goods, information and services to customers in a way that both creates customer satisfaction and is cost-effective to the shipper (p.71). Customer service has been treated as essential factor in marketing strategy and it creates added value for both their companies and customers (Christopher, 2005). Customer service is a key way to gain competitive advantage. To compete in this corporate world, companies must provide high levels of logistics services to their customers. Based on a survey conducted by Bolumole (2001) identifies the nine most important aspects of customer service as follows. On-time delivery Order accuracy Price No product damage Ease of order placement Customer enquiry handling Quality Availability Order status information Regarding the high levels of customer service, Sadler (2007) suggest that: the economic aim point of customer service level is a little below 100%, beyond this level, the extra benefit to customers is vastly outweighed by the huge extra cost of inventory, hours of opening, staff training and salary, etc (p.72). Gaining competitive advantage through 3pl: Third party logistics (3pl) can be an effective way helping companies to achieve competitive advantages. The main objective of logistics management is to drive the companies in achieving sustainable competitive advantages through improved customer service and lower costs. Overall 3pl providers can provide a major source of competitive advantages. In other words, a position of gaining superiority over competitors (Christopher, 2005, p.6). Rushton et al. (2000) proposed that companies can achieve competitive advantages through 3pl providers. First, companies may compete as a service leader, which means to gain an advantage over their competitors by providing a number of key logistics service elements to differentiate itself. Meanwhile, the companies may compete as a cost leader where it is trying to utilize its logistics resources to offer the service or product at lowest possible price. Some logistics leverages for pursuing the two competitive advantages have been summarized as follows. To achieve value/differential advantage To achieve cost/productivity advantage The logistics leverage Tailored service Distribution channel strategy Reliability Responsiveness Information Flexibility The logistics leverage Capacity utilization Asset turn Co-makership/schedule integration Low inventory Low waste Table: The two different approaches to gain competitive advantages. Source: Rushton et al. (2000, p.33). Christopher (2005) summarizes that: The source of competitive advantages is found firstly in the ability of the organization to differentiate itself, in the eye of the customer, from its competition and secondly by operating at lowest cost (p.6). Competition is always at the core of the success and failure of the firm. A companys competitiveness can be derived from achieving either a cost advantage or a value advantage, or both of them. The relationship of cost and value between a company, its competitor and its customers, named the Three Cs relationship is illustrated below. Customers Assets and utilization Cost differentials Assets and utilization Value Needs seeking benefits at acceptable prices Value Company Competitor Figure: competitive advantage and the Three Cs Source: Christopher (2005, p.6). However, a most successful company would seek a competitive position depending on attaining both costs and differentiation advantages. Christopher emphasizes the last step that how to take the company to the top right of the matrix can be the biggest challenge to logistics providers. The occupation of the position of cost and service leader means the company has achieved both service and cost advantages. Service leader Cost and service leader High Commodity market Cost leader Value advantage Low Low High Cost advantage Figure: logistics and competitive advantage Source: Christopher (2005, p.10). The three possible ways for companies to accomplish their competitive strategies are internal activities, acquisitions and strategic alliances. On the other hand through mergers and acquisitions of other possible business may meet their competitive strategy requirements. The major participants in the logistics alliances are manufacturers, retailers and logistics service providers or third party logistics providers. A strategic alliance allows a company to take advantage of what it does well and enables it to seek partners who have strengths in other areas (Bagchi Virum, 1998). Supply chain integration with third party logistics providers: The present trend of most of the modern companies is to outsource their logistics activities to third party providers. This is a type of alliance, many of the firms implementing to achieve competitive advantage in the market place (Ratten, 2004). In the recent years just-in-time (JIT) process has gained momentum, which promoted outsourcing. The term integration refers to the degree to which individual parties work together in a cooperative manner to achieve acceptable outcomes (Ratten, 2004). Approaching the third party logistics providers comes under the wider arc integration. 3pl providers encompass a wide range of supply chain services including firms outsourcing, material management and distribution responsibilities (Frohlich and Westbrook, 2001). Nowadays 3pl companies are playing more number of roles in extended supply chains such as after-sales support, customer service and reverse logistics (Srinath, 2006). 3pl providers have transformed the roles of distribution centres from storage facilities to channel assemblies by taking care of some repair jobs that do not have sent back to manufacturers (Maltz, 2004). Relationships among TPL providers and members of supply chains: Nowadays the relationship between supply chain management and third party logistics service providers has gained some momentum. Here its necessary to discuss how to fill the gaps in understanding of how third party logistics providers should offer their services more effectively to their assigned supply chains. The supply chain is, The network of organisations that are involved, through upstream and downstream linkages, in the different processes and activities that produce value in the form of products and services in the hands of the ultimate customers. -Christopher (2005). The supply chain is a chain consists of networked companies from raw material producers for the consumption of end users. According to Jarzemskis (2006), a TPL provider is An agent middleman in the logistics channel who enters into a temporary or longer term relationship with some other entity in the logistics channel Most of the logistics services are purchased on a contract basis (Maltz, 2004). Based on the research by Bhatnagar and Viswanathan (2000), successful partnerships in logistics can be achieved by triadic relationships. Order lead time of grocery retailers in the Indian markets: in a survey of Indian retail industries, Chandra and Sastry (2004) found that 98% of the firms dispatch their goods through a contract with trucking companies, while 11% of them only have their own fleet of trucks and 36% of these firms use third party logistics(3pl) service providers for transportation. The economy is expected to grow at 10% over the next 10 years in the sectors like chemicals, pharmaceuticals, textile, retail and fast moving consumer goods. The Indian retail giants Reliance and Bharti announced large retail projects in collaboration with Wal-Mart. Also Reliance considering establishing large warehouses in Thailand to take advantage of low cost sourcing from Southeast Asia. On the other hand food and grocery retail players like Subhiksha established more than 600 new retail stores in India (Chandra Jain, 2009) Logistics is an important process that minimises costs and improves customer satisfaction (Christopher, 2005). The Indian retail industry is worlds fifth largest one. All retail sectors in India are not purely organised. Especially the retail sector is growing very fastly at a pace of 25-30% annually. This sector is projected to grow from Rs. 35,000 crore in 2004-05 to Rs. 109,000 crore by the end of 2010 (Mitra,2005). Here the author is going to examine the retail operational efficiency at the secondary distribution level by measuring the performance of Indian food retailers logistics operations in terms of order lead time. Order lead time is the time between the customers placing an order and receiving the goods (Srinath, 2006). Here both the suppliers and logistics service providers need to understand two certain types of lead times. The first one, inbound lead time is the time between the orders placed by the depot and the delivery of goods by the suppliers. On the other hand out bound lead time refers to the time depot and the company stores (Maltz, 2004). According to smith and sparks (2004), logistics has been facing many major changes in the Indian food retail sector including increase in the average size of stores, introduction of new retail store formats (petrol station shops) and the increase in the range of own brand food products 3pl operations in India: The greater utilization of third party logistics (3pl) in Indian companies is expected to rule the retail markets in the future years. Its predicted to rise from US $ 1.5 billion in 2008 to US $ 4 billion in 2012. Strategic analysis of 3pl markets in Indian retail sector shows that the market earned US $ 28.1 million in 2005 and predicted to be US 89.8 in 2012 (Kaur, 2009). The Indian economic growth has recorded significant development during the past several years. According to the survey conducted by Lieb in 2007, six of the CEOs were asked to identify the best suitable industries which will offer good results for the future of 3pl services usage in India. Four of them suggested automotive industry and three of them rated high technology. On the other hand retailing and pharmaceutical industry were preferred by two of them. According to Lieb: Long trip times for relatively short transportation distances make a turnaround of vehicles impossible and increases the cost of domestic transportation. Congestion, toll road blocks and local tax make proper planning and timing, and central distribution structures impossible. Inwarding process: This process is to ensure smooth movement of stock and merchandise from warehouse, vendors and any other location to shop floor, updating the inventory and subsequently be available for sale. Goods are received according to the Stock Transfer Note (STN) issued by the warehouse. Every morning the Warehouse Incharge prints the mail from SCM support, which gives the details of the merchandise which is scheduled to reach the store (e.g. Goods in transit report). Based on the information the Warehouse incharge to allocate space for the in transit merchandise do all follow ups for goods in transit. Inform the respective Department Managers about the merchandise scheduled, so that floor space for the same can be created, if required. Delivery vehicle arrives at the store warehouse. Security personnel to receive the supporting documents and handover the same to the warehouse personnel undertaking the Inwarding. Document set is checked by warehouse personnel to ensure it contains a Stock Tra nsfer Note (STN) in duplicate and an outward gate pass issued by the dispatching warehouse. An authorised LR copy incase the goods delivery vehicle is a private transporter. Security at stores will sign the gate pass and write manual IRN (Inward Register Number) on gate pass. Security personnel to check the vehicle to ensure the seal on the cargo area are intact and secure. If any of the above documents are missing the staff should inform the Warehouse Manager, and the same should be entered in the discrepancy register. Warehouse Manager to inform the dispatching warehouse in charge and try to resolve the issue, and receive the missing documents by the next day. Under NO circumstances, the merchandise should be inwarded, in variance to the above. Outwarding: This process is to ensure smooth movement of stock and merchandise stores to warehouse, vendors and any other location and updating the inventory. This process starts when Front End Category / Category / store logistics creates a STO for the transfer of merchandise. This process ends when the Store receives goods receipts details from the receiving site. This process is triggered when the Front end Category/Store Logistic Person/Retail Category identifies products to be sent back to CDC or Vendor. Any returns from the Store should be process oriented. There may be various reasons for returns like Defects sent back to the warehouse, due to excess inventory, non- moving stocks, Interstore transfer, back to vendor, Products replaced completely for the customers having same defects or products partly replaced for the Customers, excess material in the Store received as Backup Stocks in Original Packing Condition and Materials might be received directly by the Warehouse from the Customers as replacement where the Warehouse should ensure that it is duly packed and bar coded in proper conditions. Returns to Vendors to be made as per the terms and conditions agreed with the Vendor. If delivery is going from the Store, the product needs to be properly packed in corrugated cartons, after doing a Pre Delivery Inspection (PDI) at Store level one day in advance and be certified by the DM/Warehouse Incharge. Any outwarding to be done only after the permission is given from the FEC and store manager and the supply chain team to be kept in the loop. (Vaidyanathan, 2005). Drivers for 3pl usage in India: Even though the reasons for outsourcing and the activities involved may vary from one company to another, the basic driving factors are the same. In India, Sahay and Mohan (2006) classify the reasons that drive Indian organizations to outsource logistics into three categories. The primary factor is the concern regarding cost that focuses on logistics cost reduction. The second one is focus on core competencies, access to unfamiliar markets and corporate restructuring. The third issue is associated with improving supply chain efficiency, which will cover improving customer services, increasing inventory, driving productivity improvements, achieving flexibility in operations and improving return on assets. The primary drivers in the beginning were to reduce costs and release capital. But nowadays its to increase market coverage, improve the customer service level or increase the flexibility towards the changing customer expectations (Skjoett-Larsen, 2000). Facilitate Re-engineering Strategic flexibility Outsourcing Concentrate on core business Reduce cost Figure: driving factors of outsourcing. Source: Taglisapietra et al (1999) p.4 It is one of the top reasons for outsourcing researched by the outsourcing institute (2000). According to Lankford Parsa (1999): Reengineering is the fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service and speed. (p.23). Outsourcing not only allows enterprises to grab the benefits of structural changes, but also allows them to take advantage of reengineered world-class providers. Elements for successful 3pl relationships: A successful partnership is like a successful marriage, which requires hard work from both the parties involved. Both the parties must understand each others needs and should be compatible with the values. Bagchi Virum (1998) identifies that information sharing is crucial for successful relationship between providers and users. The main elements of long-term successful relationships are compatibility, understanding of partners business needs, open communications, commitment, fairness, flexibility and trust. Based on case studies, Bagchi Virum (1998), identify six factors to the successful third-party relationships. Customer satisfaction is the key point of the relationship in all efforts. Customers need to clearly point out their needs and wants. Then its the turn for providers to understand these needs and acquire the capabilities. People are the important assets in an alliance. Also they should be well trained and motivated individuals