the outsourcing of supply chain activities

THE OUTSOURCING OF

SUPPLY CHAIN ACTIVITIES

by

ANDREW RUDOLPH

THESIS

Presented to comply with the partial requirements for the degree

MAGISTER COMMERCII

in

BUSINESS MANAGEMENT

in the

FACULTY ECONOMIC- AND MANAGEMENT SCIENCES

at the

RAND AFRIKAANS UNIVERSITY

STUDY LEADER: MR P.J. KILBOURN

JUNE 1998

ACKNOWLEDGEMENTS

Herewith, I would like to thank:

Our Creator through Whom everything is possible;

My wife Elize, for her patience and sacrifices;

My study leader Mr P.J. Kilbourn, for his inputs.

11

ABSTRACT

In order to achieve and sustain a competitive advantage in the present global trade

environment, companies need to find ways to distinguish themselves from their

opposition. One way by which this advantage can be gained, is by exercising superior

supply chain management. Shortening product life cycles and multiple possible suppliers

per product make it even more important to provide excellent customer service. Once

again, these events imply the need for superior supply chain management.

The question of how to improve supply chain management now arises. The aim of this

study is to determine whether the outsourcing of certain supply chain activities can lead

to the desired result. A secondary aim is to give an overview on supply chain

management, as knowledge on this topic is often lacking or poorly understood, while it is

seen as highly important for the reasons stated above.

A key step in the process of determining whether or not a company should make use of a

third-party supply chain provider, is in determining the strategic objectives of the

company. During this step the company needs to determine its key competencies, which

in turn helps the company to establish its goals. Once the above process has taken place,

a decision can be made on whether to consider the outsourcing of supply chain activities.

Companies that are considering the outsource of their supply chain activities, are looking

for benefits such as reduced costs and increased service, reduced capital investment,

increased flexibility to fluctuating demand, and a focus on core competencies. There are

however, possible disadvantages associated with the outsourcing decision. Examples

include, negative effects on workforce morale, a fear for loss of control by some supply

chain professionals, breaches of confidentiality, and a loss of customer contact.

111

The outsource decision, concerned with supply chain activities, will depend on the given

company and its circumstances. There are definite circumstances where a third party is

the proper solution in order for a company to obtain a competitive advantage with supply

chain management. The answer however, is not always clear cut.

iv

CONTENTS

PAGE

ABSTRACT ii

CHAPTER 1

INTRODUCTION AND PURPOSE OF THE STUDY

1.1 Introduction 1

1.2 Problem definition 3

1.3 Purpose of the study 4

1.4 Demarcation of the study 4

1.5 Layout of Contents 5

CHAPTER 2

THE SUPPLY CHAIN MANAGEMENT CONCEPT

2.1 Introduction 6

2.2 The Development of Supply Chain Management 7

2.3 The Purpose of Supply Chain Management 11

2.4 Globalization 12

2.5 The Fundamentals of Supply Chain Management 12

2.5.1 Inbound Logistics 15

2.5.2 Outbound Logistics 19

2.5.3 Customer Service 20

2.5.4 Key Enablers 21

2.6 Channel Arrangements in Supply Chain Management 22

2.7 Summary 27

PAGE

CHAPTER 3

A FOCUS ON OUTSOURCING

3.1 Introduction 30

3.2 The Development of Third Party Logistics 31

3.3 Possible Advantages of Outsourcing 32

3.4 Concerns with Regard to Outsourcing 36

3.5 Examples of Outsourcing Services 39

3.6 Summary 44

CHAPTER 4

GUIDELINES FOR OUTSOURCING SUPPLY CHAIN ACTIVITIES

4.1 Introduction 46

4.2 When to Outsource 46

4.3 Prerequisites for Outsourcing 49

4.4 Selecting a Third Party 53

4.5 Managing a Third Party 57

4.6 The Third Party's Perspective 60

4.7 Summary 61

vi

PAGE

CHAPTER 5

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.1 Summary 63

5.2 Conclusions 65

5.3 Recommendations 66

BIBLIOGRAPHY 68

CHAPTER 1

INTRODUCTION AND PURPOSE OF THE STUDY

1.1 Introduction

Companies need to obtain and keep ways to stay ahead of their competitors in the race for

market share and survival. One of the buzz terms being proclaimed as a solution is

"supply-chain management". Articles in business publications like Fortune are heralding

it as the next source of strategic advantage (Quinn, 1997b:37). This study will investigate

and discuss statements such as the one above.

Unless the product or service that is being offered can be distinguished in some way from

its competitors, there is a strong likelihood that the market place will view it as a

"commodity" and the sale will go to the cheapest supplier (Christopher, 1992:4).

However, the cost of producing goods is increasingly becoming more even for many

industries. There are many similar products available, while it costs manufacturers more

or less the same to produce these items. Hence it is important to add additional value or

to further reduce costs in order to achieve some form of competitive advantage over one's

competitors. An effective supply chain can play a role in achieving such an advantage.

What is supply chain management?

Quinn (1997a:43) states it as follows: "the supply chain encompasses all of those

activities associated with moving goods from the raw-materials stage through to the end

user. It includes sourcing and procurement, production scheduling, order processing,

inventory management, transportation, warehousing, and customer service. Importantly,

it also embodies the information systems so necessary to monitor all of these activities."

The development of supply chain management will be discussed in more detail in

Chapter Two. As an introduction however, supply chain management embraces terms

such as business logistics and the logistics supply chain, but it involves more than that.

Chapter 1: Introduction and Purpose of the Study 2

The supply chain starts with the customers' needs and ends with the supplier. It is often

taken further to include the customer's customer as well as the supplier's supplier.

Included are functions such as procurement, inventory management and distribution, with

customer service as a supply chain output. The term logistics, which is frequently used in

conjunction with these terms, is often simplified to imply such functions as transport and

distribution only. It is important to grasp that the above terms have a much broader

meaning.

What are the objectives of supply chain management?

Supply chain management aims to smooth the flow of goods and services from the source

to the end user. All obstacles must be removed and the process should be as efficient and

effective as possible. It implies that these goods and services can be obtained at reduced

costs, more timely and at even better quality than before.

Various methods exist to improve a company's supply chain. One such method is the

outsourcing of non-core supply chain activities. Outsourcing takes place when a

company decides to let a third party provide and manage certain services such as

warehousing or transport.

Outsource considerations

When companies want to improve their supply chains, they need to investigate

themselves in order to determine their core competencies. They (companies) also have to

ask the question whether or not they should consider outsourcing some of their supply

chain activities. Outsourcing seems obvious for companies who lack certain supply chain

skills. By outsourcing, these companies might capitalize on the expertise of a third-party

provider. This leads to some more questions such as:

• What are the strategic factors to consider? Could a company attain a strategic

advantage that would otherwise not be possible? This could include specialized

technologies, for example a sophisticated information system.


What are the financial implications? Is it possible to limit expenditure or increase

income by means of outsourcing activities? The impact on manpower should be

investigated.

How should such an agreement be structured? Different forms of third party

agreements, partnerships or alliances can be considered. This is especially important

when outsourcing critical functions that could also imply core activities.

How does one select a third party provider? What are the general guides to

outsourcing? It is important to learn from others experience, and to avoid the many

pitfalls that exist, particularly with reference to outsourcing supply chain activities.

What are the risks involved? As with any business principle there are risks involved

in order to obtain a profit. This has reference to the specific activity that one

considers to outsource as well as some of the aspects mentioned above, such as the

structure of the agreement, the choice of a third party provider and the level of

technology that is required.

The above questions, as well as related aspects concerned with the outsourcing of the

supply chain, will be the topic of this research.

1.2 Problem Definition

As mentioned above, companies of today are under ever increasing pressure to reduce

costs while at the same time improving service levels. They have to ask themselves if

they are focusing all their energy and resources on their core business. If not,

outsourcing some non-core activities may be the answer. The question is: how can the

supply chain be improved? The importance of the supply chain also needs to be

illustrated, as a company can only really be successful if it is successful with supply chain

management.


1.3 Purpose of the Study

The main purpose of the study is to determine whether or not it is worthwhile to

outsource supply chain activities. Reasons for outsourcing will be investigated. This will

include aspects such as strategic, financial and other reasons as mentioned in the

introduction (1.1) above.

If outsourcing is found to be a viable option in the supply chain environment, an attempt

will be made to describe the characteristics of the typical outsourcing client. Activities

will be sorted on the grounds of which could be outsourced and which not, as well as how

and when to outsource. Signs that indicate that a company might be ready for

outsourcing some of its activities will be investigated.

A secondary purpose of the study will be to give an overview of the supply chain. It

follows from the generally limited knowledge of supply chain management. The concept

of supply chain management is often poorly understood although it has existed for about

a decade (Monczka & Morgan, 1997:69). The overview will serve as an introduction and

to place the discussion of outsourcing supply chain activities into perspective.

1.4 Demarcation of the Study

The research will be limited to relevant literature. Preference will be given to current

literature on the topic of supply chain management and the outsourcing thereof. The

study will have a business management perspective and the literature will consist of

theoretical and practical applications of supply chain activities throughout the world.


1.5 Layout of Contents

This study will consist of five chapters. Chapter One consists of an introduction, the

problem definition and the purpose of the research. A demarcation of the study is given

as well as a layout of the contents.

Chapter Two will be devoted to an overview of supply chain management development

to date. Definitions will be given for the basic terms and some of the current

developments will be mentioned.

Chapter Three will look at the development of third party logistics, and investigate the

reasons for the outsourcing of supply chain activities. The question of whether such a

step is worthwhile and whether it could bring any advantages to the company will be

discussed. A brief discussion as to which activities could be outsourced will be included.

Chapter Four will be devoted to some guidelines as to what should be considered when

entering a third party agreement as well as how such an agreement should be managed.

Factors that could influence supply chain outsourcing will also be looked at.

Chapter Five will consist of a summary, conclusions and some recommendations

regarding the question as to whether outsourcing supply chain activities is a viable option

for today's companies.

CHAPTER 2

THE SUPPLY CHAIN MANAGEMENT CONCEPT

2.1 Introduction

" Corporate America has discovered a 'new' weapon for building market share and

increasing return on investment. It is not really new in the eyes of some logistics

professionals, but logistics has captured the attention of senior managers in the

upper echelons of U.S. companies. They have recognized the value-added role of

logistics that can help to differentiate a product in the marketplace and effectively

lower the cost of doing business for both buyer and seller.

There is an interesting twist to this new emphasis upon logistics in that the focus is

upon the supply chain. In other words, there is a recognition that companies are

usually part of a 'pipeline' or supply chain that brings a product to the ultimate user.

In its simplest context, the supply chain involves a company's vendors and direct

customers. The supply chain perspective ultimately recognizes that all three parties

are, in a sense, partners in bringing a product to the market." (Coyle et al., 1996:1.)

The concept of the supply chain is not new. It is described as much the same theory as

that of integrated logistics one has been reading so much about in the past few years

(Gattorna & Walters, 1996:12). This chapter will give a brief overview of the

development of the supply chain management concept. The purpose and fundamentals of

the supply chain will be discussed, and there will be a look at the key enablers as well as

some channel arrangements in supply chain management.

Chapter 2: Supply Chain Management Concept 7

2.2 The Development of Supply Chain Management

According to Coyle et al. (1996:5) the development of supply chain management can be

divided into three steps, namely those of physical distribution, integrated logistics

management, and supply chain management.

Step One: Physical Distribution. The focus of companies was on physical

distribution or outbound logistics systems during the 1960s and 1970s.

Step Two: Integrated Logistics Management. During the 1970s and 1980s

companies started to recognize additional opportunities for savings by combining the

inbound side (materials management) with the outbound side (physical distribution).

This combination was described as the (business) logistics system. See Figure 2-1.

Figure 2-1 The Logistics Evolution

EVOLVING TOTAL FRAGMENTATION

INTEGRATION INTEGRATION 1960

1980 2000

Demand forecasting

Purchasing

Requirements planning

Production planning

Warehousing \

Manufacturing planning

Materials handling

Industrial packaging

Finished goods inventory

/Distribution planning

Order processing

Transportation

Customer service

Materials management

Logistics supply chain

Physical distribution

Source: Coyle et al. (1996:7)

Figure 2 -2 Logistics supply chain


• Step Three: Supply Chain Management. During the 1980s and 1990s companies

expanded their perspective on the logistics processes to include all the vendors and

channels of distribution involved in ensuring that the final customer received the right

product, at the right cost, at the right time, in the right condition, and in the right

quantity. This concept is referred to as the logistics pipeline or supply chain. See

Figure 2-2.

Extending the logic of integration outside the boundaries of the company to include

suppliers and customers is a crucial requirement to the concept of supply chain

management (Christopher, 1992:12).

According to Krenek (1997:97): "In the simplest form, the supply chain encompasses all

business processes related to the manufacture and delivery of products". He continues by

saying that, "In a broader context, the supply chain encompasses not only the producing

company, but suppliers and customers".

Logistics and Supply Chain Management

To further explain the relationship between logistics and supply chain management, the

definition of logistics as provided by the Council of Logistics Management (Lambert &

Stock, 1993:4), is provided: "Logistics is the process of planning, implementing and

Inventory Flow

Physical distribution

Manufacturing support

Procurement Customers ■—■ Suppliers

Information Flow


controlling the efficient, effective flow and storage of goods, services and related

information from the point of origin to the point of consumption for the purpose of

conforming to customer requirements."

According to Bowersox and Closs (1996:24), when logistical operations are highly

integrated and positioned as a core competency, they can serve as the cornerstone for

strategic advantage. The fundamental paradigm of logistics is the belief that integrated

performance will produce superior results over loosely managed individual functions.

They continue by illustrating the conceptualization of integrated logistics in the shaded

area of Figure 2-3.

Figure 2-3 Logistical Integration

Source: Bowersox & Closs (1996:34)

Logistics is seen as the competency that links an enterprise with its customers and

suppliers. Two flows can be observed in the process, that of inventory and that of

information. Information flows from and about the customers through the enterprise in

the form of sales activity, forecasts, and orders. The information is refined into specific

manufacturing and purchasing plans. As products and materials are procured, a value-

added inventory flow is initiated that ultimately results in ownership of finished products

to customers.


The shaded area of Figure 2-3 depicts the integration of the internal operations of the

organization, in this instance physical distribution, manufacturing support, and

procurement. While this integration is deemed necessary for success, it is not sufficient

to guarantee that the organization will achieve its performance goals. To be fully

effective in today's competitive environment, organizations must expand their integrated

behaviour to incorporate customers and suppliers. This extension, through external

integration, is referred to as supply chain management, and is valid for all businesses,

including those who provide products and services.

Figure 2-3 can now be modified to illustrate extension of logistical integration from the

internal co-ordination of procurement, manufacturing support, and physical distribution

to include customers and suppliers. Figure 2-4 illustrates an overall supply chain

focusing on integrated management of all logistical operations from original supplier

procurement to final consumer acceptance. The overall orientation is shifted from

inventory management by each individual participant to a pipeline perspective (Bowersox

& Closs, 1996:101).

Figure 2-4 Supply Chain Integration

Inventory Flow

Enterprise

Customers 4_41 Manufacturing +A0

support Suppliers ■—■ Physical

distribution 4—■ Procurement

Information Flow



2.3 The Purpose of Supply Chain Management

Christopher (1992:24) explains that the ultimate purpose of any logistics system is to

satisfy customers. In the given context, the term logistics can be replaced with the term

supply chain. According to Quinn (1997a:46), "supply chain management in a very

literal sense begins and ends with the customer. Knowing what they want, when they

want it, and speedily delivering the goods...in a nutshell, that's what supply chain

management is all about."

The goal of supply chain management is to increase sales while reducing inventory

(Cooke, 1997a:57). Ideally no inventory should be held with products made to order.

Capital would never be tied up in materials or unsold goods and an ample supply of free

cash would be available.

According to Gattorna and Walters (1996:107), "The objective of the supply chain

concept is to synchronize the service requirements of the customer with the flow of

materials from suppliers such that the apparent contradictory situation of conflicting

goals of high customer service, low inventory investment and low operating costs may be

balanced (or optimized). It follows that the design and operation of an effective supply

chain is of fundamental importance."

From another perspective, it can be said that the universal goal of supply chain

management is to improve the flow of goods and services from the source to the end user.

This flow process should be as efficient and effective as possible, with the minimum

intervention and stops (hold points) from the participating parties. Those companies who

succeed in implementing such supply chains, are the companies who will enjoy a

competitive advantage over their competitors who have less effective supply chains.

Superior supply chain management is even more essential in the global trade environment

of today.


2.4 Globalization

Global business activity is increasing rapidly. World trade is growing nearly twice as fast

as world output (Coyle et al., 1996:483). Companies are seeking to grow their business

by extending their markets and at the same time seeking cost reductions through scale

economies. Managing global supply chains also results in higher challenges. This

follows from, among other reasons, the longer distances and more complex logistics, as

well as a demand for variation, even though the attempt is to satisfy common demands

worldwide.

Markets are becoming increasingly competitive, with producers and suppliers seeking to

minimize costs, and further, they are converging, as business practices are benchmarked

and replicated. Consumers want the best products available at the lowest prices.

Although value is important, the country of origin is of less concern. It is quality, price,

design and service that appeal to the customer (Gattorna & Walters, 1996:193).

The globalization of world trade has forced companies to have access to effective supply

systems and networks throughout the world. To a certain extent, this globalization drive

is the reason for the importance of supply chain management.

2.5 The Fundamentals of Supply Chain Management

The supply chain can be seen as a system through which organizations deliver their

products and services to their customers (Poirier and Reiter, 1996:3). This chain can

consist of a network of interlinked organizations.

According to Christopher (1992:13), supply chain management differs significantly from

classic materials and manufacturing control in four respects.


It views the supply chain as a single entity rather than relegating fragmented

responsibility for various segments in the supply chain to functional areas such as

purchasing, manufacturing, distribution, and sales.

It calls for and depends upon strategic decision making. Supply is a shared objective

of practically every function in the chain and is of particular strategic significance

because of its impact on overall costs and market share.

Supply chain management provides a different perspective on inventories which are

used as a balancing mechanism of last, not first, resort.

Supply chain management requires a new approach to systems: integration, not

simply interface, is the key.

It is also Christopher's view that the move towards supply chain management points to

top management. Only top management can be expected tot have the perspective to

recognize the significance of supply chain management, and only top management can

provide the impetus for adopting this new approach.

The Value Chain

The collection of activities that presents each company can be depicted by a value chain

as shown in Figure 2-5 (Porter, 1985:36). Porter saw the fundamental role of the value

chain in identifying sources of competitive advantage. This followed from the fact that

value chains of companies are different and that these differences may represent a

potential source of competitive advantage.

The value chain consists of value activities and margin (Porter, 1985:38). The value

activities can be divided into primary activities and support activities. Margin is the

difference between total value and the collective cost of performing the value activities.

Gattorna and Walters (1996:99) see the value chain as a useful analytical model with

which to explore the tasks and roles within the overall process of delivering customer

satisfaction. They (Gattorna and Walters) view procurement however, as a primary

activity, and not as a support activity as shown in Figure 2-5.


Figure 2-5 The Generic Value Chain

Support Activities

Primary Activities

Source: Porter (1985:37)

In the following paragraphs, the main supply chain activities will be discussed in the

context it is currently known. It is done with the aim of giving sufficient background in

order to discuss the proposed outsourcing issues in the following chapters. Keeping

Figures 2-1 to 2-5 in mind will help to place the supply chain into perspective. The

fundamental activities as presented in the value chain (Figure 2-5), will help to depict the

activities as it is illustrated in the supply chain. The similarities are found in the main

(primary) activities and key enablers (secondary activities) of the supply chain.

In the following discussion, the main activities are divided into three headings, namely

Inbound logistics

Outbound logistics

Customer service


Although customer service can actually be seen as a product of supply chain

management, it is discussed as a separate heading because of its importance.

Some key enablers of supply chain management are discussed under the last heading, as

these enablers are of key importance in any supply chain.

2.5.1 Inbound Logistics

The inbound system of logistics is frequently referred to as materials management. Coyle

et al. (1996:72) give the following definition: "Materials management can be described as

the planning and control of the flow of materials that are a part of the inbound logistics

system. Materials management usually includes the following activities: procurement,

warehousing, production planning, inbound transportation, receiving, materials quality

control, inventory management and control, and salvage and scrap disposal."

It must be noted that common activities or processes are shared by the inbound and

outbound logistics systems. These include decisions related to warehousing, materials

handling, inventory management, transportation and other activities, and all will not

necessarily be discussed under both headings in this research. The integration of inbound

and outbound systems is viewed as extremely important to the efficient and effective

management of the logistics supply chain.

According to Lambert and Stock (1993:450), "materials management is typically

comprised of four basic activities:

Anticipating materials requirements

Sourcing and obtaining materials

Introducing materials into the organization

Monitoring the status of materials as a current asset."

Some of the inbound logistics activities will be discussed below.


Procurement

Procurement consists of all those activities necessary to acquire goods and services

consistent with user requirements. Ballou (1992:545) associates the following activities

with purchasing:

Selecting and qualifying suppliers

Rating supplier performance

Negotiating contracts

Comparing price, quality, and service

Sourcing goods and services

Timing purchases

Setting terms of sale

Evaluating the value received

Measuring inbound quality, if not a responsibility of quality control

Predicting price, service, and sometimes demand charges

Specifying the form in which goods are to be received

Lambert and Stock (1993:452) shows on the difference between purchasing and

procurement as follow: "Purchasing generally refers to the actual buying of materials and

those activities associated with the buying process. Procurement is broader in scope and

includes purchasing, traffic, warehousing, and receiving inbound materials."

From a supply chain management perspective, purchasing's position at the top of the

chain, linking manufacturer and supplier, is crucial to the success of the manufacturer's

relationship with its customers down the line (Gooley, 1997:39). From a conceptual

viewpoint however, it is hard to say that any one function in the supply chain is more

important than another. In practice though, certain functions have an exceptionally

strong impact on the success of a company's supply chain program.

One of supply chain management's main goals is better cost containment. The traditional

approach of negotiating the lowest price for raw materials or components does not fit

well with the supply chain philosophy. According to Gooley (1997:40), the greatest


contribution purchasing can make to a supply chain program is in the area of vendor

relations. The purchasing function should be used to strategically manage suppliers in

order to reduce the total cost of owning materials and services. Co-operative

relationships that reduce costs and improve efficiency with the aim of lowering prices

and enhancing margins for both parties, should be the aim.

Warehousing

Warehousing is used for the storage of inventories during several phases of the supply

chain process. Two basic types of inventories are identified that can be placed into

storage (Lambert and Stock, 1993:263)

raw materials, components, and parts (physical supply)

finished goods (physical distribution), which is applicable to outbound logistics.

Coyle et al. (1996:247) point out that, in the recent past, the focus of warehousing has

changed from where manufactures produced for inventory and sold out of the inventory

stored in the warehouse. With the supply chain management philosophy, the warehouse

has taken on a strategic role of attaining the supply chain goals of shorter cycle times,

lower inventories, lower costs, and better customer service. Attention is given to the

speed with which a product moves through the facility. Warehouses are being redesigned

and automated to achieve order processing and cost goals and are being relocated to

achieve overall supply chain service goals.

Production Planning

Production planning and control involves co-ordinating product supply with product

demand (Coyle et al., 1996:82). It is necessary for a manufacturer to forecast customer

demand which is used to develop a production schedule. Production planning is closely

related to forecasting in terms of effective inventory control. Therefore the integration of

production planning into supply chain management is becoming increasingly important.


Transportation

Transportation links the different fixed points in a company's supply chain. It permits

goods to flow between the various fixed points and bridges the buyer-seller gap.

Transportation adds value to the company by creating time and place utility when goods

are moved to the desired place at the desired time.

Companies' transportation expenditures can involve significant amounts. The effect that

the chosen transportation mode has on delivery cycle time (speed) and cost has often to

be weighed against different levels of inventory needed in order to maintain similar

service levels. Transportation decisions thus have to be made while taking the effect it

has on other supply chain elements into account. All of these issues are applicable to

both inbound and outbound logistics.

Inventory Management

Modern firms are increasingly trying to minimize or eliminate inventory whenever

possible (Coyle et al., 1996:162). It is however important to understand the importance

for inventory.

Lambert and Stock (1993:399) suggests the following reasons for holding inventory:

Economies of scale. If a firm is to realize economies of scale in purchasing,

transportation and/or manufacturing, inventory is required. The disadvantage of this

is increased inventory costs and the two scenarios should be played off against each

other to find an optimum point of operation.

Balancing supply and demand. Raw materials might only be available at certain

times during the year while there might be seasonal demand for finished products. It

might not be cost effective or practical to adjust production capacity accordingly, the

result will be to hold inventory.

Specialization. Plants that specialize in certain products achieve savings from longer

production runs. Such plants then ship their products to large mixing houses from

where customer orders and products for field warehouses can be shipped.


Protection from uncertainties. Inventory can be held to protect a company against

such factors as future price increases, a potential strike, seasonal availability or to

improve customer service levels by reducing the likelihood of a stockout due to

unanticipated demand or variability in lead time.

Inventory as a buffer. Inventory is held throughout the channel of distribution to act

as a buffer for the interfaces between supplier, procurement, production, marketing,

distribution, and the consumer. Because these participants are geographically

separated, it is necessary to hold inventory at critical interfaces to ensure successful

time and place utility.

Inventory management decisions involves weighing up the cost of keeping inventory

against not having inventory when required. Cost considerations not only include the

cost of the inventory alone, but also include costs such as storage facility costs, service

costs, and the risk from obsolescence and damages. A view of the total supply chain has

to be taken in order to optimize inventory costs.

2.5.2 Outbound Logistics

Outbound logistics, also referred to as physical distribution, often receives more attention

in the literature than inbound logistics (Coyle et al., 1996:72). The most important

reasons for this phenomenon are the fact that the outgoing products are of higher value

than that in the inbound system and because customers are more directly involved by it.

The inbound system however, is just as important from a cost point of view, especially

where an interruption of inbound material can disrupt the flow of goods through the

supply chain. Although the required inbound item might be inexpensive, any resulting

loss of production capacity might be considerable. When optimizing the supply chain, it

is equally important to have a balanced inbound and outbound logistics system.

The outbound logistics system is one of the supply chain sections, which is closely

involved with the customer and thus customer service. Customer service, which serves


as the interface between logistics and marketing, is discussed in a following section. An

example of a customer service decision would be where the distribution manager has to

decide whether to keep higher inventory levels (at a higher inventory cost) while making

use of (relatively cheap) road transport, or whether to lower inventory levels and fly

(which is relatively expensive) the product to the client when needed. This case would be

applicable where speedy customer service is required and distances are substantial. Once

again, a balance needs to be achieved between a high service level and the cost necessary

to provide that service, and the benefits to the company.

2.5.3 Customer Service

According to Coyle et al. (1996:21), "successful companies will be those that can offer

customized and tailored services that are responsive to the needs of their customers, who

will demand consistent, high-quality service so that they can maintain a competitive

position in today's marketplace". They further define customer service as a process for

providing competitive advantage and adding benefits to the supply chain in order to

maximize the total value to the ultimate customer (Coyle et al., 1996:113).

Lambert and Stock (1993:111) view customer service a measure of the effectiveness of

the logistics (supply chain) system in creating time and place utility for a product. It will

determine how many potential customers become customers, and how many remain

customers.

Customer service as seen by Gattorna and Walters (1996:6), is a way in which value is

added to the product-service package purchased by the customer. Value becomes the

amount a customer is willing to pay for the products or services provided by the supplier.

Value added is the difference between what the customer pays and the cost of providing

the service.

Satisfying customer requirements are the motivation behind all activities of companies

(Bowersox and Closs, 1996:58). The objective of marketing initiatives is to penetrate


specific markets and to generate profitable transactions. Developing the supply chain is

often seen as a core competency and is treated as a critical resource to customer service

planning.

The customer can be found at any delivery location in the supply chain, whether from the

same company or a business partner at some other location. Defining the customer will

depend from where in the supply chain the specific view is taken. Whether customers are

internal or external, they should all be provided with timely and accurate product

delivery.

According to Bowersox and Closs (1996:67), it is clear that excellent customer service

performance seems to add value for all members of the supply chain. As stated earlier in

this chapter, the ultimate purpose of any supply chain system is to satisfy customers.

2.5.4 Key Enablers

Human Resource Management

As in most other business disciplines, the human resource factor makes a significant

contribution to performance where it is neglected or nurtured. The most sophisticated

(logistics) supply chain system can be rendered inoperable by an unco-operative and

unwilling workforce (Chorn, 1990:498). Human ability, motivation, organizational

culture, group norms and leadership style are some of the factors that play a role in

company performance. Because of the similarity of human resource management issues

in many companies, it will not be discussed in any more detail.

Information Technology

In the past management lacked the full appreciation and in-depth understanding of how

fast and accurate communication could improve supply chain performance (Bowersox

and Closs, 1996:28). There was also a lack of suitable technology to generate the desired

information. However, it is currently possible to obtain most information on a real-time


basis. Several opportunities have resulted from the development of information

technology.

Fast information flow, such as that delivered by electronic data interchange (EDI),

reduces the need for inventory build up to a large extent if the time for order

accumulation, mail and or batch processing of orders between customer and supplier can

be shortened. It also reduces the need for speedy delivery (transportation) while it is still

possible to improve on the supply cycle time. EDI is defined by Lambert and Stock

(1993:532) as "the interorganizational exchange of business documentation in structured,

machine-processable form".

The rapid progress made by information technology and the fact that cost of making

information available to more decision-makers has steadily decreased, while concurrently

the physical costs of business, such as facilities and inventory have steadily risen, has

been the key to the development of the supply chain concept (Gattorna & Walters,

1996:105). According to Coyle et al. (1996:396) research indicates that information

technology is being used by leading edge companies to increase competitiveness and

develop a sustainable competitive advantage.

2.6 Channel Arrangements in Supply Chain Management

Channel Arrangement Classification

Different approaches are used to describe distribution channels. Bowersox and Closs

(1996:114) describes some of these approaches of which one will be mentioned here,

namely the channel arrangement classification. It is felt that it will help to place the

relationships that exist between these channels into perspective.

Three channel classifications are identified: single transaction channels, conventional

channels, and voluntary arrangements (VAs). See Figure 2-6. These range from least to

most open expression of dependence.


Figure 2-6 Classification of channel relationships based on acknowledged dependancy

Transactional Structure Relational Voluntary Arrangement

Single transaction

Conventional channels

Administered systems

Partnerships and alliances

Contractual systems

Joint venture

Dependency

Increased formalization, information sharing, and connectivity


The above classification also provides a distinction between transaction and relational

structures. In transactional arrangements little or no dependency exists and participants

feel no responsibility to each other.

Single Transaction Channels

Many transactions are negotiated with the expectation that the relationship will be a

one-time event (examples are the purchase of real estate and of durable equipment).

While single transaction channel engagements are not important in terms of

relationship management, they are significant to the businesses involved. The

requirements might be difficult to accomplish and logistic performance is often

critical as well as costly.

Conventional Channels

The conventional channel is best viewed as a loose arrangement of firms that buy and

sell products on an as needed basis. Firms in conventional channels link up to buy


and sell products on the basis of immediate requirements without concern for future

or repeat business. Little or no attempt is made to co-operatively improve the

efficiency of the supply chain. The primary transaction element is one of price.

Involvement occurs until a better deal comes along. The conventional channel is the

most common arrangement in free market economies.

Voluntary Arrangements (VAs)

Participating firms acknowledge dependency and develop joint benefits by co-

operating. In a broad sense, all channel systems that involve two independent firms

have a degree of relationship structure. When relationships are managed to achieve

joint goals and participating firms feel obligated to each other, the relationship

becomes a VA. Four forms of voluntary agreements that are commonly found are

mentioned below namely, administered systems, partnerships and alliances,

contractual systems, and joint ventures.

Administered Systems

This is the least formal voluntary arrangement. Usually, a dominant firm assumes

leadership responsibility and seeks co-operation of trading partners and service

suppliers, although no formal dependancy is acknowledged. While it closely

resembles the conventional arrangement, the firms clearly feel dependent and

seek to perform in a way consistent with directions provided by the acknowledged

leader.

Partnerships and Alliances

As firms require greater clarity and longer-term commitment than typically

provided in an administered system, they seek to formalize their relationships

with other business. The authors describe a true partnership as one that reflects a

dependency commitment that is far greater than an administered arrangement. At

the very least, partnerships build on the expressed desire to work together and a

level of information sharing.


The essential feature of an alliance is a willingness of participants to modify basic

business practices. "In essence, the alliance goal is to co-operatively build on the

combined resources of participating firms to improve the performance, quality,

and competitiveness of the channel." (Bowersox & Closs, 1996:123.)

■ Contractual Systems

Many firms have the desire to conduct business within the confines of a formal

contract. Common forms of contractual agreements in logistical relationships are

franchises, dealerships, and agreements between service specialists and their

customers. The commitment to a contract takes the relationship out of the pure

voluntary framework that is characteristic of an alliance.

■ Joint Ventures

Some logistical arrangements are simply too capital intense for development by a

single service provider. Therefore, two or more firms may select to jointly invest

in an arrangement.

According to the authors (Bowersox and Closs, 1996:124) the more likely joint

venture scenario occurs when a shipper decides to fully outsource all of its

logistics requirements to a third party or contract service provider. This includes

facilities, equipment, and day-to-day operations. A logical way to arrange this

outsourcing is to establish a partnership between the shipper and service firm.

The establishment of a business relationship where all management groups

participate serves to reduce the risk, especially when broad-based exclusive

arrangements are required.

Other Views

"The purposes of entering into a strategic partnership are to achieve objectives that

otherwise could not be realized and to reduce the overall risk of a project while

increasing the return on investment; at the same time the partnership will aim to

maximize the utilization of scarce resources." (Gattorna & Walters, 1996:189.)


They (Gattoma & Walters) further describe vertical relationships between supplier and

customer/buyer as partnerships and horizontal relationships, such as those between two

suppliers as alliances. Organizations enter into a partnership or alliance in order to:

Achieve strategic objectives

Develop joint strategies

Reduce risk while increasing reward

Improve returns on scarce resources

The aim is usually to provide intermediate or long-term benefits from the relationship.

An example of vertical integration is that of Henry Ford who envisioned a totally self-

sufficient industrial empire (Bowersox & Closs, 1996:89). In addition to a huge

manufacturing complex he developed an inland port and an intricate network of rail and

road transportation. On the supply side Ford invested in mines, timberlands and other

factories. He wanted control all aspects of inventory moving from a network of over

forty manufacturing, service, and assembly plants throughout the United States, Canada,

Australia, New Zealand, the United Kingdom, and South Africa to dealers throughout the

globe. In the final analysis, Ford found out that no firm could be self-sufficient

Supply chain management is not the same as vertical integration (Christopher, 1992:12).

Vertical integration normally implies ownership of upstream suppliers and downstream

customers. As in Ford's case, it was once thought to be a desirable strategy. However,

companies are now focusing on the things they do really well and where they have a

differential advantage, that is to say, their core business. Everything else is out-sourced,

in other words it is procured outside the firm. An example that is often used is that of

vehicle manufacturers that perhaps once made their own components but now only

assemble the finished product.

Integrating and co-ordinating the flow of materials from a multitude of suppliers, often

offshore, and similarly managing the distribution of the finished product by way of

multiple intermediaries, leads to some challenges. In the past it was often the case that

relationships with suppliers and downstream customers were adversarial rather than co-


operative. Even today companies will often seek to achieve cost reductions or profit

improvement at the expense of their supply chain partners. These companies do not

realize that simply transferring costs upstream or downstream does not make them any

more competitive. In the end all costs will make their way to the final market place to be

reflected in the price paid by the end user. "The leading-edge companies recognize the

fallacy of this conventional approach and instead seek to make the supply chain as a

whole more competitive through the value it adds and the costs that it reduces overall.

They have realized that the real competition is not company against company but rather

supply chain against supply chain." (Christopher, 1992:14.)

The aim of the above discussion and given views on some channel arrangements was to

indicate that various different channels do exist. In the following chapters where

outsourcing will be discussed, it should be helpful to keep in mind that relationships can

be constructed in various ways.

2.7 Summary

As stated in chapter one, the concept of the supply chain is often poorly understood. This

chapter's aim was to give an overview of the development and the current status of supply

chain management activities. The background is also needed in order to fully appreciate

the following chapters that will investigate various supply chain outsourcing issues.

The ultimate purpose of any logistics system (supply chain) is to satisfy customers

(Christopher, 1992:24). Supply chain management is involved with the flow of goods

and services from the source to the end user. This flow process should be as efficient and

effective as possible, with the minimum intervention and stops (or hold points) from the

participating parties.


Markets are becoming increasingly competitive. Companies are seeking to grow their

business by extending their markets globally, which further increases the importance of

supply chain management.

The supply chain was discussed under the main headings of inbound logistics, outbound

logistics, customer service, and key enablers. In turn, inbound logistics were further

divided into procurement, warehousing, production planning, transportation and

inventory management activities.

Outbound logistics often receives more attention in the literature than inbound logistics

(Coyle et al., 1996:72). Reasons for this phenomenon are the fact that the outgoing

products are of higher value than those in the inbound system, and because customers are

more directly involved with the outgoing products.

Customer service plays a vital role in satisfying the customer, and is a measure of the

effectiveness of the logistics (supply chain) system, in creating time and place utility for a

product (Lambert and Stock 1993:111). Customer service is a process for providing

competitive advantage and adds benefits to the supply chain in order to maximize the

total value to the ultimate customer (Coyle et al., 1996:113).

Two of the key enablers in the supply chain are human resource management and

information technology. Both these enablers are critical to the success of supply chain

management. Human resource management is influenced by the state and quality of

human ability, motivation, organizational culture, group norms and leadership style

within the company. Information technology is being used by leading edge companies to

increase competitiveness and to develop a sustainable competitive advantage (Coyle et al.

1996:396).

Various channel arrangements exist whereby companies can sort their relationships with

reference to each other. What is clear from the relevant section however, is that different


views exist on how these relationships are to be structured. The most suitable

arrangement will depend on the concerned parties' objectives.

CHAPTER 3

A FOCUS ON OUTSOURCING

3.1 Introduction

Companies in general are experiencing pressure from shareholders to increase

shareholder value and to reduce capital investments in non-revenue producing assets.

These companies are also being pressurized by customers to improve their service at

lower costs. Occurrences such as these, and the drive to sustain a competitive advantage,

have moved companies to consider the outsource option. "Logistics activities are prime

candidates for outsourcing," according to Bowersox and Closs (1996:109). Support

activities are outsourced to specialists as a result of companies' desire to "rightsize" and

to focus on their own core competencies.

There has also been a refocusing on core competencies within companies. An emergence

of third-party service providers, which provide various supply chain activities for all sizes

of companies have taken place. According to Minahan (1997:59) smaller companies

might want to obtain services from the largest providers. By sharing a warehouse or

transportation network that the provider is running for another customer, small to mid-

sized companies have the opportunity to tap the services of some of the logistics

industry's leading providers at a more affordable price.

The above reasoning provides some of the motivation for companies to consider the

outsourcing of some of its supply chain activities. In this chapter an overview of the

development of third party logistics will be given. In addition some of the advantages

and concerns with reference to supply chain outsourcing will be given. A few of the

typical services which are available will be discussed.

Chapter 3: A Focus on Outsourcing 31

3.2 The Development of Third Party Logistics

The outsourcing of supply chain activities is a young and developing industry. Contract

logistics in its current form, dates back only to the late 1980's (Harrington, 1996b:B).

Companies tended to subcontract specific activity areas. A truck was replaced for a

truck, and a warehouse was replaced for a warehouse. Little value was added. Providers,

for their part, concentrated on working with their direct customers on improving

operational efficiency.

As supply chain management theories took root, companies gradually started asking more

from their logistics providers. The management of entire functional areas such as

transportation and warehousing were handed to them. This trend is likely to evolve to the

point where companies will outsource their entire supply pipeline from end to end,

including procurement and manufacturing (see Figure 3-1).

Figure 3 -1 The Industry Evolution

•

1989 1996 2001

Acti■iity 4- w Functional Pipeline

Subcontracting.. Outsourcing Outsourcing

A Truck for a • Transportation • End to End Truck Management

A Warehouse for • Warehousing • Includes a Warehouse Management Procurement

Low Value Added • Fulfillment • Manufacturing

Source: Harrington (1996b:B)


3.3 Possible Advantages of Outsourcing

A closer look, as based on several findings by Richardson, will now be taken at the

possible advantages of outsourcing supply chain activities. As different companies

consider outsourcing for different reasons, the advantages listed below will have varying

importance for each of them. Hence these reasons are not discussed in any particular

preference. Many of the items however, are interdependent, and cannot be viewed in

isolation from each other.

Cost

Expected positive cost effects are important driving forces for the outsourcing of

supply chain activities. Cost is one of the most frequently cited reasons given for

outsourcing. It might be possible for the third party provider to deliver a service at a

lower cost because of its more efficient operations, economies of scale or provider

knowledge.

By relying on third parties' assets, manufacturers are able to remove assets from their

own books. This may not always reduce the total cost of the system, but it will give

companies flexibility to respond to market and economic conditions (Anon.,

1997:21).

Service

Improved service can be expected for the same basic reasons as given for cost above.

Reduced capital investment

Third parties can improve balance sheet economics by eliminating capital investments

in warehouses, material handling equipment, and private fleets. Richardson (1992:22)

states that companies should, when comparing costs, be aware of the true costs of soft

assets such as corporate overhead, employee benefits, utilities, maintenance, supplies

and insurance.


Increased flexibility

Outsourcing can also make a company more flexible and adaptive to fluctuating

demand. If demand increases, the third party service provider will provide additional

assets to meet the required needs (Richardson, 1993:29). In other words, the provider

once again converts a fixed cost to a variable cost. The risk of excess capacity is

reduced or totally avoided.

Furthermore, outsourcing need not be permanent (Richardson, 1992:24). Agreements

can be negotiated for predetermined periods of time.

Reduced risk for obsolescence

Third parties can provide operational efficiencies with flexible resources to meet

changing needs, without the risk of obsolescence to the client.

Fast changes

The third party's resources and expertise allows it to implement changes much faster

than a company operating outside its core business.

Radical restructuring changes

In addition to the fast changes mentioned above, it is also possible to implement more

radical restructuring of supply chains when using a third party provider (a structural

change can be achieved in a short time).

Focus on problem areas

By outsourcing certain activities, logistics managers can obtain time to manage things

that do not work (Richardson, 1992:24).

Focus on core competencies

As mentioned before, outsourcing supply chain activities takes place at many

companies where it is not part of their core business. These activities are then

managed by a company that's core business is supply chain management.


Competitive advantage

Third parties can assist companies to build a logistical/supply chain competitive

advantage through sophisticated logistics strategies (Africk & Markeset, 1996:59).

Expertise and technology (on demand)

Expertise can be gained in systems, logistics, and marketing without the investment

necessary to keep the talent on staff. Third parties can be a source of considerable

expertise, once again with the flexibility of being available when needed, but not

being on the company's payroll when not required. The same goes for technology.

Sophisticated communications and electronic data interchange (EDI) capability can

be tapped into, without investing in equipment that will soon become obsolete. The

service provider makes the capital investment to update when better technology

comes along.

Benchmarking

The expertise that third party providers gain from working with other clients in other

industries, and then bring to a company, allows last mentioned to benchmark itself

against these other companies. This may lead to opportunities that can lower costs

and improve customer service.

Catalyst for change

Through cross-industry experience, third parties can benchmark and act as a catalyst

to take companies beyond where they thought they could be.

Elimination of recruiting and related actions

When personnel is being supplied by a third party, much of the headache related to

recruiting, hiring, and training personnel, negotiating union contracts, covering

medical leave or vacation time can be eliminated (Richardson, 1993:30).

Outsourcing staffing also increases flexibility if the demand varies, whether it is

expertise or dockworkers that are required.


"Full time" supply chain staff for small companies

Small companies that can not justify full time supply chain employees for certain

activities can have access to the desired services and expertise as required.

Improved measurability and control

Third party providers might have the capability to provide much better measurement

of performance and activities, with reference to cost and service. (Outsourcing in the

first place forces a company to measure what it outsources, while in addition the third

party can improve this measurement.)

Single point of contact

For the client there is only a single point of contact, and it is the third party's

responsibility to provide the necessary service.

Elimination of unnecessary handling

By making use of a third party's facilities, unnecessary handling of materials can be

eliminated, for example by means of shipment consolidation (Cooke, 1996a:53).

Reduced cycle times

If multiple warehouse locations are needed around the country, in order to make

quick deliveries, the average turnaround of products can be reduced by making use of

a third-party provider that offers a nationwide network of public warehouses (Cooke,

1996a:55).

Accelerated strategy decisions

Outsourcing forces decision-making and can help a company to develop its business

strategy (Richardson. 1992:23). The company has to define clearly what it wants

when a third party is contracted to perform certain activities.


Optimization across divisions

Contract logistics providers specialize in optimizing supply networks, which entails

balancing cost-benefit tradeoffs across a system. Some companies thus ask their third

parties to go beyond just managing logistics, and help optimize areas such as

production as well, by using their mathematical modeling capabilities (Harrington,

1996b :H).

Strategic planning

Companies are now bringing third parties into their logistics operation's strategic

planning process (Richardson, 1997a:61). Companies' management is looking at

third party providers as less of a replacement for capabilities and more as adding

another way to get things done from a logistics standpoint

The above section mentions some of the possible advantages that can be obtained through

the outsourcing of supply chain activities. A more comprehensive discussion on when

and how a company should consider the outsourcing option will follow in Chapter Four.

3.4 Concerns with Regard to Outsourcing

In spite of the many advantages mentioned above, there could also be less desirable

consequences, following the outsourcing decision. It is especially true if the resulting

actions are not managed in the most suitable or correct manner. Some of these concerns

will now be explored.

Workforce morale

The word "outsourcing" can have a negative effect on employee morale. Many

people do not welcome change, and the effect of outsourcing certain activities on

their morale should not be underestimated. Furthermore this is often coupled with a

fear for job losses. It is ironic that outsourcing can actually take some employees'

careers to a higher plane (Lonsdale & Cox, 1997:32). This scenario is applicable


where people have limited scope for advancement but a transfer to a specialist

organization could multiply their opportunities.

Loss of control

According to Richardson (1993:31) logistics professionals fear loss of control, while

some simply fear the loss of their empire. These fears can follow from a reduction in

the number of the logistics leader's "own" personnel. Allowable instructions to the

third party may also be limited by the contractual agreement.

Unforeseen eventualities

Companies that outsource might be concerned about how to prepare for unseen

eventualities. A different approach will be needed for the above actions than those

where no outsourcing takes place. Once again, it is needed that these instances are

discussed and agreed upon before a contract is finalized.

Workforce buy -in

Implementation often goes together with the difficulty of convincing certain

personnel (at various levels) to buy into the third-party program (Anon., 1992:41).

This could be the result of a lack of trust in the outside company or fears about job

security. This is not necessarily the case as many examples exist where job losses are

kept to a minimum and excess staff is redeployed elsewhere in the organization.

Loss of cross functional contact

It is often reported that contract employees are rarely as prepared as in-house

colleagues to go beyond their immediate remit and take the time to work out ideas

which may be of benefit to the company as a whole (Lonsdale & Cox, 1997:32). This

phenomenon can occur when the contract company is operating away from the

company's site, and there is a loss of profitable contact between that function and

others, which relate to it.


Breaches of confidentiality

By the result of its (outsourcing) nature, the more outsiders who have knowledge of a

company's affairs, the greater is the risk of information falling into the wrong hands.

This increases the potential for breaches of confidentiality.

Motivation for outsourcing

When managers believe that they cannot afford the resources required to solve the

problems that they are experiencing, they may see outsourcing as a solution. Apart

from the fact that the outsourcing of problematic functions often leads to

disappointing results, this activity could still be of significant value to the company

(Lonsdale & Cox, 1997:32). The outsourcing decision is worsened by the fact that

the company is unable to state its requirements adequately to the supplier. Although

the activity is problematic, it does not mean that it will never be critical to the

competitive advantage of the company in the future.

Misinterpretating core competencies

It is important to understand what is meant with core business, as those functions that

are not part of the company's core business can be overseen when outsourcing is

considered. Often "core "is used to mean the things that the company does best. This

understanding could lead management to decide to continue with activities that are

not part of their core business. The opposite side of the argument could lead a

company to outsource some of its core business activities, or as is seen above, those

activities with which it is having problems, but which are in fact part of its core

competencies.

Loss of customer contact

Another concern that exits is about giving up contact with the end customer and about

sharing the sensitive information needed to manage supply chain decisions.

Relinquishing some control and releasing information may be necessary to gain the

benefits of contract logistics (Africk & Markeset, 1996:60). The concern over losing

customer contact in recent times, is less warranted as third parties possess


communication and information capabilities and, in some cases, customer service

support that are superior to that of the client company.

Choosing the most suitable third party provider

Companies may fear that a large outsourcing company can dominate them. The

correct choice of a third partner is important (in addition to the fact that the

outsourcing agreement must be properly set up), in order to avoid this type of

occurrence.

Knowing which third party to partner with, especially in the global competitive

environment, is another concern. Richardson (1993:31) asks the question: "Who can

you trust to become an important part of your business?"

3.5 Examples of Outsourcing Services

Various forms and degrees of outsourcing arrangements exist. Typical headings under

which supply chain activities are available, include the following,

Purchasing

Transportation carriers

Warehousing providers, and

Logistics management providers

Within these arrangements it is possible to obtain many combinations of services or

equipment. The number of permutations that can be developed is beyond the scope of

this study. It will suffice to state that a large range of possibilities does exist, with new

additions and combinations being added continuously.

From a survey which was jointly conducted by Transportation and Distribution magazine,

Coopers and Lybrand, and the University of Tennessee, it is possible to derive an idea of

the variety and preference of services that are purchased from third-party suppliers

47.1%

57.5%

55.2%

0.utbound Transportation

Warehousing

Freight Bill Auditing/Payment

Inbound Transportation

lb; Cross Docking

28.7%

29.9%

29.9%

Freight Consolidation/Distribution

21.8%

7% 20

Product Marking/Labeling/Packing

Traffic Management/Fleet Operations

Information Systems

Product Returns/Repair

Selected Manufacturing Activities

Product Assembly/Installation

Customer Service

Inventory Management

Order Ent /Processin

11 .

11.5%

10.3% . 0.2%a

0.2%

8:0%

13.8%

12 6 /0

p• 4 Services Purchased from Third-Party Logistics Suppliers

4 Percent of respondents

fv

Figure 3-2

Source:T&D/Coopers & Lybrand/University of Tennessee (Survey of strategic decision making in supply chain management as quoted by Richardson, 1997b:46)


(Richardson, 1997b:43). (See Figure 3-2.) The survey examined strategic decision-

making in supply chain management (while the goal of the study was to develop a

consensus on how companies select transportation, third-party logistics, and

warehousing/distribution centre management services).

Procurement

Procurement duties are of the least outsourced activities in the supply chain. In a recent

survey by Purchasing Magazine, only 6% of the organizations surveyed had implemented


an outsourcing program with regard to their procurement operation (Millen Porter,

1997:20). A substantial percentage (46%) of these companies felt however, that there are

circumstances under which certain areas of procurement could be outsourced.

The idea is not to discuss here the relevant percentages of how many companies would

consider the outsourcing of their procurement activities. Rather, it is accepted that,

although its occurrence is increasing, procurement lags other supply chain activities when

it comes to outsourcing. The circumstances under which outsourcing would be

acceptable, is mentioned below (Millen Porter, 1997:20).

When a company lacks the extremely technical knowledge that is required for the

products or services being purchased.

When purchased items are low in value and/or standardized and where purchases are

repetitive.

When companies have limited buying power.

When administrative costs are too high or resources are lacking due to small company

size.

When the purchasing organization is pursuing a goal of becoming less transactions

oriented, for example, to reduce non-value-added work.

The main reasons for not outsourcing procurement are summarized as follow.

A lack of loyalty from third-party employees who have no stake in the company.

A lack of knowledge about the company and its products.

A lack of ownership.

A lack of understanding of the organization's processes, people and needs.

The fact that third-party procurement distributors serve many "masters."

It should be clear from the above that procurement is one of the less clear-cut areas of

supply chain outsourcing. Therefore it was discussed in more detail than other areas of

the supply chain. In the following section, only a few typical scenarios will be given on

outsourcing options that are available.


Other inbound logistics options

A manufacturer can outsource the inbound transportation itself by replacing its private

truck fleet with a dedicated contract carriage operation. The manufacturer can also

outsource the whole logistics inbound flow, allowing the third party to manage the flow

of all incoming material from vendors. Advantages can be obtained if the third party can

provide improved inbound visibility (status tracking), compared to that delivered by the

company itself. Third parties may also be able to set up cross docking and consolidation

programs among vendors, to take advantage of transportation economics, and guarantee

supply reliability. According to Harrington (1996b:F) there is no reason why a

manufacturer can not turn over the entire vendor management responsibility to a third

party logistics company (including the purchase of materials). Similar services are

available for the other materials management functions as well as outbound logistics.

One-stop service

Two aspects are of importance with regard to recent third party service requirements.

The first is the fact that companies are asking or requiring a one-stop service from third

party suppliers (Morton, 1997:85). These clients want an entire package from one

source, which will serve all of their needs. Secondly, service providers admit that, for the

most part, they can not do everything well. The result is that they are looking to

alliances. Currently these alliances or partnerships tend to be more short- than long-term

because they exist only for as long as the need exists. Once the need is gone, the

partnerships dissolve.

Thomas (1998:67) is of opinion that the market will create the one-stop, everything-you-

need third-party provider through partnerships. Third-party service providers will form

partnerships with other companies who provide similar services, as well as those that

provide complementary services. This follows from the fact that customers prefer to do

business with a single provider for all their required supply chain services. It means only

one point of contact for the customer. However, one company can not provide all those

services or solutions, thus the partnerships.


Service firms are also using alliances to improve their competitiveness (Bowersox and

Closs, 1996:110). The formation of alliances between service suppliers to increase their

operating capabilities and efficiencies is widespread. An example is that of

transportation companies who have created strategic alliances in order to combine their

services (different forms of road, rail and other forms of transport) to provide an

integrated service. Where previously these alliances where restricted to separate

providers, services are now being integrated

Global visibility

Global sourcing and distribution are already commonplace in many industry sectors

(Harrington, 1996b:M). An integrated supply chain view of international business

however, is not yet commonplace. Companies are starting to view their supply chains

globally while they want the same kind of connectivity among players that is available in

their domestic service. According to Harrington, "Contract logistics providers are

struggling to provide that integrated service. They are doing so primarily by linking up

with competent third parties in other areas of the world, and setting themselves up as the

lead logistics provider."

Global systems are extraordinarily complex and not many third parties have the resources

and expertise to provide the necessary service without the help of outside partners. No

single logistics provider can effectively meet all the distribution demands of a

multinational company (Minaham, 1996:18). Information systems play a key role in the

pursuit of global integration. Currently, information is often not linked together, but held

in a variety of places (with carriers, forwarders, and/or vendors). Because the

information is not interconnected by a single system, there is no way a company can do

something like tracking down a particular line item in the channel and diverting it to an

alternate distribution center to meet unexpected demand.

Because companies lack information on their supply chains, they cannot manage their

performance effectively and they cannot improve what they cannot measure. Companies


need the ability to feed this global movement information into their internal legacy

systems.

Third party logistics providers are racing to develop and perfect a global information

system that connects all channel partners and provides real-time visibility on product

material movement (Harrington, 1996b:N).

3.6 Summary

There may be various reasons for companies to consider the outsourcing of certain of

their supply chain activities. This chapter aimed to provide a summary of the possible

benefits, as well as concerns that have relevance to this issue.

Chapter Three firstly looked at the development of third party logistics, which is still a

developing industry (Harrington, 1996b:B). It is likely that this trend will continue to

evolve to the point where the entire supply chain can be outsourced.

The advantages that can be obtained from outsourcing supply chain activities, as

mentioned before, will differ for different companies. The most important consideration,

however, should be a strategic one. Most often the decision will be supported by the

company's decision to concentrate on its core competencies. In addition to this decision,

there will be a number of benefits. These benefits could include aspects such as

increased service, cost, or flexibility, as discussed in the text. The benefits can be

summarized by the following statement: "Logistics is the obvious choice for companies

that lack certain logistics management and execution skills and for whom it is not a key

industry success factor. By outsourcing as much as possible, they capitalize on the

expertise of the third-party provider who has already made the investment" (Spear,

1997:72).


Several concerns exist with reference to the outsourcing of supply chain activities. In the

same way that the outsourcing advantages have a strategic element woven into it, the

same applies to the concerns with reference to the topic. Again it can be summarized by

Spear (1997:72), "In-house may be the answer where companies have a distinctive

competency in logistics and it is central to success in that industry. In fact, their

proprietary logistics practices may provide a competitive advantage".

Chapter Three concludes with a brief look at some of the development areas of supply

chain outsourcing. To place this development into perspective, an example is given of

the percentage usage of different third-party services that are purchased. Procurement

activities are discussed next, as it is currently one of the least outsourced sections of the

supply chain. Procurement activities can be outsourced when certain criteria are met. It

is however less clear-cut than the most other areas of the supply chain.

It was found that clients often require a one-stop service from third-party service

providers. Most third parties however, are unable to provide such services on their own,

and thus rely on other third parties to provide certain of these services. The result is that

alliances are formed between third-party service providers. An area where alliances are

especially applicable is that is that of global supply chains. It is the result of the

complexity of these global systems and of the fact that different information systems are

needed to play key roles to this integration.

CHAPTER 4

GUIDELINES FOR OUTSOURCING SUPPLY CHAIN

ACTIVITIES

4.1 Introduction

In Chapter Three some of the advantages that can be gained from the outsourcing of

supply chain activities, were mentioned. Chapter Four will investigate the circumstances

under which a company can use these advantages in order to gain benefits from it.

Guidelines as how to select a suitable provider, as well as how to manage a third-party

relationship are given. The chapter is concluded with a brief perspective of how third

party service providers experience many of their (potential) clients.

4.2 When to Outsource

At the most basic level, companies need to determine whether managing logistics (supply

chain management) is part of its core competency (Minahan, 1997:59). While referring

to logistics, the following signs may indicate the need for outsourcing certain functions:

repeated delivery mishaps, excessive inventory, expansion into new markets, and the

need for costly investments in distribution networks and information systems. At the

same time however, it should be mentioned that these activities should be managed in

house if they are critically important to the success of the business.

It is important to realize that outsourcing is not suitable for all companies. It is not meant

for those companies for whom logistics (supply chain management) is a core

competency, or for the rare company whose logistics operation is so lean and cost-

efficient that nobody else could do it better (Bowman, 1997:34). Harrington (1996b:N)

confirms that contract logistics is not the right solution for every company. For

Chapter 4: Guidelines for Outsourcing Supply Chain Activities 47

companies that view logistics as one of their core competencies or as too critical to their

existence to entrust to an outsider, managing logistics in-house is the right answer.

Companies that do not fall in this category, however, should at least consider the option

of outsourced logistics.

Bowman (1997:34) asks the following questions when determining whether or not a

third-party provider should be used:

What are the current strategic objectives regarding services and costs?

It should be determined which (logistics) activities are driven by the need to keep

costs down, and which are geared toward achieving strategic advantage or enhanced

customer service. Some markets might require a commodity at the lowest possible

cost, where a high degree of customer service is not essential, while others require

parts on a just on time basis.

Which activities should be "owned," and which should be outsourced?

A third party might offer a cost advantage if it could use its aggregated volumes to get

better deals from underlying logistics providers. Even where customer service is

more important, a third party's built in efficiencies might be worthwhile. On the other

hand the third party might prove unnecessary or even counterproductive where full

control needs to be maintained over the supply chain. Once again the decision will

depend on the individual company's need for service, the type of commodity, and the

competitive nature of the market it serves.

Decision drivers

A company can proceed with the evaluation of its options once it knows the true costs for

a given activity (Harrington, 1996a:52). These options might be to:

perform the service in-house

own the necessary assets

turn the service over to a third party

tap an outsider's assets.

According to Harrington (1996a:52) some of the factors that drive the decision are:


Growing need for flexibility.

To be able to adapt and respond quickly to what is happening in the marketplace.

Effective use of capital.

Companies are looking to preserve cash and liquidity to have it available for higher

yielding investments and for unforeseen circumstances.

Focusing on core competencies.

The issue here is deciding what a company's core competencies are, and then

allocating resources to support them. Identifying core capabilities helps a company

establish its goals. These goals in turn, allows the company to review its strengths

and weaknesses in light of these goals.

Keeping up with technology.

This criterion is becoming increasingly important. The need for state-of-the-art

technology has become a key factor in the growth of third party logistics providers.

Companies expect third party providers to provide leading edge technology as it is

one of the chief reasons why they outsource.

Losing control.

Companies are reluctant to forfeit any of the control afforded by an in-house

operation. As logistics service and equipment providers become more sophisticated,

however, they can offer the same or even better control to the company.

Most companies find that a combination of in-house and out-of-house supply chain

services works best.

Fantasia (1993:30) provides similar factors to be analyzed when considering the

outsourcing decision:

Industry factors

The nature of certain industries lends them to participate in third party logistics. It

may be better to focus a company's attention on what it does best and turn logistics

over to an outside expert.

Company strategies and objectives


The company may decide to pursue international markets for the first time. Several

third party providers have worldwide networks in place that can help with

establishing a distribution network quickly and efficiently.

Availability of capital

Third party providers enter the business because of their availability of excess

capacity and equipment. Contrariwise a company might need such services, but

cannot afford or acquire the capital required for it.

Competition

A strategic advantage can be gained through a more efficient logistics system (than

that of the competition). A third party provider can have the physical and human

resources to deliver such an advantage.

Information systems

Information systems are crucial to an efficient logistics system. A third party may be

one of the fastest and cost effective means to a top notch information system.

4.3 Prerequisites for Outsourcing

A thorough understanding of the relevant sections of the supply chain is necessary, when

outsourcing is considered. The effectiveness and cost of each section in the business

should be determined. The effect that decisions could have, as made in other parts of the

company as well as those made by suppliers and customers, should be considered

(Minahan, 1997:59). It is essential to define the specific services that need to be

outsourced to a third party. Not knowing what services are needed could lead to

acquiring services that are not needed.

The use of a third party service provider requires utter familiarity with one's internal

operation (Richardson, 1993:30). If someone else performs certain functions, the ins and

outs of the operation must be known in order for one to be explicit about what is needed.

One also needs to know what the performance levels were, in order to determine whether

or not the same or an improved level of service is being provided.


Before approaching a third-party company, it is necessary to clearly define the goals and

objectives that are expected to be achieved from outsourcing. These objectives may

include items such as cost reduction, quality improvement, strategic expertise acquisition,

or a combination thereof.

Cost knowledge

According to Harrington (1996a:51), the first step in any own versus manage analysis is

to determine true operating costs for the particular logistics activity. Activity-based

costing (ABC) can help companies understand the true components of their costs and

enhance their decision making capabilities about whether to perform a function internally

or outsource it. It (ABC) is a method of assigning costs to goods and services that

assumes all costs are caused by the activities used to produce those goods and services

(Edwards et al., 1993:651). Costs are assigned based on how resources are actually used,

tagging them directly to the activities and customers consuming them. Such resource

costs include billing, shipping, delivery, warehousing, human resources, administrative

and management overhead, and the like.

Companies often compare their costs to those of third party suppliers, to find that their

own costs are lower. With closer examination it is found that these companies have

excluded their overheads, and thus do not have lower costs. It is of paramount

importance for a company to differentiate between fixed and variable costs. Activity-

based costing is an essential tool when calculating the different bases that leads to cost.

Companies should not only look at today's costs. The future value and costs of

equipment or facilities should also be considered. To accurately assess risk in owning

versus leasing trucks for example, the company should factor in the future value of the

equipment. This could vary because of the current availability of the mentioned

equipment.


Value

The outsourcing decision should not be made on the basis of cost alone. There should

also be the added value, which comes from flexibility and systems capabilities. The two

elements of cost and value, in combination, make much more of a difference to a

company's competitiveness than some immediate cost reductions. They allow the

company to be nimble, which is of importance today (Harrington, 1996a:52). The danger

also always exist that numbers can be tweaked to support either side of the own versus

manage debate, depending on the financial motivation of the company.

Strategic planning

The results of outsourcing are often disappointing. Reasons for this phenomenon are that

many firms believe that no strategic planning is required for outsourcing, or they attempt

to "reinvent the wheel" which leads them learning through avoidable mistakes. Lonsdale

& Cox (1997:32) have identified four broad issues that need to be considered prior to

making the decision to outsource.

Thinking strategically about outsourcing.

The danger exists that headcount and cost-cutting criteria will be the main driving

forces in the outsourcing decision. This can lead a company to outsource its core

activities. Although cost-cutting benefits can be legitimate, it should not be sought

from the outsourcing of core activities.

Limitations to knowledge and competence.

Limitations of a company's own knowledge and competence can have an effect on the

success of the outsourcing deal. Certain tasks may be taken for granted when

performed in-house. These tasks are then not explicitly identified and are omitted

from the contractual agreement. This will lead to additional cost, which was not built

into the cost comparisons. Another example is of a the third party that deliberately

allows a contract to be signed which it knows will not permit the service to be

undertaken fully, can also have additional costs as the result.

Shifts in the balance of power during the contract

It is possible for a third party supplier to introduce technologies or processes, which

increases the client's dependency on it. Therefore it is important for companies to


carefully consider the situation before outsourcing into a supply market containing

only one, or very few, feasible suppliers.

• The effect of supplier failure

Steps should be taken to minimize the effect that supplier failure could have. A

supplier could go out of business altogether or fail to achieve the high standards

required by the company.

Control

Some companies might not possess the inherent logistics expertise they need, although it

is recognized as critical to success in their industry. Upgrading their in-house capability

may be costly while they cannot afford to turn over control of a strategically vital aspect

of the business. These companies need to tap the expertise of a third-party provider while

maintaining control over the process. By structuring agreements with incentives and

penalties based on performance against agreed standards, the company can define the

logistics strategy but rely on the third party to execute (Spear, 1997:69).

Job content review

The outsourcing of certain supply chain functions may lead to changes in the way that

some jobs are best accomplished. In preparing to outsource, a complete review of job

content and responsibilities of those job positions, directly involved with the function that

is to be outsourced, is needed. This also applies to those that will interface with the

partner company (McKeon, 1991:28). It should be ensured that there is no duplication of

organizational structures or of roles and responsibilities, with reference to individuals or

departments. Such duplication could erode the benefits that might accrue from

outsourcing.

The required change might only be in the primary emphasis of the relevant job. In the

instance where certain functions will become the responsibility of the third party, the

present incumbent might shift his/her emphasis from day-to-day management of the

workforce, to more strategic issues. This can improve the ability of the company to meet


the requirements of its customers. In effect work is delegated to the outsourcing partner,

and the responsible person has more time to improve areas that have a potentially greater

impact on the success of the company.

4.4 Selecting a Third Party

Provider requirements

Bowman (1997,36) gives the following criteria whereby a potential third party should be

evaluated.

Resources

m Financial strength is seen as crucial. Annual revenues, employed assets and

financial rating are of importance.

Business experience. The strength of operating management and state of labour

management should be investigated.

Duration of experience. The opinion exists that a provider should not have less

than five to ten years contract logistics experience.

Major areas of expertise. Expertise should be demonstrated or be accessible in the

areas of administration, personnel development, information technology and

transportation services.

Range of services

The depth and breadth of services should be considered. This includes the third

party's ability in each of transportation, warehousing, procurement, customer service,

and other areas.

Real-world operations

The available services should be demonstrated in a live setting. Facilities must be

visited and customers and employees spoken to.

Cultural fit

Although not so easy to measure, the similarities and differences between the third

party's corporate culture and that of the client company should be taken into account.

According to Bowman, it all comes down to trust.


• Narrowing the field

This step is only applicable if a large variety of possible suppliers exist. It is

recommended that a general request for information be obtained first. Only after that

should formal requests for proposals be issued.

How to outsource

Once the outsourcing requirements are clearly defined, a provider is sought who most

closely meets those requirements. Minahan (1997:59) provides some guidelines with

reference to how such required services can be obtained.

Many suppliers have a specialty, such as fleet or information management. Because of

this it might be necessary to hire multiple providers, each handling a different part of the

supply chain. There need to be looked at providers that focus on the industry that the

company is in and understand the nature of the products that are being dealt with.

When selecting a provider, close attention should be paid to how candidates measure up

in the areas of financial strength, business experience, business development, support

services, and business arrangements. Companies where these providers have a solution

in place should be visited and the functional aspects of the operation as well as the

interaction of the provider with the customer should be examined.

Once having decided on a particular provider, the goals and costs of the outsourcing

project and a timetable for accomplishing these goals must be agreed upon. Also

important, there must be agreement on how these performance requirements are to be

measured.

Gain sharing-options are increasingly included in outsourcing agreements. Hereby a

provider can claim all or a portion of the savings reaped for a customer above the targets

set out in the initial contract. This can help foster an environment for continuous

improvement.


Caution against break-ups also needs to be taken. A clear understanding should exist of

what the separation of the agreement will be, in case it arises.

It is recommended that outsourcing should start small by outsourcing only a subsection of

a logistics chain or establishing a pilot project to test a providers mettle. It should have

enough volume however, for the provider to generate some sort of cost savings.

According to Minahan (1997:60), outsourcing is a long and complicated process:

"Defining needs, selecting the proper provider, and negotiating a contract takes, on

average, anywhere from two to six months. And implementing some of the more

complex logistics solutions can take more than a year. But, considering the impact a

successful logistics chain can have on a company's bottom line, it is certainly time well

spent."

If a company wishes to reap the benefits of contract logistics, it is best to approach the

project as a strategic partnership rather than as the outsourcing of a function or

department (Africk & Markeset, 1996:58). Strategic partnerships must be built on shared

values and trust and require parties to share both opportunities and risks.

Canitz (as quoted by Cooke, 1997b:49) provides a ten-step approach for the selection of

the right third-party provider.

Form a cross-functional team. This team should include members from all areas

within the organization.

Set the objectives. The above team should establish the company's objectives for

outsourcing as well as a way to measure the endeavor's success.

Determine customer-service requirements. The customer-service requirements

that the third party provider must meet are determined. Internal and external

customers should be surveyed to determine current logistics strengths and

weaknesses.

Develop selection criteria. The development of selection criteria which are linked to

the company's objectives and customer-service requirements.


Develop a list of candidates. The team should canvass the field for appropriate

third-party providers who have a similar business orientation to the company.

Query the candidates on their interest. A letter is sent out to the potential

candidates in which their interest is probed and whereby they are requested to provide

preliminary information on their company and its service capabilities.

Send out requests for proposals. Qualified providers that express an interest in the

project should be sent a request for proposal which include a format and section for a

price quotation.

Perform site visits. After the responses to the request for proposals have been

reviewed in detail, the four or five likely prospects are visited. A standard checklist

and the same team members should be used during each of these visits to facilitate a

one-to-one comparison.

Review candidates' qualifications. The financial information, strategic fit,

management philosophy, and checklist must be reviewed.

Use analytical tools to select the third party. An analytical approach is

recommended to choose a partner, which is the last and most critical step.

It is believed that exercising care when selecting a third party service provider will

minimize much of the risk of outsourcing (Richardson, 1992:24). Looking at image and

service standards will help in evaluating service providers.

Decision level

In a study of large U.S. manufacturing companies Lieb found that the decision to have

functions outsourced takes place at the corporate level, for half of the time (Anon.,

1992:39). A third takes place at the divisional level and 15% at the operational level.

Normally other departments, such as finance, manufacturing, marketing, and information

systems are also involved in the decision. They even play a significant role in the

selection process. This reflects a growing integration of logistics with other functions.


4.5 Managing a Third Party

Bowersox and Closs (1996:109) identify four attributes of logistical operations that are

essential to build strong working (service alliance) relationships with reference to

outsourcing, namely mutual dependency, core specialization, power clarity, and emphasis

on co-operation.

Mutual Dependency. A relationship that is built around the performance of

logistical service must acknowledge a great deal of dependency. This follows from

the fact that a service either happens as planned or it does not. Service providers

involved in an alliance should therefore acknowledge dependency.

Core Specialization. There is a high degree of core specialization involved in day-

to-day operational performance. Most logistical services benefit from economy of

scale and are highly vulnerable to diseconomy of scale. Therefore, a company whose

core competency involves performing an essential service has intrinsic appeal for

firms that require the service.

Power Clarity: The real power in supply chain arrangements typically belongs to

manufactures or distributors with the demand for logistics derived from market

acceptance of basic manufacturing, wholesaling, and retail business strategies. This

clarity of power focuses the attention of supply chain service suppliers on providing

their designated services.

Co-operation Emphasis: The marketing strategy of a highly successful service

provider builds on a platform of co-operation. There should be no deviation from

specification and the provider should be easy to do business with.

The introduction and hand-offs between functions during the initial stage of a third party

agreement is crucial in many ways. The first transaction sets the stage for all subsequent

transactions; therefore it is important that a sufficient amount of effort and planning is put

into the foregoing period. One aspect, which should not pass unutilized, is the planning

and familiarization of all parties to the intended processes.


Bowman (1997:40) provides several steps that can be taken in order to maintain a

successful relationship with a third party.

Solve it up front. The roles, compensation and mutual expectations of the involved

parties should be clarified at the beginning of the agreement.

Start slowly. A gradual implementation phase is advocated during which some

control is initially kept in-house.

Measure carefully. The importance of measurement should be stressed and the

information kept available to the relevant parties.

Get everyone involved. The entire organization should be committed to the

outsourcing contract. Top management needs to impose a culture of supply-chain

thinking that matches the range of services that the third party is providing.

Assign credit and blame. Even detailed contracts are not immune to occasional

disputes. Focus should be kept on the big picture, while individual mistakes are not

blown out of proportion. However, standards and tolerance levels should be

established from the start.

Keep the lines of communication open. This is seen as the crux of any good

outsourcing relationship. A designated individual must be assigned by each party to

act as chief liaison in the relationship.

How to break up. The parties should have a clearly defined exit strategy.

In the foregoing sections, much was written on the requirements that need to be in place

before, or when starting, a third-party relationship. In addition Cooke (1996b:39) states

that ongoing maintenance is required in order to build a solid relationship. Even when

one outsources certain activities, these activities still need to be managed. His checklist

for success include the following four attributes:

Good communications. Once again, communication is seen as the most important

element in third-party success. Relationships often get off on the wrong foot because

of companies' dishonesty in disclosing expectations or capabilities at the outset.

Sometimes the one party does not understand what the other sees as the benefits and

objectives of the relationship, even after a period of working together.


Commitment to succeed. Companies have to be willing to make a commitment to

an outside relationship, and to accept the third party into the corporate family.

A reward structure. The relationship should be structured in such a financial

manner so that the provider has an incentive to provide top-notch service. The third

party should receive variable compensation based on reduced costs and increased

efficiency. The client will probably be disappointed if the third party only replicates

the tasks and performance that had existed before outsourcing.

Corporate chemistry. This is obtained when the involved parties share common

business beliefs and practices.

Long term relationships

Outsourcing relationships are often more than simple vendor-customer business deals.

They are more than transactional in nature, they are strategic linkages. In the past, an

outsourcing agreement was usually approached with a procurement mentality where there

was a vendor and a customer (Harrington, 1996b:J). Now the relationships are often

becoming longer term. There is a sharing of rewards (gain sharing) as the third party and

customer work together to look for ways to improve the system.

Changing providers is a decision to be carefully considered. If new bids are collected and

a saving of 5% is possible, it should be remembered that the current provider has built up

knowledge of the company's operations (Harrington, 1996b:L). The value added by the

current provider could be much greater than the mentioned savings. Switching costs can

be substantial because of the typically lengthy learning curve required for a new provider

to get up to speed (acquainted).

Reasons for failure

The reasons for failure are typically a result of the requirements mentioned above, not

being met. These will not be discussed again, but summarized with the causes as given

by Gulisano (1997:77).

Failure to include the appropriate resources to manage the provider relationship.

Expectations are not properly set at the start of the relationship.


Overpromising on the part of the provider.

Not being clear on what the third party should provide.

The shipper and third party do not treat each other as a strategic alliance.

The third party does not insist on understanding every aspect of the operation.

4.6 The Third Party's Perspective

The cost for third party supply chain service suppliers to obtain business is becoming a

major issue (Richardson, 1997a:60). Third parties are increasingly choosing customers

with whom they have a high chance of success, particularly where their industry expertise

brings a competitive advantage.

Companies that are outsourcing for some hidden agenda such as breaking a union, getting

out of a labour deal, or shedding a building are not preferred. Companies who are

seeking the strategic value of outsourcing and who stays in the relationship are more

likely customers. Within successful deals the customer is highly involved in a true

relationship to manage that process.

The cost involved with responding to requests for proposals is a major cost driver. Third

parties need to be able to recover this cost through contracts, or up front as a fee for

service. Payment needs to be received for services delivered through a bid, as there is

value derived from it. Third parties do not want to allocate their resources unless they

have a financial commitment.

It is found that companies often solicit bids for the good ideas that are included, then

implement the ideas themselves. Companies even prohibited third parties from calling

the information confidential and proprietary.

Successful third party outsourcing partnerships also require mutual trust and information

sharing (Yeager, 1993:34). Clients must share once-privileged information and discuss


their distribution needs, goals, and expectations in an open manner if the third party is to

meet their unique requirements.

4.7 Summary

The question of whether to outsource and when to outsource supply chain activities goes

hand in hand. It can be said that if the relevant questions were asked to test if

outsourcing is relevant, the question of when to outsource will have been answered as

well.

The decision of when to outsource is influenced by various factors. The single most

important factor should be one of strategic consideration. A company should firstly

determine what its strategic objectives are, then only can the correct factors be taken into

account in order to derive at the most suitable conclusion. These factors or decision

drivers can include the need to focus on core competencies, the need for flexibility or

keeping up with technology.

Once the decision has been taken to consider outsourcing, there are some prerequisites

that are to be complied to, to ensure that the correct services are obtained. The relevant

sections of the company's supply chain must be thoroughly understood, and there must be

utter familiarity of the internal operation of the company. Knowledge and analysis of

cost for the different activities in the supply chain is necessary. A tool, which can be of

value here, is activity-based costing. Thereby costs are assigned to the activities that are

used to produce goods and services.

Adding value is one of the most important reasons for the existence of supply chain

management. Therefore the flexibility and system capabilities which can be added by

means of outsourcing should be carefully considered.


Selecting the most suitable or acceptable third-party service provider is another important

step in the outsourcing process. The potential provider should be evaluated on areas such

as available resources and range of services that are offered. The cultures of the parties

involved should also be compatible.

Once a third party agreement is in place, there are several guidelines, which are of

importance, which can help to ensure that the original goals of outsourcing activities are

met. The success of supply chain partnerships will be positively influenced by well-

defined requirements and procedures, and by communication on all levels.

From the third party's point of view, it is important that customers approach them (the

third party), for the right reasons. Companies that want to outsource in order to get out of

labour problems or other hidden agendas are not preferred. The bottom line is that

companies need to build their third party relations on mutual trust and honesty.

CHAPTER 5

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.1 Summary

The ultimate purpose of supply chain management is to satisfy customers. Supply chain

management begins and ends with the customer in a very literal sense (Quinn, 1997a:47).

In the supply chain, goods and services should be able to flow from the source to the end

user, with minimum of interference from the participating parties. Only once the above

requirements have been met, is it possible to have a truly effective and efficient supply

chain.

An effective supply chain makes it possible for companies to obtain a competitive

advantage in the world markets of today. This is especially true since product life cycles

have become shorter, and the commodity market has grown to include millions of

different products. It is usually extremely difficult to obtain a cost advantage in these

markets, thus companies aim to achieve better customer service in order to obtain or

sustain their competitive advantage in the marketplace. Supply chain management offers

a way to achieve this advantage.

Globalization has been the result of companies that are seeking to grow their business by

extending their markets, while at the same time seeking cost reductions through scale

economies. The resulting global supply chains also face higher challenges. This follows

from, among other reasons, the longer distances and more complex logistics, as well as a

demand for variation, even though the attempt is to satisfy common demands worldwide.

Globalization is one of the reasons for the growing importance of supply chain

management.

It can be derived from the above scenarios that it is important for companies to improve

the management of their supply chains. One way of achieving this goal is to outsource

Chapter 5: Conclusion and Recommendation 64

non-core activities. The purpose of this study was to determine whether or not it is

worthwhile to outsource supply chain activities.

Among others, the following advantages can be the result of the outsourcing of supply

chain activities:

Positive cost effects

Improved service

Reduced capital investment

Increased flexibility to fluctuating demand

Focus on core competencies

In the same way, some of the concerns of outsourcing supply chain activities are:

Negative effect on workforce morale

Fear for loss of control by some supply chain professionals

Breaches of confidentiality

Loss of customer contact

The above benefits and concerns indicates that there are definite positive and negative

implications that are related to the outsourcing of supply chain activities. This raises the

question of not only whether, but also when it would be suitable for a company to

consider the outsourcing option, as a means of obtaining a competitive advantage.

The most important factor that influences the outsourcing decision, is the strategic

importance of the decision. The company in question should determine its strategic

objectives in order to derive at the most suitable answer. The answer will be influenced

by the required benefits, as mentioned before.

In order to make a knowledgeable decision, the relevant sections of the company's supply

chain must be thoroughly understood, and there must be utter familiarity with the internal

operation of the company. The company might find that a combination of in-house and

out-of-house supply chain services works best for it.


Selecting a supply chain service provider requires that certain selection criteria be

adhered to. The third party supplier under consideration should be evaluated on the

grounds of available resources, range of services, and cultural fit compared to that of the

requesting company.

Once a third party provider has been selected to perform certain of the client company's

supply chain activities, the relationship is dependent on good communication and honesty

between the parties. There is a tendency towards longer-term relationships in all parts of

the supply chain, and outsourcing relationships are not excluded from this phenomenon.

5.2 Conclusions

The results of this study should be measured against the purpose of the study as stated in

Chapter One. This was to determine whether or not the outsourcing of supply chain

activities is worthwhile or not, in order to obtain a competitive advantage by means of a

more competitive supply chain.

The answer will be found in the strategic objectives of the relevant company.. The

company needs to examine its vision and goals for the future. Knowing what the

company's key competencies are, and allocating resources to support them, helps a

company to establish its goals. This is an essential requirement when determining if the

outsourcing of supply chain activities should be considered.

Once outsourcing is seen as a possible means of optimizing the company's supply chain,

there are some additional, but essential requirements. It is of crucial importance that the

(potential) client company has a thorough understanding of its supply chain process, as

well as the costs that are related to each of its process activities. In addition the company

must be able to state accurately the services that are required from the third party

supplier.


Companies that comply with the above requirements have a good chance of improving its

supply chain management, by the outsourcing some of its activities. It is thus

recommended that companies that are seeking to obtain a competitive advantage through

improved supply chain management, do consider the outsourcing option. The key to a

successful third party partnership is for the client company to know itself and its needs.

5.3 Recommendations

The research material referred to in the study was mainly of non-South African origin. It

is accepted however that the principles, which have been derived at, are also applicable to

the South African environment. For global companies, this will undoubtedly apply. It is

recommended that a study is to be done on the range and extent of services and that are

locally available. This will place some perspective on the type of supply chain services

that are locally available for outsourcing. In addition it will help to quantify the measure

of advantage that can be obtained from companies that provide these supply chain

services locally. Furthermore it will serve as a benchmarking exercise which will help to

identify improvement opportunities, and to compare available services to those that are

available elsewhere in the world.

This study has concentrated on the reasoning behind the use of third party supply chain

service providers. A next study might be able to shed some light on the number and

percentage of users who make use of particular services. This can be used to make

comparisons with acknowledged market leaders and to identify improvement areas.

Up to date there are different views on exactly what supply chain management is and

what can be achieved by improving it. There should not be doubt however, that by

improving the supply chain, by whatever means, can have a positive effect on the bottom

line of a company. This is especially true on the longer term where customer service has

an undoubtedly substantial impact on a company's existence.


A company's knowledge of supply chain management will be of great value in the

outsourcing decision. As was seen in the study, there is a general lack of knowledge

concerning supply chain management. It is thus recommended that the education of

company employees, on all levels, be improved with reference to the aspect of supply

chain management.

68

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