Outsourcing logistics

Importantly, while logistics functions were separate, they were often performed by different organizations that were hired to perform the function, or at least by different departments within the same organization. With the increasing integration of individual functions, coordinated planning has gained significance. Each logistics function can be called playing a separate musical instrument in a large orchestra. Conducting for the orchestra became more significant than the technical fulfilment of the function of each individual instrument. This is how the term logistics service provider appeared on the market. A logistics service provider meant more than just a transport provider of trucks, trains or ships.

Logistics functions can be implemented by the organization itself. Another option is for the organization to hire an external service provider to perform logistics functions. The principles of specialization and economies of scale encourage organizations to focus resources on core activities and leave non-core activities to specialized professionals in their field.  An organization can have its own trucks to transport cargo, but the main question is whether it will be possible to use the truck’s capacity in the most efficient way. In logistics, it is especially important to tackle the principal obstacle of having an in equal repartition of production and consumption areas. Especially large cities have much more goods inflows than outflows. This trade imbalance creates inefficiencies and losses, manifesting in transportation in the form of empty runs and low load factors. For example, after taking the manufactured products from the factory to the points of sale, the trucks would have to return to the factory empty. It can happen very rarely that a truck will bring raw materials for production to the factory from the same place to which it took the manufactured products. Most often, the locations of sales and raw materials do not match. Also, the transportation time and transported quantities do not match. With own vehicles, organizations will inevitably face the problem of returning empty. It seems that driving an empty truck is no problem. In a physical sense, an empty truck will use less fuel than a fully loaded one. However, from a business and economic point of view, using a resource that is not loaded is a pure loss. Running an empty truck consumes time, fuel, driver wages, moreover, it technically consumes resource of tires and engine parts too. Another consideration is the cost of owning a truck. The fact that the truck is bought, so its purchase price and amortization is be included in the cost of the transport company. When evaluating how much it costs to transport the goods, the cost of one kilometer driven with the load is often calculated. The price of one kilometer includes direct costs, such as fuel, driver’s salary, as well as the part of the price of the truck per kilometer driven, what is actually indirect costs. To reduce the cost per unit when transporting goods, it is very important that the truck travels as full as possible while carrying goods and minimize as much as possible the distance of running empty. If manufacturer or retailer has its own trucks to carry its own goods, it is likely that almost half the mileage will be returned empty, a significant part of the time the truck will be standing, waiting for the next load. Very large factories or wholesalers or retailers can ensure continuous operation of their trucks, so that there is no need to wait for the next load and the truck has no downtime. However, even in this case, the problem of returning empty is not avoided. Due to these described situations, it is cheaper to outsource transportation service than to do it in-house. To an inexperienced specialist, it may seem the opposite, because usually the cost of owning a truck and return empty mileage are not evaluated, but only fuel and driver’s salary are compared. Specialized trucking firms that provide transportation service ensure that the truck has as little mileage as possible when empty and the mileage and fill rate of a loaded truck are as high as possible. For example, a truck with a semi-trailer of a specialized transport operator run approximately 15,000 kilometers per month in Europe, and even up to 20,000 kilometers in North America. It is very rare for trucks belonging to a manufacturer, wholesaler or retailer to operate such distances per month. Specialized transport operators work for profit, so they invest in innovation, fleet management, order management systems, and achieve significantly higher efficiency than a non-specialized organization can do. Although this example is about the transportation of goods by road, but the same principle applies when we talk about transportation by rail, sea transport or air cargo. Similar examples of efficiency gains can be found in other logistics functions, such as warehousing. In the case of storage, the costs are calculated for the use of the warehouse capacity. An organization that specializes in warehousing will usually make better use of warehouse capacity than an organization that stores its own materials or products in its own warehouse.

Ex. 12‑4 4 levels of logistics integration

Keywords: logistics integration

According to the degree to which logistics functions are performed by the organizations themselves, and in which case the function is performed by an external service provider, it is customary to divide logistics into four levels (Exhibit 12-4). First-party logistics (1PL) is the case when an organization provides the logistics service itself, i.e., has its own vehicles, drivers, warehouses. This name comes from the fact that the user and the provider of logistics services are essentially one same organization. Although it may seem less efficient than buying services, it works in certain cases. For example, a food retail owner or a catering business driving with own vans to the food wholesale market for his daily supplies and using the same vans for deliveries to final customers. In the case of 1PL, logistics services are exclusively focused on self-serving the organization’s core business, and although it is more expensive, the focus and priority may in some cases be more important than the price. When services are provided by another organization, it can always happen that organization have to wait longer for service, or the service provider will not agree to have highly specialized equipment that is needed for a specific factory or merchant. Having own logistics resources allows to increase readiness, reliability and sometimes quality. This is less often seen in business, but for example the military, police, emergency services rely on their own logistics resources, rather than outsourcing transport services.
Second-party logistics (2PL) is the performance of selective logistics functions, when an organization purchases a specific logistics service from a service provider. For example, if a factory, wholesaler or retailer outsource transportation service by hiring a trucking firm, it is considered second-party logistics. Having chosen this model, organizations buy one of logistics services – storage or transportation, or packaging, or any other service from specialized providers of these services. 2PL can be called a non-integrated procurement of individual logistics functions from external suppliers.
Third-party logistics (3PL) is a case of purchase of integrated logistics services for external provider. Instead of separately hiring transportation services, storage services, packaging, labelling or other logistics services, an organization buys the entire package of logistics services from a so-called 3PL service provider. This means that the organization does not hire many service providers for separate logistics function but hires one service provider who will take care of all logistics services. 3PL providers often have their own fleets of vehicles, their own warehouse network, order planning, management, packaging and other functions. If the 3PL service provider cannot implement some required function with its own resources, then it subcontracts those functions from other third parties. For example, if the 3PL provider does not have its own warehouse in the required location, or these capacities are not enough, then they outsource the service from a third party. If it is more profitable for the 3PL provider to send a non-own truck to pick up the customer’s cargo, then the 3PL provider finds a service provider in the market that covers the resource gap efficiently. This is where the name comes from, which means that three parties are involved in the provision of services – the cargo owner, the 3 PL provider and, as needed, specialized individual logistics service providers, such as transport firms, warehouse owner and others.
Fourth party logistics (4PL) is a level where consultants are involved in planning the details of organizing logistics services. These consultants can be called logistics architects or logistics managers. Logistics architects prepare logistics strategy and detailed plans for its implementation, and logistics managers also supervise and manage the implementation of these detailed plans for logistics implementation. 4PL providers are basically organizations that provide intellectual services, they usually do not have physical logistics resources – vehicles, warehouses, etc., but they basically provide an external logistics service planning and supervising function. 4PL providers essentially plan and manage the entire supply chain, from raw materials to the end user, outsourcing the physical performance of services to 3PL or 2PL service providers, depending on the need.
The demand for 3PL and 4PL services has been driven by globalization, but at the same time, these services have further propelled globalization (Exhibit 12-5). Advances in transport technology, available infrastructure, and standardized containers made it possible to make logistics services cheaper, which in turn reduced the importance of distance when choosing raw materials, production and consumption locations. Global production networks have been created in the world, in which the distances between raw materials, production and consumption markets have become long, and logistical solutions are quite complex and require a very good knowledge and experience of various types of transport, technicalities of ports, and warehouses. It has become quite difficult for the organization itself to organize the entire supply chain, and this has further encouraged the development of specialized 3PL and 4PL service providers, for whom this activity is a core competence. 3PL and 4PL service providers ensured better utilization efficiency of logistics assets and applied the principles of economy of scale in logistics. 3PL and 4PL providers have been able to balance the needs of not one, but several customers by offering freight pooling.
3PL and 4PL service providers have managed to apply the principle of consolidation of freight flows, which has allowed shipbuilders to build increasingly larger ships, cargo equipment manufacturers to produce cranes with higher capacity and performance, which has made it even cheaper to transport one cargo unit over long distances by ocean.

Ex. 12‑5 Driving forces of 3PL and 4PL

Keywords: global coverage, specialisation, utilisation

This has created an opportunity for 3PL and 4PL service providers to invest in technological and managerial innovations and, due to economies of scale, and to have a good return on investment. More about cargo grouping is described in chapter 13 of the book.

Over time, the logistics system allowed some logistics functions, such as warehousing and stockpiling, to be transferred to independent logistics providers in such a way that it became possible to have just-in-time delivery. For manufacturers it means to work essentially without warehouses for raw materials or production components, or to minimize the need for them. In the operations of average size manufacturer, wholesaler or retailer to invest into logistics capacities and logistics innovations is not efficient, because of relatively small volumes of freight. Meanwhile, 3PL and 4PL providers have usually reached the aggregated freight volumes when the investment in logistics technology or process improvement will pay off well.

Globalization has led to the emergence of more and more international manufacturers and traders, and to serve them, it has become necessary for logistics service providers to be also international and cover all territories and modes of transport. Among the 2PL service providers it is possible to find national local operators, then 3PL and 4PL providers are mostly international, quite often operating worldwide.

Basically, to find a clear dividing line between 3PL and 4PL is sometimes not possible, because more and more 3PL service providers offer one or the other service that is characteristic of 4PL service providers; especially difficult is to have a clearly separated definition when it comes down to the quality of information systems in place to support the delivery of the services, because IT providers offer software and hardware products and information management tools and features that are used similarly in both 3PL and 4PL. Therefore, it is customary to consider 3PL and 4PL services as a certain gradient, which includes 3PL core services, supplemented service, complete package and finally fully integrated logistics services, which truly could be perceived as a 4PL service complex (Exhibit 12-6). Fourth-party logistics providers focus on an integrated view of the supply chain and look for all possible ways and methods to reduce logistics costs for the customer and improve the reliability and service level of supply chains.

Physical delivery of raw materials, semi-finished products or finished products plays a very significant role in logistics. Transport companies, regardless of what is transported, usually use the definition “cargo” or “freight”. The cargo can be anything – raw material, semi-finished product, component, or consumer product.

From the point of view of the transport operator, any product is just simply cargo, where the weight, volume and shape of the shipment, and the method of packaging are more important characteristics than the nature of product itself. During transportation, specific requirements are imposed, which are named as number as requirements, such as 6Rs or 7Rs, depending on the author (Exhibit 12-7).

Ex. 12‑6 Gradient of 3PL and 4PL scope of the services

Keywords: logistics services, 3rd party logistics, 4th party logistics

These logistics requirements are understood as goals of the implementation of order, delivery, quality and price.

Order requirements are understood as delivery of the Right product and the Right quantity. This is ensured during cargo loading at the departure warehouse. Sometimes it happens that when loading goods by mistake, the wrong product is loaded as ordered, and sometimes a different quantity of product is loaded than ordered. In case incorrect raw material delivered or in incorrect quantity, it can mean factory downtime, especially if the factory is operating on a just-in-time logistics basis. Sometimes it happens that the cargo is not delivered, or only part of the cargo is delivered, and the reasons for this are theft. Although it is already the 21^st century, goods from trailers are still stolen while the drivers are sleeping in the parking lots, and cargo ships are attacked by pirates who ask for ransom after stealing a cargo or kidnaping a crew.

Delivery requirements include getting the product to the Right place at the Right time. In this case, the correctness of the place and time is determined by the agreement between the recipient of the goods, the sender and the logistics provider. A product that arrived earlier is also considered not to meet the concept of right time. For example, the factory may not yet have storage space ready, so raw materials or semi-finished products arriving too early would cause problems because there would be nowhere to unload and store them. Delay in delivery is often an even more damaging situation. Some factories operate with no or minimal inventory of raw materials so the delay in the arrival of any raw material would mean that the entire production line will be stopped, and the factory worker and equipment will experience downtime. Errors with the delivery address are also happening sometimes. These may simply be technical typing errors, or errors when the recipient’s office or head office address is printed in transportation documents instead of a warehouse or factory address. Very often, organizations store their products or have their production capacity at other addresses than the organization’s office and administration, sometimes even in other cities. If upon arrival it turns out that the wrong address was entered by mistake, the cargo has to be transported to another place, which is additional costs for the transport operator and almost guaranteed delay in delivering the cargo to the agreed place on time. In addition to the order requirements, some researchers also include the requirement of delivery to the Right customer (in this case, 6R becomes 7R). Incorrect entry of the customer to whom the goods are delivered in the transport documents is a relatively rare phenomenon. Nevertheless, for example in urban deliveries it is common that the entrance door for goods deliveries is different from the recipient address, for example back door and front door of large buildings, and requires stopping at different streets, using different routes. Driver knowledge is essential for time accuracy, as the navigation systems still don’t include loading bay location, or pedestrian walking time between vehicle stop and goods reception desk, or final customer address in upper building floors.

A very important aspect is the Right quality of the delivered cargo. During transportation, the cargo may be damaged physically, by impacts, by water or just humidity, by a cold or excessive heat. Cases of cargo damage are quite often. Cargo transportation is regulated by international treaties and conventions that determine specific markings, conditions and rules for the transportation of temperature-sensitive, perishable or dangerous products. Cargo is insured against damage in transit, but if a damaged cargo arrives, the consequences are often equal to or more severe than a delay or delivery to the wrong address.

The Right price of the delivery is also an important element, because logistics is considered as an important cost maker that affect the final costs of product unit for manufacturer. As logistics costs increase, these costs have to be included in the price of the product to the end user. Higher-than-expected logistics costs can lead to a higher price of the final product and can have a significant impact on the competitiveness of the product itself in the market.

In the beginning of the 20^th century, separate logistics functions were more perceived as auxiliary, but with globalization separate logistics functions integrated with each other.

Ex. 12‑7 7R’s in logistics

Keywords: time, location, quantity, quality, price, customer, product

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