Third Party Logistics: An Analysis of the Feasibility and

Contexts of Strategic Relationships

Madhu Ranjan, Richard Tonui

The Third Party Logistics (3PL) Industry

Third Party Logistics (“3PL”) emerged in the early 1990s when logistics service
providers started offering consolidated services and an increasing number of
customers, for a variety of reasons, entered into longer business contracts with
the logistics service providers. The total logistics market in 2003 in the US was
$910 billion (Delaney, 2003) and the 3PL market was around $65 billion
(Gordon, 2004). The 3PL market has been increasing for the last 10 years at a
rate of more than 20 percent. A survey of 221 companies in the US reported that
78% of US companies are using 3PLs for logistics services and spending 49%
of their logistics expenditure on outsourcing which is likely to grow to 56% by
2006-08(Allen et al, 2003). The growth of the 3PL industry is much faster than
the growth in total logistics expenditure indicating that the market is still in its
formative stage which makes 3PLs an interesting area of study.

Motivations & Methodology

Individual companies no longer compete with other stand-alone companies but
supply chains compete against other supply chains (Christopher, 1997). The
performance of the supply chain depends on the operations of all participants.
The participants could include suppliers, manufacturers, carriers and retailers.
The globalization of corporations has increased complexities and challenges in
the supply chain. The companies are now targeting overall cost reductions in the
complete value chain. That is, they are shifting from local or silo optimization
to global optimization of supply chains. Strong competition, coupled with the
factors stated, is motivating companies to build relationships with stake holders
in the supply chain. Thus 3PLs, as one of the stake holders, are increasingly
playing a vital part in customers’ supply chains. Our study, on relationships
between 3PLs and their customers, aimed to answer the following two
questions:
 1. In which logistics outsourcing contexts are strategic 3PL relationships more
effective?
2. What capabilities and organizational attributes 3PLs should develop in order
to become strategic partners?

The methodology for study consisted of literature review on previous studies on

relationships between 3PLs and their customers. We segmented the
relationships into clearly defined categories- simple, privileged and strategic.
Then to understand the existing relationships and to understand how 3PLs
segment their customers into these categories, professionals in the industry were
interviewed.

Key Findings
Several recurring findings and themes were gathered. The study reveals that
most respondents have a general understanding of the presence of a range of
relationships in their customer portfolios. However, none of the respondents
communicated pre-existing or alternative segmentation models of relationships.
The primary factors and characteristics found in the study that distinguish
strategic relationships are (1) Long Term Contracts (2) Compensation Plan /
Gain sharing (3) Value-Added Services (4) Complexity in Supply Chain (5)
Profit (6) Joint Planning (7) Information Sharing (8) Consultancy (9)
Continuous Improvement (10) Joint Venture.

The spread of relationships across the segments are Simple (0-90%), Privileged
(0-60%), Tactical (0%) and Strategic (2-80%). While we anticipated a range of
results from different participants in the study, the interviews yielded some
surprising results. The most striking was the range in the simple and strategic
segments. As expected, tactical relationships within the definition presented in
the framework were not reported.

The key findings on strategic relationships were:

1. Importance of Value-Added Services
One of the motivations for this research was the reported trend towards
commoditization of 3PL services and efforts by 3PLs to expand the range of
Value-Added Services offered (Lieb et al, 2003). Our research found evidence
to support the view that Value-Added Services provided by 3PLs to customers
aid in moving customers and 3PLs along the path to strategic relationships.
2. Compensation Plan Influences the Nature of Relationships
One of the characteristics of relationships described in a framework we
reviewed is risk, and the allocation of risk. Relationships on the more closely
integrated end of the “coordination spectrum” display a higher level of risk
sharing. Strategic customers had a gain-sharing mechanism in their
compensation plan. An important finding in this area was the potential for
difficulties in relationships when clear performance measures and targets are
absent. Despite concerns about performance measurement, the research showed
that risk and reward sharing is often an identifier or characteristic of strategic
relationships.
3. Complexity of Customer Supply Chains
A recurring concept revealed in the course of the research was that complexity
in the supply chain is a factor influencing the nature of 3PL/customer
relationships. Some of the participants explicitly stated complexity as the reason
for the development of strategic relationships. This complexity was both at
specific points in the supply chain, such as in warehouse processing, as well as
in overall coordination of the supply chain.
4. The need for 3PL Expertise and Continuous Improvement in Operations
One of the reasons firms give for outsourcing is to gain expertise in non-core
areas of their operations. Our research revealed that 3PL expertise was also a
factor that contributed to the establishment of strategic relationships. While
consulting received less emphasis than traits such as gain-sharing, we observed
that some of the distinct characteristics generated by our study are not mutually
independent in practice. An additional finding was that this expertise needed to
be demonstrated through continuous improvements in the operation of the
customers’ supply chain.
Recommendations

I) Contexts for effective strategic relationships

A primary goal of this research was to assess the contexts that are conducive for
the development of strategic relationships. Recommendations regarding the
contexts in which 3PLs should seek to establish strategic relationships are
detailed below.
1. Seek suitable target industries
A factor contributing to the duration and intensity of the interaction between
3PLs and customers was the complexity of the supply chain in the industry.
This insight reveals an effective way in which 3PLs, by first segmenting
industries, can better tailor the level of effort invested in establishing strategic
relationships. Industries with complex logistics requirements are more likely to
desire relationships that can assist in ensuring minimal risk of disruption in the
supply chain.
2. Seek suitable target clients
Within specific industries, customers can also be segmented based on the
complexity of their supply chains. Customers within the same industry may
have a diversity of assets and approaches which affect their logistics needs. An
added dimension to this focus is the presence of competitors within any one
industry. It is necessary for 3PLs to remain aware of the implications; pursuit of
one shipper may require the 3PL to forego the business of the shipper’s
competitors.
3. Establish the right environment through willingness to share risk
As can be discerned from the experience of some 3PLs, compensation plans
have a bearing on the nature of relationships that develop between 3PLs and
Customers. Depending on the nature of contracts, it is possible for adversarial or
otherwise difficult relationships to arise. Some 3PLs have instituted gain-
sharing as part of their compensation plans, facilitating an alignment of interests
of both the provider and the user.
II) Capabilities

In addition to selecting environments which facilitate strategic relationships,

3PLs can also enhance their suitability for strategic relationships. We analyzed
our research findings to identify some attributes and capabilities that 3PLs
should cultivate. These capabilities and attributes are enumerated below.
1. Develop a range of Value-Added Services
Value-Added Services are the functions performed by the 3PLs beyond
traditional basic services such as transportation, warehousing and freight
forwarding. Value-Added Services serve as a differentiating factor for 3PLs.
Expanding the range of services offered also increases customers’ dependence
on 3PLs by allowing 3PLs to penetrate deeper into customer’s supply chains. A
related consequence is the raising of entry barriers for the competitors.
2. Develop expertise in areas of operation
As described in our research findings, customers look upon the 3PLs as experts
in the field and this constitutes one of the important reasons for logistics
outsourcing. During our interview some of the industry professionals described
this as a basic requirement for a strategic relationship.
3. Develop alliances to provide a broad and deep set of services
Customer requirements in complex supply chains often require expertise that
extends beyond the capabilities of any one supply chain vendor or service
provider. Forming alliances with businesses that have complimentary
capabilities can help provide the appropriate combination of expertise and value
added service that is needed by the customers.

As can be determined from recommendations, the 3PL operating environment

consists of forces that are outside the control of 3PLs as well as factors that
3PLs can influence when seeking to establish strategic relationships. Our
research highlights these factors and suggests ways in which 3PLs can address
them in their relationships.
References:
Allen, Gary R., Langley Jr, John C. , Dale, Thomas A., Dort, Erik van and
Caporale Donato “Third Party Logistics – Results and Findings of the 2003
Eighth Annual Study”, 2003.

Delaney, Robert V(2003),“14th Annual “State of Logistics Report”,

www.clmnert.org/Presentation%20Library/Excerpts%20from%2014th%20State%
20of%20Logistics%202003.ppt, (15 April, 2004).

Gordon, Benjamin. “Riding the Third Wave” Traffic World: Jan 19, 2004.

Lieb, Robert and Bentz, Brook A, “The Year 2003 Survey: CEO Perspectives On
The Current Status And Future Prospects of The Third Party Logistics Industry In
The United States”, 2003.

Christopher, Martin. (1997) “Marketing Logistics” Butterworth-Heinemann,

Oxford, UK.