STRATEGY FOR HIRING LOGISTICS SERVICE PROVIDERS

This article will discuss the main decisions related to the definition of a strategy for contracting logistics service providers (LSP). As we will see, there are choices that a company must make even before starting the selection and hiring process that will determine everything from the effort devoted to selecting the PSL to even the form of remuneration to be used.

In this context, we are defining PSL, based on the concept developed by ABML, as being “the provider of logistics services, specialized in managing and executing all or part of the logistics activities in the various stages of the supply chain of its customers (…) and that has competence to, at least, simultaneously provide services in the three basic activities of inventory control, warehousing and transport management. The other services, which may be offered, work as differentials for each operator.”. We are also considering that LSPs can undertake operations with a very restricted scope, limited, for example, to just one type of service.

The strategic decisions we will deal with refer, therefore, both to hiring specialized service providers and to integrated service providers. Some of the strategic decisions even lead to the definition of which type of service provider to hire. In addition, some of the “discussions” presented here can also be applied in defining the strategy for contracting carriers, if we consider them to be service providers specialized in transport.

The choices we are referring to can be classified into 2 groups:

• Decisions related to the scope of the process to be outsourced and the type of service providers • Decisions related to the size of the base of service providers that will be hired.

As we will see, these choices must be made considering, mainly, the following main aspects:

• The company's internal capabilities in relation to the logistical processes to be outsourced; • The level of risk (exposure) and dependence on the service provider; • The characteristics of the market offer of logistics service providers, that is, the capabilities available on the market.

Our main objective here is to help organize part of the decision-making process typical of outsourcing logistics activities, identifying the factors that favor one way or another.

Typical Process for Outsourcing Logistic Activities

Figure 1 - Typical Logistics Outsourcing Process

The need for a structured process for selecting and contracting logistics service providers is motivated by the complexity, relevance and increasing scope of activities being outsourced. It is therefore necessary to adopt more sophisticated procedures for identifying and selecting service providers in order to minimize the chances of failure and its negative impacts on the entire operation. These procedures are ideally organized according to the diagram illustrated in figure 1 above.

The object of our discussion, the definition of the outsourcing strategy, is positioned as one of the initial stages of a typical outsourcing process. Based on the decision to outsource logistical activities, the starting point of the entire process, guidelines should be defined regarding the scope of activities to be outsourced, the type and number of service providers that may be contracted.

These definitions are of fundamental importance and will guide the entire subsequent process. For example, they will determine the selection criteria based on which potential service providers will be evaluated, such as size, areas of expertise, experience and necessary skills, among other criteria. Finally, they will determine where to direct the “focus” of the search for suitable service providers.

The outsourcing strategy will also determine the effort required in conducting the entire process. It can lead to a shorter process based on price quotes for a set of specific activities. Or it could lead to a long process, where profound changes in the logistics system are discussed together with potential service providers. As an example, one can cite those outsourcing processes that involve the redesign of the logistics network and even the redefinition of the information systems to be used between the service provider and the shipper.

References on the organization of the subsequent phases of the typical outsourcing process can be found in Nazário (2001), Ribeiro (2002), Gould (2003) and Lynch (1998).

Defining the Scope of Outsourcing Agreements and the Type of PSL

The entire discussion on outsourcing strategy definitions is subordinated to outsourcing drivers. These motivators can be cost reduction, improvement in the level of customer service, greater focus on core business, increased flexibility, reduction of assets, among others. The strategic definitions refer to formatting the path by which these objectives should be achieved. And one of the main definitions refers to the scope of outsourcing contracts.

One way to measure scope coverage is to measure the number of logistics activities under the same service provision contract. Companies that adopt more comprehensive contracts are seeking to give more visibility and more freedom so that the service provider can propose innovative solutions, seek internal and external operational synergies, etc.

Behind this strategic decision is the expectation that there are advantages to adopting a single-coordinated operation for as much of the logistical process as possible. This expectation is in line with the widely disseminated concepts of integrated logistics, where the aim is to reduce the total cost of the operation and not the specific costs of a given activity.

For example, a service provider that is responsible for the storage and dispatch operation and also for the transport operation can choose to have an extra vehicle loading capacity, because this can reduce loading and unloading times and increase the turnover of the vehicle. fleet. This configuration can lead to higher storage and shipping costs, but on the other hand, it could reduce transport costs to a greater extent, leading to a reduction in the total cost.

It is also true that expectations of cost reduction and service level improvement are higher when more comprehensive outsourcing contracts are applied to more complex logistics systems. These systems are characterized by a large number of products, a large number of supply and demand points, high levels of customer demand and low predictability of demand. Because it is in these cases that greater visibility over the entire process, intensive use of information and capacity for planning and optimization are fundamental to the service provider. In less complex systems, on the contrary, the most important attribute on the part of the service provider is specialization, where the advantage lies in efficiently performing specific activities.

Figure 2 below illustrates the relationship between the scope of outsourcing and the profile of the most suitable service providers. As the breadth or scope of outsourcing increases, the adequate profile for a LSP shifts from a traditional service provider, specialist in a given functional activity, to an operator with great integration capacity. This logistics service provider is strongly based on information, as opposed to the traditional service provider, which is heavily based on assets, since its capabilities are related to the coordination, monitoring and control of the operation.

On the other hand, this movement tends to occur in relatively complex logistic systems, which require these competences. In logistical systems that are not very complex, on the contrary, what is sought is operational excellence, whether in transport or storage, which is compatible with the profile of a traditional service provider. In this case, the role of coordination tends to be the responsibility of the shipper himself, without the need for an “integrator”.

Figure 2 - Relation between breadth of outsourcing scope and LSP profile

Up to this point, we have spoken generically about outsourcing contracts with greater or lesser scope and we have seen that there are situations with potential advantages with the adoption of broader contracts.

But even in these cases, some activities are still commonly kept outside the PSL's scope of action. Table 1 below shows the activities that are commonly carried out by LSPs, whether they are part of the same contract or not. Activities that are commonly NOT performed by PSL are also shown.

Defining the size of the service provider base

The size of the service provider base is influenced by several factors, some acting to expand it and others acting in the opposite direction. Each of these factors is discussed below;

Factors that favor the expansion of the provider base

• Expanded supplier bases tend to lead to a biggest competitionbetween service providers. This competition can occur even among a relatively small base of PSL's and its effects are not only manifested in more competitive prices. It also creates the possibility of comparing the performance between the LSPs and even exchanging best practices.
• Advantages of using PSL with high expertizefunctional make the company hire several service providers, dedicated to specific functions within the logistics process.
• Advantages of using PSL with expertizeregional lead to the hiring of PSL dedicated to regions of the country. These advantages are generally associated with the existence of a pre-existing customer base, which generates scale and efficiency in the transport or storage operations of a given LSP. The advantages may also be due to the need for in-depth knowledge of regional specificities.
• When the availability riskof the PSL is high and the consequences very serious, broadening the base brings security. Therefore, measures such as limiting the billing volume of each PSL to a certain percentage of its total billing are common.
• intense seasonalityor the concentration of production or demand in certain short periods of time leads to the need to divide the volume handled between different LSPs. The concentration of the supplier base, in this case, could lead to very large idleness in “valley” periods and consequently high operating costs.

Factors that favor the reduction of the Service Provider base

• A reduced supplier base enables a closer relationship, cooperative and stable. As a result, there is an environment conducive to the search for continuous improvements and the necessary confidence to make longer-term investments.
• Scale gainsare expected when greater volumes are concentrated in a smaller number of PSL. As a consequence, there are, for example, larger distribution centers or vehicles running with less idleness.
• Shippers also have  greater bargaining powerwhen they dedicate a considerable volume to a small number of PSL.

Figure 4 below schematically illustrates these last two factors. The change from 1 to 2 , as shown in the figure, represents a cost reduction due to a gain in scale. This may have been the result, for example, of a greater dilution of fixed costs of a storage operation that starts handling a larger volume. The movement from 2 to 3 represents a change in the parameters of the curve, resulting, for example, from a reduction in the service provider's margin in exchange for a higher total billing.

Figure 3 - Scale Curves

The definition of the number of logistics service providers to be hired is highly dependent on the strategy of adopting more or less broad scope contracts. Because the larger the contracted scope, the smaller the number of service providers in the supplier base will tend to be.

Conclusion

Throughout the text, we seek to identify the elements that favor one or another strategy related to the scope of the service provision contract, the choice of service provider profile and the definition of the size of the supplier base.

We discussed the motivations for adopting broader service provision contracts and the most suitable profile for the service provider. We also saw that opposing strategies, of reducing the scope of the contract and seeking greater specialization on the part of the service provider, can also be successful when applied in logistics systems with a relatively low level of complexity.

It should be noted that the definition of the hiring strategy is just one of the initial stages of the outsourcing process, but it guides the entire subsequent process through the definition of the criteria to be followed. Only with the continuation of this process, with the selection and negotiation steps forwarded, will it be possible to assess with a greater degree of certainty whether the predefined path can be implemented. This is because it is at this point that the market restrictions of service providers will be known and whether the desired capabilities are available.

We also discuss the factors that influence the size of the supply base thus covering some of the key aspects of formulating a contraction strategy.
Suggested Bibliography

GOULD, Stephen, How to source logistics services strategically, September/October, Supply Chain Management Review, 2003

NAZÁRIO, Paulo, ABRAHÃO, Fabio, Structured Outsourcing: The Use of RFI – Request For Information – As a Logistics Operator Selection Tool, Tecnologística Magazine, 2002

RIBEIRO, Aline, Relationship Management with Logistics Service Providers, Tecnologística Magazine, 2002

LACERDA, Leonardo, RIBEIRO , Aline, Forms of compensation for Logistic Service Providers – from price tables to profit sharing, Revista Tecnologística, 2002

RAZZAQUE, Mohammed Abdur, SHENG, Chang Chen, Logistics Outsourcing – Literature Review, International Journal of Physical Distribution & Logistics Management, Volume 28, No. 2, 1998 pp. 89-107

LIEB, Robert C., RANDALL, Hugh L. A Comparison of the User of Third-Party Logistics Services by Large American Manufactures, 1991, 1994 and 1995. Journal of Business Logistics, vol.17, n.1, p.55- 62. 1996.