Price vs. Value:  The Outsourcing Conundrum

By Clifford F. Lynch

Logistics Management, February 2002

There are almost as many reasons for outsourcing as there are firms who do it, but in a broad sense, most companies outsource for the same basic reasons.

To many of these, operating costs will be the most important consideration.  Surveys conducted on the reasons for outsourcing almost always find cost/price to be in the top three determinants.  A 2001 survey by J. P. Morgan Securities found that price was among the leading factors in choosing a logistics service provider.

The Cap Gemini/Ernst & Young 2001 Third Party Logistics Study reported that 63% of the firms that do not outsource refrain from doing so because their costs will not be reduced.

This attitude has been encouraged by the providers themselves who advertise, sometimes inaccurately, that “we can do it cheaper”.

There is general acceptance of the fact that outsourcing allows the user firm to improve its return on assets.  By reducing the significant investments in technology, warehouse facilities, and expensive equipment, returns can be enhanced significantly.  The capital can be invested in those ventures that are part of the core competencies or basic businesses of the user firms.

Even so, many potential outsourcers will expect, in addition to capital savings, reductions in operating costs, as well.  Obviously, this is important and is often the case; but the sophisticated firm sometimes will find this not to be true.  If a company has an efficient, well-managed distribution system, outsourcing that system may not reduce operating costs.  Subcontracting, however, may add to the value of the system.  While the absolute dollars spent may be more, the value received can more than offset the premium.

There are several examples of value that can be added to an already efficient, cost-effective logistics network.  “Just In Time” techniques have been utilized in the automotive industry for a number of years, and many of the associated functions have been performed by outside providers.  One such firm dispatches trucks to its clients’ parts suppliers where the parts are collected and delivered to a cross dock.  From here shipments are consolidated and shipped to twelve different assembly plants in North America.  The parts are never warehoused or inventoried at the plants.

In the grocery industry, Collaborative Planning, Forecasting and Replenishment, or CPFR, links customer demand with replenishment scheduling.  This joint planning, if successful, can lead to a smooth flow of products through the entire length of the pipeline.

Designed to reduce inventories in the system, these techniques result in smaller, more frequent shipments.  Rather than handle these from their own facilities, grocery manufacturers have turned to the contract logistics companies.  With a multiple client base and sophisticated systems, the providers are able to combine these smaller shipments into truckloads, reducing freight and handling costs, as well as enhancing the entire process.

Perhaps the most important value that has been added to the outsourcing offerings in recent years is that of information technology.  For many firms the increasing demands for new information systems, resources, and real-time visibility to products and orders often can be met more efficiently through outsourcing.

Today there are firms that can assist in identifying logistics problems and provide integrated, end-to-end supply chain technology solutions.  In many cases, some costs can be reduced, but most important, the outsourcing firm is able to obtain a technology capability that would be impossible to implement internally.

Obviously in outsourcing some value is added through cost reductions, but the knowledgeable logistics manager will look beyond this to the total gains in customer service, information, and state-of-the-art techniques.

A Mercedes costs more than a Ford, but that does not necessarily make it a bad investment.

Clifford F. Lynch is principal of C. F. Lynch & Associates, a provider of logistics management advisory services, and author of Logistics Outsourcing – A Management Guide.  He can be found at www.cflynch.com.