Make Sure Third Parties Are Financially Sound

By Clifford F. Lynch

Logistics Management, May 2002

Given the slowdown in the U.S. economy and the recent bankruptcies of several large providers, some companies that are considering outsourcing are becoming concerned about the health of third-party logistics service providers (3PLs).  Although its woes have not been as widely publicized as those of some other industries, the third-party logistics industry has had its share of financial difficulties.  Companies are finding out - sometimes the hard way - that some providers simply do not have adequate financial resources.

In 2000, for example, Burnham, a major logistics service provider owned by a large venture capital firm, filed for bankruptcy.  The provider had touted its ownership by the venture capital firm as irrefutable evidence of its financial stability.  Yet we all know that such firms don't enhance their returns by continuing to back a losing horse.  The provider in question went from an acquisition mode directly into Chapter 7, giving several large clients a serious case of heartburn.

Another example is the recent bankruptcy of Computrex, a large freight bill audit and payment firm, which left its clients liable for as much as $25 million in unpaid freight bills.  Shippers had already paid many of those bills, but they may have to pay them again because freight payment companies are agents of the shipper and the payment obligation is not met until the carriers receive the funds.

Despite these conspicuous exceptions, I believe that the industry is for the most part financially stable.  Such isolated failures should not taint the industry any more than the problems of Kmart should spell doom for all retailers.  Most logistics service providers are fiscally sound, well-managed businesses.

On the other hand, these occurrences do demonstrate the importance of conducting thorough financial due diligence when selecting a third-party provider.  This can be a relatively straightforward matter if you need to investigate a provider that is publicly held.  Readily available financial statements will reveal any cause for concern.  Some providers, moreover, will furnish serious prospects with audited financial statements before they sign the final agreement and every year thereafter.

Most third-party providers, though, are privately held and there is reluctance, if not absolute refusal, on the part of many owners to reveal detailed financial information.  They might, for example, provide banking information, which sometimes can be helpful but is not always an absolute indicator of financial health.

Their reluctance is understandable, but because of the startup cost of an outsourcing agreement and the value of the products involved being quite high, it is critical that the potential client be able to satisfy itself regarding the provider's financial stability before a contract is signed.  If a provider is financially healthy, responsible and capable of handling the business, it will find a satisfactory method of demonstrating this to its clients.

There are a couple other precautionary steps companies can take.  In addition to conducting due diligence, some users of third-party services require their providers to maintain minimum levels of financial assets.  Others award contracts only if the total value of the contract falls below a certain percentage of the provider's total revenue.

Whatever the case, thorough financial due diligence must be at the top of a company's list when qualifying potential providers.  Today's supply chain initiatives are complex and expensive and should be considered with the same care as any other large financial transaction.