CSCMP's Supply Chain Quarterly
Third-Party Logistics
October 24, 2018
Third-Party Logistics

A look beneath the surface

Despite a strengthening economy, signs of instability are beginning to appear in the third-party logistics industry. It's a good time for both 3PLs and their customers to reevaluate their relationships and their contracts.

The third-party logistics (3PL) marketplace is a lot like an ocean: what you see on the surface is not necessarily indicative of all that's happening below. For instance, by many indications the 3PL industry has never been stronger—the economy has started to bounce back, the United States has become a place to build (and, therefore, ship) things again, the Internet is opening up whole new ways of selling and shipping, and in the oil fields, the advent of hydraulic fracturing, or "fracking," offers the promise of lower-cost energy down the road.

But beneath the surface of that positive outlook lie some potentially disturbing undercurrents that could affect both 3PLs and their customers in the future. One of the places we look for such signs of trouble is our proprietary AlixPartners Early Warning Model, which tracks the financial health of companies across many sectors, including third-party logistics. Over the years, this model has proved to be a highly accurate predictor of corporate distress (insolvency, bankruptcy, and so forth).

Article Figures
[Figure 1] AlixPartners early warning model - U.S. 3PL companies
[Figure 1] AlixPartners early warning model - U.S. 3PL companies Enlarge this image

As seen in Figure 1, our model shows that the probability of distress for the logistics service provider side of the industry (taken as a group) is less than 10 percent. That may seem low ... until you consider that the rate has almost quadrupled in the past year and a half, and has risen by about 30 percent since the beginning of this year alone. For 3PL customers, that's what we'd call a warning sign.

Here are some other warning signs derived from our (highly quantitative) model:

  • Nearly half of all third-party logistics providers in the U.S. market have seen their revenues decline in the past five years, by a total of US $43 billion.
  • Over the last five years, the combined revenues generated by the top 25 third-party logistics providers in the U.S. market have declined by more than $50 billion. This suggests that shippers have been "insourcing" a lot of services they previously had farmed out to 3PLs.
  • Twenty percent of the third-party providers are new entrants in the U.S. market within the last five years or so, and they account for 24 percent of the industry's total revenue. This suggests that established players are being attacked from two directions—shippers are switching to competitors as well as engaging in more insourcing.

A good time to reevaluate
Do those storm signals mean 3PL customers can look forward to a buyer's market, and perhaps lower prices?

Not necessarily. One reason is that a weakened supply base (in any industry, including logistics) can weaken the main customer as well. Weak 3PLs, for instance, could cause their shipper clients to provide skimpy service and unreliable shipping to their own customers. That, in turn, could cause the clients to lose business, and even contribute to the ultimate nightmare: a shipper "disappears" overnight due to financial problems, leaving the customers that depended on its products in the lurch.

Despite that risk, the increased competition we are seeing in the marketplace today suggests that buyers of third-party logistics services should be able to negotiate more favorable agreements in line with market conditions. In fact, now is a smart time for 3PL users to review all of their logistics activities, including whether or not their insourcing and outsourcing decisions are still the right ones given current conditions and future plans. One important area to consider is the service-level agreement (SLA), including whether its terms still make sense or should be renegotiated when it expires.

Providers of logistics services, meanwhile, should reexamine what they offer, and at what price. It will not pay for them to wait for customers to propose renegotiating their SLAs. If they do, they may find out too late that their customers have switched to another provider that has taken a more aggressive posture toward partnering.

Trends for the future
What's on the horizon for 3PL customers and providers? A wide range of service offerings will become more important in the near future. A few examples include:

  • Dynamic routing optimization, which takes advantage of customized software and management of direct-store-delivery (DSD) routing on a daily, dynamic basis. These capabilities are especially attractive to sectors like the food and restaurant business, where perishability is a big factor. In the future, though, almost all industries will need more dynamic delivery to meet the needs of an ever-faster-moving world.
  • Energy- and space-efficient use of warehouses, zoning them by type of product and handling characteristics (such as frozen and chilled foods) for optimum efficiency. This will be especially critical for 3PLs that are directly or indirectly responsible for the facilities' utility costs.
  • Site selection and geographic network design, where users and providers alike look at better placement of facilities along with better customer-to-facility alignment. This will help to drive significant cost reductions and improve delivery performance to end customers.

All these innovations make it increasingly difficult to determine "what lies beneath" the current state of the third-party logistics industry in terms of costs and services, especially since many of the services have been unbundled, insourced, or parceled out over various external and internal providers. However, the good news is that in the ever-evolving 3PL marketplace, tools (such as business intelligence and applied analytics) are available to help companies make responsible and competitively advantageous decisions. To be effective, however, those tools must be coupled with the right kind of experience and insight.

It's tempting to think that relatively "calm seas" today portend the same thing for tomorrow. But for both 3PL providers and their customers, the best way to make sure they remain successful in the future is to take proactive measures today.

P. Foster Finley is a managing director at the global business advisory firm AlixPartners LLP. Dr. Michael Albritton is a director at the global business advisory firm AlixPartners LLP.

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