Outsourcing is a mature practice in the supply chain world. To some degree, most companies outsource for manufacturing, procurement, logistics or information technology, or at least they have tried. Some companies outsource a great deal of these activities, while others-sometimes in the same industry-outsource very little. So why the differences in approach?

"Outsourcing can be a powerful, transformational strategy that continuously lowers cost and improves operations," says Robin Shahani, who heads the supply chain practice for Equaterra, a Houston, Tex.-based consulting firm specializing in business process improvement and outsourcing governance. Equaterra clients include such consumer products companies as Adidas, Best Buy, Procter & Gamble and Unilever. To gain these long-term benefits, however, companies have to make long-term commitments and invest in a strategic process.

"Not too many companies have top managements that are willing to devote the time, resources and money to make outsourcing a transformational process," says Shahani, "so it is not surprising that outsourcing is not enthusiastically embraced by these firms."

In too many cases, companies look to outsourcing as a quick way to reduce operational costs. They are simply taking a piece of their supply chain and finding a provider that will do it cheaper.

"When companies think about this approach, they are often thinking about offshore labor arbitrage," says Shahani. "It is not a long-term winning strategy because it produces only one-time benefits. A smart CFO would much prefer to reduce operating cost over the long run, not just once on the budget."

He says companies take this narrow view for a variety of reasons, and some are more justifiable than others. If may be that the supply chain is very fragmented, so there is no clean way to recognize cost savings across functions and processes. One-time improvement opportunities may seem to be the limit. Another common reason for cost-driven outsourcing is that a company may simply have had very poor results performing certain activities in-house. They outsource a function just to get it out of their hands. The most common and least defensible reason, however, is that companies view too many of their activities as core functions within their supply chain. They are convinced that their supply chain is so unique that only their own people can properly perform all of the activities.

"In every instance we have seen, this perception has been wrong," says Shahani. "Whether it is logistics, procurement, manufacturing or some other activity, all supply chains include components that can and should be outsourced. Companies that refuse to consider this approach are very short-sighted. They do not grasp that supply chains should be transformed and optimized over time."

More enlightened companies take a different approach to outsourcing. They are willing to make a long-term commitment to outsourcing in order to gain additional capabilities and continuous improvement. They understand that to accomplish long-term optimization they have to make investments and take a longer-term view than one-time labor arbitrage.

"This transformation approach requires thinking through processes strategically," he says.

Companies must analyze how each process works in the supply chain, and how they can be automated or replaced with a better methodology. They have to investigate what technologies are available, which sourcing options exist, and so on. It takes a bold management team willing to question tried-and-true industry processes.

For example, in the grocery industry one of the most basic functions is replenishment of product from the supplier all the way to the store shelves, so product is always in stock and customer service at the highest levels. Because this function is so critical, it is not something grocery chains are willing to outsource across all lines and products.

Equaterra has been working with a supermarket chain that wants to outsource the entire replenishment function to achieve cost improvement and customer service performance superior to industry standard.

"Think about the complexity of outsourcing complete replenishment," says Shahani. "The grocery chain is willing to trust a logistics provider to manage the most important function in the grocery business, and they were willing to invest in the technology and automation to make it happen. This deal is on hold right now for reasons unrelated to the basic plan, but we'll see if it comes back."

Equaterra's most extensive work in long-term improvement process has been in the consumer packaged goods industry. It has worked with Unilever to help it outsource more of its non-production procurement on a global basis. For example, Unilever has long operated in places like Africa where it has not been possible to have single suppliers serve all the factories in all countries on the continent. Unlike North America or Europe, suppliers there have always been country or regionally focused, so internal procurement operations has been equally local. Equaterra helped Unilever change the paradigm by working with a few suppliers to drive their coverage across large parts of Africa, which has allowed more procurement outsourcing.

Unilever had to show its suppliers how to expand geographically and functionally. The CPG company had to implement new processes and technologies as well as develop a new service delivery model.  Initially, Unilever had to pay more for its procurement function, but the long-term benefits have greatly offset these costs. The initial financial hit included the cost to get the service provider up and running, recruiting a team, severance for displaced workers, investment in technology and licenses, integration with existing systems and double running cost for maintaining the existing function while the new one is transitioned in.

"For any company expanding its outsourcing, there is always an investment in governance because managing a third-party requires a different skill set than performing the function internally," he says. We see an investment of three to five percent of the total deal value going to finding, hiring and training the right people to manage the outsourced relationships."

While Equaterra has worked with many CPG companies, it now sees similar transformation opportunities in the pharmaceutical industry, which is facing fundamental changes in its business model. Given the huge gross margins that the pharma industry has enjoyed, managing supply chain costs has not been a high priority. The priorities are changing.

"Many pharma companies are experiencing significant revenue fall-off from expiring patents, so they now have to manage their cost base much more closely than they ever had to in the past," says Shahani. "Outsourcing is a powerful way to accomplish these cost savings."

Integrating Outsourcing

For some forward-thinking companies, outsourcing has been an integrated strategy from the very beginning. Take Phoenix Brands, for example. This Stamford, Conn.-based consumer products company was formed four years ago by purchasing established brands from Unilever and Colgate-Palmolive, such as RIT Dye, Fab, Dynamo, Ajax laundry detergent and several others. In its short history, the company's annual sales have grown to $350m. Just in the last two years, its sales have doubled.

Its outsourcing strategy is one reason Phoenix was able to create a business that scaled from zero to the big leagues overnight. From its beginning, Phoenix has focused all of its energy on marketing and sales. Just about everything else, including most manufacturing and logistics, is outsourced.

Because logistics is so important to providing competitive service levels, one of Phoenix's first decisions was to select a top 3PL that had broad distribution capabilities and expertise in transportation and information systems. It selected Menlo Worldwide Logistics.

Menlo set up the initial network of distribution centers, signed agreements with carriers, and established operations and processes to manage Phoenix Brands' transportation and demand planning strategies. It even helped the company with its IT systems.

According to Lori Sullivan, director of customer operations for Phoenix Brands, the company now has four Menlo locations in the U.S. and two in Canada.  Menlo also handles inbound and outbound transportation management for these facilities. Half of Menlo's network for Phoenix is made up of dedicated facilities. The other half is multi-client warehouses, which not only allow the business to grow incrementally, but are also ideally suited to handling promotional sales surges.

"Two of the laundry detergent businesses we purchased from Colgate-Palmolive are highly promotional, so we need flexibility in storage and distribution capability," says Sullivan. Laundry detergent is a bulky product, so when Phoenix does promotions its logistics requirements balloon, but only for a short time.

When Phoenix is planning a promotion, it shares its product forecast with Menlo, so both parties know when, where and how much additional space and transportation resources will be needed. For example, normal daily shipping volume for a laundry detergent brand may be 20 to 25 truckloads, but during a three- to five-day promotion, it will ship an additional 300 loads.

"Menlo's multi-client distribution centers allow us to have additional warehouse space just when we need it to support these promotions," says Sullivan. "Our outsourcing strategy, especially with Menlo's multi-client facilities, has worked for us to keep our costs in line as well as keep our customer service where we need it."

Flexible Outsourcing

Other companies have successfully embraced outsourcing as a strategic answer to business challenges in their industry. Lam Research, for example, is a Fremont, Calif.-based semiconductor equipment manufacturer that struggled with side effects of the chip industry's cyclic nature until it adopted a serious outsourcing strategy in 2002.

"Our CEO had an epiphany," says Ballan Campeau, managing director, global logistics for Lam Research. "When times are good in the semiconductor capital equipment business, they are very good, and when they are bad, they are awful. Our CEO looked at the highly cyclical nature of our industry and realized that we needed a different way to handle non-core functions."

Because its business cycle is so volatile, a key element of Lam's outsourcing strategies was to find large outsourcing partners that could stand the wild gyrations in volumes endemic to the business.

"We cannot deal with a constant churning of suppliers and providers," says Campeau. "Turnover involves a lot of start-up cost and wasted time."

Also, Lam decided that it did not want to expend resources in areas that were not its core competency, which is helping its customers create better semiconductors. Lam Research equipment etches and cleans wafers for the world's major semiconductor manufacturers. It sells multimillion-dollar machines and aftermarket parts throughout the industrialized world. It uses Menlo Worldwide Logistics to handle its warehousing and related supply chain functions.

Menlo manages Lam Research's local and global warehousing functions at a shared facility in Fremont, in close proximity to Lam's manufacturing plant.  The warehouse supports Lam's production and assembly operations and its spare parts as well.

Menlo's Fremont distribution center allows Lam to utilize just the amount of space its needs, which can vary depending on its business cycle. The flexible space capability also allows Lam to make its logistics cost more variable based on the number of transactions that actually move through the facility. The benefit of a multi-client facility has been twofold. "We have the benefit of the space reallocation variability and the human resource reallocation," says Campeau. "This has been a big win for us."

Orders for new products and aftermarket parts worldwide are fulfilled from the Fremont location. Lam has no warehousing of its own, but to meet very stringent service level agreements with customers, it maintains spare parts inventories in 45 locations around the world. About half of these forward stocking locations are in customers' fabrication facilities. The other half are with various providers close to customer locations.

"A machine that is down is very costly to customers, so these forward locations allow us to have parts available to customers anywhere in the world within four hours," says Campeau. "Service level agreements are a key aspect of our business."

Menlo helps Lam meet its tight SLA standard by expediting parts for emergency fulfillment anywhere in the world. For each level of emergency for each customer location, Menlo follows a routing guide it has established with Lam. In Europe, Menlo also provides an emergency depot and cross-dock operation in Amsterdam.

A major part of Menlo's responsibility is shipping outbound orders worldwide. Assembling, packing and shipping a complete new system for a customer is no small task. Because of their high value and delicacy, Lam's products move by air.  A complete shipment can weigh 10 tons and consist of 35 crates so large they have to go on the upper deck of a 747. Many of the pieces require processing in a clean room before packaging and shipping. Before the logistics was outsourced to Menlo, the shipments were assembled in the warehouse and then shipped to Lam's manufacturing facility for processing and packaging in its clean room. When Menlo took over, it worked with Lam to set up a clean room in the warehouse, so all pre-shipment processes could be handled in one location.

Campeau notes that Lam's six years of intense outsourcing has taught it what makes sense and what does not. Logistics is at the top of the list.

"I am a programmer, and here I am managing logistics," says Campeau. "Logistics and warehousing worldwide is not something we are ever going to be good at."

However, Lam closely monitors its inventory and shipment visibility in-house with its SAP system, which it uses to connect to customers and other providers even at the smallest depots.

"We have enhanced the inventory management capability of the SAP system, so everyone in our supply chain can see just what they need."

Getting Started

For most companies, however, outsourcing has been a short-term answer to a tactical problem, not a strategy integrated into the fabric of the business. How can that change?

A company cannot simply jump headlong into a widespread outsourcing campaign, according to Bill Schneiderman, founder of The Results Group (TRG), a consulting firm based in Mountain View, Calif., that specializes in outsourcing and business process improvement.

"Outsourcing is best adopted as a gradual progression that builds on success after success," says Schneiderman. In the case of logistics, outsourcing progresses from lower value activities such as storage warehousing to higher value activities such as order configuration and fulfillment.

Mike Sulaver, a principal in TRG, explains that his firm has helped a semiconductor client gradually increase its logistics outsourcing. It first outsourced its North American warehousing, and then it outsourced its transportation management. More recently, it has opened up its European operations to outsourcing. It then outsourced its manufacturing warehouse to that same 3PL, having it co-locate the distribution warehouse near the manufacturing facility.

"That semiconductor company is growing rapidly, so they no longer have the time or resources to handle tasks that are not core to the company growth," says Sulaver.

No company transitions immediately from no outsourcing to massive outsourcing, but there are drivers that speed the progression. The most powerful driver is business urgency caused by expansive market growth.

"We have a client that needed to expand its operations to Europe and do it in a hurry," says Schneiderman. "The only way this growth could be accommodated was to outsource all the logistics to a 3PL."

According to Sulaver, cost was not really an issue in this situation, but in an increasing number of instances, cost pressure is a major accelerator for rapid outsourcing.

"As logistics becomes more capital intensive and more dependent on big investment, it often makes sense to outsource activities that leverage the capital investments that 3PLs have already made," says Sulaver. He points out that competitive logistics operations today require sophisticated software, state of the art facilities and materials handling systems, as well as expertise in international trade and regulatory compliance.

"When a company is faced with a large expenditure to fund these projects, that is the trigger to look at what the big logistics providers can offer."

The decision to outsource is easier if it involves a common service that many companies use, so there is little advantage in looking for a competitive advantage or special handling. For example, every importer uses container consolidation, cross-docking, intermodal shipping and breakbulk services, but this concept extends to higher-value services.

"Electronics manufacturing and supply have been so heavily outsourced throughout the globe because processes and materials are standardized across every link in the supply chain," says Sulaver. "Where ever there is a common denominator, there is an opportunity to outsource with little pain."

Schneiderman and Sulaver caution that there are constraints on what companies can or should outsource. At the top of the list are processes that form a company's value proposition, whether they involve manufacturing, procurement, logistics or aftermarket support.

"A company has to control what makes its business unique," says Schneiderman. However, narrowing down exactly how that activity differentiates a company is often hard to determine. One measure is to consider if an outside provider can, or will, perform the activity.

"If a provider can't make money investing in making you unique and keeping you that way, that's an indication that it was meant to be kept in-house."

A related constraint on outsourcing is where there is a high rate of change in the product, the suppliers or customer requirements.

"A third-party needs process stability to do a good job for the customer and to make money for itself," says Sulaver. "Volumes can go up and down, but the processes and requirements cannot."

For example, Schneiderman points to a client whose products and orders require a great deal of special configuration. This client has the knowledge to handle its configuration needs, but it has not been able to transfer this capability to a 3PL on a global basis. There is just too much tribal knowledge to transfer.

If there are too many rules that are not codified, a provider may not be able to pick and pack for a customer. If kitting decisions are too complex and require too many if-then decisions, the job shouldn't be outsourced.

Reverse Logistics

While outsourcing is usually adopted to improve manufacturing, sourcing, distribution, sales or some forward-looking aspect of a company's business, Schneiderman advises companies not to overlook reverse logistics. He sees a huge opportunity for outsourcing reverse logistics that has only begun to be exploited.

Just as forward logistics gradually progressed from storage to transportation to value-added services and information processes, Schneiderman sees a similar pattern with reverse logistics. In its early stages, reverse logistics has largely been about storage and movement, but 3PLs and other outsourcing firms are just beginning to provide more value-added services in this area.

Given the globalization of many supply chains, the time is especially ripe for outsourcing reverse logistics. Many companies have manufacturing, either owned or outsourced, around the world, but few have the ability to handle reverse logistics for repair, redistribution or disposal. If a product with significant value needs to be returned, replaced or repair, it usually has to be shipped long distances to a central location. It may have to be shipped again for resale. An outsourced provider can do an initial screen of returned product in order to avoid unnecessary transportation of product to a refurbishing point, perhaps a continent away.

A provider with the right IT capabilities can capture information on returned products to help in that process. For example, one global client of TRG says 40 percent of its returns that appear to be perfectly good product are  resold locally without returning them all the way back to the repair center. For whatever reason, the product did not meet the customers' needs.

Sometimes, the same product comes back multiple times, but the company does not have the information to recognize that there really is a problem with the item.

"A provider can scan the product's serial number to see if it has ever come back before as a 'no trouble found' return," says Schneiderman. "A good information system will flag that product and direct it into the reverse logistics process for repair or disposal. Otherwise, it can be resold. The provider's data handling becomes part of the triage process."

Such reverse logistics services are a natural for outsourcing, according to Schneiderman, and various types of providers are candidates for taking advantage of the opportunity.

"This opportunity will be fought over by electronic manufacturing services and traditional 3PLs, or these providers could  partner," he says. "Logistics companies are very good at bringing product in and out, but not necessarily dealing with the triage process and all it entails."