Analyst Insight: The make-versus-buy decision at the heart of any outsourcing decision is not as black-and-white as many procurement professionals think. Over the past two decades, progressive sourcing models have emerged, enabling companies to work more strategically with suppliers to create value and drive innovation. Options such as performance-based agreements and vested outsourcing arrangements are proving to be powerful tools for working more strategically, with suppliers achieving more results such as lower costs and higher service. 

Whether to keep logistics work insourced versus contracting with a partner organization is not a yes or no question. Rather, the decision should center on what’s the most appropriate sourcing model for your situation. 

Today, more than ever before, progressive companies are seeking ways to work more strategically with the supplier to create value and drive innovation. The Third Party Logistics study (available for download at www.3PLStudy.com), released annually at the Council of Supply Chain Management Professionals conference, indicates that 62% of shippers plan to outsource more. They are seeking cost containment and price concessions, as well as wanting their 3PLs to invest more in technology. 

Many shippers are starting to put their money where their mouth is, with 39% of shippers turning to longer-term contracts. While this is a good start, we argue it is insufficient to escape the outsourcing paradox. 

Businesses say they want a strategic outsourcing solution — but they are still writing tactical, transactional contracts. The result is that companies using conventional sourcing and contracting methods find their service providers may be meeting their contractual obligations, but they are not driving efficiencies and investing in technology at the pace their customers would like to see.   

Let’s take a closer look at two common perverse incentives of transactional contracts. One lies in transactional pricing, in which a 3PL is paid per activity (per pallet, per shipment, per mile, etc.). The more transactions, the more profit the 3PL makes. But there is little incentive for a 3PL to invest in technology to optimize inventory and pallet storage when they are getting paid for every pallet stored.   

A second common trap is that, while companies may be writing longer-term contracts, they also want flexibility to terminate. In fact, the annual 3PL Study shows that 63% of shippers were putting an increased emphasis on flexible termination clauses. The catch-22 is that shippers want their 3PLs to invest in technology, but that’s typically a long-term investment. Ask any chief financial officer at a 3PL, and they will say a 90-day “termination for convenience” clause means that they really only have a 90-day contract. While it’s unwise to eliminate termination clauses, there are better ways to balance each party’s needs. 

To escape the outsourcing paradox, business leaders from both shippers and 3PLs must move beyond the conventional “what’s in it for me?” mindset, and make the shift to “what’s in it for we?” A good guide to what this actually looks like comes from the University of Tennessee’s research library, which now includes 7 books, 23 white papers, and 20 case studies that document and analyze the success stories of organizations that have made the shift away from transactional to relational contracting methods. 

Outlook: As all signs point towards an increased demand for long-term relationships, it’s high time to reset and re-align our contracting methods to match.  Although change takes time, it is also inevitable. The I-win-you-lose, non-transparent, power-based methods that became ingrained over the last century are no longer appropriate for today’s complex, inter-dependent outsourcing challenges. 

Resource Link:

www.utk.edu