Advantage of Third Party Logistics in Supply Chain Management

Abstract

Logistics has been called the last frontier that even at the present time, the improvement of logistics has been the primary source of firms to make new profits and maintain competitive advantage. There are also several instances where the logistics system has become the cause of bottlenecks in the firm's overall management. The potential for reducing total cost and for improving the quality of services provided to customers can be increased through the elimination of these bottlenecks. Also, from the social standpoint, an efficient logistics system could offer possibilities to reduce road congestion and environmental pollution, which could result in increased macroscopic economic productivity. Several innovations have been developed to advance the logistics system. These innovations can be classified broadly into innovations to improve individual processes of logistics, and innovations to improve the logistics system totally. The former includes innovative hardware such as new inter-modal terminals with efficient transshipment ability, and innovative software such as truck route planning with ITS (Intelligent Transport System) and GPS (Global Positioning System). These piecemeal innovations can be developed to their full abilities only when they are employed into improving bottlenecks.

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HitotsubashiUniversityRepository
Title AdvantageofThirdPartyLogisticsinSupplyChain
Management
Author(s) Nemoto,Toshinori;Tezuka,Koichiro
Citation
IssueDate 2002‑01‑15
Type TechnicalReport
TextVersion publisher
URL http://hdl.handle.net/10086/16053
Right

Advantage of Third Party Logistics in Supply Chain Management
Toshinori Nemoto
Graduate School of Commerce and Management, Hitotsubashi University
Naka, Kunitachi, Tokyo 186-8601, Japan
cc00330@srv.cc.hit-u.ac.jp
Koichiro Tezuka
Graduate School of Commerce and Management, Hitotsubashi University
Naka, Kunitachi, Tokyo 186-8601, Japan
BZE12763@nifty.com
1. Introduction
Logistics has been called the last frontier that even at the present time, the improvement
of logistics has been the primary source of firms to make new profits and maintain
competitive advantage. There are also several instances where the logistics system has
become the cause of bottlenecks in the firm’s overall management. The potential for
reducing total cost and for improving the quality of services provided to customers can
be increased through the elimination of these bottlenecks. Also, from the social
standpoint, an efficient logistics system could offer possibilities to reduce road
congestion and environmental pollution, which could result in increased macroscopic
economic productivity.
Several innovations have been developed to advance the logistics system. These
innovations can be classified broadly into innovations to improve individual processes
of logistics, and innovations to improve the logistics system totally. The former includes
innovative hardware such as new inter-modal terminals with efficient transshipment
ability, and innovative software such as truck route planning with ITS (Intelligent
Transport System) and GPS (Global Positioning System). These piecemeal innovations
can be developed to their full abilities only when they are employed into improving
bottlenecks.
However, it is unlikely that firms merely have one bottleneck in their business processes.
Rather, they have many potential bottlenecks, such that eliminating one bottleneck
would usually make another one to emerge. This is why we have to control the business
process as a system, and have to develop system-management innovations. Among the
1

innovations which have attracted the people’s attention are Supply Chain Management
(SCM) and Third Party Logistics (3PL).
This paper will focus on SCM and 3PL, and will examine their relationship. The key
questions are as follows: If SCM becomes a common tool, is it beneficial to outsource
logistics activities that are sub-functions of the supply chain? If so, how should it be
done (in particular, 3PL utilization)? In order to answer them, we will first review the
background and purpose of the diffusion of SCM, and show that logistics plays an
important part in SCM. We will then outline 3PL and examine its advantages and
disadvantages from the viewpoint of logistics performance. After clarifying the
relationship of SCM and 3PL, we will indicate that 3PL will also play an important role
in SCM, and that SCM and 3PL have positive interactive effects.
2. Development of SCM
2.1 What is SCM?
The supply chain consists of a set of processes associated with the flow of goods,
information, and money among firms, from the raw materials supply stage, through
production and consumption stage, and finally to the recycling stage. A tool to optimize
the supply chain through integrated management is called Supply Chain Management
(SCM).
SCM resembles Efficient Customer Response (ECR) and Quick Response (QR) in the
sense that these tools aim to efficiently coordinate the firms in the total supply chain in a
Just-In-Time (JIT) manner. However, these two tools are targeted for specific industries.
ECR is developed for the food processing industry, while QR is for the clothing industry.
SCM is not necessarily targeted for any specific industry. All these tools generally aim
to maximize total value within the supply chain.
Since SCM involves inter-firm activities, its processes includes various functions such
as raw materials supply, production management, transportation, inventory management,
information system management, order processing, material handling, and customer
management, among others (the simplified term “logistics” will be used in later
discussions and is defined as the combination of these functions). Furthermore, the
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procedures related to customs clearance are added in the case of international SCM.
One of the main features of SCM is that vertical-process integration from suppliers to
customers can be performed through inter-firm strategic alliance. On one side of the
pole, there is the case where the whole vertical process is carried by one firm (e.g.
former General Motors). As total optimization is superior to the sum of partial
optimization in general, total optimization in supply chain is superior to the sum of
partial optimization in the individual chain. However, if a firm would enclose all supply
chain processes in-house and becomes a large-scale organization, it would bear high
administration costs. On the other side of the pole, there is the case where each firm is
independent of other firms and transacts individually in vertical process without
inter-firm strategic alliance, which makes less optimization benefit and less
administration costs. The position of SCM is between these two polar cases. Each
independent firm cooperates strategically with other firms in vertical process
integration.
2.2 Advantage and disadvantage of SCM
Thus, a well-designed SCM yields positive net value by creating benefit, reducing cost,
and improving financial viability (such as profitability.) The firms in the well-designed
supply chain could share gains reasonably, resulting in what is called a “win-win”
relationship.
First, the sources of creating benefits include lead-time compression or flexible
response for customers, which reduce total cost (e.g. inventory cost) from upstream to
downstream and enhance service levels for customers. Such improvements can make
supply chain firms competitive. These advantages are derived from concentrating firm’s
resources to their core-competence and creating value by having flexibility and
adaptability against changing market environment.
Second, the cost can also be reduced in relation to the integrated advantage. There is
economies of scale and scope in vertical integration of process; for example, avoiding
redundant investment in warehousing, and reducing inventory level by information
sharing.
However, in order to maximize such net value by SCM, “inter-firm alliance with
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reliable partnership” is needed. In practice, making a reliable inter-firm alliance entails
high transaction cost, and requires three conditions. First, the period of relationship
should be long enough to make good partnership and commitment. Second, the firms in
the supply chain should have the necessary abilities and should share reasonable
responsibilities (risk sharing). Third, various information, such as ordering, inventory or
customer demand, among others, should be shared and processed properly. With regards
to the third point, the recent IT development can contribute to SCM.
2.3 SCM and development of IT
In designing how to manage the flow of goods in the supply chain, we always consider
the issue of how to process information. Information processing is one of the central
functions of SCM. Latest developments and innovations in IT have provided
opportunities to increase information processing capabilities, and therefore, to improve
the performance of SCM.
IT could make two contributions in the SCM: one is improvement in information
sharing among firms, and the other is prompt problem identification and optimization.
First, it is argued that the introduction of Electronic Data Interchange (EDI) is an
effective way of promoting prompt information sharing among firms so that it coincides
with the objective of SCM. EDI is defined as "connecting computers on-line, and
exchanging information on transactions among firms" (Tsuru, 1998). However, a typical
EDI needs to introduce a Value Added Network (VAN) or a dedicated line in order to
share a network. The large amount of capital needed to invest in a VAN or a dedicated
line has been the main reason why the progress of EDI, particularly logistics EDI, has
been very slow.
However, such investment problem may also be potentially solved by the spread of
Internet technology. Information sharing among firms can be carried out with Web-EDI,
instead of a dedicated EDI line. Despite the fact that the Internet presents some
problems on security and standardization, Web-EDI is advantageous because of its low
cost of investment compared with construction of a dedicated line, and the enjoyable
open nature of the Internet. From these merits, Web-EDI has provided opportunities in
promoting information sharing between firms (Tsuru, 1998). Furthermore, the use of the
Internet combined with ITS present opportunities to improve the urban logistics system
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(Nemoto, et al., 2001).
Information sharing is not only introduced by the private firms, but by the public
authorities, as well. For example, in international logistics, since the government
authorities are not efficiently connected with each other or with the private companies
when doing customs procedures, this becomes a source of bottleneck in logistics.
According to the Ministry of Finance (2001), the cooperation of different systems, such
as Nippon Automated Cargo Clearance System (NACSS) of the Ministry of Finance,
Food Automated Import notification and inspection Network System (FAINS) of the
Ministry of Health, Labor and Welfare, Japan Electronic open network Trade Control
System (JETRAS) of the Ministry of Economy, Trade and Industry, and Port EDI of the
Ministry of Land Infrastructure and Transportation, could advance information sharing,
and provide one-stop services to reduce costs of information exchange.
In addition to the practical uses of EDI or web-EDI, Enterprise Resource Planning
(ERP) has also been gaining wide attention. ERP is a method of managing information,
such as sales, production, purchase, and accounting, aimed at sharing company
information on real time. The introduction of ERP in each firm is mutually
complemented by EDI in order to perform information sharing among the firms in
SCM.
Second, as information sharing provides many data available, we should formulate
problems based on the data, and find the ways to solve them. The development of
application software to actually solve various problems has gained wider interest with
the development of IT in recent years. The software for realizing SCM is collectively
called Supply Chain Planning Software (SCPS.) SCPS includes several software on
manufacturing planning, demand forecasting, transportation planning, inventory
management, scheduling, etc. (Task IT Pocketbook Editor, 2000). Generally speaking,
the progress of IT has promoted rapid sharing of information among firms needed for
SCM, and has caused improvement in the quality of application software for processing
information or supply chain planning software.
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3. SCM and logistics
3.1 Logistics management in SCM
As mentioned above, SCM encompasses flow of goods, information and money from
the raw materials supply stage, through production and consumption stage, and finally
to the recycling stage. SCM is composed of several management tools. Different
approaches in accounting, production management, information processing, marketing,
etc. have been developed to solve the problems in SCM. For example, accounting
approach to SCM mainly focuses on cash flow in the supply chain, while information
processing approach focuses on the flow of information.
In this paper, we will take our attention to logistics in SCM, which is strategic
management of goods flow in the supply chain. According to the CLM (Council of
Logistics Management), logistics is that part of supply chain process that plans,
implements and controls the effective flow and storage of goods, services and related
information from the point of origin to the point of consumption in order to meet
customers’ requirements. Logistics management includes inventory control, material
handling, order control, transportation, warehousing, etc. Although the concept of
logistics mainly focuses on goods flow, other flows such as information and money
flows are also given attention. In particular, information management has close relation
and then cannot be ignored.
3.2 Coordinating logistics in SCM
The general idea of logistics is to strategically manage the total flow of goods. Thus,
logistics optimization is not only accomplished from the viewpoint of one firm, and
therefore, total optimization of the flow of goods including firms in the supply chain is
required.
When trying to optimize the total flows within the supply chain, it must be pointed out
that the interests of firms in the supply chain may conflict due to the partial distribution
of cost and benefit among the firms. Thus, coordinating the interests of the firms is
necessary for logistics management in SCM. They likewise have different skills or
competencies, which are complementary and require further coordination. For example,
coordination is needed between the firms in the areas of production and transportation
6

planning. In fact, it is not easy to coordinate many firms with different profiles. If a
parts supplier and a manufacture like to synchronize their production, they have to share
their production schedules and coordinate transportation of parts between the factories.
In order to realize this, they are required to have IT abilities and to fulfill their
responsibilities correctly.
A firm, which possesses logistics know-how on coordinating economic resources, may
have opportunities to make advises. Such a logistics coordinator, also called Third Party
Logistics (3PL), has been gaining attention. 3PL is a new type of industry where the
firm’s logistics activity can be outsourced. It came into existence during the
deregulation of freight transport industry in the 1980’s, and has progressed in the 1990’s
along with the development of IT.
4. 3PL and its functions
4.1 What is 3PL?
Originally, 3PL means outsourcing logistics activities including transportation and
warehousing to outside firms, which are not a consignor or a consignee. However, it is
not common 3PL practice to outsource a single activity of logistics independently, but to
outsource multiple activities from the firm's strategic point of view.
3PL (or 3PL provider) has the following features at present:
1. integrated (or multi-modal) logistics service provider
2. contract-based service provider
3. consulting service provider
First, a 3PL provider is regarded as an integrated logistics service provider. IT-related
activities for controlling goods flow such as order processing, and inventory
management, among others are also included in the function of the 3PL provider.
However, the 3PL provider need not provide all the services solely. The 3PL provider
can outsource some activities to sub-contractors.
A 3PL provider can be classified into the asset-based and the non-asset-based. The
7

asset-based 3PL provider owns some assets, particularly transport-related assets such as
trucks, warehouses, etc., while the non-asset-based 3PL provider does not own such
assets, and usually relies on sub-contractors’ assets. Examples of non-asset 3PL
providers include forwarders, brokers, marketing companies, and information system
management companies.
Second, the service of 3PL is contract-based. Recently, a contract was written about the
way to share responsibilities assuming various situations in detail. Such strict contract
would make reliable relationship between the parties, and strengthen the alliance.
Third, offering consulting-services to the firms is an important feature of the 3PL. The
3PL provider can make various advises to answer customers’ requirements concerned
with marketing strategy, information system configuration, cooperative transportation,
etc.
4.2 Advantages and disadvantages of 3PL
One of the advantages of using 3PL results from economies of scale (merits from large
truck fleets, warehouses, etc.) and economies of scope, which encourage firms to
increase net value by reducing costs. The effects of these economies are obtained
depending on the type of 3PL provider (e.g. IT-equipped, marketing-based,
non-asset-based (and then flexible), etc.) Competent 3PL providers possess high
coordination ability, enabling them to search reliable partners or sub-contractors, and to
manage efficiently the inter-firm flow of goods. Such ability can be developed through
experiences as a 3PL.
Likewise, by outsourcing logistics activities, firms can save on capital investments, and
thus reduce financial risks. Investment on logistics assets, such as physical distribution
centers or information networks, usually needs large and lump sum costs, which
involves financial risks. Furthermore, the 3PL providers can spread the risks by
outsourcing to sub-contractors.
Although there are several advantages of using 3PL, some disadvantages also exist. It is
not easy to establish a reliable and cost-effective partnership between the firm and the
3PL provider. In order to establish reliable partnership, efforts should be made in two
stages; 3PL provider selection and contract signing.
8

First, in the stage of selecting a new 3PL partner, it is important to select the 3PL
provider which has the ability to provide better services. If the firms cannot select
reliable 3PL providers, they may suffer from economic losses. It is not easy for firms to
judge the ability of the 3PL provider during the selection stage owing to the issue of
information asymmetry between the firm (principal) and the 3PL provider (agent). To
solve this problem, complex selection procedures are necessary to identify their ability.
However, the complex selection procedures may involve additional transaction costs.
Second, it is important to establish a system to maintain their reliable partnership once
the 3PL partner is selected. Information sharing and apparent risk sharing between the
parties is always required. Concerning information sharing, it is needless to say that
smoother information exchange will result in a more efficient logistics activity.
However, related costs may increase if some information essential to the firm would
leak. Therefore, the commitment of each party in information sharing is required, and a
scheme to ensure these commitments has to be prepared. However, this would also
involve additional transaction costs.
Constructing a risk sharing scheme between the firm and the 3PL provider is critical in
establishing reliable partnerships. Some of the risks involved in using 3PL are demand
risk, inventory risk, and financial risk, among others. The questions are on who will take
these risks, and how to compensate the risk holders. "Gain sharing" is a popular
example of a rewarding scheme in which the 3PL provider holds part of the risks, and
then is given incentives based on the increase of the firm’s profit. This risk-sharing
method is apparently some sort of a division of work between the firm and the 3PL
provider. Establishing good risk sharing also involves transaction costs, although the
associated costs can be reduced through the cumulative experiences and IT
development.
5. Interactive effects of SCM and 3PL
As mentioned above, SCM and 3PL have individual advantages. It is recommended that
firms which aim to develop SCM, should utilize 3PL, and that firms which plan to
introduce 3PL, should employ SCM. It is believed that SCM and 3PL have positive
interactive effects, or synergy effects. This section will show the best combination of
9

SCM and 3PL that would benefit the firm with their interactive effects.
When a firm contracts-out logistics activities to a 3PL provider, the 3PL provider needs
to establish transaction and inventory management systems involving other firms in the
supply chain; i.e. supplier, manufacturer and retailer, etc. The 3PL provider does not
usually provide all logistics activities solely. Some activities are outsourced to
subcontractors. For example, non-asset 3PL providers may outsource a transport activity.
Such relationship between the 3PL provider and the sub-contractor likewise constitutes
a part of the supply chain process.
Figure 1 describes two kinds of alliance, SCM and 3PL. This figure is modeled on a
supply chain of manufacturing industry, where parts or materials are well standardized,
resulting that production outsourcing is easy and inexpensive. In the alliance of SCM,
Manufacturer A and Supplier B have a principal-agent relationship. In the alliance of
3PL, Manufacturer A and 3PL provider D also have a principal-agent relationship. They
have to be cooperative in order to enjoy economies of scale and scope, and have to be
flexible enough to revise the contract or to switch partners if the market environment is
changed.
SCM
Manufacturer
A
3PL Provider
D
Warehouses Carriers
Transaction
Logistics
services
Transaction
Logistics
services
Outsourcing
Further
outsourcing
3PL
Supplier
B
Retailer
C
Figure 1 Two kinds of alliance – SCM and 3PL
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Table １ Advantages and disadvantages of SCM and 3PL
SCM 3PL
Advantage:
Creation of
net benefit
•
•
•
•
•
•
•
Economies of scale and scope
Concentration to core
competence
Lead time reduction
Flexibility to customers
Economies of scale and scope
Savings on capital investment
Risk-sharing
Disadvantage:
Increase of
administration or
transaction costs
Creation of SCM alliance
•
•
•
•
•
•
Searching efforts
Coordination efforts
Information sharing (e.g.
production schedules)
Creation of 3PL alliance
Searching efforts
Coordination efforts (e.g. risk
sharing)
Information sharing
The advantages and disadvantages of SCM and 3PL are shown in Table 1. With SCM,
firms can reduce total cost through economies of scale and scope and can increase
benefit by improving customer services. The disadvantages include increase of
administration or transaction costs in the selection of reliable partners and sharing of
responsibilities.
The effects of 3PL are produced in a similar fashion as SCM. Advantages include cost
reduction by economies of scale and scope, savings on capital investment, etc., while
disadvantages include additional administration or transaction costs.
Figure 2 describes possible appropriate combinations of SCM and 3PL as characterized
by the degree of logistics and production outsourcing. A low degree of logistics
outsourcing (LOL) implies in-house operation, while a high degree of logistics
outsourcing (LOH) could be realized in several forms; for example maximum utilization
of e-logistics to match cargo and transformation needs on real time. 3PL is in-between
(LOM) these two levels. A low degree of production outsourcing (POL) is observed in
the case of a mega-manufacturer or a conglomerate, while a high degree of production
outsourcing (POH) is performed by an e-manufacturer or an e-retailer which can
procure the necessary parts or materials by web-trading. SCM is in-between (POM)
these two levels. From this figure, we can forward three hypotheses.
11

Legend:
 : excellent
{ : good
U : fair
¯ : failure
Degree of
logistics
outsourcing
U
{
？
E-logistics
LOH:
U
{

3PL
LOM:
U
{ ¯
In-house
operation
LOL:
POL: POM: POH: Degree of
production
outsourcing
mega-
manufacturer
or
conglomerate
e-
manufacturer
or
e-retailer
SCM
Figure 2 Strategic combination of SCM and 3PL
Hypothesis 1: given a firm which seldom outsources their production (POL), doing
logistics activity in-house (LOL) might be suitable.
Hypothesis 2: given a firm which outsources most of production (POH),
it might be beneficial to use 3PL providers (LOM). E-logistics usage
(LOH) might be suitable but is unknown for firms without sufficient
experiences.
Hypothesis 3: given a strategic SCM alliance (POM), best performance might be
achieved using 3PL (LOM). Using e-logistics (LOH) might also be
beneficial.
Hypothesis 3 means that the 3PL provider could demonstrate their full ability if a
strategic SCM alliance exists. Although SCM and 3PL have a principal-agent problem
by nature, combining SCM and 3PL has an effect to alleviate it. The 3PL provider can
audit the performances of the firms in the supply chain fairly as an outsider, which gives
good stimulus to the firms. In the same way, the upstream (or downstream) firm can
audit the performances of the manufacturer and the 3PL as an outsider, giving suitable
12

advises to them. This is why the combination of POM and LOM is expected to be
successful.
6. Conclusion
In this paper, we have considered the relationship of SCM and 3PL, and offered some
hypotheses about logistics and production outsourcing. It is recommended that joint
usage of SCM and 3PL should be promoted because of their positive interactive effects,
as indicated by the hypotheses. That is, when firms are intent on introducing SCM, it
would be beneficial to outsource logistics activities and utilize a 3PL provider. The
reverse could be true as well.
Issues for further study can be classified into two: theoretical and empirical. First, as
mentioned in hypothesis 2, we could not fully clarify the relationship between
e-logistics usage (LOH) and the e-manufacturer or e-retailer (POH). This is because we
do not have a confident perspective about IT and its implications on SCM and 3PL,
partly owing to insufficient experiences. However, if we could acquire adequate
cumulative experiences of e-business, we will be able to assume the relationship
between LOH and POH. We could then offer new hypotheses and revise Figure 2.
Second, we have to conduct case studies in order to justify our hypotheses empirically,
which could also bring practical suggestions and recommendations for private firms,
and bring new ideas for further theoretical development.
13

14
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