When to consider a 3PL New Harbor Consultants

The US third-party logistics (3PL) industry continues to grow at a brisk pace. Total net revenues of $52 billion in 2023 are up nearly 10% annually since 2019[1]. Is outsourcing of warehousing or distribution right for your business?

As an initial step before launching a thorough business case analysis, we find it helpful to start with a high-level, qualitative assessment of the merits of inhouse versus outsourced warehousing and distribution operations.

This Brief offers a practical assessment framework and examples. Our approach can be applied to your business as a whole or to specific business segments. The latter is most typical, since many companies choose to outsource only selected logistics operations, and in only some business segments.

Six 3PL impacts to consider

Customer service
Inhouse logistics operators have a deep understanding and history of the company’s products and customers. They also know who’s who in the organization, to quickly troubleshoot problems or direct customer feedback to the right internal resources. On the other hand, a 3PL brings cross-industry experience, leveraging best practices from other companies that may enhance the customer experience in your business.

While a highly capable 3PL should be able to quickly get up to speed on your products, customers, and organization, sometimes we find the customer experience so unique or challenging, that outsourcing logistics operations may put that experience at risk.

Concerns about a 3PL being able to handle customers flawlessly can be a show-stopper. Yet it is important to recognize that for other 3PL users, their customer experience is also super critical. Mutual trust, empowerment, and measurement can enable both parties to deliver.

Formal agreements and active monitoring, including SLAs (contractual service level agreement) and KPIs (key performance indicators), are best practices to keep in mind as you consider a 3PL. Accountability is paramount – whether an internal group or a 3PL runs your logistics.
Operational know-how
Operational excellence is essential to delighting customers. If your product handling and customer requirements are highly specialized, it may be difficult to find a 3PL with the right capabilities.

But 3PLs can offer logistics expertise and technology that is difficult to build and maintain in your company. 3PLs also offer leading IT systems which they can leverage across multiple clients. Since they concentrate on logistics, 3PLs can bring better ways of working, leveraging cross-industry best practices.

We recently supported a post-merger integration effort where two business units shipping differentiated building products, but in the same category, took opposite approaches. One successfully used a 3PL. The other BU had established its own inhouse operation and was also satisfied.
- The company board raised two questions: was one or the other approach best for these existing operations? And for a new cross-BU facility, should it be in-house or outsourced? The BU opting for the inhouse option believed that its customer base, service requirements, and operating specs were unique and would be risky to hand to a 3PL.
- We began by taking a high-level qualitative approach to assess in-house vs outsourced. In this process, we spoke with sales and operating personnel, observed operations, and spoke with customers. We found that the customer service and product handling requirements were not that different between the BUs. Moreover, the requirements were similar to those of other building materials companies, many of whom use 3PLs successfully.
- Considering the pros/cons, we recommended launching a business case and RFX process seeking a 3PL, while keeping the in-house option open. Our quantitative analysis then showed that the third location would yield valuable service improvements and cost savings. This led to the company to source a 3PL for the new site. It will also reconsider the existing in-house operation when that building lease comes up for renewal.
Cost
If a 3PL can deliver customer service excellence and operational know-how, this can often translate into cost savings. 3PLs typically have greater buying power for logistics assets, whether real estate, material handling equipment, systems, or even labor. Moreover, for small and mid-sized companies, they can share these assets across multiple clients. And even balance one client’s high season against another’s low, enabling higher average asset utilization than possible with an inhouse operation.

3PLs charge for their services, including a profit margin, of course. So your costs depend on the 3PL’s underlying operating costs, its profit margin, and how the efficiency gains are shared. Some relationships are open book, with costs and profit margins visible to both parties. Others are closed book with 3PL profits baked into their rates. At the qualitative level (before launching an RFX process to get hard numbers), understanding how a 3PL could be more efficient with your business provides a start in assessing the potential for an outsourced solution to lower your costs. Be sure not to overlook your internal costs to manage the 3PL.

When it comes to cost and operational excellence, geography often matters. If the operation will reside far from the company’s home base, domestically or overseas, a well-established 3PL may have the local expertise to deliver superior service at a lower cost. For example, one footwear company runs its main US distribution centers internally, finding that such large, highly customized, and capital-intensive facilities could be most effectively run by their own team. Meanwhile, it outsources overseas facilities to regional logistics providers with deeper local know-how to optimize cost and service performance.

We have also seen companies outsource only a part of their logistics. We worked with a major retailer that kept its large, mission-critical distribution centers inhouse while using 3PLs for the numerous regional customer returns processing centers.

Companies can include more than one 3PL in the solution to obtain high levels of customer service, operational know-how and cost performance. For example, a cleaning products company sought product blending and distribution in a new region. While some 3PLs offered an integrated solution, the complexity of the blending process required selecting two best-in-class providers, one for blending and packaging, and the other for warehousing and distribution.
CapEx
For companies seeking to avoid large upfront capital outlays for logistics assets and fixed expenses, a 3PL may offer monthly variable pricing – based on activities performed. Or a combination of a monthly fixed charge, plus a variable component. This approach often works well for small and mid-sized companies. For very large, capex-intensive operations, a 3PL may be reluctant to make the required investments without the customer backstopping its investments. Or a 3PL may have a higher cost of capital, driving up its fees thereby eroding its competitiveness.

For a new facility, a mid-sized retailer opted to start with a 3PL who designed and invested in a semi-automatic operation. As the operation grew, the retailer shifted to a mixed model. It found that it was more cost effective to take on the capital equipment ownership, as it had a lower cost of capital and sought to save the 3PL’s markup on its capital investments.
Scalability
A capable, broad-footprint 3PL can quickly scale up operations as your business grows – adding space, headcount, and new locations incrementally and just in time. Once operations reach a critical size, the 3PL’s scalability advantages diminish. Buildings become dedicated to one specific customer, with only limited ability to share space, labor, and other logistics assets. If the solution is also highly capital intensive with unique operating characteristics, 3PLs offer less advantage versus inhouse solutions.
Risk
Risk cuts both ways. It may be considered risky to launch a self-operated warehouse in a new geography rather than working with a well-established 3PL in that region. Choosing to outsource – selecting a provider, contracting and on-boarding the 3PL-run operation – brings risks as well. Fortunately, the 3PL industry is well established and there are many best practices available to help companies identify and manage risk.

Final thought on assessing a 3PL alternative

Consider including this kind of qualitative inhouse vs 3PL advantage-disadvantage assessment in your strategic and annual planning efforts. Your assessments will likely change as your company grows, adding customers, geographies and products. A simple scorecard approach can be useful, rating 3PL advantages in each of the six areas above.

Even if you already outsource operations to a 3PL, this framework can help you zero in on new opportunities or even challenge how you currently use providers. A better understanding of potential 3PL advantages and disadvantages in your business also helps when drafting an RFP and ultimately to deliver a compelling business case.

Periodic consideration of a 3PL solution also challenges the inhouse operation to prove itself as unbeatable!

[1] Warehousing and distribution segment only. Source: Armstrong & Associates and NHC analysis.

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David Frentzel is a Partner at New Harbor Consultants. Dave brings 30 years of management consulting and hands-on executive leadership experience to improve business outcomes. Prior to joining New Harbor, he held various senior positions at 3PL and supply chain technology companies. Dave has extensive global management expertise helping companies with their go-to-market, organizational, sourcing, manufacturing and supply chain strategies and operations.