Why grocers are outsourcing distribution to 3PLs


The trend towards third-party logistics (3PL) distribution outsourcing within the grocery industry has two dimensions: warehousing and trucking.

It is important to discuss these separately because strategies vary depending on a company's operating environment.  I'll discuss transportation outsourcing in this blog and in my next blog entry, I'll discuss warehouse outsourcing.

On the transportation front, the trend is towards a hybrid environment whereby grocery retailers are increasingly dividing the workload between third-party carriers and private fleet operations.

There is a number of reasons behind the trend towards hybrid transportation outsourcing.

1)     Like most other industries, truck drivers are beginning to retire in increasing numbers.  It is becoming more difficult for some grocery companies to recruit replacement drivers.  The result is that these companies are having to become more creative about how they leverage third-party carriers to offload work that has traditionally been performed by in-house drivers.

2)     The use of third-party trucking companies enables provides more flexibility which is especially valuable during peak and valley time periods.  For example, when outbound activity is lower, the grocery retailer can reduce the number of loads being outsourced. Conversely, during peak time periods, the 3PL can be leveraged for additional support.  In this case, the third party carrier acts as a workload balancing buffer that is not available in a strictly private fleet operation.

3)     For companies that operate across a wide geographical region, the use of third-party carriers is often an excellent strategy because the carrier can perform a one-way linehaul at a lower cost than the private fleet operation can do the work.  This is because the 3PL carrier can perform other work after the deliveries are done rather than returning home empty.  This is also a strategy that can be used to avoid layover costs that may otherwise be incurred with a private fleet operation.

4)     Labour strategy is another reason for third-party outsourcing.  In this case, the grocery retailer intentionally leverages the use of a third party service provider to reduce the risk of a total shutdown in the event of an organized labour conflict.

5)     Asset reduction is another reason though we see this less often.  In this case, the grocery retailer needs to reduce debt on the balance sheet hence the outsourcing decision is typically made as a means to sell of the private fleet equipment to reduce debt.  This is a one-time cash gain the typically ends up costing much more in the long run.

So these are five reasons that serve as examples as to why grocery companies outsource some or all of their trucking operations.  Of course there may be other reasons that I have not mentioned but we will use these as a starting point.

The question that needs to be asked when outsourcing a subset of the trucking operation is whether or not the cost proposal from the 3PL carrier is good for business.

Many grocery companies are aware that they may actually be paying slightly more to have a third party manage the outsourced trucking activity.  After all, the 3PL carrier needs to make a profit margin which is not the case in a private fleet operation.

However the thinking is that the benefits outweigh the additional expenses because the flexibility factor is so critical to the business.  Thus better overall productivity can be achieved through the hybrid transportation model.

The trick is to know your cost structure down to the penny.

For example, let us that the 3PL provides a service that includes the driver and the tractor but not the trailer.

Or what if the loads being outsourced are return trips that do not require a layover?

Lastly, let us assume that the fixed cost of routing, load planning, equipment maintenance, fueling facilities and the like all stay the same even when some loads are outsourced.  The third-party carrier will likely be offering a price that is subject to fuel price surcharges and a commitment for a minimum annual level of transportation volume.

To run a clean cost comparison of private fleet versus a 3PL operation, it becomes imperative to do some sharp cost accounting:

1)     The annual transportation operating budget should be married up to annual operating data as a starting point so that the cost per incremental running mile, with and without driver labor, is clearly understood.

2)     All fixed overhead expenses need to be removed from the picture because these stay the same.  Similarly, trailer depreciation expense would need to be removed as per the example provided, because this expense remains the same.

3)     A solid understanding of the cost per mile as it relates to fuel expense needs to be developed.

4)     The cost per mile for a refrigerated load is different than a dry load and this needs to be identified as well.

5)     In this example, the key is to define the incremental cost per running mile for driver plus tractor excluding backhaul revenues, the cost of trailers, fixed overhead, layover expense and any other expenses that are not applicable.  Only when this expense is known can you sit down and negotiate a fair rate with the 3PL carrier that is considerate of their need to make a profit.

All too often we hear it said that the 3PL is charging the same rate that we pay per mile hence it is a good deal for us, but in fact it is a good deal for the 3PL because the wrong numbers are being compared.

In conclusion, the trend towards 3PL transportation is on the increase for the reasons cited.

For grocery companies considering the outsourcing of a subset of transportation activity, it is imperative to have a solid handle on each general ledger item within the transportation budget.

This accounting information needs to be married up to transportation operating activity to enable a true incremental cost per mile analysis (i.e. the cost to drive one mile further down the highway).

Only when you have a solid understanding of your own cost structure can you enter into a meaningful negotiation with the third-party service provider.

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