Evaluation of private warehouse verus 3rd party logistics service provider

What are private warehouses?

Private warehouses are warehouses that are occupied on long-term lease, or privately owned by the companies that use them. They are typically used by companies that have a stable enough warehouse need to make a long-term commitment for this fixed facility(initial investment and warehouse labour force).

Some of the largest users of private warehouses are retail chain stores, for example NTUC FairPrice(a local supermarket retailer with more than 80 stores island wide).
They handle large volumes of inventory on a regular basis and one of the ways they benefit from economies of scale is by integrating purchasing and distribution functions with that of the warehouses.

For a manufacturing company that have their manufacturing plants overseas(eg. Nike has many factories in Malaysia), the products are shipped from the factory to the company's regional distribution warehouses. There are also products which require complicated handling characteristics which public warehouse operators may prefer not to handle, resulting in some of these manufacturers investing in their own private warehouses.



What are the advantages and disadvantages of using private warehousing?
Advantages:

1. Higher degree of control over warehousing operations, thus giving efficient warehousing and services
2. Higher flexibility, with more control the warehouse's layout can be designed into one that suits the needs of the products/customers(eg. medical supplies that require special storage)
3. It is cheaper than renting a public warehouse when throughput level is very high
4. Confidence as there is greater care when the company's own employees operate the warehouse and handle goods

Disadvantages:

1. Lack of flexibility - In the long term when the company grows, the fixed size and cost will restrict the company's growth
2. Low ROI(return on investment) - Funds could have been channeled to other projects that have higher ROI
3. Finance - High start-up costs and hiring employees to manage the warehouse is costly and time consuming. Handling equipments and storage equipment especially ASRS are complex and capital intensive

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What are 3rd party logistics service providers?
3rd party logistics(also known as 3PL) service providers are firms that provide outsourced or "third party" logistics services to a company. Types of services would include public warehousing, contract warehousing, transportation management, distribution management, freight consolidation.

An example of a 3PL company is UPS:


Distribution management is the efficient management of transferring goods from the manufacturer to the end-user or consumer. This includes activities such as warehousing, materials handling, packaging, stock control, order processing, and transportation.

Freight consolidation is a service that assembles smaller shipments and ships them together in order to enjoy better freight rates and cargo security.



Transportation management is the management of transportation operations of all types.
This includes tracking and managing all aspects of vehicles(including fuel costs, maintenance), mapping out the route to be taken, warehouse, communications, EDI implementations etc.

Public warehousing is used by companies that either cannot justify the costs of having their own facilities or prefer not making a commitment to owning and operating their own facilities.
It is usually used as the initial alternative due to it's flexibility in terms of space and location.

One of the warehousing service they provide is contract warehousing.
It is a customised version of public warehousing, usually used by companies who want higher quality services as they are designed to adhere to higher standards and provide specialised handling needs for products like pharmaceuticals, electronics and high-value manufactured goods.

It is basically a partnership between manufacturer and the service provider.
They handle the manufacturer's warehouse and product needs and can be considered as a "One-Stop-Shop" Logisitics Centre.



Examples of customised logistics services provided by them are storage, break-bulk, consolidation, order assortment, spot checking, in-transit mixing, inventory control, transportation arrangement, logistics information systems and any other logistics support services a client needs.

By having 3rd party logistics service provider handling the manufacturer's logistic functions, the manufacturer can concentrate on manufacturing and marketing.

Aside from cost savings being the main advantage, the other important advantages are:

1. Compensation for seasonal products - Eg. Toy"R"Us (a chain kids store for toys, video games, baby products, and more) would enjoy a peak during holiday seasons like christmas, and have less sales during other periods. The peak and troughs will not result in capacity of warehouse wasted, as the warehouse do not belong to them.
   
2. Increased Geographical Coverage - A company can now have warehouse locations in different regions with zero capital investment in warehousing. The geographical market coverage is increased without any additional costs through the 3rd party logisitics service provider.
3. Flexibility in testing new markets - Companies who want to market their products in a new area, or introduce new products can use short-term contract distribution services to test market demand for products. Building a new distribution facility could take years, and the capital investment in the warehouse could also tie companies down.
4. Gain management expertise and deciated resources - The 3rd party logistics service providers are experts in logistic functions who can provide innovative distribution ideas and cost reducing product-handling procedures. For some contracts, they will dedicate space, workers and materials handling equipment exclusively to the client's products.
5. Permit off-balance-sheet financing - Physical distribution assets for a private warehouse yield the lowest ROI(return on investment) of all corporate assets, tie up corporate funds and sometimes are not fully utilised. By having a 3rd party logistics service provider provide the distribution services, these assets are taken off the balace sheet increasing a company's ROI.
6. Reduce transportation costs - Due to 3rd party logistic service providers consolidating freight into full truckloads(FTL), they are able to offer significant freight savings.
7. Low Opportunity Cost(low risk) - As there are no funds that have to be commited, there will not be any switching costs for changing warehouses if the company decides to produce a new kind of product that requires a different type of warehouse.
   

Disadvantages:

1. Outsourcing costs possibly exceeding private costs, especially when the throughput level is very high.
2. Lose control of logistics function(personnel, hiring practices, policies, and procedures) and high value products must be careful of employee theft.
3. Incompatibility with company needs - Possbility of insufficient space and fixed locations for the warehouses.
   

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Cost comparison between private warehouse and 3rd party logistics service provider:



As seen from the graph, when the throughput level is low, using 3PL service provider costs less as it consists of only variable costs(no capital investment). However, as the throughput level increases the cost per volume for private warehousing starts to drop and total costs becomes lower than 3PL service providers.

How do we know when to use private warehouses or 3PL service providers? We now know the advantages and disadvantages of private warehouses and 3PL service providers, effects of throughput volume on costs.

Other factors include stability of demand and density of market area.
Stability of demand - when demand is stable at a high throughput volume, we should use a private warehouse. When demand is unstable or low, it is more advisable to use a 3PL service provider.
Density of market area - With respect to shipping costs, it is cheaper to go for private warehouse in the dense area and 3PL service providers in the low dense area.

Below is a table we have drawn to highlight some factors which will help you to decide which to use:


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What are the usefulness and constraints of this topic in DCM?
Usefulness

• 1. This topic talks about the evaluation of comparison between private warehousing and 3rd party logistics service providers and provided us with a helicopter view of the differences and the advantages/disadvantages of using each. It is very useful as we know the consequences or effects each choice would lead to, such as higher cost savings and other important factors such as the degree of control we would have over our warehouses. This will allow us to make an appropriate choice between getting a private warehouse or 3rd party logistics service provider.
  

• 2. We have gained valuable insight on rising global trends from this topic. Understanding the global market trend is especially important for a company to expand operations further. Being able to make the optimal decision for warehousing functions will give companies a competitive edge among its competitors.
  

Constraints

• 1. The constraints of this topic is that the scope is too narrow as private warehousing covers less functions than 3rd party logistics service providers(with warehousing being part of the functions of 3PL). Going in-depth by comparing private warehousing to public warehousing or contract warehousing would make differences and similarities more clear-cut.

• 2. Employees' skills, capabilities, morale and attitude are not included. This is important as effectiveness and efficiency of these logistics function may vary according to these. Without proper employee welfare, effectiveness and efficiency may drop drastically.
  

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Question & Answers section

These are the queries other groups have given to us.

Chinkwang's Group: Are there any 3PL service providers engaged by major companies or organisations?
Answer: Yes! Did you know that DHL was the 3PL service provider that helped make F1 happen in Singapore? DHL has been the official logistics partner for Formula One (F1) since 2004, and works closely with the Formula One Management (FOM).
Here is a quote from Dan McHugh, CEO of DHL Express Asia Pacific:
"Throughout the F1 racing season, DHL moves up to 300 tons of equipment per race across four continents and between 17 countries by land, sea and air, to a tightly controlled timetable."

You'll never have imagined just how important 3PL service providers really are! If you are interested in finding out more about DHL and F1, you can visit the link below for an article about it.
http://www.marketing-interactive.com/news/8634

Roland's Group: What are the current global trends for companies that intend to expand their market coverage? Do they use 3PL service providers to replace private warehouses completely?
Ans: Many current existing companies now reduce their private warehouses to only a few centralized facilities and contract out regional market coverage to a contract warehousing company or 3PL service provider.
By using this combination of private and 3PL warehousing network, these companies can continue to have a high degree of control over the centralised facilities and use the contract warehouses to increase geographical market coverage.

This is because even though a 3PL service provider is an excellent choice for expanding market coverage, they would still need to use private warehousing for their high throughput(or dense) volume market areas as the total cost would be lower than using a 3PL service provider.