External Service Providers

Risk Involvement: The trend toward increased use of external service providers has, in part, resulted from increased willingness on the part of specialists to assume more active participation in risk associated with channel performance. Naturally the willingness to assume greater risk has its reward structure. To fully understand this change in additional posture, it is necessary to explore the changing nature of services being provided. Examples are drawn from the public warehouse industry as an illustration.

The initial concept of public warehousing was to provide temporary storage of products. In a passive sense, the public warehouse specialist concentrated on providing high quality storage and material handling for a fee. The risk of the warehouse operator was limited to providing safe, damage free storage. In today’s environment, many public warehouse firms contact and operate dedicated facilities that are leased to customers on a long term basis. Such contract warehousing typically involves management, staffing material handling equipment, and the provision of specified information services. It is also common practice for warehousing firms to perform dedicated transportation services. Many warehousing firms contract to perform customized value added services such as product sequencing, labeling and various forms of light assembly and manufacturing. Thus, public warehousing as it exists today is significantly different from originals concept. The firm specializing in warehousing has significant assets at risk and offers an array of value added services focused to the needs of specific customers.

The trend toward greater specialization and dedicated facilities is not limited to warehousing. Similar trends more or less exist in almost all forms of support services. An area of extensive specialization is in the design and operations of customized transportation services. Because the providers of customized services have a great deal at risk with a single user or buyer, new and innovative ways of pricing and sharing or spreading liability have evolved. One example is an upside downside contract. That the contract amounts to is a sharing of productivity benefits between supplier and user. When the service is conducted at near optimum upside performance levels, users share in productivity benefits. Likewise when volume drops below a pre-agreed performance level necessary to cover fixed cost, the financial burden is shared on a pre-agreed basis by the service user. Other examples of risk sharing are performance related incentives and penalties, agreements to purchase assets in contract termination situations, and arrangements to suspend or reduce service contract payments if the primary channel business fails to achieve a predetermined percentage of forecast.

A wide variety of performance agreements exist among suppliers and buyers of specialized services. While the specifics of such agreements vary significantly, their objective does not. The primary motivation behind such customized agreements is a basic recognition of the risk that many specialized service providers have in overall channel performance.

Large scale multiple facility warehouse operations that offer a range of integrated services are growing rapidly. Small scale single facility public warehouse operators are rapidly being absorbed. Itel Distribution Systems was formed in 1988 by the purchase of Lease way warehousing. Within two years Itel further expanded system wide capacity by the acquisition of two regional warehouse operations, the Dornbush group and Paul Jeffrey. A similar collection of individual service businesses is being orchestrated by Excel Logistics a subsidiary of the United Kingdom based conglomerate NFC. By early 1990, Excel had acquired Dauphin Distribution Services Company, Distribution Centers Inc. Allied Van Lines, Merchant’s Delivery, and Yankee Express as the nucleus of a nationwide logistics based service.

Supply side concentration means that fewer specialists are more deeply involved in the business affairs of primary channel participants. Most firms that use outside services have reduced the number of different suppliers they regularly utilize. Whereas the popular purchasing strategy of the recent past was to spread service requirements across many suppliers relying on competition to assure lowest price, the trend today is to develop a closer working relationship with a few key service providers. The essence of supplier alliances is to generate a cooperative forum for continuous productivity improvement. In fact, some organizations have gone so far as to source service requirements with a single supplier. For example, the core carrier concept of transportation is to use a single hire specialist to provide all service requirements. The basic core carrier idea is that focusing all transportation requirements with a single service supplier creates an optimum balance of economic and operational concentration. Needless to say, such concentration has inherent risk that must be offset or contrasted by detailed working and terminating agreements.