Expert Insight:

Your Global Supply Chain Tower Has A Memory

by Greg Johnsen

As promised a couple of weeks ago, I am writing a handful of columns over the next couple of months on various riffs on questions around supply chain outsourcing.

I started a couple of week’s ago with one way to look at the topic: Supply Chain Core versus Context, which readers seemed to find of interest – a couple emailed us that it was “very deep,” or something like that.

My theme this week is this: Can, or should, most companies really just shed most of their supply chain assets?

I have actually been thinking about this for some time, starting maybe two years ago at an industry even I was attending. There, during a roundtable type session that if memory serves me correctly was on something like “Supply Chain Strategies for the Downturn,” one supply chain manager rather vehemently (not sure what the exact context was at the time) argued (paraphrasing) that “You have to reduce your fixed costs. Outsource everything you can. Get rid of the assets.”

That, of course, is a widespread sentiment, at the executive level if not always in the supply chain. There is almost no question to me that one of the lessons that CEOs will take from this severe downturn is that the less of a fixed cost structure they have, and hence moving to a more variable model, the better they can withstand the economic ups and downs. In general, supply chain execs often see less fixed infrastructure and cost as a way to boost supply chain flexibility.

“Accordion Logistics” is a term sometimes used – your network simply expands up and down depending on current volumes and needs. I have been at two recent events where 3PLs were promoting that concept using that exact term to audiences of shippers.

The funny thing is, even the outsourcers themselves sometimes think this way: in general, the value (based on acquisition activity) of “non-asset based” 3PLs is usually higher per revenue dollar than asset-based providers. A board member at one public company 3PL recently told me that this company “had navigated the downturn much better than most because they are non-asset based.”

So even many of the outsourcers don’t want the assets. I really don’t know yet if we have reached the stage of “non-asset based contract manufacturer,” but it seems likely we will someday if we haven’t already.

Back to the meeting: when the one attendee made the remark about shedding assets, almost simultaneously my friend Greg Aimi of AMR Research and I both had the same thought – somebody has to own the darn assets. So who will it be?

Which has left me with a question ever since: As manufacturers, shippers, and even 3PLs look to similar strategies, who are going to be the stupid SOBs that get stuck with the assets in the end?

And a few more questions: Is in not possible that at some point there may issues for the companies outsourcing supply chain assets in terms of capacity and cost? Can the accordion really being expanded indefinitely?

Maybe yes and maybe no.

Awhile back, I asked Chris Munro, an accomplished executive in the 3PL industry for many years and now a partner at private equity company Fenway Partners, which makes investments in logistics service providers, some of these questions.

Here is a basic one for me: If there is “risk” and cost in owning supply chain assets, don’t 3PLs, contract manufacturers and other outsourcers in turn bear those same risks and costs? And doesn’t that in the end have to reflect itself in prices back to the outsourcers?

For example, if one driver of the desire to shed supply chain assets is to improve a company’s return on assets (basically, annual profit divided by net asset levels on the books, a key metric looked at by Wall Street), does that by definition imply someone taking or offering those assets is willing to accept a lower return? Otherwise, how can it make a good financial choice for the company outsourcing? Doesn’t the outsourcer have to price in the cost and risk of holding the asset?

Yes, but in a way that can work for both sides, Munro says.

“For a variety of reasons – certainly through offshoring – an outsourcer can often bring a lower labor cost structure that it would just be too hard to for the company outsourcing the function to get too quickly,” Munro says.

However, he also said that the returns Fenway Partners expects from its assets are certainly no less – and perhaps often even more – than manufacturers or distributors.

“But what the outsourcer can often bring to the equation is the skill to really “sweat” those assets,” he said. In other words, the outsourcer often has as a core competency in relentlessly managing a return on the supply chain assets it builds or buys that is simply not the way most regular supply chain managers, focused on operating cost, customer service, and other pressures, rarely think about it in the same way.

That can mean that it is possible for the outsourcer and outsourcee (to invent, I think, a terrible new term) to both win. The outsourcer can offer the service of its assets at a way that still saves the outsourcee money because they simply have to get more out of the asset to make a profit, and focus great effort there.

Frankly, Munro added, there really is something to the notion of “what stupid SOB gets stuck with the assets” notion.

“There is something of a pecking order in the logistics industry, and yes, the less capable owners and managers often do often wind up with the worst, least profitable asset bases,” he said. Enough to make a living, perhaps, but not a great one.

Clearly, the potential to embrace an Accordion Logistics or Accordion Manufacturing (haven’t heard that term yet) strategy appears to make a lot of sense when there is tremendous overcapacity among service providers, as there is now. Will that always be these case?

Perhaps for a long while, and maybe indefinitely. Just take the asset-heavy trucking industry, for example. About every time things start to swing in the truckers’ favor, they immediately start individual company market share plays that collectively take rates right back down again, to the shippers’ delight.

There is also almost always an advantage to buyer over seller, so I suppose that is another factor in making this work, though it says the outsourcers’ returns may in fact be lower than that of their customers, unless they really are exceptional at “sweating” those assets, as Munro says.

It is a fascinating topic to me – on the logistics side, this noting of “flex manufacturing” has been around for a long while. “Accordion Logistics” is much newer – we’ll explore this in more detail soon. But I will just say here companies really need to be sure just how expandable that accordion is.

Finally, as I learned well at two manufacturers I worked for early in my career, the fixed versus variable question isn’t so clear cut. More variable costs are great when volumes decrease in a down turn, but when times are booming a more fixed cost structure can deliver some huge profits (think highly automated DC, for example).

This is a question simply at the “core” of supply chain strategy.

What’s your reaction to Gilmore’s comments? Do you expect the drive to shed supply chain assets will continue and even increase? How do you analyze this at your company/clients? Let us know your thoughts at the Feedback button below.

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What were the "three V's of supply chain" first articulated in the mid-1990s by then Gartner  analyst Art Mesher, now CEO of Descartes Systems Group?

Visibility, Velocity, and Variability.