Applying My One Big Thing in 3PL Management to The "Capacity Crisis"

Yesterday I blogged about the "One Big thing" for managing your 3PLs.  This was essentially ensuring the incentives and goals of the 3PL perfectly align with you as the shipper.  I talked about how no one can really serve two masters and each will always act in their own best interest.  It is for this reason those interests have to be perfectly aligned.

Today I want to explain this through an example which highlights the risks of letting your 3PL buy the transportation and then charge a "mark up" over the rate to you (with no transparency this is a disaster with some transparency it is just not good).  We can see this in the "Capacity Crisis" issue. 

The 3Pl / brokerage company has an incentive to report to you the capacity crisis is bad and getting worse.  In fact, they can even blame their own poor performance in tender discipline, carrier management and routing guide compliance to this nebulous issue called the "coming capacity crisis".  They can point to a few reports and tell you if you only would pay more you would be a preferred customer of the underlying transportation companies. 

They convince you and you pony up.  All the while this is going on they are negotiating with the carriers and their story is something completely different.  Why?  Because your goals are not aligned!  The 3PL in this situation has a goal to expand the spread between what they pay for the transportation and what they resell it to you for.  While it appears they are giving "advice" to you what they are actually doing is working to improve this spread.  What are you to do about this as a shipper. A few things:

1. As I have said before, I highly recommend you do not get into this situation in the first place; keep procurement in house and let the 3PL execute.
2. If you have already outsourced procurement, work hard to insource it!
3. If those two do not work then become extremely smart in what is happening in the transportation market.  The 3PL cannot be your trusted advisor because they have another set of incentives.  You need to build that expertise in house.  For example, when they talk about "capacity shortfall" ask them:
• In what lanes is this shortfall prevalent?  Do I ship in those lanes
• What about mode conversion?
• What  are you doing to reduce my fuel costs and make my fuel costs more aligned to what you are actually paying for fuel?
• What is your carrier base?  Have you looked at regional carriers?
• What are you doing to leverage your spend to keep my rates down?  (if you are hiring this expertise you expect they will not just perform at market but below market - remember, market price is what you get without even trying)

In the end you can see this type of relationship actually causes more work rather than saves work.  You will not only pay for the outsourcing but you will also have to employ a "shadow" organization just to ensure you are getting a competitive deal. 

Again, unless you do not believe in the basic tenants of capitalism you have to see where this relationship is fraught with misalignment and conflict.  In this case, the 3PL will use a market event (or non event) not to better your business but to better theirs at the expense of yours.

When Selecting a 3PL Ensure Your Goals and Incentives are Aligned

As I travel and speak to industry leaders I am always asked about strategies for shippers to manage their 3PL relationships.  There are many theories from transactional "beat them down" relationships (which I do not advocate) to the "Vested Outsourcing" espoused by Kate Vitasek (Which I believe is a great framework for how to manage any third party relationship).  And, of course, there is everything in between. 

While a great strategy to manage these relationships is a subject too complex for a blog posting, and usually too complex for my short discussion, I do get asked "what is the one thing" they can do.  Well, here it is:

The One Thing: - Align Goals and Incentives

Let me start with my philosophy on human behavior and one which is built into the DNA of a capitalist society. People will always act in their own self interest.  Think about this as you develop your relationships and let me use an example totally outside of our industry -  Financial advising.  There are two broad categories of financial advisers:  Those who work for a fee for which you pay and those who get commissions, 12b-1 fees, rewards etc. from the products they are selling.  The latter looks like a good deal because you do not pay the up front fee.  But is it a good deal?

When we apply my general philosophy of people will always act in their self interest  to this case the answer becomes clear.  The financial planner who is considered "free" has an incentive to sell to you the product which will make them the most amount of money - and they will.  Two products, one of which if sold gives her and her family a free trip to Hawaii v. another which gives her just a few bucks commission are the selection.  Which do you think she will sell to you?  If you picked Hawaii, you are right.  

Now, the former advisor, the one who you pay a fee for has a fiduciary responsibility to work in your best interest. In fact, because you are their sole source of income, they have no incentive to provide anything to you that is not in your best interest.  The only way their income continues is if you are happy and that only comes if they work in your best interest.  In this case the goals and incentives are aligned.

Let's apply my philosophy (again, it is people will always act in their self interest) to the world of the 3PL and specifically to the outsource model of transportation management.  I see many models where both the operations and the procurement of transportation have been outsourced.  The key question here is whether the goals and incentives are aligned when you are in a relationship where the 3PL essentially acts as a broker for you. 

Imagine that the "broker" 3PL relationship comes across a way to lower your overall transportation costs knowing however that it will eat into their margin on the spread they make between what they are selling transportation to you for and what they are buying it for.  In this situation they have a choice to make:  Will they act in your best interest  or will they act in their own self interest?  Both my guiding principle philosophy and my experience is that the answer is clear: The 3PL, when confronted with a conflict between their self interest and the client's, will almost always choose their self interest first. This is especially true if they have shareholders (whether public or private) to report to.  Why would they do anything different.

However, if their goals and incentives are aligned - such as the my recommended solution which is the shipper should always retain the procurement process in house and NEVER outsource this part of it - then the 3PL will never be put in this conflict situation.  You pay them for a service and they execute that service.  

The critical point here is the 3PL should not make money on both sides of the transaction.  As soon as that is the case, they will be in conflict. The only way the 3PL should be able to make money is by acting in the client's best interest.  In other words, they have a sole and singular fiduciary responsibility and that is to you the shipper. 

This is "The one thing".  If you are a shipper who has outsourced your procurement to a 3PL you should think again and ask yourselves what is driving the 3PL thought process (By the way this also applies to "dedicated" fleets who make money leasing equipment to you - are they working in your best interest or in the best interest of the profitability of their leasing operation).

I am not one to quote the Bible much in public but, if you do not believe me about this then listen to what Matthew has to say:

"No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other. You cannot serve both God and money."

In my case change the last sentence to: You cannot serve both sides of the transaction.  

The Rush to Brokerage

Much like the early '80s there appears to be a rush to brokerage going on in the transportation industry. While I still feel eventually the asset players will rule (eventually someone has to provide a truck or container) I do think this new breed of brokers is something to watch.

In reality, as I have written before, they are not really brokers in the old sense of the word.  While they are not full 3PLs (because most strictly deal with transportation) they are starting to get more into the over all supply chain management beyond just calling for trucks.  Some shippers are sole sourcing to these new breed of brokers as a way to essentially outsource their transportation.

One which bears watching (and I highlighted back in November of 2012) is XPO logistics and Seeking Alpha just published a great review of this company (XPO Logistics Has Huge Ambitions but Wall Street Has Real Doubts)  along with some interesting statistics about the industry.  Some highlights on the industry:

1. A $40bl - $50bl industry
2. Growing at twice the pace of GDP
3. Very fragmented with over 10,000 (brokers) and the top 25 companies have less than 40% of the revenue. 

This last statistic is the reason XPO is essentially trying to grow incredibly fast through both "cold starts" but also a lot of acquisition.  My guess is there will be a lot more acquisition in the near future for this company which, as Seeking Alpha states, makes it very interesting and very risky.

The biggest risk I see in this strategy (beyond running out of money, being leveraged and what happens in a downturn) is the risk that the acquisitions will come too fast and data will be missed.  Echo Global logistics is now suing over this where they purchased a company and now believe data was misrepresented.  Also, we all know the Hewlett Packard story.  

Time will tell if this strategy is right and as I have said for a while now that the truck brokerage business is far more interesting than it has been in a long time.  However, at the end of the day, someone has to own and operate a truck which tells me this idea of "everyone being a broker" model cannot sustain itself long term.  

Perhaps we should call this what it is which is essentially the outsourcing of shipper transportation departments.  

Companies Mentioned in this Post:  

XPO Logistics

Echo Global Logistics

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XPO Logistics - Insane Growth?

I just read a great article on XPO logistics which is growing their brokerage business very dramatically. I have been close to this company since it was just Express-1 and the leadership had the foresight to see the potential growth in brokerage.  They started this business at exactly the right time and now it is the fastest growing part of the business.

As you can see from the graph below (Source: Seeking Alpha) the revenues from brokerage are really taking off.  The other key point I draw from this graph is they have a really nice mix of business.

XPO Logistics

I think this is a company to watch very closely and it is at a major point.  They clearly have shown they have the capability to bring in acquisitions and grow the revenue.  Like most companies in a major growth period they are losing money but I do believe in the leadership and the strategy of the company.  

As a shipper, I have always loved doing business with companies in this sweet spot.  Big enough to do what I need them to do, they are willing to invest and yet they are small enough that you are a big player in their portfolio.  You generally get much better attention and you have the ability to be a core customer regardless of size. 

I could be wrong but I had the same feeling about Coyote Logistics when it was much smaller and so my intuition tends to be pretty good on these things.  Watch XPO.

The New Face of Brokerage

I have really stayed away from endorsing certain companies just because I want to discuss more macro issues in the logistics industry however I will break with tradition for this post.  I am seeing a trend develop with brokers where it is not your "father's broker" anymore.  They truly are becoming logistics experts who do more than just "dial for diesels".

One such company I have talked to many times is Coyote Logistics. This company is young, aggressive, extremely smart and a leader in technology.  They listen and understand your needs then formulate solutions.

I say this because people who have been in the industry a long time (include me in this!) have a mindset of "no brokers".  We remember the days of brokers just calling and wanting your freight but taking no ownership in true logistics solutions.  They were "brokers" in ever sense of the word:  matching up buyers and sellers and that was it.  After meeting Coyote I can tell you the model I described above is dead.  Long live the new generation of brokers!

As a shipper you may want to look at companies such as Coyote to manage certain segments, certain promotional events, moves or even your full transportation needs.  It is not a one size fits all and there are reasons to use these new breed of brokers and reasons not to.  However, I would tell you that if you still have the mindset of "brokers are bad" I highly suggest you call Coyote and see if this new breed can change your mind.  It certainly did mine.