Thoughts on Retailers Buying XPO Logistics and What The Right Strategy Should Be

I generally do not like to comment on something so speculative however Friday ended with a huge bang in the supply chain industry with Amazon and a major retailer apparently thinking of buying XPO logistics.  I was asked by many what I thought of this so let me give you some pre-holiday thoughts:

First, this is a very normal activity as companies go upstream and downstream in the value chain to try to capture as much as they can in that chain.  Remember your business classes:  The value chain starts essentially at the extraction of raw materials and ends with the consumer (some say it goes through post consumption disposal and return of unconsumed raw materials to Mother Earth.  I agree with that however let's leave that alone for now.).  In between extraction and consumer you have activities such as transport of raw materials, conversion of raw materials to something of value, transportation to distribution, merchandising (either on line or in store) and final mile delivery (whether completed by the consumer or completed by the seller) to the point of use (the home).

Three things you will notice in that scenario:

1. Conversion is very specific to a good.  Meaning, it is not fungible and if you wanted to capture that portion of the value chain you would have to buy a lot of companies.  You may want to vertically integrate a very high margin company but not all of it.
2. Transportation is pervasive across the value chain all the way back to the raw materials movements to the final mile.
3. Delivery Final mile (v. customer pick up) is growing rapidly and it touches the consumer.  This makes Final Mile transportation part of the merchandising and consumer touch point process - and this is why retailers want to vertically integrate. The impact of final mile on the consumer experience and consumer loyalty is huge.  

There is one other dynamic happening right now and that is the current capacity crunch.  Rather than get into an "arms race" of ever increasing rates, the retailer may decide to just buy their own capacity and this is another reason to get the "Elephant Gun" out and look for carriers to buy.  

If the retailer is thinking they want to capture the final mile and protect themselves against the capacity crunch, they could do a number of things:

1. Buy technology to facilitate the final mile but not buy the assets.  Think Target's acquisition of Grand Junction.  Or their more recent acquisition of Shipt for grocery shipping.  Even Wal-Mart's acquisition of Jet.com would be part of facilitating this process.  (The biggest issue with the Wal-Mart acquisition was one of culture - Wal-Mart eliminated Jet's long standing practicing of having drinks and happy hours in the office.  That since has been reinstated).
2. Buy transportation assets and make them "in house" assets.  This is where the discussion of buying XPO comes in.
3. Build the transportation assets yourself - i.e., Amazon's acquisition of planes and doing "power only" where Amazon owns the trailers, are examples of this.  Many retailers follow this power only model.  The benefit of this is you can swap carriers pretty quickly and you can leverage small carriers since the retailer owns the trailer.  The problem with this strategy is the "crunch" is with the power not with the trailer.
4. Develop "Vested" relationships which give the specific retailer "most favored nation" status with one or more asset providers.  While this idea is championed by Kate Vitasek at University of Tennessee (read about this concept at The Vested Way) it really was "founded" in the logistics industry by the infamous J.B. Hunt agreement with the BNSF.  This gave J.B. Hunt a preferred status with BNSF which, to this day, makes it impossible for other carriers to really compete with JBH.  For the most part, the rest of the industry fights over what JBH does not want.  If JBH wants it, they win. 
5. Work within financial risk mitigation constructs. An interesting new development is to protect capacity (does not really help with final mile) by participating in the new futures exchange developed by Craig Fuller called TransRisk.  This will definitely assist with the stabilization of rates and capacity however it is at least one year away from implementation  and, while I absolutely think it will work, it is unproven.  

There are hybrids of all of these however these are the major actions a retailer could take to capture more of the value in the value chain and mitigate capacity risk.  Number 2 above, Buy Assets, has garnished all the excitement going into Christmas weekend.  My quick thoughts:

1. No one is buying XPO and if they did the Government would stop it.  XPO, as it currently is constructed, is too big and would have too big of an impact on industry assets to allow one retailer or on-line provider to buy it.
2. They could split XPO up and buy pieces of it.  While this would probably make it easier to get through government regulators, I believe this action would be value destroying not value creating.  For example, the final mile portion of XPO was created by XPO acquiring a company called 3PD.  3PD are executives who came out of retail and therefore just "putting it back" could be possible.  Combine 3PD with the final mile technology of Optima (which is a final mile technology company XPO purchased back in 2013) and you may have a platform for a good final mile service.
   
   However, don't forget, neither XPO, 3PD or Optima own the transportation assets. They merely find, qualify and route.  The "work" is still outsourced to smaller delivery companies and therefore this would be more of an example of buy technology  (along with getting very good people) versus buying transportation assets.
   
   The big question this would leave is what happens to the rest of XPO?  Is it just a carcass laying out there to be pecked at by private equity investors? Does Brad Jacobs still run it?  Are the pieces as valuable as the whole?  I think not.  I think the value of each piece of XPO diminishes significantly as other pieces get sold off. This is why I believe splitting XPO up would be value destroying not value creating (unless, of course, the buyer of a piece is willing to either pay a huge premium for the portion they buy or be willing to immediately divest of certain portions of the "carcass")

I think the logical action for retailers is to concentrate heavily on #1 (Buy Technology) along with #4

 (Develop Vested Relationships).  I would also heavily participate in #5 (Work within financial risk mitigation constructs) once it becomes available. 

Interestingly, and somewhat off the radar, this is what Target appears to be doing (after hiring Preston Mosier and Arthur Valdez from Amazon).  Perhaps everyone, including Amazon, should be focused more on what is happening in Minnesota.

Have a very happy holiday season!

If You Expect Your 3PL to Invest, You Have to Commit

I have been doing a lot of thinking lately on the state of the 3PL industry.  I have not worked in the industry for a number of years but I have been a consumer of it and I have stayed very close to those in the industry.  What always amazes me is the turnover in 3PLs.  They are used, bid out, then discarded at a moment's notice.  I also hear over and over again from customers of 3PLs that the 3PLs they use do not invest in technology and people as much as they should. This caused me to ask why?

This feedback has been around for ages on 3PLs and I always wondered why it has not been addressed.  In fact, I would say the industry has really run away from what was true 3PL work and the brokerage industry has co-opted the term 3PL for itself.  3PLs today are mostly just brokerage houses.

So, why all this talk of "partnerships" yet bidding still happens at a torrid pace to reduce costs. A consumer of 3PL services should ask themselves the following questions when looking for cost reduction:

1. How will value truly be created?  Remember, taking money out of one pocket and putting it in another does not add value to the extended supply chain.  This activity will just merely reallocate the value which is already there.
   
2. Is the value truly sustainable?  For example, building cost reduction from paying below market wages is simply not sustainable.  Something will give.  Yet, I hear consumers of services say things such as " I don't care how they do it, just do it".
   
3. Are the governance structures supporting the relationship aligned with the overall goals of the program?  Too many times I hear the terms "partnership" and "vested relationships" yet when you look deeply at the contracts and the governance structure, it becomes clear the relationship does not support overall value creation.  

I am sure most reading this will say "not me..." but reality is that this covers 99% of the relationships which exist out in the industry.  How do we know?  Just look at portfolio turnover of the 3PL and look at duration of contracts.  Both suggest that what I am stating above is true.  

So, what can a consumer of 3PL services (warehousing, transportation brokerage etc.) do to ensure the 3PL you are working with is going to be a true value added partner?  Here are a few ideas:

1. Make contracts long enough for the 3PL to recover investments.  We ask the 3PL to invest in huge amounts of capital (technology, buildings, automation) yet we write the contract for 3 years. Imagine how expensive this is if the 3PL has to recover this investment in 3 years!
   
2. Build a payment structure that allows the 3PL to gain from applying innovation.  If the payments are fixed, why would the 3PL invest in innovation?  They need to benefit from this and there are payment structures which allow that to happen.
   
3. Build a management governance structure which ensures the 3PL can survive.  For example, in fast growing wage environments, do you really want the 3PL to keep wages low and thus attract the not so best employees?  That is what they will be forced to do if you do not have a structure which allows for real business decisions such as raising wages and everyone sharing in that cost.  

The bottom line is apply all the same values and principles you have in running your company to the 3PL.  I think you will find the 3PL will invest, will apply innovation and will, in the long run, add huge value.  If you bid every few years you are not partnering and not adding value, you are just shifting money from pocket to pocket.  

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 Value of S&OP in Logistics

I have been talking a lot at various events recently on the value of Sales and Operations Planning to the logistician and specifically to those managing transportation.  I have found many so called "great" S&OP processes stop at the end of the factory and just assume unlimited capacity and capability from the distribution arm of the supply chain.  Very few look holistically at the entire chain from raw materials to the consumer and most just look at their particular part of it with some input from upstream and downstream suppliers.

This should and must change. The S&OP process is critical to the proper execution of the logistics' plans of a company.  It is also vital to give your carriers a decent forecast on the capacity needed at a time in the future.  I will remark more on this later in a post soon however I do want to remark on Kevin O'Marah's comments relative to the core aspect of S&OP - Trust.

Even the core of Vested Outsourcing  is built on trust.  In S&OP Gotcha: Bad Collaboration, Kevin discusses how egos and the desire to "win" ultimately can kill a good S&OP process.  Before entering into a true S&OP collaborative process across the virtual enterprise (this includes all participants in the supply chain) you have to agree on core principles and on trust.  If one is trying to get "leverage" over another then I truly believe it is a waste of time to enter into a S&OP process.  Just understand the situation you are in and make the best of it.  The core ideas to S&OP are:

1. Each trusts each other's data.  If you feel data is manipulated or hidden, you are starting at a weak point right from the beginning. 
2. Each agrees the "solution" is what is right for the ultimate end user - the consumer. 
3. Each agrees the "solution" has to be profitable for all.  No one will stay entered in a relationship if it is not profitable.  There is nothing wrong with this.  Where it goes wrong is where one side withholds information or changes information to gain profits at the expense of the other. 
4. Each agrees to open book sharing.  If key data is withheld then it just will not be possible, long term, to maintain a solid S&OP process. 

For the logistician, the output of this has to then tie to capacity requirements, possibilities and constraints of the logistics network.  One cannot assume whatever the outcome of the core S&OP process can be executed without constraint.  That is a recipe for failure. 

Logisticians need to force their way into the S&OP process of a company and make their voice known.