New growth opportunities and risks along with pressure to increase competitiveness and efficiency all pose fulfillment challenges for supply chain executives. Should they build new logistical capabilities or partner with providers that have them? This paper offers seven considerations to weigh when making that decision.
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Supply chain pros are continually faced with new challenges. These include supporting new growth opportunities, building resilience to potential risks, and increasing competitiveness and efficiencies, among others. Each challenge presents a range of possible solutions, many of them costly. In many cases, the first question a supply chain executive must consider is whether to build the required logistical capabilities or partner with providers that have them? With that in mind, this paper will offer seven considerations to weigh when making that decision.
The Outsourcing Alternative in Fulfillment
According to the 2023 Third Party Logistics report from the Council of Supply Chain Management Professionals, 55% of companies surveyed expect to increase their use 2 of outsourced fulfillment partners. This isn’t surprising, considering third-party logistics providers, or 3PLs, have built robust physical networks and invested in sophisticated information technology, allowing them to provide services efficiently and to respond quickly to market conditions.
But outsourcing is a big decision, particularly for manufacturers that have managed their own product receiving, storage and shipping in the past. Many logistics managers at manufacturing companies that are expanding into new markets are being asked by senior executives for the pros and cons of outsourcing versus expanding their in-house fulfillment operations.
This white paper is designed to concisely summarize the key issues manufacturers will want to consider as they make this important decision. We’ll look at seven questions that many manufacturers will want to consider:
- Cost: What will it cost to build and manage additional fulfillment operations versus outsourcing those operations to a third-party logistics provider, or 3PL?
- Expertise: Do we have the internal capabilities to meet the demands of a new type of customer, or would a 3PL do it better?
- Control: What would it take to ensure a 3PL provides the level of customer service I expect and the flexibility my company will need as our business evolves?
- Geographic reach: If new sales channels require fulfilling orders nationwide, are we better off taking on that ourselves or turning to a provider with an existing national distribution network?
- Infrastructure and labor: What new capabilities do we need to service new sales channels? What would it cost to acquire those capabilities, versus using a 3PL with existing equipment, labor, and facilities?
- Information technology: With data playing an ever-bigger role in efficient fulfillment, what are the IT requirements of an in-house fulfillment operation for a new sales channel? What integration challenges might we face if we work with a third party?
- Seasonality: If we expect sales peaks in a new sales channel, will we be as able to handle those order surges as well as a 3PL could?
Let’s look at each of these questions.
There are costs associated with both building or leasing distribution centers a manufacturer would operate itself and with outsourcing fulfillment to a 3PL. Those costs are growing because of increased demand for warehouse space and rapidly rising labor costs.
Ecommerce accounts for a big part of that growing demand for warehouse space. ProLogis, a developer of industrial facilities, says warehouses dedicated to fulfilling online orders require three times more space than those shipping bulk orders to accommodate the picking and packing of orders of varying sizes and to handle returns.
The dramatic growth of online purchasing by both consumers and businesses during the pandemic dramatically increased warehouse space demand. In fact, the U.S. vacancy rate for industrial real estate declined to a record low of 3.9% in mid-2022, according to Plante Moran, a tax and real estate advisory firm. As new buildings came online, the vacancy rate increased to 5.2% by the third quarter of 2023, but Plante Morgan predicts robust demand will keep that rate below the 20-year average of 7.3%.
When demand outpaces supply, prices go up. Rent for industrial space, which includes warehouses, averaged $7.51 in September 2023, an increase of 7.4% from the prior year, according to CommercialEdge, a unit of Yardi Systems Inc., a provider of property-management software.
Whether a manufacturer decides to buy or build fulfillment capacity, it will be dealing with costs that are rising due to higher demand.
What it Costs to Build a Warehouse
What’s the price tag for building a new warehouse? It varies based on many factors, including the size of the building. Construction company Division 9 Commercial Inc. provided the following estimates in March 2023:
- 10,000-square-foot warehouse: $125,000 to
- 50,000 square feet: $750,000 to $1 million
- 100,000 square feet: $1 million
And project costs can be much higher depending on location and the sophistication of the material handling equipment, racking, technology, and other features of the distribution center.
For example, Van Trust Real Estate announced plans in late 2022 to build a 1 million-square-foot distribution center near Jacksonville, Florida, at a cost of $52 million. Seventeen Amazon DCs of at least 1 million square feet each require between $75 million and $100 million of capital investment, estimates location-advisory firm Site Selection Group.
There is a myriad of costs beyond land, labor and materials that go into any large construction project. For a distribution center these costs would include:
- Legal advice
- Architectural and engineering services
- Planning and project management
- Regulatory compliance (safety, hazardous materials, perishable goods)
- Canopies on loading docks to protect merchandise and workers from weather conditions.
- Internet and information technology
What 3PL’s Charge For Their Services
While the costs of building distribution centers may be daunting, they must be compared to the costs associated with outsourcing fulfillment. Third-party logistics providers typically charge every time they move a client’s product as well as for storage space.
The accompanying chart provides a summary of how 3PLs typically charge for their services.
3PL Pricing: An overview
There are three main elements of all 3PL pricing: Inbound, Storage and Outbound. There may also be charges in such other areas as Value-Added Services, Freight, Account Management and Technology.
Most pricing is per unit and based on an activity, such as receiving or shipping a carton or pallet. But in some instances, pricing can be hourly. Hourly pricing should be a last resort for a customer, as it does not guarantee a fixed rate for work accomplished by the 3PL. Instead, charges by the hour can vary based on the efficiency of the person performing the work.
It is important to remember that all pricing will vary by geography and volume of the account.
These are charges to bring a customer’s inventory into a warehouse. When charged as an activity, pricing could vary depending upon the unit or ship mode being received.
- Pallet (Single SKU)
- Floor Loaded Container
These are charges to store the product in the facility until the product is shipped. Charges can either be by location, stocking unit or cubic feet of product.
- Full Carton
- Cubic Feet
These are charges to ship the product and are applied by the unit shipped. There also can be additional charges per order along with packaging (over boxing) if required. Pricing can also be added up to make one flat rate per order or carton shipped.
- Each Picks
- Carton Picks
- Pallet Picks
- Order Charges
- Corrugate or Pallet Supplies
These are usually more custom and will require the customer to give a detailed description of the process needed. Examples could be additional labeling, product prep, kitting, etc. It is more common to charge an hourly rate for these services, especially in the beginning of working with a 3PL, until they understand the process.
- Hourly Rate
These are fixed charges to support a customer by a 3PL. They cover business reviews, dedicated support and customer service related to the customer. It’s important to note that some 3PL’s may not charge an account management fee but still provide these services as a cost of doing business. This could relate to the size of the account or the desire to roll this cost into other areas of pricing.
Customers can choose to use the freight plan of their 3PL provider. In many instances the 3PL will have better freight rates for small parcel carriers, LTL (less than truckload) or truckload shipments than a customer could provide on their own.
Depending on the complexity of a customer’s needs in relation to setting up connections with the 3PL provider there could be additional charges. This could cover EDI, APIs, or any custom development work by the 3PL on behalf of the customer.
- Hourly Rate
A manufacturer can limit expenses by working with a 3PL that charges only for space used, says Adam Gleason, manager of Essendant Fulfillment Services, the outsourced logistics unit of Essendant Inc., which also is a major distributor of office supplies, JanSan, and industrial products.
For example, some 3PLs charge storage fees for each pallet, regardless of whether there is one carton or 60 on the pallet. Others offer the option of paying by the “cube,” the actual volume of product stored, and thus would charge less for a single carton versus 60. Gleason notes a manufacturer can also benefit from the large volumes shipped by a 3PL. Essendant, he says, gets volume discounts from carriers based on the total it ships for all clients, and a client might as a result get lower rates through a 3PL like Essendant than it could based on its own volume.
Also, when a company builds or leases a facility it’s paying for the entire structure, when it might not need that much space, says Tim Engstrom, senior vice president of supply chain at Essendant.
“If I really need 210,000 square feet and the most suitable building available is 320,000, I may have to take the entire building if the landlord is not willing to sublet part of it,” Engstrom says. “That increases my operating costs.”
In short, while 3PLs must add their profit margin to the services they offer, there may be instances where they provide services at a lower overall cost than a manufacturer can on its own.
There’s always a learning curve when expanding into a new line of business. And that includes learning to fulfill orders in new ways.
Manufacturers typically have well-established procedures for receiving large quantities of products from suppliers and shipping pallets or truckloads to business customers. Whether they manage logistics internally or outsource it to partners, they have lots of experience in negotiating contracts, measuring performance, and making decisions on when to invest in new infrastructure.
But their experience, technology and infrastructure may be lacking when it comes to selling in new ways. Here are five common scenarios facing manufacturers today:
- Selling direct to consumer via manufacturer websites: Many manufacturers are taking advantage of the opportunity to sell directly to shoppers via websites and online marketplaces. But that means shipping orders of a single or a few items, instead of cartons or pallets. Warehouses designed to move pallets often are ill-suited for picking and packing small orders. Nor are they designed to handle returns of individual items.
Plus, consumers now expect websites to tell them whether an item is in stock and when they can expect it. And they increasingly expect the item they’re ordering today to be delivered in a few days, whereas business customers often place orders on a set cadence and expect deliveries on an agreed-on schedule, such as once a week. That kind of schedule might accommodate a 5-day workweek for fulfillment personnel, whereas retail commerce might require 6- or even 7-day operations.
- Selling direct to consumer via marketplaces: Online marketplaces, such as those operated by Amazon, Walmart and eBay, account for 60% of U.S. online retail sales, according to Digital Commerce 360. And many manufacturers are selling on these big shopping sites, which can be especially useful for liquidating excess or aging inventory.
But each of these marketplaces has specific rules for how sellers communicate with the marketplace operator, the kinds of labels that appear on packages, order accuracy, delivery times and more. Meeting those requirements can impose unanticipated costs for a manufacturer that’s not sold this way before. Some 3PLs can manage those relationships on behalf of manufacturer clients.
- Drop-shipping: Increasingly, retailers and distributors, seeking to minimize the inventory they hold, are asking suppliers to drop-ship items directly to customers. That way they can hold only the most popular items but still offer customers a broad range of merchandise. A manufacturer may choose to store some inventory with a 3PL with experience in handling drop-ship orders, rather than seeking to add that capability to its distribution centers geared to bulk orders.
- B2B ecommerce: Business buyers are purchasing more online, just as consumers are. This provides a cost-effective way for manufacturers to reach more business customers, as those buyers can serve themselves by placing orders online, rather than speaking with manufacturers’ sales reps. But manufacturers with large minimum order requirements may drive away businesses that want to place smaller orders. As with handling direct-to-consumer orders, turning fulfillment of smaller B2B orders to a 3PL may make more sense for a manufacturer than revamping its distribution operations to manage such orders.
- New product lines: Manufacturers often expand by introducing adjacent products. Zach Zalowitz, a principal in the order management solutions group—digital practice at consulting firm Perficient Inc., cites the example of a footwear manufacturer that added apparel items but wasn’t confident it could accurately predict sales. Outsourcing fulfillment can be a way to minimize risk when a company is unsure about how much it will sell, and the new products require specialized handling. With that in mind, Zalowitz says, “they may decide to use a 3PL for one or more of those new lines, since the demand isn’t fully understood yet and the products have specific pick/pack requirements.”
There are many more facets to fulfillment, but these examples illustrate the kind of expertise a manufacturer may need as it enters new sales channels. The question for a manufacturer becomes whether it wants to make fulfillment a core competency.
“If fulfillment is going to be a manufacturer’s competency, it’s also an organizational commitment to understand the most efficient way to deliver products to the end-user, while attempting to remain as agile as possible,” says Schneider of B2B-Squared.
The alternative is for the manufacturer to outsource fulfillment of orders from new sales channels to 3PLs that already have developed that expertise.
If fulfillment is going to be a manufacturer’s competency, it’s also an organizational commitment to understand the most efficient way to deliver products to the end-user, while attempting to remain as agile as possible.
Schneider | B2B-Squared
When a manufacturer manages fulfillment in-house it controls how much it spends and the technology it uses and can react if performance falls short of its goals. When a 3PL manages fulfillment, a manufacturer no longer has total control, and that’s a concern for many companies.
But 3PLs are aware their clients want assurance that they will get the level of service they want at the prices they’ve budgeted. Logistics providers consequently are prepared to include provisions in contracts to ensure clients get the service levels and pricing they expect.
Contracts with 3PLs often include “out” clauses that allow clients to cancel a contract after providing required notice, such as 90 days in advance of ending the contract, according to Chris James, senior director of fulfillment operations at Essendant. Pricing can also be guaranteed for a specified period, he says.
Service-level agreements can also be negotiated to mandate performance on several key metrics of fulfillment, including:
- Order accuracy
- On-time delivery
- Inventory accuracy
- Damaged goods percentage
- Missed shipment rate.
- Returns-handling efficiency.
A successful 3PL relationship must afford the manufacturer continuous and accurate visibility into the inventory in the partner’s facilities and delivery status, says Schneider of B2B-Squared.
“That might be easier to understand and control when a manufacturer builds and operates its own fulfillment centers,” he says. “But, for those leveraging 3PL models, it’s key to have full visibility and hold partners accountable for performance.”
Recognizing that clients want that kind of visibility, Essendant provides customers with an online portal that gives them access to all the data about their inventory and orders, Gleason says.
“If they want to know what’s in inventory, where is a particular package, with our robust system they have that at their fingertips,” he says.
It’s hard to give up control. But 3PLs recognize that concern and often offer the kind of visibility that enables clients to stay on top of their business and make changes when needed to adapt to market conditions.
For those leveraging 3PL models, it’s key to have full visibility and hold partners accountable for performance.
Schneider | B2B-Squared
#4: Geographic Reach
A manufacturer shipping truckloads of product to large customers may be able to cover the entire United States with just one or a handful of distribution centers. But that model doesn’t work as well when fulfilling online orders directly to consumers.
That’s because online shoppers increasingly demand free and fast shipping. And both are expensive to offer without having inventory in warehouses across the country.
Orders shipped to consumers in California from a manufacturer’s warehouse in North Carolina will cross many delivery zones, and carriers charge more for each zone traversed. Given that free shipping is the top delivery demand of consumers, a manufacturer selling direct to consumers must seek to minimize delivery expense so that offering free shipping is not prohibitively expensive.
It’s also noteworthy that consumers increasingly expect fast delivery. 68% cited that as a top-5 delivery differentiator in a July 2023 survey by Digital Commerce 360 and Bizrate Insights. That’s significantly more than the 44% who cited delivery speed as important two years earlier.
The requirement to provide both free and fast shipping is often what leads manufacturers to add distribution centers, says Zalowitz of Perficient. “At the distribution network level, the expansion is typically more a function of increasing speed-ofdelivery, while trying to avoid too many zone-skips during fulfillment,” he says.
But for a manufacturer to build its own nationwide network of distribution centers would require a major capital investment.
Larger 3PLs have dozens of warehouses across the U.S. and can place inventory strategically so that it’s near a manufacturer’s core markets, without requiring that every item is stored in every facility. For manufacturers selling online, whether to consumers or small business buyers who frequently behave like consumers, the broad geographic reach of a logistic partner’s network can be a major advantage.
#5: Infrastructure and Labor
Fulfillment operations require buildings, material handling equipment, racks, conveyor belts and frequently sophisticated technology to manage and automate order flow. It also requires workers and truck drivers to move products.
All of that is expensive and requires management time to oversee. Any manufacturer deciding how to fulfill orders from a new sales channel or product line will want to carefully evaluate all those costs and compare them to the fees charged by 3PLs for their services.
A company planning to make a new type of product must consider any new requirements for storing and moving that product. For example, if the product is very heavy, it will require forklifts and racks capable of handling that weight. Hazardous materials may require inspections by government agencies and specialized insurance. The same is true for perishable food items, chemicals, and cosmetics.
A manufacturer can make the investment to handle fulfillment of such products. But it might find that there are 3PLs that already have made those investments and can handle such items at a lower cost. That’s particularly true if a manufacturer ism testing the waters of a new product and wants to measure demand before making a big capital outlay.
In direct-to-consumer fulfillment operations, infrastructure today often includes robotics and other advanced technology that reduces the cost of picking and packing orders.
“Instead of forklifts moving pallets, you may need robots putting merchandise into totes moving down computer-guided conveyor belts,” says James of Essendant. “That’s expensive to build, but you need that kind of efficiency to be competitive.”
Outsourcing such a direct-to-consumer operation may be especially attractive for manufacturers that generate 80-90% of their revenue through their traditional wholesale businesses. The manufacturer could continue to manage wholesale fulfillment internally, while using a 3PL to handle delivery to consumers. That way the manufacturer gets an incremental revenue stream without tying up a lot of capital.
Labor Shortages Impact Fulfillment
Managing people is an increasingly challenging part of fulfillment now that the U.S. unemployment rate has fallen to historic lows.
Logistics managers are keenly aware of this challenge, according to the 2023 Third Party Logistics study produced by the Council of Supply Chain Management Professionals, a trade association.
78% of shippers surveyed for the survey and 56% of 3PLs said labor shortages are impacting their supply chain operations. And 27% of shippers and 29% of 3PLs believe this reflects a permanent shift rather than a temporary anomaly.
Particularly acute are the shortages of truck drivers and mechanics.
“The truck driver shortage remains a top concern in the trucking industry, reaching an all-time high for the industry of 80,000 drivers,” the CSCMP study says. It also notes a Bureau of Labor Statistics prediction that there will be more than 28,000 openings for diesel service technicians and mechanics for each of the next 10 years.
Manufacturers that expand their internal fulfillment operations take on those labor headaches themselves, while those that outsource can let 3PLs deal with this challenge.
#6: Information Technology
A manufacturer committed to operating a state of-the-art fulfillment operation will need a great deal of advanced equipment and software. If it outsources fulfillment, its inventory, order, planning, and customer management systems will have to exchange data efficiently with the 3PL’s systems.
Either way, IT is a big part of fulfillment. Most companies already have warehouse management systems, software that translates orders into action items for warehouse personnel. Among many other tasks, a WMS might sort orders by priority and organize picking instructions for each order by product location within the facility.
The addition of computer-driven conveyors and automated sorting and retrieval systems requires a new kind of software to manage that equipment, often called warehouse control systems (WCS). An even more advanced kind of software, a warehouse execution system (WES), manages labor as well as equipment.
As an example, material-handling consulting firm Conveyco says a WES might recognize one of five zones in a distribution center has fallen behind in picking orders and assign that zone orders that would be easier for the workers and equipment in that area to pick until the zone catches up.
All this technology falls within the buy-versus-build discussion. Many 3PLs have invested in it, whereas a manufacturer building a new facility would have to invest in it.
There are also new requirements that come from selling into new sales channel. For example, consumers expect websites where they shop, including those of manufacturers, to show inventory availability, when they can expect an order to arrive and shipping costs. Those are capabilities that may not be built into the order management system of a manufacturer that until now has only sold truckloads to wholesale customers.
In general, 3PLs are ahead of companies that ship goods—manufacturers, distributors, wholesalers, and retailers—when it comes to IT investments, according to a Kearney analysis of a 2022 study by NTT Data, Penn State and Penske. For example, 51.5% of 3PLs can access real-time supply chain data compared to 31.5% of shippers.
Those technology investments enable 3PLs to help clients improve their own operations. In a 2022 CSCMP survey, 71% of shippers said their fulfillment partners provided new and innovative ways to improve logistics effectiveness.
Integration with 3PLs
A manufacturer that decides to outsource fulfillment will have to integrate its systems with those of the logistics partner. That includes mapping data from the manufacturer’s enterprise resource planning (ERP), order management and other systems so that they can send data to the provider and receive information in return.
The good news, says James of Essendant, is that “3PLs are pretty adept at this as they’ve done it before.” He says a major 3PL would have experience working with the ERP, order management and warehouse management systems many manufacturers use.
But he advises manufacturers that engage a 3PL to allow adequate time for the two companies to integrate their systems and perform testing before going live. “A really fast integration can happen in 60 days,” he says, “but it’s better to allow 90.”
Manufacturers can smooth out wholesale fulfillment operations by collaborating with customers to predict demand and set shipping schedules. But that’s not the case when selling online.
Any manufacturer operating an ecommerce site open to all visitors is likely to see sharp swings in orders based on seasonality and shifts in trends. A pop star showing up at the Grammys wearing attentiongrabbling earrings can drive sudden demand for similar products, while an impending blizzard can empty warehouses of emergency generators overnight.
A manufacturer operating its own fulfillment network must find ways to store significantly more inventory than usual during peak seasons and arrange for the workers, trucks, and other equipment to fulfill orders.
3PLs with extensive warehouse networks often can accommodate a manufacturer’s peak season needs. Contracts can be written to guarantee a manufacturer additional storage space only during peak seasons.
“The risk is far lower when using a 3PL that does this all the time,” says Gleason of Essendant. “With a
partner, storage and replenishment can change with the ebb and flow of your demand. If you have a peak in the summer, you can change your replenishment pattern, increase inventory for four months, then go back down. When you own a building, you’re static. You’re stuck with that space.”
Conclusion: Resilience Takes Precedence Over Cost
CSCMP’s 2023 State of Logistics report includes a warning to supply chain executives: Don’t underestimate the magnitude of change or assume that things will go back to normal post-pandemic.
All the factors that contributed to the supply chain disruptions of recent years—from the shifts in customer buying patterns to geopolitical tensions—are ongoing. And that requires new thinking about supply chain operations and a resetting of priorities.
“The age of building supply chains just around cost-reduction considerations is over,” the CSCMP report says. “A new value has taken center stage: resilience.”
There are more risks, but also new sales opportunities. It’s in the context of this environment of rapid change that manufacturers must weigh whether tooutsource fulfillment.There is no answer that’s right for all companies. But one conclusion seems clear: The more a company’s new fulfillment needs mirror its existing operations, the stronger the argument is for expanding internal fulfillment capacity.
But the converse is also true: The more a manufacturer’s new requirements diverge from its current operations, the more sense it makes to consider collaborating with companies that already have the infrastructure and expertise to handle the new lines of business.
The outsourcing decision should be made as part of crafting a plan that assumes there will be unexpected shocks as well as new opportunities. The manufacturers that succeed will be those that most effectively leverage their internal strengths while finding dependable partners that offer complementary capabilities.