SUPPLY CHAIN MANAGEMENT

FOCUS ON
LOGISTICS

Resources are tight and customer expectations are high,

which means that logistics has never been more important to an
organization’s success, profitability and ability to serve its customers.
In this special digital edition of Supply Chain Management Review,
we focus on getting the most from your logistics organization.
 SUPPLY CHAIN MANAGEMENT
welcome
FOCUS ON LOGISTICS
Focus On Logistics
contents In a growing
economy, where
State of strategic transportation sourcing resources are tight
What’s so strategic about transportation sourcing? Read on. and customer
expectations are
State of logistics: Accelerating into uncertainty high, transporta-
Buffeted by crosswinds, logistics is accelerating into uncertainty. tion, warehousing
and distribution have never been
Get better 3PL bids more important to an organization’s
A cost-effective 3PL agreement can be a game changer, with the right terms.
success, profitability and ability to
serve its customers. And as we all
Transportation’s tricky balancing act know, the market is putting a pre-
Economies of scale can lower a carrier’s average costs. The trick is
getting the right balance. mium on all three.
In this special digital edition from
Transportation trends: The last mile, history repeating Supply Chain Management Review,
Look beyond the hype around last mile delivery, you’ll find it’s been done before. we’re bringing together the best of
our recent stories on logistics, rang-
Fighting Amazon’s supply chain takeover ing from how to get better 3PL bids
The online retailer is positioned to buy space on container ships at wholesale to ways to compete with Amazon
rates and resell at retail rates. Here’s how you can compete.
on logistics to a look at autonomous
vehicles. We hope you’ll find them
How they did it: Service and price come together useful as you put a focus on your
Knorr-Bremse Asia Pacific Ltd. created a rating system that links the performance of its
logistics providers with their bids for transportation lanes. The result will surprise you. logistics.

NextGen supply chain: We gonna rock down to electric avenue?

The transportation industry is worried about the likes of Uber. We should be
watching the electric vehicle space.

Bob Trebilcock, Editorial Director

Transportation management systems expand in Comments? e-mail me at
NextGen supply chains: btrebilcock@peerlessmedia.com
This is a time of innovation in TMS as the software.

Editorial Staff
Michael A. Levans Bridget McCrea Peerless Media, LLC
Group Editorial Director Contributing Editor, Brian Ceraolo
Technology President and Group Publisher
Bob Trebilcock
Executive Editor Maida Napolitano Kenneth Moyes
Contributing Editor, President and CEO
Francis J. Quinn
Warehousing & DC EH Publishing, Inc.
Editorial Advisor
John D. Schulz
Patrick Burnson Editorial Office
Contributing Editor,
Executive Editor 111 Speen Street, Suite 200
Transportation
Sarah Petrie Framingham, MA 01701-2000
Executive Managing Editor Christopher Lewis 1-800-375-8015
Creative Director
Jeff Berman
Group News Editor Wendy DelCampo
Art Director
John Kerr
Contributing Editor, CMYK GRAYSCALE B/W
Global Logistics
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Strategic Transportation Sourcing

State of Strategic
Transportation Sourcing
Strategic
sourcing
in general
provides
the policies,
guidelines and
processes
for operative
sourcing, i.e.
purchasing.
So, what is
strategic about
sourcing?
BY PATRICK BURNSON,
EXECUTIVE EDITOR

T
oday, it’s more than just about price. But how do
shippers put together a transportation and supplier
sourcing strategy that will earn them the capacity that
they need aat a price that works for all parties? Fortunately,
for the past year industry analysts and thought leaders have
been sharing strategic transportation sourcing tips designed to
develop a collaborative solution.
Strategic sourcing in general provides the policies, guide-
lines and processes for operative sourcing, i.e. purchasing. So,
what is strategic about sourcing?
According to Jurgen Anke, a research analyst based in
Dresden, Germany with expertise in IoT (internet of things),
logistics managers must first have a strategic goal. This means
aiming to reduce overall spending, reduce dependency on
suppliers with high bargaining power, and to improve security
of supply with their transportation partners.
“To get a handle on this, you look at your suppliers, the
goods and transportation services you buy, as well as the pur-
chasing organization and its controlling factors,” he says.
The tools required for that are spending analysis (who
spends how much on what?), supplier management (from
whom do I buy what?), contract management (which frame-
work contracts do I have with which conditions, to what
extent are they utilized and when do they expire?).
To manage these tools logistics managers must first
develop strategies related to local and domestic sourcing
while weighing the risks and advantages of global sourcing;
single vs. multiple sourcing; and just-in-time vs. case-by-
case vs. stock procurement.
“It is important to find the right mix of price, security and
dependency related to the importance and spending of a cer-
tain good or transportation service,” says Anke. “Finding the
right suppliers can then be supported with approaches like
reverse auctioning.”
Reverse Risks
In its basic form, a reverse auction is an online, real-time
dynamic auction between a buying organization and a group
of pre-qualified suppliers who compete against each other
to win the business to supply goods or services that have

4 FOCUS ON LOGISTICS scmr.com

clearly defined specifications for design, quantity, quality, slice of the pie,” he says.
delivery, and related terms and conditions. His argument is that procurement should be involved
According to analysts at CAPS Research in Tempe, AZ, in all areas, including revenue activities that can
these suppliers compete by bidding against each other enhance a supply chain’s responsiveness to customers,
online over the Internet using specialized software by sub- especially in transportation.
mitting successively lower priced bids during a scheduled “What we’re really talking about is transforming procure-
time period. This time period is usually only about an hour, ment from a paper- pushing, back office function to a strate-
but multiple, brief extensions are usually allowed if bidders gic value creator,” he adds.
are still active at the end of the initial time period.
The process is facilitated both directly and indirectly by Trusted Advisor
a number of converging internal and external developments For analysts at The Hackett Group – an intellectual prop-
and forces, including: erty-based strategic consultancy based in Chicago – the
• Widespread ability for buyers and suppliers to economically ultimate measure of procurement’s performance is its ability
communicate in real time, worldwide, via the Internet. to support the company’s strategic sourcing and overall busi-
• Development of robust, user-friendly Internet-based soft- ness strategy. Becoming a “trusted advisor” is key.
ware systems to support worldwide reverse auction events that “This will require some procurement organizations to
are either hosted by a third party or designed to be run by the make far more than incremental improvements,” allows
buying company with little or no outside assistance. Patrick Connaughton, Hackett’s Senior Research Director.
• Recent order-of-magnitude improvements in quality and cycle- “As procurement’s operating budget is expected to grow
time reductions have resulted by just 1.1% this year, it can
in buying companies perceiving To manage these tools logistics managers afford to fund only a select
superior quality and service must first develop strategies related to local few of its highest- priority
as “givens.” Thus, they have
and domestic sourcing while weighing the initiatives.”
shifted their emphasis toward According to The Hackett
low price as a major sourcing
risks and advantages of global sourcing; Group’s 2016 Key Issues
decision variable. single vs. multiple sourcing; and just-in-time Study, virtually all companies
The birth and accep- vs. case-by-case vs. stock procurement. will be facing economic head-
tance of reverse auction winds and other challenges in
tools has not been without controversy, however. This 2016. Finding new sources of revenue growth remains
is because, for some, its process is contradictory to the difficult, resulting in pressure to protect margins through
long-term benefits associated with collaborative/coop- cost control.
erative buyer-supplier alliances. “This in turn is straining business services functions’ bud-
“While reverse auctions might be a useful tool for the stra- gets,” says Christopher S. Sawchuk, Hackett’s Principal &
tegic sourcing process in some situations, it’s too often used in Global Procurement Advisory Practice Leader. “Our study
lieu of negotiations management techniques,” says Robert A. found enterprise cost takeout is the most prevalent initiative
Rudzki a former Fortune 500 Senior Vice President & Chief on the business agenda, but all the priorities identified can
Procurement Officer, who is now President of Greybeard be viewed as defensively-oriented. To support the enterprise
Advisors LLC, a leading provider of advisory services for pro- agenda, procurement functions must continue to increase
curement transformation and strategic sourcing. their own efficiency, upgrade their talent, become more
According to Rudzki, strategic sourcing has the capabil- agile, and ensure that their strategy is in line with that of the
ity to impact the four drivers of Return on Invested Capi- company as a whole.”
tal, or ROIC, and Cash Flow. Against this backdrop, the study findings reveal a
“Those drivers are revenue, cost, working capital, and change in procurement’s priorities from last year, when
capital expenditures. When we work on all four of those elevating its role to a trusted advisor was top-ranked. In
things simultaneously, we can have a huge impact on the 2016, reducing purchase costs placed slightly higher on the
ROIC of the company. The problem is that most procure- list. Balancing these sometimes conflicting goals will be
ment departments are responsible for a relatively small difficult this year, add analysts.

scmr.com FOCUS ON LOGISTICS 5

Strategic Transportation Sourcing
Elevating the role of procurement to that of a “trusted
advisor” is not an easy, analysts admit. They note that
attaining this position is dependent on a new type of tal-
ent: one comfortable with technology, able to speak the
language of the business, and politically adept enough to
navigate complex organizations in order to drive change.
“Exceptionally-trusted advisors are not always the ones
bringing the most innovative or transformational solutions
to the table. In fact, when asked to name the most impor-
tant characteristic of a trusted advisor, 77% of respondents
chose “consistently delivering on the basics,” says Saw-
chuk. “The message is that in 2016, while procurement is
building out its strategy to upgrade its role, it must not lose
focus on its day-to-day responsibilities.
Big Data Considerations
When asked to identify the trend with the greatest poten-
tial impact on the way procurement does it job over the
next decade, the majority of the Hackett Group study par-
ticipants chose predictive analytics or forecasting.
Analysts observe that as procurement’s role matures
from transactional facilitator to trusted business advisor,
proficiency with the next generation of analytics – a.k.a.
“big data” – will be a key enabler. Big data, they say, has
been a game changer when it comes to customer analyt-
ics, offering an unprecedented ability to quickly model
massive volumes of structured and unstructured data
from multiple sources.
Donna Wilcek, vice president and VP of product mar-
keting for Coupa – a cloud-based spend management soft-
ware company based in San Mateo, CA, agrees, noting that
too much “noise” can be overwhelming.
“We believe that suppliers and transportation partners
must work with your company to drill down through all
the data and create a sourcing event,” she says. “Everyone
from the CFO on down the command chain should have
access to this transparency, so that risk is mitigated and
costs are contained.”
“State-of-the-art” sourcing solution for all modes of
transportation has never been a more difficult proposition,
say anlaysts. Transportation sourcing, including carrier
contract negotiations, is a complex, large-scale function,
often not well supported by a Transportation Management
System (TMS) or ERP suite.
Logistics procurement strategies also vary by transpor-
6 FOCUS ON LOGISTICS
tation mode, whether truckload sourcing, LTL sourcing,
ocean sourcing, air freight sourcing, or multi-modal trans-
portation procurement. Transportation buyers should look
at both price and non-price bid information from carriers,
in order to make the best possible and lowest risk decision.
Coupa’s recent whitepaper, Understanding the Sourcing
Organization Maturity Model, posits that “immature” mod-
els may not have much of a process for project planning at
all– sourcing projects are handled on an ad hoc basis.
“As sourcing organizations move up the maturity ladder,
projects are managed centrally but still may not be planned
upfront,” says Andy Chiang, ‎Director of Product Manage-
ment at Coupa.
Further up the ladder, says Chiang, sourcing projects
are strategically planned out and results are reported to
the CEO. The best-in- class companies are continuously
updating their category knowledge and spend information,
and feeding that back into the sourcing process.
“Another aspect of sourcing maturity is the process for exe-
cuting sourcing projects and when it’s used,” he adds. “Often
companies in the early stages of development don’t even have
a standard sourcing process defined. As companies mature
they establish a standard strategic sourcing process.”
Companies at the strategic stage of development are
incorporating TCO and other risk factors into the sourcing
process in order to effectively evaluate their supply base,
analysts agree.
The best-in-class Sourcing Organizations have a stan-
dard set of key performance indicators or KPIs that include
things like savings goals and spend under management,
which are continuously updated and reported, and which
drive action from both the buyer and the supplier.
The goal for best-in-class organizations is to achieve
95% spend classified, with 95% accuracy. The only way to
achieve this is to employ technology.
“Technology is the underpinning that supports the
process and people, so that the organization can become
best-in-class,” says Andrew Bartolini, Chief Research
Officer of Ardent Partners, a Boston-based strategic
sourcing consultancy. “
Without solid technology, Sourcing Organizations can
only hope to reach the reactive stage of development.
Regarding e-Sourcing software. “If you’re doing strategic
sourcing, I think you have to strip out the word ‘strategic’ if
you’re doing offline sourcing today.” •
scmr.com
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State of Logistics

Accelerating
into uncertainty
Buffeted by crosswinds as the pace of change accelerates,
the logistics industry is accelerating into uncertainty.

I
BY SEAN MONAHAN AND ndustries churning with economic and political
MICHAEL ZIMMERMAN disruption. Technology and innovation undermin-
ing old business models. Consumers demanding
immediacy, personalization and convenience. These
are just some of the insights revealed in
the Council of Supply Chain Manage-
“It behooves us to adapt ourselves ment Professionals’ “2017 State of Logis-
to the times if one wants to enjoy tics Report” authored by A.T. Kearney.
continued good fortune.” Buffeted by crosswinds as the pace of
—Niccolo Machiavelli (1469-1527) change accelerates, the logistics industry
is accelerating into uncertainty. As the year
Sean Monahan is a partner
closes, the geopolitical arena is sending an array
and global lead for the
of mixed signals that vexes decision-makers, who
Operations and Performance
see consumer confidence rise while GDP growth
Transformation practice
disappoints, and government officials struggling to
at management consulting
take clear action related to growth, infrastructure
firm A.T. Kearney. He is
and trade policy. The industry appears destined for
based in New York and
a prolonged bout of cognitive dissonance, coupling
can be reached at Sean.
frustration over subpar growth with the optimism
Monahan@atkearney.com.
reflected in rising stock market values, technology
Michael Zimmerman is a
investments and consumer confidence data.
partner and Americas lead
As company leaders weigh options in a fast-chang-
for the Analytics practice
ing business environment, they also face increasing
at management consulting
political risk. Rising protectionist sentiment around
firm A.T. Kearney. He is
the world threatens to constrict global trade flows, the
based in New York and can
lifeblood of logistics. Political decisions on tax relief,
be reached at Michael.
regulatory reform and trade restrictions will all have
Zimmerman@atkearney.com.
an impact on logistics. A.T. Kearney identifies four
scenarios that have the potential to significantly affect
profitability, and even the future viability of some
logistics sectors (see Figure 1).

8 FOCUS ON LOGISTICS scmr.com

scmr.com FOCUS ON LOGISTICS 9
 State of Logistics

Scenario 1: Plain sailing. With trade barriers and onerous ments focus on established solutions that face fewer regula-
regulations minimized, a truly frictionless market emerges tory hurdles, such as truck platooning and clean-fuel vehi-
and competition among carriers drives down costs. Ship- cles. Carriers that can’t afford such investments fall behind.
pers benefit from lower costs and better service as carriers Scenario 4: In the doldrums. Restrictive U.S. trade policies
differentiate themselves through innovation. Investment create strong headwinds for carriers while tough economic
in supporting infrastructure is essential, but regulators try conditions impede adoption of new technology that might
to balance safety and sustainability with business-friendly improve matters. A price-slashing race to the bottom ensues,
leaving only the financially strongest
FIGURE 1
carriers standing as overall volume in
Four scenarios
the industry declines. Shippers benefit
Free trade
from lower prices at first but eventu-
STEMMING THE TIDE PLAIN SAILING ally face higher rates as carrier attrition
Growing trade and stringent A barrier-free open market
regulation will accelerate the adoption will increase competitiveness
reduces industry capacity and import
of disruptive technology and automation among carriers across modes costs rise. Some carriers with financial
Global trade policy

wherewithal turn to technology to

Restrictive

Lenient
U.S regulatory environment survive, adopting productivity-boosting
tools such as predictive analytics and
IN THE DOLDRUMS CHOPPY WATERS
Tough investment and operating Boosting American production
connected vehicles.
conditions will raise costs and will bring shifts in modal volumes Each of these potential scenarios
hinder technological advancements but no major logistics growth
carries distinct and specific implica-
Protectionism tions for various US logistics stake-
Source: A.T. Kearney analysis holders, but the likely new impact
of any possible outcome is unclear.
deregulation. Meanwhile, powerful incentives to reduce Forecasting the future is always difficult, especially when
trade inefficiencies spur adoption of new technologies an unsettled political environment makes it hard to pre-
like blockchain-enabled “smart contracts.” dict the likelihood, breadth and speed of potential policy
Scenario 2: Choppy waters. A renewed emphasis on Ameri- changes. As we look to the future, supply chain manage-
can manufacturing and labor revives domestic industries ment professionals must weigh current macroeconomic
such as heavy manufacturing and steel. The unique logis- factors affecting logistics with their own state of prepared-
tical needs of these industries lead to modal shifts: Rail ness, and uncover ways to accelerate opportunities.
traffic increases while cross-border trucking and port activ-
ity decline as import tariffs and other trade barriers force Optimism amid uncertainty
companies to source more raw materials and components The International Monetary Fund predicts 3.5% worldwide
domestically. Carriers scramble to adjust their service offer- economic growth in 2017 as prospects brighten in key
ings and assets, and shippers prepare for possible supply developed and emerging markets. Stronger performance in
disruptions as carriers navigate the shift. From a technology the United States is a big factor in global growth expecta-
perspective, “Uberization” of freight accelerates, taking on tions. Resurgent domestic demand has lifted growth as
a key role in realigning inflexible freight networks to serve a incomes have risen, job prospects improved, household
growing domestic manufacturing base. wealth increased and inflation remained low. Consumer
Scenario 3: Stemming the tide. Tighter regulations on emis- spending has averaged 4.5% monthly growth since last fall,
sions and driving hours—perhaps accompanied by the and the National Retail Federation forecasts 3.7 to 4.2%
unionization of truck owner-operators—boost shipping costs retail growth in 2017. Retailers account for a big share of
and possibly diminish service levels. But rising global trade business at third-party logistics providers, while surging
volumes motivate major carriers to pump capital into new digital sales channels drive growth at parcel delivery com-
technologies that reduce costs for shippers. Initial invest- panies and others involved in e-commerce fulfillment.

10 FOCUS ON LOGISTICS scmr.com

Table 1. Logistic Sector Highlights
Motor Carriers Results through Q3, compounded by hurricane-driven demand spikes, support carrier optimism as rates con-
tinued to rise. Carriers expect rates will continue to firm up well into 2018 as stronger economic growth helps to
reduce excess capacity.

Shipper-Carrier Advanced technologies and better processes are reshaping business models and redefining relationships.
Relationships Methods such as multiple-round annual bidding, closer collaboration on best lane and load allocation, and
detailed feedback drive efficiencies. More shippers are embracing Dedicated Contract Carriage (DCC) arrange-
ments that lock in capacity, rates and service levels while mitigating potential service disruptions caused by
regulatory changes, but they are also expecting DCC providers to leverage technology and their networks to
monetize backhauls.

Parcel E-commerce has turned parcel delivery into the hottest logistics sector. Parcel volumes rose 6% last year as
online retailers flooded delivery networks with small packages destined for individual consumers in their houses,
apartments, offices, and dorm rooms. The surge shows no sign of abating, and forecasters predict parcel ship-
ping revenues will climb to $93 billion by 2019 from $78 billion in 2015. Unprecedented growth has altered
parcel industry relationships. For example, Amazon is UPS’s largest customer, but the online retailing giant
launched its own delivery service in 2016. Traditional parcel carriers stand to lose significant volumes as ship-
pers expand in-house logistics operations.

Rail Despite revenue and volume declines, operating ratios are improving as railroads focused on productivity; ser-
vice levels went up and railroads reduced dwell times and increased train speeds.

Water Waterborne shipping rates fluctuated dramatically in a tumultuous year. Carriers have managed to hold onto a
good portion of improved rates in 2017 by idling ships and accelerating scrapping to constrain capacity. But, if
history is any guide, capacity discipline will crumble as carriers continue building ever-larger ships that swamp
the market with new supply and send prices plunging.

Air Freight Demand is expected to be strong for the next five years, powered by e-commerce and pharmaceutical ship-
ments. Such pricey cargo is the lifeblood of air freight, which represents less than 1% of global shipping vol-
umes last year but more than one-third of total value. Air freight depends heavily on international trade making
it susceptible to increased protectionist sentiment around the world. To offset depressed load factors, freighter
airlines are developing innovative cost-cutting tactics, such as dedicated hubs at smaller airports that offer
lower freight handling fees and greater scheduling flexibility.

Pipeline The midstream oil and gas pipeline industry retrenched last year as volumes and rates flattened out under pres-
sure from substandard oil prices. With leaner cost structures, improving industry fundamentals, and favorable
political conditions, pipeline companies can grow profitably at lower prices.

Freight Business is on the verge of disruption as global economic trends pressure profit margins while new competitors
Forwarding and technologies undermine longstanding business models. Outsiders including technology giants IBM, Verizon
and T-Systems see an opportunity to disrupt the largely paper-based freight forwarding industry by offering cut-
ting edge digital capabilities unavailable from most forwarders. E-commerce powerhouses Alibaba and Amazon
are inviting other shippers to help fill space in their cargo containers, cutting forwarders out of the loop.

Third-Party Third-party Logistics is evolving away from a transactional business model focused on discrete services such
Logistics as transportation management or warehousing and toward a one-stop-shop for end-to-end logistics solutions.
The demand for one-stop logistics services is strongest among small companies that spend less than $30 mil-
lion a year on logistics and large shippers that spend more than $300 million. Smaller shippers say one-stop
shops offer access to larger volumes across various transportation modes, while large shippers hope single-
source providers can better manage complex worldwide logistics networks and global P&L requirements.

Warehousing Operators are turning to new technologies to meet the demand as e-commerce surges. Many are also design-
ing seamless inventory systems that integrate warehouse fulfillment across various customer purchasing chan-
nels to create omnichannel delivery capabilities. Widespread adoption of fulfillment methods such as ship-from-
store and in-store pickup of online orders is improving inventory allocation, speed-to-market and peak-season
variability management.

scmr.com FOCUS ON LOGISTICS 11

State of Logistics
Consumer sentiment is up, but 2017 GDP remains dis-
appointing despite recent optimism based on second and
third quarter results. Orders for non-defense capital goods
(a proxy for business investment) edged down in 2016
even as business confidence indicators remained sky-high.
However, the positive trend since the first half of 2016
continues to reflect growing optimism. Business inventory-
to-sales ratios have remained relatively stable as companies
appear uncertain about future demand. Continued uncer-
tainty over future economic trends impedes longer-term
planning throughout the supply chain, forcing companies
to continuously monitor inventory levels and exacerbating
month-to-month fluctuations in freight volumes.
Adapting logistics while preparing for disruption
Overall spending on logistics dropped despite a rise in
energy prices. This marks the second straight year in which
the two have moved in opposite directions, indicating
energy prices are no longer the primary factor in logistics
costs. This year reinforces the powerful impact of rising
consumer demand for e-commerce deliveries. While over-
all transportation costs fell .7% last year, spending on pack-
age delivery services jumped 10%. Parcel and express deliv-
ery has surpassed railroads as the second-largest logistics
sector behind motor freight. Meanwhile, energy-sensitive
pipelines and railroads saw rates and volumes stall or drop
as oil prices remained at historically low levels despite the
upturn in 2016. Cross-currents also affected inventory
carrying costs last year. Storage expenditures rose 1.8%
and are now as important as the financial carrying cost of
inventory, and are expected to keep growing as available
space grows scarcer.
There are common trends driving the action across vari-
ous logistics sectors (see Table 1). Overcapacity and rate
pressures fueled cost-cutting and consolidation, particu-
larly among motor carriers and ocean freight companies.
Cutting-edge technologies brought new efficiencies to
sectors such as warehousing, parcel delivery and motor
freight. Along with technological advances came new busi-
ness models in third-party logistics, freight forwarding and
rail, among others. Parcel carriers and warehousing capi-
talized on surging e-commerce volumes to raise rates and
continued reconfiguring their networks to meet consumer
expectations for faster delivery.
Politics and government policy-making will have major
12 FOCUS ON LOGISTICS
positive or negative impacts on all logistics sectors. The
best scenario would see pro-growth measures enacted
quickly in the United States while political leaders around
the world reject protectionism and renew their commit-
ment to global trade flows that boost demand for logistics
services. In the worst scenario, the pro-business domestic
agenda stalls in Congress while import barriers spark trade
warfare, damaging the entire logistics industry.
Technological innovations enabling
next generation
While conflicting political signals leave shippers and logis-
tics providers with little clarity on economic fundamentals
as they make vital decisions about capacity, pricing and
strategy, one constant remains. Changing consumer trends
and innovations catalyzed by today’s nascent technology are
shaping the next-generation supply chain. Customers will
expect immediacy, personalization and convenience; new
technologies and advanced analytics will be the enablers.
A fluid, connected digital supply chain would allow
manufacturers and retailers to fulfill shipments from assem-
bly lines, warehouses, urban distribution centers and brick-
and-mortar stores. Inventory requirements may decline as
3-D printing enables manufacturers to fabricate spare parts
on demand and retailers to personalize merchandise for
individual customers. With shipping focused on same-day,
last-mile delivery, new vehicles such as sidewalk robots and
aerial drones would proliferate. Algorithms matching car-
rier or original equipment manufacturer assets to shippers’
needs would give rise to a ride-sharing model for long haul
shipping, further encouraging shared vehicle ownership
and reducing demand for vehicles. Carriers would invest in
sustainable assets that save money and resonate with envi-
ronmentally conscious consumers. Significant advances are
already taking root. The logistics community is developing a
wide range of next-generation capabilities that will disrupt
multiple modes of transportation (see Figure 2).
Connected vehicles and “Uberization” have the great-
est near-term disruptive potential. Several manufacturers
already produce connected trucks outfitted with hundreds
of sensors that collect and transmit vehicle performance
data, enabling carriers to increase uptime through predictive
maintenance. Energy efficient technologies and practices
have weakened the link between energy prices and logistics
costs, a trend likely to continue as electric powertrains and
scmr.com
FIGURE 2

Innovation grid: a 10-year outlook

Impact
High
Uber for trucks Fully autonomous trucks
Anticipatory logistics
Electric fleets
Hydrogen fuel cells
Semi-autonomous trucks Logistics
marketplace
Drone
Coopetition
Platooning and UAV
supply chain
On-demand delivery
Omnichannel On-demand 3-D printing
courier delivery logistics

Fleet monitoring Augmented reality

Medium Airless tires
system
Remote diagnostics
Tube logistics
OTA engine updates Cloud logistics Bionic enhancements

Warehouse sharing Circular

Predictive cruise control economy Multipurpose networks
Vehicle logistics
e-wallet

Low Timing
0 years 5 years 10+ years

Sharing economy IoT and analytics On-demand logistics Alternative energy Autonomous solutions

Notes: IoT is Internet of Things. UAV is unmanned aerial vehicle. OTA is over-the-air.

Source: A.T. Kearney analysis

hydrogen fuel cells create alternatives to gasoline-powered
vehicles. Several of these capabilities are coming on faster,
with greater potential to transform logistics.
Accelerating into the future
Logistics is moving toward a fully digital, connected and
flexible supply chain optimized for e-commerce and last-
mile, last-minute delivery. The next-generation supply
chain will enhance fulfillment capabilities and drive effi-
ciencies through technologies ranging from big data and
predictive analytics to artificial intelligence and robotics.
The industry must also reckon with the social cost of rapid
technological evolution as automation tempers employ-
ment growth or eliminates hundreds of thousands of tradi-
tional jobs in warehouses, trucking and other sectors.
The four scenarios each carry distinct and specific impli-
cations for US logistics stakeholders. Plain sailing assumes
regulatory constraints recede, global trade flourishes and
technology improves efficiency. Choppy waters anticipate
new policies favoring US manufacturing forcing shippers
and logistics companies to adapt, spurring faster adoption of
technologies. Stemming the tide brings tighter regulations
that increase operating expenses and accelerates investment
in cost-saving technologies. The last scenario, puts logistics
in the doldrums as regulatory costs rise and tough economic
conditions deter technology investments.
In this unsettled environment, the first step for any
shipper or carrier is to identify the major forces at play in
each scenario and articulate the most extreme manifesta-
tions of each, and how combinations of factors could influ-
ence your potential strategic responses. Next, consider
emerging technological innovations, regulation and trade
policy. While technology will shape the next-generation
supply chain over the long term, decisions by regulators
and policy-makers in the near term will determine the
speed and direction of its evolution. Identify which innova-
tions are most likely to influence your strategy and assess
the potential implications for rapid or delayed adoption.
Finally, create a flexible framework of well-informed stra-
tegic choices to guide decision-making. Although some
scenarios may seem more likely than others, successful
companies hope for the best-case scenario and prepare for
the worst-case scenario as they chart routes to growth in a
world accelerating toward a new era of uncertainty. •

scmr.com FOCUS ON LOGISTICS 13

3PL bids

Get better 3PL bids

Deanna M. Rainwater is a senior manager in Tata Consultancy Services’ Global Consulting Supply Chain Practice.
Alison Schoch is a business consultant in Tata Consultancy Services’ Global Consulting Supply Chain Practice.

Shantanu Ginodia is a business analyst working with Tata Consultancy Services’ Global Consulting Supply Chain
Practice. They can be reached at deanna.rainwater@tcs.com, alison.schoch@tcs.com and ginodia.shantanu@tcs.com.

14 FOCUS ON LOGISTICS scmr.com

 An improved business operating
model enabled through a cost-
effective 3PL agreement can
be a game changer if terms
are thoroughly evaluated and
properly negotiated.

T
he rapidly growing global market for
3PL services is forecasted to be worth
almost a trillion dollars by 2020. Not
only is the demand for services increasing year
over year, so too is the complexity of supply
chain services, creating unique challenges for
anyone trying to evaluate the pricing models
for 3PL warehousing and fulfillment services.
In this article, we will examine some of the
major obstacles faced by companies that pro-
cure these types of services along with provid-
ing options to improve current practices.
Specifically, we will provide insight into
ways to establish an improved and more com-
prehensive 3PL pricing evaluation methodol-
ogy to better analyze bid proposals and maxi-
mize 3PL contract terms and pricing for all
types of warehousing and distribution services.

3PL services on the rise

There are many reasons that companies are
more compelled than ever to outsource their
logistics needs to a third party whose core
competency is warehousing, transportation
and order fulfillment. For starts, ever rising
customer expectations for personalized ser-
vices, greater selection and speedy delivery are

BY DEANNA M. RAINWATER, ALISON SCHOCH

AND SHANTANU GINODIA

scmr.com FOCUS ON LOGISTICS 15

3PL bids

placing extra burdens on those companies that try to keep
order fulfillment in-house.
Furthermore, many companies need a means to increase
product distribution and scale more quickly or desire to
employ more innovative technologies to further optimize
their supply chains without necessarily investing time and
money in fixed assets, specialized systems and operational
infrastructure.
Entering new markets or introducing new product lines
can also lead to increased sales forecast risk and other
business ramp-up considerations that may be a better
match for a 3PL that already has the required expertise and
infrastructure (people, processes, systems) in a specific
geography or industry segment. By leveraging a 3PL pro-
vider’s geographic reach and shared infrastructure a 3PL
provider may be a more flexible and cost-effective solution
to reduce initial and ongoing business capital and opera-
tional expenditures.
Finally, an improved business-operating model enabled
through a cost-effective 3PL agreement for warehousing
and distribution services can help boost overall cash flows,
while also driving innovation and market competitiveness if
negotiated properly.
When to outsourcing
The decision criteria for selecting a new 3PL provider typi-
cally includes both qualitative and quantitative business
success factors.
While these may vary significantly from company to
company, many of the commonly used qualitative factors
companies consider before outsourcing include:
• service quality and reliability;
• flexibility and responsiveness;
• cultural fit and compatibility;
• security and safety;
• reputation and experience;
• trust and fairness;
• infrastructure capability (e.g. systems, facilities,
manpower);
• geographic coverage and locations;
• financial viability and stability; and
• logistics innovation (e.g. analytics, technology).
While these factors are all-important in the decision-
making process and the long-term suitability of the 3PL
provider, the quantitative area that includes the proposed
pricing terms and the bid comparison process between
logistics vendors is often inadequate.
By closely examining current 3PL provider selection
processes and capabilities and taking the necessary steps to
upgrade current bid evaluation tools and practices, a com-
pany can better optimize future agreements. An improved
bid review methodology and approach can also reduce the
risk of billing surprises, or of being stuck with a contract
that is ill suited or consists of inflexible pricing terms.

FIGURE 1

Understanding common 3PL contract types

CONTRACT TYPE CALCULATIONS PROS CONS

Actual costs + ▲ Quick transfer of management ▼ No incentive to reduce cost or increase productivity
Cost
management fee = ▲ Deal for complex processes with ▼ Requires constant monitoring/management
plus
COST no internal competency ▼ Unpredictable costs as volume fluctuates

Fixed costs + ▲ Fixed warehouse space ▼ Shared risk with 3PL

Fixed +
(profile volumes x and dedicated staff
variable ▼ Fixed cost as a percentage of sales increases
activity based rates) =
combination ▲ Incentive to increase productivity as volume decreases
COST

(Storage rates + ▲ Predictability of cost per UOM ▼ Potential higher activity rates due to increased risk to 3PL
Variable
activity based rates) x
(Activity based ▲ Incentive to increase productivity ▼ Inventory management is critical for low cost
profile volume =
costing) ▲ Limited financial risk to company ▼ Requires constant service
COST

Source: Authors

16 FOCUS ON LOGISTICS scmr.com

 FIGURE 2
By better understanding and
Shipping and receiving weekly volume comparison
quantifying the proposed 3PL
20,000
pricing terms up front, and by
18,000 Actual volume – 60,000
understanding the potential
16,000 Forecasted volume – 60,000
impacts of volume fluctuations

Volume
14,000
and other components such
12,000
as fixed price commitments,
10,000
companies can take more con- 8,000
trol in contract negotiations. 6,000
That leads to improved pricing Monday Tuesday Wednesday Thursday Friday

terms and a more competitive Source: Authors

cost structure for warehous-
ing and distribution services.
FIGURE 3
Enhancing these processes can
Shipping and receiving weekly labor costs comparison
also reduce the risk of entering
a sub-optimal, non-compet- $3,000 Forecasted cost
$2,800 $10,000 + 15% = $11,500
itive contract due to primary $2,600 Actual cost
Operating cost

emphasis on qualitative or sub- $2,400 $11,200 + 15% = $13,110

$2,200
jective factors. $2,000
Understanding common $1,800
$1,600
3PL contract types $1,400
The first step to exercising $1,200
$1,000
best practices in pricing analyt- Monday Tuesday Wednesday Thursday Friday
ics is to understand the multi- Source: Authors
ple types of contracts that 3PL
providers employ. The three
most common are Cost Plus, Fixed + Variable Combina- using the operational profile and business process flows
tion and Variable Cost (or Activity Based Costing). provided by the customer. These documents provide key vol-
A key input that 3PLs use to determine the proposed ume and product handling information that a 3PL correlates
terms is the operational profile provided by the potential to its operational work flows to approximate the required
customer. 3PLs develop their pricing proposal based on labor and operational costs. The 3PL’s profit margin is then
their anticipated costs and profit margin targets. Additional added to the simulated cost to generate a bid. Because the
services outside of the outlined requirements in the RFP 3PL ultimately determines how its operations are run and
may be provided to cover any other potential 3PL service factors such as volume can change throughout the year, it is
charges. By better understanding the three typical contract much harder for a customer to forecast and control its costs.
types and the pros and cons of each (summarized below), Figure 2 and Figure 3 illustrate one of the pitfalls of a
a company is better able to evaluate and select the pricing Cost Plus agreement. In Figure 2, we see that overall vol-
terms that are most cost effective for their specific busi- umes matched the forecast volumes, but with significant
ness model and cost objectives. Let’s look at each. daily volume fluctuations. The result, as is illustrated in
Figure 3, is those fluctuations resulted in higher than fore-
Cost Plus agreements cast labor costs.
Cost Plus contracts typically simulate the actual cost of As a result, Cost Plus contracts require considerable
managing the operations outlined in the RFP with a profit customer oversight to ensure that only permissible costs
margin included. The 3PL estimates its operational costs are charged and that the 3PL is complying with reason-

scmr.com FOCUS ON LOGISTICS 17

3PL bids

able cost controls. Striving for increased productivity gains Still, while these Variable Cost agreements
or decreasing the unit/case handling costs in future years types of contracts Variable or Activity Based
is not incentivized for the 3PL unless it is agreed upon may be costlier, Cost agreements are com-
upfront in the contract. Lastly, Cost Plus contracts with customers may pletely variable and fluctuate
unpredictable volumes can cause an increase in overall choose them for in relation to the volume.
operating cost even when the total volume forecasts are There are no fixed or mini-
startup operations,
accurate for a given period. mum costs that must be met,
Still, while these types of contracts may be costlier, cus-
for a business unit so the pricing is entirely
tomers may choose them for startup operations, for a busi- that is in transition based on the throughput
ness unit that is in transition or in situations where quality or in situations activities performed by the
is more important than the bottom line cost. where quality is 3PL. The pricing for each
more important 3PL service is clearly defined
Fixed + Variable Combination agreements than the bottom and often treated as a flat
As the name suggests, a Fixed + Variable Combination line cost. fee per transaction, such as
Cost agreement is a combination of fixed costs for operat- a cost for each case or unit
ing the facility and activity-based costing on a per unit handled. Because the total
basis in accordance to the volume and storage forecast cost is entirely dependent on volume, this type of con-
from the operational profile. tract has a lower financial risk for the customer.
The fixed costs usually pertain to the anticipated That said, a 3PL might set higher transactional rate to
overhead of the facility and often include the costs of mitigate the risk of a forecast error and maintain its profit
warehouse space and any dedicated management and margins. For that reason, customers should comparison
administrative personnel. This cost structure will, in shop and must include service level agreements (SLAs) to
most cases, lower the variable costs for the operational guarantee that quality levels are always maintained.
activities performed within the DC as the anticipated This type of contract is the most desired and sought
fixed costs have been broken out separately. If the com- after of the three due to the cost savings potential. It is also
pany exceeds its volume forecasts, the overall percent- one of the easiest to implement and enforce due to the
age increases in cost are lower due to the activity-based pricing structure.
component of the cost structure. Conversely, if the
company is well below its volume forecasts fixed costs as Apples to oranges
a percentage of sales can increase due to potential underuti- If an RFP is sent to multiple 3PL providers without spe-
lization of fixed assets. Additionally, unlike a Cost Plus agree- cific instructions and protocols that facilitate a consistent
ment, the 3PL is incentivized to increase productivity because response among vendors along with the preferred contract
it will improve its profit margins. type, the proposal comparison process may be like com-
While these types of contracts often result in less expense paring apples to oranges. Additionally, an incomplete RFP
than a Cost Plus agreement, they can still be risky due to the can result in incomplete bid responses prompting multiple
increased business forecast risks. For this reason, they may additional information or proposal clarification requests.
not be a good fit if there is business uncertainty, such as what To improve the effectiveness of the quantitative
occurs with mergers or divestitures. analysis of each 3PL bid, a well-defined methodology
Customers may prefer this contract type because it must be in place. This begins with a detailed and eas-
includes a more accurate reflection of services rendered and ily understood operational profile that links to a 3PL
actual expenses occurred, and a more realistic unit handling bid response template that the vendor must complete
prices as the 3PL does not have to build excessive overhead to submit their respective pricing terms and conditions.
into the handling rate to hedge potential losses related to their This response requirement enables the requesting com-
fixed costs. pany to perform an effective quantitative analysis with

18 FOCUS ON LOGISTICS scmr.com

scientific data driven insights—allowing for apples-to- The most effective trailer. Value-added services
apples comparisons. operational profile can also be a huge part of the
Some of the primary components that are critical to operational profile depending
captures all of the
completing a thorough financial analysis of each 3PL bid on the industry and specific
activities needed
include: products being handled.
• operational profile;
to receive, put Outbound order fulfillment
• bid response template; away, store, induct, requirements must also be
• sensitivity analysis; and receive orders and defined based on how prod-
• advanced analytics. ship out products uct is shipped to the cus-
to include any tomer and the average size of
Providing an operational profile required value- each order. As any company
As the name suggests, a detailed operational profile outlines added services transitioning to smaller and
specific functions that are needed to fulfill the company’s more frequent deliveries or
such as labeling or
distribution requirements categorized into multiple variables e-commerce knows, full pal-
kitting.
over the proposed contract period. These variables focus let orders are less costly to
on different activities within the warehouse from storage fill than mixed pallets, mixed
requirements to product handling and can include all or a cases and single line orders.
portion of a customer’s distribution network. Lastly, the operational profile should reflect the fore-
At a minimum, the operations profile should encompass casted volume for the requested duration of the 3PL
the following areas: contract. As 3PL contracts typically span multiple years, a
• inbound handling summary; company may need to forecast out three years to five years,
• outbound handling summary; projecting growth rates and business seasonality.
• customer returns volume;
• cross docking requirements; Get a consistent bid response
• value-added service requirements; The operational profile should closely correspond and link
• storage type requirements (e.g. ambient and to a bid response template that is included in the initial
temperate controlled); and RFP request. This template should be designed to cap-
• inventory levels (e.g. positions, square footage) ture all possible warehousing and distribution cost com-
Clearly outlined operational requirements give the bid- ponents, with clear instructions to ensure that all 3PL
ding 3PLs the ability to more accurately price out and respondents have an opportunity to provide all associated
roll up the total cost of the proposed operations. Most pricing terms details.
importantly, a 3PL will know how to staff its operations for There should be defined sections for both variable and
a fully functional facility. Sufficient information and under- fixed cost inputs for each function along with any company
standing also decreases the probability of a disruption to preferences regarding the type of pricing terms. Because
the customer’s business and shipments during the transi- variable pricing terms are typically the most cost-effective,
tion period to a new 3PL vendor. the bid response template can be built to encourage this
The most effective operational profile captures all of type of proposal response.
the activities needed to receive, put away, store, induct, The bid response process should be designed to permit
receive orders and ship out products to include any each 3PL bidder to input their pricing directly into the
required value-added services such as labeling or kitting. template or through a company designated web portal.
For example, there are different costs to receive and This practice helps enable the requesting company to
unload a trailer of product. Pallets of a uniform product receive more uniform, consistent and easily comparable
take less time and require less labor to unload, validate responses that are easier to analyze and compare. Without
and induct than a pallet of mixed SKUs or a floor-loaded this standardized bid response approach, it is often very

scmr.com FOCUS ON LOGISTICS 19

3PL bids

FIGURE 4
difficult or impossible to com-
Cost sensitivity analysis
pare the various 3PL bids as the
$2.00
terms and pricing typically vary $1.80

Cost per outbound unit

significantly. $1.60
$1.40
By developing an improved $1.20
process that leads to more uni- $1.00
$0.80
form responses, a company can $0.60
more quickly pinpoint any pric- $0.40
$0.20
ing anomalies and quickly clarify 0
those questions with the 3PL. -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50%

This standardization reduces Volume forecast variance

guesswork and ensures that each Source: Authors

outsourced function obtains

more competitive pricing over
the specified contract term.
Cost sensitivity analysis
By definition, sensitivity analysis is “the study of how the
uncertainty in the output of a mathematical model or
system (numerical or otherwise) can be apportioned to dif-
ferent sources of uncertainty in its inputs.” The aim is to
evaluate how uncertainty and potential changes to indepen-
dent variables such as operational volumes will affect the
total cost quoted by the 3PL vendors.
Because units and volumes are often calculated consid-
ering historical sales and forecasted growth, there is a very
low probability that these future forecasts will ever be 100%
accurate. For that reason, a sensitivity analysis needs to be
performed as part of the quantitative analysis. This analysis
provides a means to pragmatically assess the level of fluc-
tuation in the overall cost quoted by the 3PL vendor over a
wide variation in operational volumes.
By determining how the cost per handling unit varies
across a wide range of volume fluctuations, such as an
increase or decrease of 50%, a company can better assess
how costs will trend by 3PL vendors based on their pro-
posed pricing terms.
Additional benefits of conducting a sensitivity analysis
include:
• providing a means of considering the impacts of any
forecast error;
• accounting for any cost increases or decreases in spe-
cific volumes of activities;
• incorporating both fixed and variable cost of activities; and
• factoring in the cost impacts of any specified cost
minimum(s) specified by the 3PL, if any.
The result of a cost sensitivity analysis considering a
wide-range of volume forecast variances is illustrated in
Figure 4 below. The total cost and cost per unit is estimated
for a wide range of total volumes to include + / - 50%. The
forecast as depicted in the operations profile is the baseline
and assumes 0% error. By considering, a range of potential
increases or decreases in volume, a company can evaluate
the associated variances in cost and the overall viability of
any 3PL bids received.
Leveraging advanced analytics
Sensitivity analysis helps define a standardized meth-
odology for an apples-to-apples comparison between
different 3PL bids while providing insight into how any
changes in volume affects the overall cost to serve. It will
also depict how bid proposals that have high fixed cost
components may be cost prohibitive or riskier if volume
forecasts are not met or business conditions change. To
further enhance this analysis, a Monte Carlo simulation
may be employed to estimate variable costs.
Monte Carlo is an advanced analytics tool used to
approximate the probability of certain outcomes by run-
ning multiple trial runs, or simulations, using random
variables. It provides visibility to possible outcomes of
multiple scenarios and assesses the impact of risk and
allows for better decision making under uncertainty.
This methodology brings the analysis closer to real
world variations by incorporating flexibility in the vari-

20 FOCUS ON LOGISTICS scmr.com

 FIGURE 5
ables and making these
3PL vendor A – variable cost variation
variations independent of
$1,900,000
each other. For example,
$1,800,000
with X% change in outbound $1,700,000
volume, inbound volume can

Variable cost
$1,600,000
vary from - ∞ to +∞. This $1,500,000
concept helps determine the $1,400,000
average cost to serve by tak- $1,300,000

ing a simple average of mul- $1,200,000

$1,100,000
tiple variations and randomly
$1,000,000
assigning the percentage 0 50 100 150 200 250 300 350 400 450 500
change to every variable. Number of scenarios
A number of variable Source: Authors
inputs can be used to model
warehousing and distribu-
tion costs in a Monte Carlo FIGURE 6
simulation, ranging from the 3PL vendor A – variable cost probability
cost of purchase order pro- 50 100%
cessing to labeling charges 45 90%

Cumulative frequency
40 Frequency 80%
for value added services to 35 Cumulative 70%
Frequency

the cost of storing oversized 30 60%

25 50%
pallets in a cooler, to name 20 40%
a few. 15 30%
10 20%
By applying this approach, 5 10%
which may result in hun- 0 0%
1,291,763
1,314,775
1,337,786
1,360,798
1,383,810
1,406,821
1,429,833
1,452,844
1,475,856
1,498,868
1,521,879
1,544,891
1,567,902
1,590,914
1,613,926
1,636,937
1,659,949
1,682,960
1,705,972
1,728,983
1,751,995
1,775,007
1,798,018
1,821,030
1,844,041
1,867,053
dreds of iterations for each
scenario, a constant line will
emerge that will indicate the Costs
average total variable cost Source: Authors
that will most likely result.
In Figure 5, for instance, the
average total variable cost is 3PL bid process, a company needs to evaluate its exist-
estimated at $1.6 million. ing RFP processes and bid evaluation capabilities. Are
This analysis can also be expanded to help reduce they sufficient or is there a need for further guidance
the uncertainty and risk by analyzing the wide range and/or development of a clearly defined methodology
of variable costs calculated and the frequency of that is supported by templates and other bid evalua-
each occurrence. In Figure 6, it was estimated that in tion support tools? If improvement is needed, a com-
approximately 90% of the situations, the total variable pany may need to develop a 3PL playbook to establish
cost would be less than $1.8 million. defined procedures that reinforce desired bid evalua-
tion best practices and include supporting 3PL pricing
Bringing it together evaluation analytics. Employing these tools can help a
There is little question that the demand for 3PL fulfill- company better optimize any future 3PL pricing and
ment services will continue to grow. Before beginning a contract terms. •

scmr.com FOCUS ON LOGISTICS 21

Economies of scale

Transportation’s
tricky

balancing
act
BY DARREN PROKOP,
PROFESSOR OF LOGISTICS IN
THE COLLEGE OF BUSINESS AND
PUBLIC POLICY, UNIVERSITY OF
ALASKA ANCHORAGE.

Done right, economies of scale can lower a carrier’s average costs and the
freight rates charged to their customers. Getting it right is a balance.

22 FOCUS ON LOGISTICS scmr.com

I
n just about every episode of Shark Tank at least one
of the wealthy investors will ask an aspiring entre-
preneur if the deal they’re pitching is scalable. It’s
certainly a good question for investors to ask. After all, they
want to make their money back as quickly as possible and
then sit back as the profits from sales roll in. Of course,
that would be hard to do if the business in question needs
to pile on costs just in order to increase its market share.
In other words, investors like to see a business’ sales rev-
enue grow faster than its costs. This is what they mean by
scalable or, more specifically, economies of scale.
The term “economies of scale” is a popular one in the
business world. Many, however, use the term incorrectly.
Furthermore, many shippers who rely on inbound and out-
bound transportation to bring in raw materials and distrib-
ute their finished goods may not realize the multitude of
ways that transportation carriers can achieve “scale.”
The good news is that economies of scale can lower
a carrier’s average costs and potentially lower the freight
rates charged to their shipper customers. The bad news
is that economies of scale don’t go on indefinitely. There
is a point when average costs will actually rise as scale
increases. This is known as diseconomies of scale. Getting
this right to maximize your transportation strategy is a bal-
ancing act—regardless of the mode or modes of shipping.
How economies of scale affect that balancing act is
the subject of this article. We’ll look at the specific costs
involved in defining economies of scale and set out three
items which are important in the definition. We’ll dis-
tinguish between the internal and external sources of
economies of scale and diseconomies of scale. Finally,
we’ll discuss the various ways “scale” can be achieved by
transportation carriers.
Why is this important? Because an understanding of the
opposing forces of economies and diseconomies of scale is
necessary for shippers and carriers to know how to strike
the right balance in their transportation planning.
Defining economies of scale
Let’s start with a definition of economies of scale and con-
sider three critical items. The first item is that the term
economies describes what happens to operating cost as
the size of the operation itself increases. The term doesn’t
scmr.com
directly relate to sales revenue or to profit. Specifically,
when a business takes advantage of economies of scale its
total costs rise at a decreasing rate.
Many business people make the mistake of thinking
that costs will fall when economies of scale are exploited.
Sorry, but that’s just not the case. Technically, as total cost
rises at a decreasing rate it is only the average cost that is
decreasing. After all, it’s hard to think of a business that
increases its scale of operation by, say, 25% and finds that
with all the extra labor and capital now employed that its
total cost has actually fallen.
No, what happened is that the scale of operation increased
by 25% while total cost increased by some lower percentage.
Because average cost is defined as the ratio of total cost over
the current level of production, the ratio declines as scale
increases when economies of scale are exploited. Conversely,
when facing diseconomies of scale, total cost rises at an
increasing rate. The result is that the average cost rises.
Item two is the role of technology. Economies of scale
is assumed to occur over a production process experienc-
ing no technological change. The means by which inputs
are turned into outputs—an equation that economists call
the production function—does not change as the business
increases its scale of production. The implication is that
more qualitative inputs such as managerial skills remain
constant and there are no innovations taking place that
would affect the production process.
While these don’t hold in the real world, the assump-
tion is that economies of scale looks at how a given set of
inputs are turned into specific outputs. Changing the qual-
ity of inputs or substituting in other more innovative inputs
means the equation for the production function would
have to be redefined to account for these. This changes
how total and average cost behave.
In this context, economies of scale have little mean-
ing. The good news for businesses seeking innovations is
that technological change has a long history of reducing
production costs and bringing improved products to the
marketplace. Innovations in science or management can,
indeed, make a business more scalable; but one cannot
explicitly build innovation into production plans. The
sources of economies of scale to be discussed later in this
article are more systematic.
FOCUS ON LOGISTICS 23
Economies of scale
The third item to be aware of is that the term
economies of scale is what economists call a long
run concept. This means businesses must plan in
advance for a certain scale of operation and, once
achieved, they have to live with the consequences
until, in the long run, the plan can be revised to
meet new market realities.
This interim period is known as the short run:
This is where some components of a business’
operation are fixed in size, such as the capacity of
a warehouse, the duration of a lease on a vehicle or union
wages set through collective bargaining. Thus, the choice
of scale is a strategic exercise because it involves a forecast
of what market conditions are expected to be over the
short run interim.
Inside and outside
With the definition of economies of scale, now there are
three important questions to consider:
1 Will the chosen scale provide enough product to meet
downstream customer demand?
2 Will upstream vendors be able to provide enough
inputs to facilitate the level of production necessary
to fulfill point (1)?
3 Will financial and operational costs be low enough
to set a product price that will generate enough sales
revenue to stay in business in the long run?
Those are all internal questions that can be answered
inside the enterprise. But, it’s not that simple. Outside the
enterprise, a business may face competitors who are like-
wise trying to achieve an appropriate scale of operations.
With a fixed level of consumer demand, vendor supply
and financial capital, it becomes harder for one business
to achieve higher scale if one or more competitors are
already larger and have a lot of market share. Each busi-
ness is striving for so-called internal economies of scale.
On the other hand, more competition may be beneficial
for all competitors in an industry if it attracts external play-
ers which help to grow the entire industry. This is what’s
meant by the term external economies of scale.
Consider more carefully the internal and external
sources of both economies and diseconomies of scale.
Internal circumstances can lead to either a decrease or
24 FOCUS ON LOGISTICS
an increase in long run average costs as the busi-
ness grows larger. As a business increases in
scale from a small labor force it makes sense to
divide production into more specialized tasks
with specific departments set up to manage
these tasks. This division of labor can lead to
efficiencies. The modern assembly line is the
best example of this. If tasks become too nar-
row, they can become mundane and quality
control can become a problem. Also, as the busi-
ness becomes larger it may become more bureaucratic,
mired in red-tape and less flexible because more and
more time is spent pushing paper and attending meet-
ings. Guarding against these pitfalls is a very important
organizational task. In fact, it is a balancing act between
lean and lethargy and flexibility and inflexibility.
As for external circumstances, as a business becomes
larger it may make sense for local government to improve
transport infrastructure in the vicinity in order to get work-
ers, vendor supplies and customers to and from the place
of business. On the other hand, a business can become so
large that it creates congestion within a given infrastruc-
ture, or it begins to exhaust a free publicly-available input
such as clean water, and costs begin to rise. Thus, it’s also
incumbent on a business to follow the workings of govern-
ment and plan accordingly when trying to exploit external
economies of scale.
There is also an interplay between internal and external
economies of scale through the set-up or sunk costs of a
business. Any business will incur such costs because the
production plan must be conceived, vendor relationships
must be established and distribution channels created.
The larger the business the more these set-up costs are
distributed over the pool of output.
In this way, long run average cost declines. As a simple
example, consider advertising as an upfront cost to setting
up a distribution channel. A minute of commercial TV
time during the Super Bowl is so expensive it only makes
sense for the largest businesses to pay for it. They have
more output and sales revenue to validate such a purchase.
Size matters
Basic economics looks at scale in a singular fashion; just
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the size of the operation. But for a transportation
carrier, the scale of an operation can take many
forms. These include: the size of a vehicle or ship-
ping container; the number of vehicles in a fleet;
efficiencies in the transportation network; and a
shipment’s weight and distance carried. Each of
these will be discussed in turn.
But, recall, such sources of economies of scale
will eventually become diseconomies of scale.
Therefore, striking the right balance in transporta-
tion planning is very important. With that as back-
drop, let’s look at it in the context of transportation, using
size as it applies to the most prevalent modes of truck, rail
car, airplane, water vessel and pipeline.
Vehicle/container. Economies of vehicle or container
size come about because the volume or carrying capacity
of a truck trailer, rail car, airplane, water vessel or pipeline
increases faster than the quantity of side material needed
to build it. For example, compare a 3’x 3’x3’ container with
a 6’x 6’x 6’ container. The material used on each side would
increase by four times; that is, each side increases from 9
square feet to 36 square feet.
However, the capacity of the smaller container is 27
cubic feet while the larger one is 216 square feet, an
increase of eight times. The good news is that carrying
capacity, an important source of carrier revenue, increases
faster than the material cost involved in expanding that
capacity. The bad news, however, is that the vehicle or
container can become too big to haul shipments along a
given road or canal. An airplane could be so big that it takes
too long to load and unload passengers. The pipeline could
collapse under its own weight when loaded. These are all
examples of diseconomies of scale.
Fleet. Economies of fleet size come about when con-
sidering how vehicles can be deployed efficiently within an
interconnected market area. Consider one truck that heads
only north-south and another that only travels east-west.
Suppose their routes cross each other at some point. These
trucks are independent operations within the motor car-
rier’s fleet. However, the cross-point offers the opportunity
to interline, or exchange cargo at a warehouse. The good
news is that this interconnectivity effectively offers six
routes of service instead of just two. Such interline points
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are essential in less-than-truckload (LTL) opera-
tions which are characterized by trucks filled with
multiple shipments going to multiple locales. The
bad news comes when the warehouse becomes too
congested to effectively offer LTL service in a time
frame that shippers are willing to pay for. Exam-
ples of important interline points are Chicago,
where all seven Class I railroads converge, and
Memphis, where FedEx maintains its “super hub”
with all of its air cargo routes spreading worldwide.
Network. Economies of network efficiency come
about when the design of the system of routes allows for the
fleet configuration to be diversified. Consider the hub-and-
spoke network that airlines have deployed since deregulation in
1978. Large capacity airplanes carry passengers from hub-to-
hub while smaller airplanes are used along the spokes around
an air carrier’s hub airport. For example, a commercial flight
from Anchorage, Alaska to Spokane, Washington will likely
route through the SeaTac airport hub. Without hub airports
it is unlikely that many city-to-city combinations would be
cost effective. Of course, diseconomies of scale sets in when
the hub airport becomes congested due to the multitude of
spoke routes and their incoming and outgoing passengers. It
certainly does not help that airspace in the United States isn’t
as efficiently utilized as it might be due to antiquated air traffic
control systems.
Shipment. Economies of shipment weight and distance
come about when considering all the costs that increase as a
shipment’s characteristics change. For example, doubling the
size of a given shipment or hauling a given shipment double
the distance should not double all of the costs associated with
that delivery. Just one pilot and one copilot are necessary for
a fully laden cargo jet travelling 5,000 miles or 10,000 miles,
or carrying 50% or 100% capacity. These costs will taper off as
weight and/or distance increase. In other words, these costs are
spread over the extra revenue to be had through hauling more
or hauling for longer distances. That’s the good news.
The bad news is that this only continues until it’s neces-
sary to increase the labor involved in the shipment. This could
involve adding more shifts of drivers over long distances or more
personnel to load and unload vehicles. Diseconomies of scale
also occur when an infrastructure’s capacity must be expanded
but indivisibilities require expansions larger than needed.
FOCUS ON LOGISTICS 25
Economies of scale
For example, if a truck trailer is at capacity and the
motor carrier wants to expand operations, it must increase
in increments of one trailer even if that is much more
capacity than is desired. If a road is congested it must be
expanded in increments of an extra lane. But, if market
demand sufficiently expands then the investment in a new
trailer or extra lane offers economies of scale up and until
capacity is maximized again.
Scale and scope
Two other related terms are worthy of mention in a trans-
portation context. One is constant returns to scale. This is
the absence of either economies or diseconomies of scale.
The other is economies of scope. In this case, the carrier is
trying to achieve efficiencies through a mixture of services
instead of through a larger scale of one service. Constant
returns to scale occurs when there is a built-in rigidity or
independence to the operation while economies of scope
indicate a degree of flexibility.
As an example of constant returns to scale, consider U.S.-
Asia ocean vessel shipping. Many container vessels travel
to and from ports on the U.S. West Coast to ports in Japan,
South Korea and China with no stops along the way. Of
course, the vastness of the Pacific Ocean necessitates this
non-stop service. These vessels follow similar routes along the
“great circle” between the U.S. West Coast and Asia, taking
them through or near the Aleutian Islands in Alaska. While
their routes may cross, there is no possibility of interlining
in the way truck, rail and air carriers can. Each vessel in the
ocean carrier’s fleet in these waters serves as an independent
network and enjoys no economies of fleet size. Expanding
operations in these waters requires a different vessel, crew
and port dockage authority. For these reasons, the carrier does
not see its average cost rise or fall as the fleet expands. Long
run average costs are constant and face indivisibilities as the
fleet expands one vessel at a time. Of course, interlining in
the ocean vessel sector does occur in other routes. The Port
of Singapore is an example of an important container transfer
point in Europe-Asia trade lanes.
Economies of scope offers carriers a chance to diversify
their operations in order to expand market share or mitigate
a decline in a current market. Many examples exist in trans-
portation. A commercial airline can offer charter service if
scheduled service is in less demand. A less-than-truckload
(LTL) carrier can offer truckload service (TL) if the shipper
26 FOCUS ON LOGISTICS
is willing and able to fill an entire truck and pay a dedicated
freight rate. Of course, it is certainly easy enough for a rail
carrier to attach boxcars to passenger cars and provide a mix-
ture of services.
Diseconomies of scope emerge, however, when the car-
rier begins to forget its core competency and diverts too
many resources into its secondary operation. In transporta-
tion, this is best explained in terms of cargo services versus
passenger services. Cargo transport is always a part of the
production process while passenger travel is often a part
of the consumption process. Inputs such as cargo and car-
riers facilitate the production process by moving inputs to
where they need to be.
Passengers on vacation are enjoying the “consumption”
of their leisure time and carriers facilitate this consumption
process. Indeed, cruises and train tours are themselves an act
of consumption. Why is this distinction important? Because
production is governed by the state of technology and this is a
large factor used in pricing the provision of transportation.
Consumption is governed by tastes and preferences
and pricing transportation is more nebulous in this case.
Furthermore, passengers are “freight that complain” and,
therefore, must be treated differently than cargo. As noted
above, economies of scale don’t directly relate to a busi-
ness’ sales revenue and profit. Achieving the lowest long
run average cost makes sense when market conditions
suggest that low cost businesses will have staying power.
But there is no reason to believe that such a business will
maximize profits. Markets that are easy to enter and exit
tend to be very competitive and do not offer many options
to increase scale at the expense of competitors.
However, for businesses such as the railroads and
pipeline companies, economies of scale can act as a barrier
to entry for other competitors. Once the railway or pipeline
infrastructure is in place there is little incentive for a direct
competitor to challenge the incumbent along that route. In
this way, monopolistic profits are possible if the market is
unregulated or uncontestable.
Finally, when considering transportation hubs, it is no
coincidence that shippers and carriers tend to locate in
areas which are hospitable to them. As noted above Chi-
cago, Memphis and Singapore are important examples.
These are also sources of external economies of scale
because business and government are able to serve each
other’s needs, with the latter via infrastructure provision
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and the former via taxes and fees.
Urbanization policies that take into account these busi-
nesses help to insure a steady pool of labor, vendors and
customers. Applicable R&D through local universities may
come about as well. Of course, as noted above, R&D benefits
deviates from the assumption of constant technology. None-
theless, these are all very important aspects of successful
logistical hubs and knowledge clusters.
Achieving balance
While all five modes of transport (truck, rail, air, water vessel
and pipeline) have been used to illustrate various examples
of economies of scale, some modes are more prone to it than
others. For various reasons, it is more likely that less com-
petitive markets will benefit from economies of scale. Why?
Barriers to entry in the form of set-up costs. As long as most
roads are publicly provided it will always be easier for a motor
carrier to buy a truck and offer, say, a 100-mile route than
would a railway or a pipeline company.
Worse still, if railways and pipeline companies are less
competitive, why should they take full advantage of econo-
mies of scale and try to lower the costs of their operations?
In part, the answer lies with intermodal competition. If one
mode offers some level of alternative service in the eyes of
shippers then these “contestable” markets may see a greater
exploitation of economies of scale than might otherwise be
the case. Shippers must maintain a discriminating eye for
the mode of transportation.
While it might seem that this balancing act is some-
thing for the transportation carrier to handle alone, it’s not.
Their shipper customers have a role to play as well. After
all, transportation is part of supply chain management
which is, of course, at its most effective when collabora-
tion takes place both upstream and downstream. As we’ve
seen, shippers can wait for, or hope for, scientific innova-
tions to help lower the cost of transportation. But until
then a transportation carrier has a menu of options through
which to find appropriate economies of scale when pro-
viding services to shippers. Collaboration would certainly
improve the flow of raw material, components and goods
along the supply chain.
Consider economies of scale from the shipper’s perspec-
tive: Shippers who are able to provide loads that fully utilize
vehicle capacity can reap the benefits of economies of
vehicle/container size. Because the carrier’s costs do not rise
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as fast as its carrying capacity it’s likely that the freight rates
paid by the shipper won’t rise as fast either. But what about
small shippers who can’t provide such large shipments?
Well, they have the option to utilize the services of a
third-party logistics provider (3PL) whose job it is to con-
solidate small loads into larger ones and negotiate favorable
freight rates with the carriers. This intermediate step helps
to create loads with similar physical and delivery character-
istics which, in effect, passes the benefits of economies of
vehicle/container size on to many shippers within a trans-
portation network.
If shippers are moving numerous loads from multiple
origin-destination points within a given transportation net-
work, there is a benefit in timing the pick-up and delivery
requirements so that the loads can be interlined by the car-
rier at appropriate cross-points and hubs. Doing so helps the
carrier achieve economies of fleet size.
Barring any emergencies most shippers prefer lower
cost to faster delivery within the norms of a given mode of
transport. Transportation carriers, therefore, have incentives
to design intricate transportation networks. By routing the
heaviest traffic from hub-to-hub and moving lighter traffic
along spokes, carriers can take advantage of the economies
of network efficiency. Routing through hubs may add more
time to the delivery of shipments but the cost efficiencies
can help keep freight rates paid by shippers lower than they
would be with more direct transport.
Finally, globalization and the rise of information technol-
ogy have made it easier for businesses to seek out vendors
and customers all over the world. Off-shoring parts of the
supply chain has necessarily increased the distance of ship-
ments. Bulk discounts when available have necessarily
increased the weight of shipments. In other words, longer
supply chains created by their shipper customers have
prompted carriers to take advantage of the economies of
weight and distance.
Transportation planning is a complex task. It is depen-
dent on the nature of the marketplace, the state of technol-
ogy, government regulation and cost control. As we’ve seen,
economies of scale is an important concept when it comes
to cost control. •
Darren Prokop is a professor of logistics in the College of
Business and Public Policy at the University of Alaska An-
chorage. He can be reached at djprokop@alaska.edu.
FOCUS ON LOGISTICS 27
Kicker

28 FOCUS ON LOGISTICS scmr.com

 The last mile,
history repeating
“History merely repeats itself.
It has all been done before. Nothing
under the sun is truly new.”
—Ecclesiastes1:9

A
BY DAVID WIDDIFIELD

s King Solomon noted nothing new is ever really created, just

updated to meet the current environment or situation. This
is true of last mile logistics delivering products to consum-
ers. When you look beyond the hype of all the new, innovative ser-
vices and suppliers in the logistics space and view things through
the perspective of the past, we find this delivery service capability
has been used efficiently and successfully in the past. We only need
to look back to the 1940s and the successes America experienced on
the battlefields of World War II.

Rise of the importance of final enabling the buildup of large invento-

mile logistics
As the U.S. emerged from WWII,
military tacticians credited a majority
of the U.S. military’s success in the
European and Pacific theaters to the
U.S. capabilities of mass production
ries of supplies such as ammunition,
clothing, food and vehicles, and the
ability to combine civilian and military
storage and transportation operations
to move vast quantities of supplies in
an efficient, expeditious manner and

David Widdifield is the director of retail

solutions for Crane Worldwide Logistics – DFW
in Carrollton, Texas. He can be reached at
David.widdifield@craneww.com.

scmr.com FOCUS ON LOGISTICS 29

 Last Mile Delivery

FIGURE 1

Vested outsourcing model

Reduced cost to company

Goal
Performance
partnership that
optimizes for mutual
desired outcomes

Innovation, improved service Improved margins to provider

Source: Vitasek, K., Cummins, T., & Ledyard, M. (2010). Vested Outsourcing: a better way to structure
outsourcing contracts. International Association for Contract and Commercial Management. Ridgefield, CT.

to deliver ammunition, materials, personnel or vehi-
cles to the battlefield when, where and in the right
configuration needed to support military objectives.
Yet, the logistics lessons regarding the importance of
the delivery function getting the product to the end
user were quickly forgotten as the war concluded.
Consumers now have virtually 24/7 access to a wide
variety of products across domestic and now
international geographical boundaries, coupled
with cross border online shopping that brings goods
directly to their homes in a matter of a few days.
Shifting from a wartime to peacetime economy
unleashed years of pent up consumer demand for
goods as disposable incomes rose. The mass pro-
duction processes that produced war supplies were
quickly adapted to the manufacture of consumer
goods. However, the processes of efficient distribu-
tion methods to deliver goods to the point of con-
sumption were not given as much emphasis. Pro-
ducers and retailers placed more emphasis on the
production of inventory and locating it at central
retail locations while minimizing the importance
of transportation to satisfy consumers. Consumers
were content to acquire their products wherever
they were available as long as they were purchased
at the “right” price. Even after Bernard J. (Bud)
LaLonde, the noted Ohio State University logistics
professor, provided research showing the positive
impacts efficient delivery methods could have on
consumer satisfaction and profitability, manufactur-
ers and retailers continued to rely on mass produc-
tion and large inventory levels to meet consumer
demand.
This situation, while being updated with modern
processes and technology, persisted within the
retail sector for the next 60 years until the emer-
gence, and now dominance, of the e-commerce
retail channel and the direct delivery of consumer
goods to the home. Moving from a novelty, the
ability to view goods online has rapidly risen to
being the preferred shopping channel. Consumers
now have virtually 24/7 access to a wide variety of
products across domestic and now international
geographical boundaries, coupled with cross border
online shopping that brings goods directly to their
homes in a matter of a few days.
The efficient delivery operations that focused
on the movement of goods from a manufacturer to
a retail location are being radically redesigned to
handle the movement of consumer goods from a

30 FOCUS ON LOGISTICS scmr.com

manufacture, distribution, or retail location. The les-
sons learned during WWII regarding the importance
of being able to deliver goods when, where and in the
right configuration to the consumer have now become
a guiding principal as retailers develop new delivery
capabilities using existing and new equipment, pro-
cesses, suppliers and technology.
Faster delivery: The emergence of next and
same day shipping
As e-commerce continued to grow throughout the
2000s, consumers continued to demand faster
delivery of goods to their homes. As this shopping
channel has increased, delivery time requirements
have decreased. Today e-commerce business is driv-
ing approximately 12% of total U.S. retail sales, with
some companies reporting as much as 80% of their
sales revenues in this channel. This growth rate
has been partially attributed to evolving consumer
demand for faster delivery service. That really began
in 2013, when e-commerce sales reached 6% of total
retail sales, and with over 40% of transactions made
via a mobile device and requested delivery service
of 2-3 days. Today, e-commerce now generates 12%
of total retail sales with nearly 60% of transactions
conducted via mobile device with standard 1 or same
day delivery service.
During 2016, same day delivery service usage
increased over 30% from 2015 results as retailers
such as, Macy’s, Nordstrom and Walmart offered
consumers the ability to have online purchases
shipped from nearby stores. Even today, the delivery
service cycle time is once again being compressed to
an hourly and now 10-minute time frame from point
of order.
These rapid changes are severely challenging tradi-
tional retail logistics models and operations. Note that
FedEx and UPS, the two largest U.S. largest parcel
carriers, announced the volume of small packages for
1-day or same day service overwhelmed them. Retail-
ers and logistics service providers alike are rapidly
assessing and modifying capabilities, networks and
supplier relationships to accommodate consumer
expectations regarding delivery service needs.
To prepare for this and future shopping seasons,
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supply chain managers need to engage key stakehold-
ers (consumers, buyers, manufacturers, procurement/
sourcing and service suppliers) to review current
logistics operations and strategically assess whether
or not they are prepared to meet existing consumer
expectations as well as have agility and flexibility in
design to change with future consumer needs.
To achieve this goal, supply chain managers and
service providers will need greater levels of collabo-
ration and trust to honestly and openly operate their
combined logistics network. The development of a
collaborative partnership framework is essential to
success in this endeavor. One such framework that
can be used to guide their efforts and ensure both
are successful is the vested outsourcing framework
(see Figure 1).
This is the type of collaborative approach in partnering
with an internal or external supply chain service
provider that can ensure your company has the ability
to meet existing and future consumer expectations
along with proactively addressing operational capability
and resource constraints.
Developed by Vested Outsourcing Inc. and the
University of Tennessee, this framework is based
on the principle of mutuality or “what’s in it for we”
WIIFWe (pronounced “whif-wee”). This means that
each party is focused on benefitting the consumer
and each other’s companies. This is the type of col-
laborative approach in partnering with an internal
or external supply chain service provider that can
ensure your company has the ability to meet existing
and future consumer expectations along with proac-
tively addressing operational capability and resource
constraints.
With the upcoming 2017 holiday season fast
approaching and projections from organizations such
as Salesforce that a majority of consumers will com-
plete 80% of their holiday shopping online during
the Black Friday and Cyber Monday periods, having
those final mile logistics capabilities to handle all
consumer delivery service levels is going to be criti-
cal in defining success or failure for retailers this
year and beyond. •
FOCUS ON LOGISTICS 31
 Fighting
amazon’s
supply chain
takeover
BY MICHAEL BENTLEY

In late 2015, Amazon received a license from the U.S. government to act
as a freight forwarder for ocean container shipping. That approval came on the
heels of Amazon winning a similar license from the Chinese Ministry of Com-
merce. Armed with licenses from both countries, the online retailer is now
positioned to buy space on container ships at wholesale rates and resell at retail
rates, which will allow the company to connect two of the world’s largest mar-
kets while cutting out competitors.

Michael Bentley is a partner at Revenue Analytics, a tech-enabled consulting

firm in Atlanta, Ga. He can be reached at mbentley@revenueanalytics.com.
For more information, visit revenueanalytics.com.

32 FOCUS ON LOGISTICS scmr.com

Amazon’s
investments in
freight forwarding
and air transport
present new
competition to
logistics providers.
Here’s how freight
forwarders and air
cargo companies
can adapt and
survive.

scmr.com FOCUS ON LOGISTICS 33

The Amazon effect

Then came another bold step: Amazon signed a their biggest competitor—Walmart—out of the water,
deal with Air Transport Services Group to lease 20 as an example of what their futures could hold if they
Boeing 767 aircraft to shuttle merchandise around the don’t make some drastic changes.
U.S. as part of the online retailer’s efforts to reduce its In fact, one freight forwarding giant has already
high shipping expenses. Combined, these moves con- fallen. As mentioned above, the world has just wit-
firm earlier reports that Amazon is planning a global nessed the largest container shipping bankruptcy in
expansion of its “Fulfillment by Amazon” service, history with the collapse of South Korean shipping line
Hanjin, the world’s seventh-larg-
While the full extent of the Hanjin fallout est container carrier. While the
is not yet known, companies should be worried that, as full extent of the Hanjin fallout is
competition decreases, Amazon will have an even greater not yet known, companies should
opportunity to swoop in and dominate the market. be worried that, as competition
decreases, Amazon will have
an even greater opportunity to
which provides storage, packing and shipping to small swoop in and dominate the market.
independent merchants that sell products on Ama- As for the air cargo industry, the following are the
zon’s Website—a project dubbed “Dragon Boat.” number of planes in some of the biggest companies:
By signing the Air Transport Services Group deal United Cargo, over 700; FedEx, over 600; UPS, 237;
and receiving a license to act as a wholesaler for ocean and DHL, 120. While so far Amazon has only a small
container shipping, Amazon once again can reduce its number of planes compared to these established com-
inflated shipping costs and reliance on third-party panies, they must continue to monitor both the prog-
logistics providers. As evident from the recent Hanjin ress of Amazon’s investments in the industry and how
bankruptcy, shipping and air cargo companies can they perform at a comparable profitable rate.
expect to see a continued shrinking market as Amazon There are steps, however, that the shipping and
enters the fray. cargo industries can take to ensure they adapt, sur-
Just as Amazon’s retail competitors have had to vive and even thrive in the world of Amazon. Below,
develop new strategies in order to survive, Amazon’s I examine how this new endeavor will affect these
newest competitors will need to determine what they industries and what both can do to combat the latest
can learn from the online retail conglomerate, and expansion of Amazon’s ever-growing footprint.
then move resources to the most advantageous and
vulnerable areas of their industry. Takeaway No. 1: You can’t ignore this
The competition from Amazon comes amid a well-
Where do we stand? documented decline in revenue for shippers in the
Given Amazon’s new deal with Air Transport Services, past several years. In 2014, revenue decreased
freight forwarders and air cargo companies have 3% compared with 2013, following a 5% decline
reason to worry that they are the next vertical to be from 2012. As of 2015, industry revenue remains
disrupted. Because of this, the shipping industry can more than 16% below its 2008 peak, according to a
expect to see a decline in demand and heightened report from AlixPartners.
price competitiveness. In 2015, the top five ocean With the freight forwarding industry already see-
freight forwarders were listed, in order, as: Kuehne ing downward pricing pressure and greater internal
+ Nagel, DHL, Sinotrans Limited, DB Schenker competition, the danger of some companies failing
and Pantos Logistics. These companies should look even before Amazon’s entry was a real possibil-
to Amazon’s e-commerce sales last year, which blew ity. Given the fresh state of turmoil, Amazon will

34 FOCUS ON LOGISTICS scmr.com

 undoubtedly make things worse for companies States. This means that they will buy at a higher
that do not appropriately prepare. capacity than their competitors and use more
In fact, freight forwarders that willfully ignore advanced analytics, resulting in a faster and more
this move will not survive past the next few years, efficient delivery model. Based on volume, scale
as Amazon sinks its highly analytical teeth into and buying power, Amazon will command more
the market. attractive pricing than other freight forwarders,
While the problem is less immediate for air cargo enabling them to secure capacity at a lower cost
companies, those in the industry that take this and ensure profitability as they fill that space more
change seriously will be better situated in the long easily than competitors.
term to compete with Amazon. This is
largely because air cargo firms have a The most obvious place to look is in commodities
better business model than freight for- Amazon does not ship, such as agriculture,
warders and have shown strong revenue automotive, building supplies and heavy machinery.
growth in the past decade.
But, they shouldn’t get too comfort-
able. Air cargo companies face many of the same Besides its sophisticated analytics, Amazon has
challenges as freight forwarders in that Amazon another distinct advantage: The incredible sup-
will invest significantly in leveraging analytics and port of its shareholders has allowed for a business
cost-cutting practices to become highly competi- model that places profits second to the goal of
tive with current companies. The best thing they growing market share first. No freight forwarders
can do is to establish a strategy that makes them or air cargo companies can say the same. Many
well positioned to compete with the e-commerce of these companies are already seeing a declining
goliath. If freight forwarders and air cargo com- profit growth rate and any further cuts could result
panies follow the strategy outlined below, they in a cessation of business.
will be well equipped to drive profitable revenue Ultimately, companies that take on reactionary
growth and remain competitive. tactics to Amazon’s moves in an attempt to retain
market share will not be able to sustain them in the
Takeaway No. 2: Imitation will get long term. These companies cannot compete with
you nowhere Amazon’s boundless resources and will only lose
As many retailers have learned, freight forwarders money by trying to copy them.
and air cargo companies should not try to imitate
Amazon. The online retail giant has a notable track Takeaway No. 3: Focus on where you can
record of beating incumbents in every market it grow market share
enters, and that’s largely due to the fact that compa- As Amazon grows its presence in the market,
nies mistakenly try to copy their strategies. freight forwarders will struggle to compete, and
Additionally, Amazon uses some of the most that means even more industry infighting. As
sophisticated analytics and technology avail- mentioned earlier, the top ocean freight forward-
able. Freight forwarders simply do not have the ers include Kuehne + Nagel, DHL and Sinotrans
resources to compete at the same level and those Limited—all of which already compete aggres-
who try may not be able to maintain a reasonable sively for market share.
level of competition. Given this ultra-competitive environment, freight
It is expected that Amazon will replicate their forwarders should focus on areas where they pos-
existing small package business model in the United sess a strategic advantage in capturing and growing

scmr.com FOCUS ON LOGISTICS 35

The Amazon effect

market share. The most obvious place to look is in leverage them to maintain, and possibly increase,
commodities Amazon does not ship, such as agri- market share.
culture, automotive, building supplies and heavy
machinery. While the consumer goods and retail Takeaway No. 4: Ramp up your analytics
space will surely decrease for freight forwarders, Amazon uses advanced analytics in every aspect of
companies that focus on capturing share in these its business. When they apply this analytical rigor
less competitive segments will establish a position to the shipping industry, companies that do not
implement similar tactics
While the full extent of the Hanjin fallout is will see their pricing actions
not yet known, companies should be worried that, as consistently outmaneuvered
competition decreases, Amazon will have an even greater and business taken away. As
opportunity to swoop in and dominate the market. I mentioned before, com-
panies cannot and should
not exactly match Amazon’s
of strength, leading to the potential to drive signif- business practices. However, those that cannot
icant organic revenue growth outside of Amazon’s present credible, high-level numbers to back up
core segments. their business proposals and contracts will see cli-
However, freight forwarders exploring these ents begin to disappear.
spaces for the first time will face an uphill climb. There are two techniques freight forwarders
With Amazon’s expected impact on the market, these should consider implementing:
companies will no longer be able to use the project-
by-project tactical approach that is the industry
norm. Amazon’s resources, especially in sophisti-
1 BEHAVIORAL SEGMENTATION. Rather than rely-
ing on dated business segments and a one-
size-fits-all solution utilized by much of the
cated analytics and data, will squeeze companies industry, those that leverage their unique
who refuse to change their business models. business models and historical data to study
Conversely, air cargo companies will have a which products and customers generate the
stronger recourse for fighting Amazon. While UPS most volume and profit will be able to use that
and FedEx both experienced strong growth in information to adjust prices accordingly.
2015, they should not become complacent. Com-
panies that currently dominate the air cargo indus-
try will eventually be forced to lower costs to com-
2 PRICE SENSITIVITY. Freight forwarders that use
their wealth of transaction-level data to mea-
sure how sensitive customers are to price will
pete with Amazon, and those with reputations for allow them to make the necessary changes to
delays and logistical problems will see shrinking streamline processes and determine how much
revenue streams. Although both UPS and FedEx they should raise or lower rates, driving profit-
are currently experiencing success, Amazon’s foray able growth.
into the market means they will no longer be able Air cargo companies should implement these
to maintain their current business strategies in the same techniques. As Amazon invests more
long term. resources into understanding the industry, it will
Both air cargo companies and freight forwarders begin to realize where costs can be cut and prices
must look for areas where they have a differenti- can be lowered. Companies that prepare for this
ated value proposition. Just as Amazon has built a will be much better prepared to stay competitive
reputation as an expert in retail products, compa- and retain current clients. They can do this by
nies that have known value in specific niches must leveraging available data to ensure that they have a

36 FOCUS ON LOGISTICS scmr.com

 holistic understanding of their own internal prac-
tices, as well as those being used by competitors.
These bespoke solutions have seen huge suc-
cess in the U.S. retail market. Using a myriad
of competitor and merchant data, companies
have been able to scientifically determine where
and when lower competitive prices should be
matched, as well as answering when value-added
components offset higher prices. In fact, one
leading consumer goods retailer saw a 6.8% rev-
enue uplift when using this targeted approach,
with a 30% uplift in select product lines, equat-
ing to tens of millions of dollars when extended
across the organization.
Amazon didn’t become one of the most
sophisticated companies in the world overnight,
and neither will anyone else. The best way to
implement change at a company is to treat it as
a unique entity. While some companies look to
cookie-cutter approaches and generalized soft-
ware, it is much more beneficial to invest in a
bespoke solution specific to their own businesses.
This approach will deliver organic revenue
growth and a greater return on investment.
One major ocean freight company used com-
prehensive statistical analysis to develop an
analytically driven pricing framework and cor-
responding strategy. This approach identified an
opportunity to lift gross profit by 4.2% annually,
driving change across analytics, data manage-
ment, corporate strategy, business processes
and operations.
These types of investments prove that profit-
able growth is still possible in the shipping indus-
try. Companies that invest internally to identify
where opportunities exist to drive revenue growth
are much more likely to succeed than those who
simply price match against competitors.
A first step
This is only Amazon’s first step toward enter-
ing the $350 billion ocean freight market. Even
when companies implement advanced analytics
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and figure out where they can compete with
Amazon, there will be additional challenges as
the conglomerate continues to pour money and
resources into the industry in order to fully inte-
grate across verticals.
Amazon’s growth leaves up for grabs only a
percentage of the demand that existed before for
retail. Those in the space that continue to com-
pete as before will be forced to price their ser-
vices at unsustainable rates. This shaky business
model will put them at significant risk of being
out of business within the next several years.
Instead, the freight industry can best combat
this by further exploring other B2B commodities
that Amazon does not ship. Companies that focus
on these areas will improve their chances of
locking down those markets, and achieving
market share growth. This will stall the inevitable
rise in competition from companies shut out
of the retail market and in need of fresh
sources of revenue.
Although Amazon is still in the early stages
of entering the air cargo industry, companies in
the space should be concerned that Amazon will
underbid them and fully integrate its shipping
process, providing an end-to-end solution from
warehouse to doorstep.
There is already significant downward pricing
pressure in the shipping industry, and Amazon’s
entry is sure to create even more aggressive com-
petition in the space. The best course of action
is to push hard to leverage analytics in an effort
to capture market share in products Amazon does
not sell (cars, commodities, agriculture, etc.).
Only by establishing a position of strength in
the remaining markets will these companies sur-
vive and potentially thrive. As Amazon prepares
to extend its reach further into the retail sup-
ply chain industry, failing to act is no longer an
option for shipping companies. This supply chain
power play may be the catalyst that sends the
industry into a Darwinian scenario of survival of
the most analytically fit. •
FOCUS ON LOGISTICS 37
 How They Did it:

Service and price

R
egardless of the mode, shipping is complicated. Shippers may have limited control over
freight expenses due to their intrinsic complexities. Meanwhile, freight forwarders often
claim they have limited control over the complex cost structures associated with ship-
ping, and shift most of the risk back to shippers, who are typically in a weak negotiating position
while trying their utmost to satisfy their customers with timely—and on-time—deliveries.
That was certainly the case for those of us working with logistics and freight forwarders at
Knorr-Bremse Asia Pacific Ltd. Like many shippers, we often found we were trading lower costs
for inadequate service levels that satisfied no one in our organization. In order to address those
constraints, we introduced a structured program that provides feedback from our internal opera-
tions departments to our freight forwarders about their performance, and links a quantifiable
“service factor” to the transportation provider who is assigned an order. The service factor is the

Sebastian Schmidt-Eckert is the Director of Purchasing Rail Asia Pacific for Knorr-Bremse Asia
Pacific (Holding) Limited in Hong Kong. He can be reached by e-mail at sebastian.schmidt-
eckert@knorr-bremse.com. For more information, visit www.knorr-bremse.com.

38 FOCUS ON LOGISTICS scmr.com

 To get the most value for its transportation spend, Knorr-Bremse
Asia Pacific Ltd. created a rating system that links the performance
of its logistics providers with their bids for transportation lanes.
The result: Service has been improved; costs have been contained;
and logistics departments, freight buyers, and freight forwarders
are working together on continuous improvement.

come together BY SEBASTIAN SCHMIDT-

ECKERT

scmr.com FOCUS ON LOGISTICS 39

 Knorr-Bremse
measure we created to rate service level performance.
The result: In order to gain more of our business, freight
forwarders are motivated to cooperate and strive to deliver
continuous improvement on their service factor. That has
allowed us to eliminate penalty clauses and create a culture
of cooperation that provides a new view on the value spent on
freight deliveries. This is how we did it.
A History of Innovation
Based in Munich, Germany, the Knorr-Bremse Group is
the world’s leading manufacturer of braking systems for rail
and commercial vehicles. For more than 110 years now the
company has pioneered the development, production, mar-
keting, and servicing of state-of-the-art braking systems. In the
rail vehicle systems sector, the product portfolio also includes
intelligent entrance systems, HVAC systems, power conversion
systems, control components, and windscreen wiper systems,
as well as platform screen doors, friction material, driver assis-
tance systems, and control technology. Knorr-Bremse also offers
driving simulators and e-learning systems for optimum train
crew training. In the commercial vehicle systems sector, the
product range includes complete braking systems with driver
assistance systems, as well as torsional vibration dampers,
powertrain-related solutions, and transmission control systems
As a shipper, we are tasked
first and foremost with doing
whatever we can to satisfy the needs of our
customers even while we must control costs.
It is a delicate balance.
for enhanced energy efficiency and fuel economy.
In 2014, the Knorr-Bremse Group posted €5.2 billion in
revenue. Our expertise ranges from the systems level right
down to the individual components—and efficient overall solu-
tions. One example is the brake control system for the Chinese
CRH380 B high-speed train, which was designed to cope with
temperatures down to -40°C and expands the geographical
scope for the module’s use.
With a global footprint, the company is organized into
three regions in the Americas, Europe/Africa, and Asia. The
Asian Group is headquartered in Hong Kong. Freight ser-
vices for the region are procured through a lead buyer team
located in Suzhou/Jiangsu, China. The contracted freight
services that led to the initiative described in this article
40 FOCUS ON LOGISTICS
were sourced to import parts and components from Europe
and the U.S. to supply Knorr-Bremse factories in Beijing,
Qingdao, Dalian, Wuxi, Suzhou, Shanghai, Chongqing,
Guangzhou, Hong Kong, Sydney, and Tokyo. Those imports
are critical to our manufacturing operations in Asia.
Beyond Cost
As with any shipper, Knorr-Bremse Asia Pacific Ltd. is under
tremendous pressure to satisfy the needs of its external and
internal customers. In this instance, our internal customers
were factories in the Asia region that relied on the timely
delivery of parts and components to meet manufacturing
schedules. As such, the lead buyer team’s goal was fast and
reliable service that met the needs of the plants.
At the same time, when it comes to the different players
in the logistics supply chain, including the service provid-
ers and freight forwarders, the lead buyer team had the least
amount of power to influence costs. After all, many rates are
involved, such as those for pick-up, document checks, the
mode selected, seasonal mark-ups; fees for packing, loading,
and consolidation; and, of course, fuel, airport fees, airport
taxes, unloading, customs clearance, duty, import tax, storage
charges, terminal charges, and express charges all factor into
the cost of moving goods. While a freight forwarder may have
influence over some of those
components, such as pick-up
or consolidation costs, fuel
rates are set by markets; import
taxes, customs clearance, and
duty charges are determined by
governments; and airport rates
vary from facility to facility. And,
while a shipper is the customer, even payment processes may
be beyond their control: In certain instances, a freight forwarder
can claim that a late or damaged delivery was affected by exter-
nal influences, or claim force majeure (generally intended to
include occurrences beyond the reasonable control of a party),
and still insist on timely payment for lackluster service.
Meanwhile, as a shipper, we are tasked first and foremost
with doing whatever we can to satisfy the needs of our custom-
ers even while we must control costs. It is a delicate balance,
and too often the effort to control costs is in conflict with ser-
vice level agreements. When that happens, no one is satisfied.
Risk = Cost + Service
Risk = Cost + Service: This was just the situation we
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faced at Knorr-Bremse Asia
Pacific Ltd. about five years Price reductions may also
ago. As buyers of freight
present an opportunity for
services, we needed to get
control over the cost and ser-
a shipper
vice level of our shipments,
and shift some of the risk to the
especially imports from Europe freight forwarder. Again, it is a
and North America. At the
same time, our expertise was
in mechanical engineering
and not freight forwarding. We were not able to trace or
understand the dynamics of the different cost elements
of a freight transaction. We believed the freight forwarder
was the expert in the best position to manage the risks
involved. As a result, we expected a complete package of
services from freight forwarders, including the assumption discovered that low prices often led to low levels of service.
of the risks involved in shipping.
What are those risks? Primarily, they are the price we
as a shipper are willing to pay for freight services, and the
quality of service we receive in return. One has an impact
on the other. For instance, service quality is one way ven-
dors keep costs low, especially new vendors: They often
offer a very low bid in order to win business only to find
that they are unable to meet our service level requirements.
Or, they skimp on service in order to preserve their mar-
gins. Our risk is that having accepted the low bid to control
our costs, we end up suffering from production disruptions
because of delayed shipments. At the same time, the trans-
portation provider is at risk from price reductions because
they can lose margins if some of those cost components
beyond their control go up, such as the cost of fuel or air-
port rates. Price reductions may also present an opportunity
for a shipper to lock in some savings and shift some of the
risk to the freight forwarder. Again, it is a delicate balance.
Development of a New Approach
As we looked at this situation, it made sense to develop dif-
ferent strategies to manage the risks of cost and service: The
initial concept was that service could be addressed offline
through detailed discussions with our lead buyer team in
China, our operations departments that depended on timely
deliveries, and the freight forwarders. Meanwhile, the price
could be determined in a highly competitive situation, like
e-bidding under limited time.
We rolled out this new strategy in 2011, when we
launched a bidding process: The most important rule was
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to lock in some savings
delicate balance.
that all quoted prices must be fixed for six months and
include all fees and rate changes that might occur during
that time. Initially, this was done in two phases.
In the first phase, we organized manual biddings and then
began to work with the low-cost bidder. Soon, however, we
Increasingly, the lead buyer team received complaints from
the operating departments in our local factories about late deliv-
EXHIBIT 1
Service Feedback Questionnaire
A. Service Management
• Do we get early warnings of potential problems or process nonconformity?
• How is the general capacity planning?
• Do they provide the failure analysis and valid corrective action plans?
• How is their corrective action implement quality?
• Do they provide the capacity planning during the spring festival and
other holiday?
B. Rate Management
• How is the data quality of the rate sheets?
• Do we get lane quotations on time?
• Does their cost competitive compare to the marketing level?
• Do we receive frequent changes to the rate agreements?
• Do they spend the right invoice based on the bidding agreed rate?
C. Communication
• Have delay, damages, complaints etc. been reported on time?
• Have special events been reported on time?
• Do they have the system/manual tracker?
• Can they provide the necessary shipping information as your request?
• Is track and trace timely updated?
D. Key Account Management
• Do they provide adequate failure analysis support?
• Are there open and honest channels of communication?
• Is their local contact always available for you?
• Does their local contact achieve all requirements?
Note: Each Question is Scored 1-5, Maximum for A.B.C.D. is 24 Points
Source: Knorr-Bremse
FOCUS ON LOGISTICS 41
 Knorr-Bremse

eries and deviations from promised ETAs. By the end of that EXHIBIT 2
first phase, some of the factories were refusing shipments from
Service Factor Computing
the vendors selected by the regional lead buyer.
Service Evaluation
That led to phase two, in which we established Supplier Final Ranking Factor Score
performance KPIs with the vendors and agreed on If you are a known supplier, your final ranking is: 1.00 24
1.04 23
contractual penalties for service short falls. While that Final Ranking Rate = 1.08 22
looked good on paper, the reality was that when service short Submitted Rate 1.12 21
* 1.16 20
falls resulted in penalties, we had unpleasant conversations Service Factor 1.20 19
about root causes and responsibilities and vendors were less 1.24 18
1.28 17
willing to cooperate. If you are an unknown supplier, your final ranking is: 1.32 16
Clearly, something had to change. In response, we devel- 1.36 15
Final Ranking Rate = 1.40 14
oped a concept to link the service profile of our logistics provid-
Submitted Rate 1.44 13
ers directly upstream to the bidding process. Through meetings * 1.48 12
Service Factor 1.52 11
with our operating departments and freight forwarders, we * 1.56 10
1.4
developed a “supplier service evaluation” questionnaire that we 1.60 9
1.64 8
continue to use today. The questionnaire considers four crucial
1.68 7
areas: service management, rate management, communication, Remarks: 1.72 6
• Above mentioned service factor according 1.76 5
and key account management (See Exhibit 1). 1.80 4
to table on the right.
There are four to five questions about each of those areas • Rounding method will be used. 1.84 3
1.88 2
and each question can be answered with a score of 1 to 5. • The supplier selection will refer
1.92 1
to above final ranking rate.
Finally, each of the four service areas is weighted with a per- 1.96 0
centage and a maximum score of 24. That score is then trans- Source: Knorr-Bremse
lated into a “service factor” from 1.0 to 1.96 (Exhibit 2). That
factor is applied to the quoted price of each vendor. with 1.22, and the 3rd vendor is new and will be rated 1.4.
This process was transformative. With the questionnaire, The result of the quote is shown in Table 1 below.
the lead buyer team could now assign a monetary value to the
TABLE 1
service level from a transportation provider that became an
element of the bid. On this basis, the price for the pure trans- Service Evaluated “Cost” for Service
Vendor Quote ($) Factor Price ($) Deficiencies ($)
portation can be clarified independently in a highly competitive
e-bidding process (Exhibits 3 and 4) without compromising on #1 100 1.04 104 4
#2 80 1.22 98 18
service levels anymore. The lead buying team could determine
#3 76 1.40 106 30
if a low bid was truly worth the cost of poor performance, or if
a higher bid might deliver greater value when service was fac- Source: Knorr-Bremse

tored into the equation.

Implementation
Since the implementation of the questionnaire, the operat-
ing departments assess all existing vendors regularly, and
each knows their service factor. New vendors entering the
bidding procedure for first time are required to perform a
self-assessment. The result of their self-assessment is multi-
plied with a newcomer malus of 1.4.
Today, we hold e-bidding events every six months with the
original criteria that all quoted prices must be fixed for six
months and include all fees and rates that might occur. Now,
let us assume three participants quote for a specific lane:
One vendor is rated with a service factor of 1.04, the second
With this approach, the service deviation now has a defined
cost. As a shipper, we have to factor this in as a cost of doing
business. At the same time, the vendor’s quote is less attrac-
tive by the same amount.
Impact
With the tool in place, the Knorr-Bremse Asia Pacific lead
buyer team is bidding regularly for 20 main lanes and 300
sub-lanes around the globe. If an established vendor tries to
crack the bidding by low-balling prices, it is conceivable that
the vendor could win a number of lanes. But, as a rule, we will
only grant one pilot lane to a new vendor, even if that vendor
wins more. Thus, the risk for Knorr-Bremse—as well as the

42 FOCUS ON LOGISTICS scmr.com

risk for established vendors who know their costs—is
kept to a minimum. If that new vendor demonstrates
good performance during the first year on a pilot lane,
the concerned operating departments can assess the
service performance. Thus, a service factor based on real
performance is being set up for application in the next
bidding round. Internal stakeholders and external ven-
dors appreciate this rule as practical and helpful.
After several years of working with this price-per-
formance strategy, our practical experience has been
very positive. We have managed to satisfy internal cus-
tomers’ expectations, to be a reliable and transparent
partner for our vendors, to significantly improve service
levels, and keep prices on a market minimum. It is a
clear, fair, and effective procedure for all parties.
For the first time, service expectations are defined in
detail. We have a regional standard specification that is Source: Knorr-Bremse
fully transparent. Communication about service level
contributions, questionnaire scores, and service factors
between the lead buyer team and vendors is open and hon- cost of doing business with them is lower due to superior
est. That has improved the atmosphere for cooperation and service. Internally, the operations departments no longer
has reduced unpleasant discussions about service casual-
ties and penalties. Instead, there are more general discus-
sions about customer expectations and vendor capabilities.
More importantly, vendors have a motivation to reduce
the cost of their service deficiencies; they are proactively
working on improving their service factor scores in order
to raise their chances of winning business even if their bid
EXHIBIT 4
A Knorr-Bremse Ticker Auction
Auction Run Strategy
Start Target-oriented
• Purchaser setting start price and running time
Auction Process
• Simultaneous bid of standardized price Total Price Element
breakdown (price elements, margins, Transparency for Further
rebates, etc.) Negotiation Arguments
• Purchaser determines bidding increments Drive the Auction to
and continuously falling target price thresholds Target Price Level
• Times for re-calculation are being Enable Price Reliability
planned within the auction process for Safe Execution Later
• Bidders who don’t confirm are being Search for Best
excluded from the further auction Competitiveness
• Auction is being repeated until no price
Identification of
threshold is being confirmed anymore or
Winner
a pre-defined number of bidders remains
Source: Knorr-Bremse
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EXHIBIT 3
Preparation of a Knorr-Bremse Ticker Auction
Preparatory Steps Strategy
• Definition of participants according to critical
capabilities (global reach, facilities close to Aptitude Check
shipper, cultural match, references, etc)
• Set individual evaluation factors (service
Raise Comparability
factor, approval cost, and other charges)
• Upload and communication of Equal Chance
bidding specifications for All Bidders
• Communication of “service factor” Increase Competitive
attributes to all bidders Stress
• “Warm-up bid” to ensure common under- Fix Start Point for
standing, define data set for new entrants, Automated Result
and fix start position Evaluation
is a little higher than the competition because the overall
blame our lead buyer teams for buying bad service to save
money.
Last—and perhaps most important—this initiative is
aligned with our efforts to strive for continuous improve-
ments in our operations and to develop and improve the
capabilities of our vendors’ organizations. In this way, we
and our freight forwarders are “pulling on the same rope.”
The feedback we receive from our internal operating
departments influences the service factor we apply
to logistics providers for the next round of e-bidding.
Thus, the operating departments—and Knorr-Bremse
as a shipper—have turned the traditional relation-
ship between shipper and logistics provider on its
head: Instead of operating from a weak position, it has
allowed us to gain leverage with our service providers. It
may still be difficult to influence costs, but service defi-
ciencies can now be punished with fewer opportunities
to win business. Ineffective—and unpleasant—penalty
clauses are no longer necessary. Instead, we now have a
powerful tool that is fully transparent and accepted by
all participants. •
The author expresses his gratitude to George Yu and Maggie
Wu from the lead buyer team located in Suzhou/Jiangsu,
China for their substantial contributions to the development
of this program.
FOCUS ON LOGISTICS 43
 NextGen supply chain:
We gonna rock down
to electric avenue?
The transportation industry is focused on
competition from the likes of Uber Eats,
DoorDash, Roadie and Zifty, but we should be
paying close attention to what’s occurring in
the electric vehicle sphere.
BY KEVIN ZWEIER, CHAINALYTICS
A
s vehicle manufacturers and investment firms
continue to pour money into new vehicle technol-
ogy that supports green initiatives, the transition to
electric vehicles across all areas of transportation continues its
rapid expansion. This push, combined with advancements in
vehicle automation capabilities, proves once again that change
is imminent and should no longer exist as an oversight. And
while other transportation services such as parcel and food
delivery are faced with innovative and industry changing com-
petition from “sharing communities” like Uber Eats, Door-
Dash, Roadie, Zifty and others, the transportation industry
should be paying very close attention to what’s occurring in
the electric vehicle sphere.
Electric vehicles sales continue to increase
As most have probably heard by now, Volvo announced earlier
this summer that it is scrapping vehicles that rely solely on the
internal combustion engine and producing five new models
that will have an electric component, either hybrid engines or
fully electric. As a result, Tesla gained some major competition
in the electric vehicle market, and it’s not just Volvo. Nissan
and Chevy already offer affordable electric vehicles, BMW
plans to unveil their all-electric 3-Series sedan later this fall,
44 FOCUS ON LOGISTICS
and Volkswagen has vowed to produce one million electric
vehicles by 2020.
Furthermore, predictions suggest electric vehicle sales will
increase from 700,000 (2016 record) to 3 million in 2021, 5%
of European light-duty auto sales, and will eventually make up
54% of global new car sales by 2040. As of August 2017, US
sales of fully electric vehicles are up 86% from 2016. Also by
2040, electric vehicles are supposed to make up 67% of the
European market, 58% in the U.S., and 51% in China. Some
analysts predict all new vehicle sales will be electric models
by as early as 2025 as interest levels, access, and affordability
continue to increase.
Even more interesting, most predictions do not include
heavy duty vehicles sales such as buses and commercial
trucks, nor lower-duty such as motorbikes and low-speed
“micro-cars.” Also, the technology continues to see a cost
reduction with a simultaneous performance increase. For
example, lithium-ion batteries have gone from $1000 per
kWh (2010) to $273 per kWh (2017) and are expected to
be $73 per kWH by 2030. Furthermore, Tesla’s Gigafactory,
the lithium-ion battery plant located in Nevada, is poised to
double the world’s battery production and reduce battery pack
prices by an additional 30-50% in the coming years.
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Contributing factors mance capability and more torque than their fuel operated
These developments, along with several other factors occurring counterparts. As one analyst puts it, with electric motors you
in transportation, are brewing a perfect storm for disruption. receive “Porsche performance for Buick prices1.” Morgan Stan-
For example, France has announced plans to ban the sale of ley analysts Adam Jonas and Ravi Shankar estimate the Tesla
any car that uses petrol or diesel by 2040, other countries as semi truck to cost around $100,000 (if separately leasing bat-
early as 2025. The oil industry continues to watch prices drop teries) and be up to 70% cheaper to operate than a traditional
as the oil supply surplus continues despite the mounting pres- truck, which is traditionally priced around $150,000. Even if
sure for carbon reductions from city and national governments Tesla charges an additional $100K-125K than Jonas’ estimate,
worldwide. Global corporations continue announcing methods if the 70% cost reduction proves true, Tesla’s model will merit
to reduce carbon emissions as the push for sustainability and serious ROI consideration.
eco-friendly operations continues.
However, the factor most likely to sooner impact freight Embrace Innovation
markets will be the revelation of Tesla’s Class 8 electric freight Even though diesel prices are not as high as they were a few
truck this October. While the Tesla Semi won’t be the first years go, carriers and shippers should start investigating strate-
electric freight vehicle to be revealed, Elon Musk is generating gies or scenarios that involves utilizing an electric fleet. Even
significant buzz around their contribution to the industry. Elon initial releases with shorter ranges can prove beneficial in spe-
Musk claims it has the power to haul freight as effectively if cific markets and can help implement cost reductions while
not more so than a traditional diesel truck. So
as not to be left behind, Daimler Trucks and The increased investment in the technology surrounding
TransPower are also testing technology that
electric vehicles has exponentially increased capability
will help them be both relevant and competi-
tive in the electric freight market. People
while drastically driving down the price of batteries,
see the change coming, but no one has any manufacturing, etc. and will continue to do so as the
idea on what the initial and long term impact demand increases over the next several decades.
will be on the Class 8 weight segment of the
industry which generates $30B+ of revenue annually in North improving sustainability efforts. Oftentimes when a new trend
America alone. is labeled a disruption, it can be attributed to major players
in an industry failing to go to market when the opportunity
Will electric semis become the standard? first presents itself, usually several years before the “disruptor”
To be clear, with little information known about range and evolves into the norm or “industry standard.”
charge time requirements of Tesla’s new semi model, it’s dif- The increased investment in the technology surrounding
ficult to assume anything. Cummins Class 7 electric truck is electric vehicles has exponentially increased capability while
limited to 100 miles and takes approximately an hour to charge, drastically driving down the price of batteries, manufacturing,
though the company hopes to drop that timeline to twenty min- etc. and will continue to do so as the demand increases over
utes by 2020. Initial reports claim Tesla aims for a 300 mile the next several decades. With demand levels expected to
range, but the company has declined to confirm that statistic. be high, moving forward without a plan could leave shippers
Also, with production likely still two or three years away, the empty handed when order placement begins.
full-scale immersion of electric semis will occur gradually. The electric vehicle’s progressive rate of advancements
While traditional trucks will still dominate the road for the primes its disruption to occur on a scale previously unseen.
time being, the potential benefits of an electric truck are eye Their development stretches across multiple areas of inno-
opening and certainly warrant some discussion. For starters, vation including energy storage, artificial intelligence and
the electric motor possesses 90-95% energy efficiency com- computing power, autonomy, robotics, and more. Continued
pared to 17-21% of the internal combustion engine and are 10x advancements in these areas will not only reduce costs
cheaper to charge/fuel than traditional engines. As far as main- of goods and services but produce huge benefits for both
tenance is concerned, internal combustion engines contain developed and undeveloped countries across the globe.
2,000+ moving parts to the electric vehicle’s double digits (the With drone delivery service and driverless technology mov-
Tesla Model S powertrain possesses only 18), creating a drastic ing ever closer from theoretical to operational, shippers and
reduction in maintenance and spawning long running warranty carriers will have to brace themselves for sustained shock-
plans such as Tesla’s “Infinite Mile Warranty.” waves of disruption just as the data from the initial shift
Additionally, electric vehicles can possess a higher perfor- starts to iron itself out. •

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NextGen supply chain

Transportation management systems

expand in NextGen supply chains

This is a time of innovation in TMS as the software’s capabilities broaden

significantly, improving its deliverables across the supply chain.
BY GARY FORGER, SPECIAL PROJECTS EDITOR, SUPPLY CHAIN MANAGEMENT REVIEW

T
ransportation is transportation. Not much change
there except for the talk about autonomous trucks,
right? Well, not exactly. Especially if you’re taking a
look at the NextGen evolution of transportation management
systems (TMS).
The software doesn’t manage the warehouse, pick orders or
do tactical or strategic planning in the supply chain today.
However, TMS does manage the transportation of
goods, including shipment and rate management functions
as well as load building and back hauling not to mention
carrier communication.
All important functions, but limited in scope for sure. At
least, that’s the way TMS has been.
Talk to some experts in the field and it’s clear that TMS is
on the move to expand its portfolio.
Over at Chainalytics, vice president of the transporta-
tion practice, Kevin Zweier, talks about how capabilities of
TMS are expanding.
He goes so far as to say the expansion of TMS across all
modes is the dominant trend in the software today.
This chart from Chainalytics shows five key functions core
to the software today.
The other nine functions in the chart are accomplished by
an integration of TMS and complementary software solutions.
Now don’t look for TMS to run the warehouse or picking. But
do look for it to be actively involved in the tactical and stra-

46 FOCUS ON LOGISTICS scmr.com

tegic planning tools going forward. And the expansion of its A key player in the development of TMS’ expanding
capabilities is not going to stop there. capabilities is the Cloud. In the accompanying NextGen:
The perfect example of those planning tools is the devel- The Interview, Zweier says that “Cloud is a now thing not
opment of carrier capacity management, explains Geoffrey a future thing. All TMS will eventually be in the Cloud.
Milsom, senior director of enVista’s transportation consulting Cloud improves usability of the software as well as the user
practice. Being effective here requires both strategic and tacti- experience.”
cal sourcing to facilitate carrier capacity at a reasonable price. Cloud also makes it possible to integrate TMS, not just
Milsom says the objective is not just better utilization of with complementary software solutions but with NextGen
equipment but of drivers down to the specific day or days of technologies from AI to IoT. The outcome, says Cunnane,
use. Not to mention delivering a better shipper experience is “smarter systems, improved visibility, an increased use of
when shipments and deliveries occur on schedule. sensors for real-time asset tracking, temperature controls
Making that and other metrics.”
happen going Visibility is increas-
forward requires ingly becoming a
TMS to team up big deal with TMS.
with several Next- According to Milsom,
Gen technolo- 50 to 60% of shippers
gies, says Chris and 3PLs use TMS
Cunnane, senior today. But less than
analyst at ARC 10% of those TMS
Advisory Group. users have an external
“There are or third party visibility
NextGen TMS software application
solutions out there integrated into their
that are or will be TMS for real-time vis-
using machine ibility. However, that
learning (artificial breadth of use is ris-
intelligence or AI), ing rapidly thanks to
advanced analyt- the hard dollar value
ics and Internet of visibility solutions,
of Things (IoT) to says Milsom.
drive efficiencies In fact, hard dol-
for shippers and carriers alike,” he says. Part of TMS’ expan- lar value has long been a strong suit of TMS. And it’s get-
sion into the planning process is last-mile routing. “Machine ting better even before the expansion of TMS’ capabilities.
learning and AI will be very important here,” says Cunnane. Cunnane says that a recent ARC survey shows an average
“The time a job takes to complete is dependent not just 8% freight cost savings with TMS. “That’s a two percentage
on the miles that need to be driven, but on the congestion, point improvement from the last time ARC surveyed TMS
the product being delivered, the type of delivery destination users,” he adds. “As TMS functionality improves, systems
and value-added services,” he adds. “Machine learning can be become ‘smarter’ and e-commerce and omni-channel
used to ‘learn’ these constraints rather than having to do time become more important, TMS will continue to drive effi-
studies and hard code these constraints into the solution.” ciencies.”
There are other NextGen technologies likely to team up From all indications, Cunnane has it right when he says,
with TMS, says Milsom. One is blockchain. But he expects “it is truly a time of innovation in the transportation space.” •
that to be a longer process than autonomous trucking. He
expects long-haul, over-the-road and irregular route trucking Gary Forger is the special projects editor for Supply
to all benefit greatly from autonomous trucking managed by Chain Management Review. He can be reached at
expanded TMS capabilities. grforger@gmail.com.

scmr.com FOCUS ON LOGISTICS 47