Third-Party Logistics: Strategic and Financial Benefits

Introduction

The terms “logistics alliances”, “logistics outsourcing”, “contract distribution”, and “third party logistics” are used interchangeably. According to Coltman, Devinney, and Keating (2010), third party logistics refers to “organizational practice of contracting-out part of or all logistic activities that were previously performed in-house” (p. 141). It entails the provision of numerous services. Previously, third party logistics was associated with the provision of warehousing and transportation services. Coltman et al. (2010) hold that the current third party logistics arrangements “are based on formal contractual relationships as opposed to spot purchases of logistics services” (p. 147). Some scholars argue that shipping lines and freight forwarders form an integral component of third party logistics. Third party logistics has strategic, operational, and financial benefits to businesses. This paper will discuss the merits and demerits of third party logistics. It will also discuss various theories associated with third party logistics.

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Theories on Third Party Logistics

Flint, Larsson, and Gammelgaard (2011) posit “Third party logistics studies are weakly theorized, with 69% of the papers having no theoretical foundation and just describing trends in the industry” (p. 119). It corroborates some scholars’ views that logistics studies are devoid of a theoretical foundation. Nevertheless, some theories have tried to explain the concept of third party logistics. They include the transaction cost theory (TTC), the social exchange theory, and the commitment-trust theory among others. The transaction cost theory explains why business people outsource or purchase particular services.

Flint et al. (2011) aver that a deal arises whenever a product or service is shipped across a technically separated interface. According to Flint et al. (2011), using market mechanisms is associated with many costs. They include the cost of “negotiating contracts for each exchange transaction as well as the expenses for specifying the details of a deal in the contract” (Flint et al., 2011, p. 129). Based on the TTC, the cost of a transaction determines if an organization will opt for third party logistics. The transaction cost theory is premised on two essential behavioral suppositions. They are opportunism and bounded rationality. The theory tries to envisage the services that are contracted to third parties by assuming that businesses endeavor to cut down on costs. Thus, they tend to outsource activities based on their costs.

Advances in exchange practices and institutional markets make it hard for scholars to use a single theory to elucidate governance mechanisms. Previously, transactional cost theory was sufficient to explain the factors that underlie third party logistics. However, today, there is a need to use numerous theories as TTC appears to lose explanatory power. The study of inter-organizational relationships has led to the birth of social exchange theory. Frankel, Naslund, and Bolumole (2009) maintain that social exchange theory is critical to understanding third party logistics. It elucidates the factors that contribute to the success of third party logistics and other forms of outsourcing. According to social exchange theory, businesses invest in third party logistics because they consider it rewarding. Thus, companies are likely to continue to use third party logistics as long as they deem it satisfactory. Frankel et al. (2009) allege that third party logistics allow organizations to attain operational efficiency and flexibility. As a result, enterprises are likely to embrace it as long as they are guaranteed returns.

Frankel et al. (2009) posit, “Commitment-trust theory is a young theory which, based on the social exchange theory, views commitment and trust as central elements of trade relationships” (p. 193). The theory considers opportunism as a critical factor in third party logistics and outsourcing. According to Frankel et al. (2009), marketing has to differentiate between relational exchange and distinct transactions. Today, the relational exchange continues to become critical. Hence, there is a need for relationship marketing to streamline partnership concerns. Selviaridis and Spring (2013) define relationship marketing as “all activities directed toward establishing, developing, and maintaining successful relational exchanges” (p. 129). The commitment-trust theory enables people to understand the concept and significance of third party logistics because it gives deeper insights into the establishment of thriving exchange relationships.

Types of Third Party Logistics

According to Selviaridis and Spring (2013), third party logistics providers include courier companies and freight forwarders. There are four groups of third party logistics providers. They are standard third party logistics providers, service developers, customer adapter, and customer developer. Selviaridis and Spring (2013) hold that the standard third party logistics provider is the most basic category. It offers warehousing and distribution services. Besides, it conducts other activities like pick and pack. A majority of the companies in this group do not specialize in logistics only. Instead, they have other principal activities. Service developers offer enhanced value-added services to their clients. They include cross-docking, tracking, specific packaging, and tracing. Moreover, they provide exclusive security services. Service developers have a strong information technology foundation.

Besides, they value economies of scale. According to Gentry and Vellenga (2010), a customer adapter is a category of third party logistics providers that “comes in at the request of the client and mostly takes over complete control of the company’s logistics activities” (p. 41). It helps an organization to boost its logistics activities. Nevertheless, the logistics provider does not have the authority to introduce innovative services. The customer adapter does not enjoy a significant customer base. Gentry and Vellenga (2010) allege that the customer developer is the pinnacle of the third party logistics. The logistics provider assumes full control of the logistics activities of the customer. In most cases, logistics providers in this category have a limited number of clients. However, they execute rigorous and in-depth tasks for the clients.

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Consideration for Third Party Logistics

The decision to contract third party logistics depends on both internal and external factors. Anderson, Coltman, Devinney, and Keating (2010) identify factors like “cost and service trade-offs, the centrality of logistics functions, risks and controls, information technology, and relationships with logistics service providers as some of the conditions that influence consideration for third party logistics” (p. 101). Additionally, process- and product-related needs like handling requirements and cycle times affect third party logistics. According to Anderson et al. (2010), market concerns such as customer services and demand variability affects third party logistics. Moreover, supplier dependence impacts third party logistics. Companies that rely heavily on suppliers are likely to source third party logistics to minimize operations costs. The organizational structure of the shipping firm can also determine if a business will seek the services of a third party logistics provider. Companies with spread out “line activities” at the enterprise unit level are likely to invest in third party logistics (Anderson et al., 2010). On the other hand, businesses with centralized activities do not require the services of logistics providers.

According to Anderson et al. (2010), the cost/service trade-offs determines if firm contracts third party logistics. The decision to procure the logistics services depends on the cost evaluation of alternative options. The costs attributed to “executing logistics functions in-house and investing in capital assets are traded-off against service provider fees” (Anderson et al., 2010, p. 107). Entrepreneurs then select the most economical option. One should acknowledge that cost is not the single most critical factor that influences consideration for third party logistics. Entrepreneurs also consider logistics service issues. For instance, many companies do not use third party logistics due to customer service issues. Numerous authors have used the transaction cost theory to explain the factors that influence the decision to utilize third party logistics. As per Anderson et al. (2010), “high asset specificity coupled with difficulties in performance measurement should lead to in-house distribution” (p. 111). On the other hand, high transaction frequency forces organizations to seek the services of third party logistics providers. Little uncertainty coupled with the high- or medium-specific asset may lead to the use of third party logistics providers.

Capability and resource considerations can also influence the decision to use third party logistics. According to Coltman et al. (2010), establishing a healthy relationship with third party logistics providers saves an organization the costs associated with investing in innovative capabilities and assets. It enables organizations to focus on their core businesses. Besides, variations in business environment, demand for cost reduction, intensified rivalry, and the need to reorganize supply chains may lead to companies contracting third party logistics providers. Whatever the reason for liaising with third party logistics providers, the decisions should be evaluated on the background of business and logistics plan at a given period.

Benefits and Risks

Authors attribute numerous benefits and risk to third party logistics. The advantages and risks can be categorized as finance-, strategy-, and operations-related. Contracting non-strategic processes to third party logistics allow businesses to concentrate on core competencies. The companies direct their resources and energy to areas they are skilled. According to Gentry and Vellenga (2010), third party logistics can help a business to enhance customer services. The logistics providers have sophisticated information technology systems that enable them to track and respond to customer needs. Most manufacturing companies cannot consistently change their information technology systems to meet the needs of the target customers. A business can use third party logistics to reach a global market, thus serving a broad customer base.

Gentry and Vellenga (2010) argue that third party logistics is associated with multiple cost-related benefits. It helps to cut down on asset investment. A business does not have to procure the infrastructure required for product distribution. For instance, a company does not require investing in transport and warehouse facilities. Additionally, contracting third party logistics helps to minimize equipment maintenance and labor costs. Logistics service providers “serve multiple customers and can utilize capacity better and spread logistics costs, thus achieving economies of scale” (Gentry & Vellenga, 2010, p. 39). As per Gentry and Vellenga (2010), third party logistics has operational benefits to an organization.

It helps to cut down on inventory levels. An organization does not incur the cost of managing a huge inventory. Additionally, it contributes to reducing order cycle times. The business reaches many customers. Consequently, the number of requests increases. Gentry and Vellenga (2010) allege that third party logistics facilitates the enhancement of customer services. A company can deliver products on time as the logistics providers have a global network. Selviaridis and Spring (2013) maintain that third party logistics providers offer numerous services that manufacturing or selling companies may not afford due to the increase in operations costs. In return, they help businesses to manage their resources such as workforce size. Contracting third party logistics providers enable organizations to do away with fixed costs.

Loss of contact with clients is cited as one of the major risks associated with third party logistics. An organization that uses third party logistics to distribute its products lacks direct interaction with customers. Hence, it is unable to gather customer feedback (Selviaridis & Spring, 2013). Nevertheless, organizations use a mixed strategy that enables them to retain critical logistics activities. For instance, most organizations ensure that order management remains as an in-house business. Even though third party logistics enable organizations to boost flexibility, it makes it hard for them to respond to consumer needs. Selviaridis and Spring (2013) claim that contracting third party logistics leads to a company losing in-house capabilities. Moreover, the company does not influence the logistics functions. Selviaridis and Spring (2013) argue that third party logistics utilizes unrealistic fee structures that contribute to increased operations costs. Additionally, the logistics service providers’ margin is too high. The margin counterbalances the cost reduction. A majority of the companies do not have adequate knowledge regarding internal logistics costs. It makes it hard for entrepreneurs to ascertain the cost-related advantages of third party logistics.

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Conclusion

Third party logistics providers offer numerous services to businesses. They include transportation, warehousing, and integrated operations. Various theories explicate the concept of third party logistics and its benefits to businesses. They include transaction cost theory and social exchange theory among others. Process- and product-related needs, information technology, risk and controls, and costs/service trade-offs are some of the factors that influence the decision to hire third party logistics providers. The benefits associated with third party logistics include small capital investment, flexibility, focus, and cost and time savings. On the other hand, the risks attributed to third party logistics include loss of contact with customers and in-house capabilities.

References

Anderson, E., Coltman, T., Devinney, T., & Keating, B. (2010). What drives the choice of a third party logistics provider? Journal of Supply Chain Management: A Global Review of Purchasing and Supply, 47(2), 97-115.

Coltman, T., Devinney, T., & Keating, B. (2010). Best-worst scaling approach to predict customer choice for 3PL services. Journal Business Logistics, 32(2), 139-152.

Flint, D., Larsson, E., & Gammelgaard, B. (2011). Logistics innovation: A customer value-oriented social process. Journal of Business Logistics, 26(1), 113-147.

Frankel, R., Naslund, D., & Bolumole, Y. (2009). The white space of logistics research: A look at the role of methods usage. Journal of Business Logistics, 26(2), 185-208.

Gentry, J., & Vellenga, D. (2010). Using logistics alliances to gain a strategic advantage in the marketplace. Journal of Marketing: Theory & Practice, 4(2), 37-44.

Selviaridis, K., & Spring, M. (2013). Third party logistics: A literature review and research agenda. The International Journal of Logistics Management, 18(1), 125-150.

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