Wanted: Internet logistics expertise

Online retailers seek logistics service providers offering high-quality supply chain management knowledge. But new research by supply chain management professor Elliot Rabinovich shows retailers need to look before they leap into a contract with a provider.

With Thanksgiving just around the corner, American consumers are gearing up for the annual shopping frenzy that comes with the holiday season. As more and more shoppers opt to avoid long lines and crowded malls by clicking through their gift lists at online storefronts, Internet retailers must gear up their supply chain and fulfillment operations to meet the increasing demand.

The spike in Internet holiday shopping — Jupiter Research predicts an 18 percent increase in online sales this year compared to 2005 — is good news for Internet retailers, provided they can keep up with demand and deliver goods on-time; bad news if they cannot. As such, many online retailers are turning to third-party logistics service providers (LSP) to help improve their fulfillment and service capabilities.

What exactly is an LSP? These companies are "the link between customers and Internet retailers, providing support in the 'last mile' of the supply chain around the delivery process that companies such as UPS, FedEx, DHL, and the U.S. Postal Service execute," says Elliot Rabinovich, an assistant professor of supply chain management at the W. P. Carey School of Business, who, along with A. Michael Knemeyer of The Ohio State University, recently examined the relationships between LSPs and online retailers.

LSPs offer online merchants a wide variety of asset- and non-asset-based services such as shipment processing; reverse logistics; inventory control; and order verification, confirmation, and delivery, among others. They also bring to the table knowledge of and access to suppliers, customers, and carriers. This combination of services can help online sellers gain internal efficiencies — such as reduced costs, improved fulfillment times, and expanded inventory — as well as better customer service for its users. But LSPs are not a cure-all for Internet merchants.

Rather, companies must closely examine their supply chains and the capabilities of third-party providers to determine whether or not an LSP will provide the sought-after efficiencies, according to the study. Rabinovich surveyed roughly 200 Internet sellers with online sales of more than $1 million per year, and researched company examples such as LinensNThings, Netflix, WalMart, 1-800Flowers, and PetsMart.

Online sellers must be able to decipher whether or not joining forces with an LSP will enable them to price their offers in ways that will improve margins. "LSPs are not equally beneficial for all firms," Rabinovich explains. "The success of outsourcing to an LSP depends largely on how specific the Internet company's functions are, and the level of uncertainty of the conditions surrounding those functions."

Online Retailing 101

To comprehend the importance of retailer-LSP relationships, it is crucial to understand the underlying components of online retailing and Internet supply chains. Internet retailers face specific challenges that are different from their offline counterparts; managing e-commerce supply chain and distribution functions comes with a set of unique headaches.

"In the traditional retail environment, customers go to a store, buy certain products, and take them back home. If a product is not there, consumers might buy something else, or they might go somewhere else until they find what they're looking for," says Rabinovich. "With Internet retail, however, customers have the power to drive the supply chain in a very direct way because fulfillment has to reach them, not the other way around. For the first time, customers are playing a stakeholder role in the supply chain."

"Because of this, the type of service online merchants require is very unique," he continues. "Fulfillment, for example, is particular to the last mile. You no longer have full truckloads arriving at a distribution center or the back door of a store, but rather small orders — an Amazon.com order may be one book or a couple of CDs, for example — delivered at particular discrete locations."

With consumers at the steering wheel, it's no surprise that product commoditization is rampant in online retailing. For every widget you need, there are three or four web sites willing to sell it to you — and competing to offer it for the lowest price, which is often the deciding factor for a web site shopper. But competing to be the lowest-cost provider is a losing proposition for online sellers. Internet merchants that embrace logistics best practices have a better chance of getting out of this price-leadership battleground because they can offer service differentiations to their customers, says Rabinovich.

"Internet retailers that don't create effective supply chains face a double effect," he says.

"They miss out on the opportunity to differentiate themselves with service and reap all the implications good service brings, such as loyalty, repeat purchases, viral marketing, and the ability to increase price point. They also erode their own profitability because they don't have the cost efficiency necessary to sustain price leadership."

In addition, Internet sellers that are slow to address deficiencies in their logistics operations will increasingly face desertion by customers unhappy at receiving orders late, wrong, or in some cases not at all, says Rabinovich.

Look Before You Leap

LSPs have jumped into this fray offering value propositions that are attractive to Internet merchants struggling to overcome these particular hurdles. But the very challenges that make LSPs so enticing are the same ones that make them not always the best solution. Because online retailers face such specific supply chain challenges, it can be difficult for LSPs to offer the cost-effective, strategic services these merchants desire.

Rabinovich's research identifies several important factors online retailers must consider when making outsourcing decisions. Complexity is a major impediment to LSP efficiency, he says. The more complex and specific an Internet seller's business model, the less likely an LSP can provide a cost-efficient solution. If the LSP cannot offset the cost of developing a capability or service for one customer by offering that capability to another customer, it becomes cost-prohibitive for the LSP to perform that service at a price point that makes sense to the retailer, explains Rabinovich.

He points to online DVD rental service Netflix as an example. Netflix's ability to offer customers a choice of more than 65,000 titles and promise delivery of the next title in a customer's movie queue in about 48 hours is a competitive advantage. But to do this requires specialized inventory and an infrastructure of 41 localized distribution centers (DCs).

"Netflix's DCs are strategically located because they have to be close to customers to meet the order cycles," Rabinovich explains. "For those reasons, it would be difficult for Netflix to hire an LSP to handle its inventory." For some Internet retailers, such as online grocers, the complexity in their transportation processes makes partnering with an LSP a dubious choice. Fresh Direct, for instance, uses a "milk run" setup to deliver groceries to groups of customers in similar areas — all in a very specified timeframe.

"Fresh Direct has to determine how to optimize the route to cluster customers around a particular location, dispatch the trucks properly, and avoid as much as possible having empty trucks travel back to replenish at the DC," Rabinovich explains. "This is a very specific operation for which UPS or FedEx could not offer a great deal — it is too complicated." Uncertainty — about both the LSP's performance, and the environment surrounding the logistics service in question — also impacts the efficacy of outsourcing.

Online retailers that spend a disproportionate amount of time trying to gauge expected LSP performance levels or train their providers to adjust to uncertain market conditions are less likely to outsource, finds Rabinovich. In addition, he says, online retailers seeking to partner with an LSP should consider the following questions in order to match up their needs with the correct provider and make sound outsourcing decisions:

• In addition to its own services, does the LSP offer capabilities through a network of relationships with other providers?
• Do you need a provider that is physical asset-based or information-based?
• Are its functions focused on suppliers, customers, or delivery? Which do you need?
• Do the provider's services fit with those available at your suppliers and carriers?

Ultimately, it makes sense for online retailers to partner with an LSP when doing so provides the retailer with value-added benefits and helps it improve customer service. "Internet sellers run into problems when they sign a contract thinking they will save money, but end up stuck in a situation where the services scare away the customers," says Rabinovich.

"Retailers might be able to cut costs by using an LSP, but if services are not meeting customer expectations, it becomes counterproductive." Whether outsourcing ends up being the right decision or not, understanding the nuanced supply chain roles of LSPs and acting on that knowledge to assess the appropriateness of using an LSP will help Internet sellers gain a competitive edge, says Rabinovich.

The Bottom Line

• A highly competitive atmosphere and new, web-specific challenges make the Internet supply chain tricky to manage efficiently. Because of this, many online retailers are turning to logistics service providers (LSPs) for help.
• When evaluating whether or not to contract with an LSP, Internet sellers need to determine whether the LSP's services will allow them to improve their margins.
• Retailers must be sure that hiring an LSP will not impede customer service, as customers will often abandon a web site if they have a poor shopping experience.
• The more complex and specific a retailer's logistics processes are, the less likely they are to successfully outsource functionalities to an LSP.