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The Coming Wave of Supply Chain Convergence
Change continues to ripple through the supply chain industry. Over the past decade, we have seen warehousing companies become logistics companies, watched logistics managers become supply chain professionals, and seen 3PLs become 4PLs and even 7PLs (which, according to one company, is the combination of 3PL and 4PL).
What will be the next big trend in the supply chain industry? I believe the watch words will be "supply chain convergence."
Convergence is all about the combination of relevant services to provide customers with a broader set of solutions. In the 1990s, convergence meant the fusion of warehousing, freight forwarding, and transportation management to produce lead logistics providers or 4PLs. Companies like Menlo, UPS and Kuehne & Nagel, developed integrated supply chain solutions and enabled customers to reduce the number of logistics suppliers they used. Today, companies are increasingly choosing to compete by combining services. For instance, PWC Logistics acquired GeoLogistics, Trans-Link, and Transoceanic in order to add freight forwarding, event logistics, and project logistics to their arsenal of contract warehousing-based capabilities. Similarly, UTi has acquired Standard Logistics, Unigistix, and market transport in a bid to add warehousing, reverse/value-added logistics, and transportation management to their freight forwarding base. The convergence of logistics services is already well underway.
In the current decade, we are beginning to see the emergence of the next big wave of convergence: the combination of outsourced logistics with other forms of outsourcing. For example, in a recent survey of logistics CEOs at the International warehousing and Logistics Association (IWLA), we found that, out of five topics, the subject that generated the highest level of interest was titled: "Where logistics outsourcing converges with other outsourcing." In fact, 100% of respondents picked this topic!
Why is convergence so important? First, let's look at the data. Global logistics is a $179 billion market. But contract manufacturing generates $170 billion. And outsourced technology represents a $300 billion market! All of these markets are maturing, as 20-30% growth rates from the 1990s have fallen to 5-15% today. Increasingly, as other outsourcing markets mature alongside logistics, we will see convergence. See the chart for more information.
Consequently, smart logistics executives are watching other outsourcing industries for new ideas. General Motors,(GM) for instance, has just reconfigured their outsourcing of IT. GM awards $15 billion in annual spending on outsourcing contracts. Historically, GM relied on a large number of outsourced IT providers, played a hands-off role, and signed long-term contracts. But today, CIP Ralph Szygenda is leading a new initiative. His objectives are to reduce the set of IT outsourcing candidates to a top-6 group, manage the outsourcing contracts more actively, and shorten contracts from 10 years down to 5.
This move will have several implications for the logistics industry. First, just as GM's move (over 15 years ago) to dedicated contract carriage with Schneider, ushered in a new era of dedicated contract carriage growth, so GM's moves in IT outsourcing may represent a broader trend. Second, logistics outsourcing contracts are likely to follow the same path as the IT outsourcing route. Third, aggressive IT outsourcers are seeking logistics partners. Some are even pursuing mergers. Companies like EDS, Accenture, and other IT firms are looking at logistics acquisitions as a way to extend their outsourcing capabilities. Meanwhile, logistics companies like New Breed and Menlo are bolstering their IT capabilities in a bid to accomplish a similar goal, but from a different direction. Convergence is already underway!
At the same time, customer demand is also accelerating this trend toward convergence. As Fortune 500 customers have sought to reduce the number of supply chain providers they use, companies like Gillette, Kimberly Clark, and Nortel have increasingly prioritized the selection of suppliers that can provide a broader scope of services. Forward-thinking logistics companies are responding by combining new services to provide more integrated solutions.
A prime example is Power Group, which was sold to Exel in September 2002. Exel, a $7 billion global logistics company, transformed itself from value-added warehousing into full-blown supply chain solutions through a targeted acquisition program. From 1999 to 2001, Exel acquired more than five companies. In 2002, they expanded into contract manufacturing and packaging with the purchase of Power. In turn, Power provided primary packaging of branded products (dry food and beverage) in cartons, bags, sticks and pouches, as well as plastics and glass bottles, in the U.S. and Canada. Due to the high level of strategic value in the combination of packaging and logistics, Exel was able to pay a premium price. In a market where valuations are typically in the range of 4 to 6 times earnings before interest, taxes, depreciation and amortization (EBITDA), according to public sources, Power was valued at approximately 9times the EBITDA.
Why was this warehousing-packaging combination such a valuable deal? In short, it provided the ability to combine manufacturing, packaging and supply chain services into an integrated solution to create value for customers. It also enabled Exel to transfer Power Packaging's core skills and expertise in dry food and beverage to other product categories such as health and beauty aids, pharmaceuticals and medical devices. Finally, it enabled Exel to improve the use of existing warehouse facilities, while also raising the revenue per square foot as a warehouse-based logistics giant.
In short, smart logistics companies should respond by evaluating the growth in outsourcing services such as IT, HR, manufacturing, packaging, and other new services, and decide whether acquisitions of new capabilities make sense. As outsourced supply chain services converge, the winners will be those that continue to evolve.