A new shade of 3PL

Being asset-poor has long been the path to riches. But as truck users face what may be a lengthy period of supply contraction, will a new type of intermediary come to rule the roost? By Mark B. Solomon, Dcvelocity.com

A new shade of 3PL

For more than 30 years, nonasset-based third-party logistics service providers (3PLs) have been on the right side of virtually every meaningful trend. A multidecade buyer’s market for truck capacity has given 3PLs enormous pricing power and the flexibility to match carrier supply with shipper demand. Producers, recognizing they weren’t logisticians, began offloading many logistics-related functions to 3PLs. An increase in offshore production required a deeper understanding of long-distance supply chains and regulatory compliance, responsibilities that companies were all too happy to relinquish to their 3PL partners. As technology requirements expanded, shippers turned to 3PLs to manage IT networks and build value through automation.

All this converged to usher in what has become a golden era for 3PL services. Since 1996, domestic 3PL revenue has grown at a 10-percent compounded annual rate, according to Armstrong & Associates, a consultancy. Armstrong estimates U.S. 3PL revenue will exceed $150 billion this year, which is five times higher than in 1996. Over the past 17 years, only once—in recession-wracked 2009—did the domestic sector report year-over-year declines in revenue, according to the firm. Tompkins International, another consultancy, expects 3PL growth in 2013 to range between 7 and 10 percent, three to four times that of growth in gross domestic product. Since January 2000, equity values of publicly traded 3PLs have outperformed the Russell 2000, a diversified basket of smaller-capitalization stocks, by 400 percent, says Robert W. Baird & Co., an investment firm.

3PL use today appears as strong as ever. Of the top 100 firms in the **ital{Fortune} 500 index, 96 use a 3PL, according to Armstrong data. Of the remaining 400 companies, 80 percent engaged a 3PL in 2012, up from 65 percent in 2008, according to Armstrong.

The factors that goosed 3PL demand initially show little signs of abating. The question is who will reap the spoils of future growth. Until now, the nonasset-based players have been the prime beneficiaries. But there are some who argue the pendulum could be swinging toward providers with physical assets that can also bring a nonasset-based component to the table.

According to those who share that view, the catalyst will likely be a capacity crunch brought on by the chronic shortage of drivers and the reluctance of fleet operators to invest in equipment that will boost capacity rather than just replace aging iron. Baird estimates that trucking supply, which grew 3 percent a year from 1992 to 2006, has shrunk by 10 percent since then as a freight recession and the subsequent economic downturn caused shipper demand to contract. Carriers struggling with the subpar economic recovery and a host of escalating costs from fuel to tires to engine replacements, driver availability, and government regulations have spent the past five years playing it safe. Benjamin Hartford, lead transport analyst at Baird, said in an October research note that carriers are “managing from the trough,” analyst lingo for adopting a minimalist approach to their operations.

As their traditional haulage business stumbles along, carriers looking to generate new revenue streams have been expanding into nonasset-based services, Hartford says. The resultant convergence of asset- and nonasset-based coverage is causing problems for the nonasset-based players, especially those without sufficient buying power or a unique product niche, Hartford says. Shippers worried about reliable access to truck capacity are now more willing to utilize asset- and nonasset-based providers, the analyst added. This reflects a change in mentality from previous cycles, when shippers tilted toward nonasset-based firms that were more “carrier neutral,” Hartford says.

Jonathan Starks, director of transportation analysis for consultancy FTR Associates, says shippers seeking capacity stability are reducing the amount of “random-route” freight they tender in favor of a dedicated contract carriage strategy, where a carrier dedicates capacity for a multiyear period in return for a volume commitment. Because the random-route traffic is a broker’s bread and butter, this migration is bound to slow broker growth, Starks reckons. The continued tightening in supply will accelerate the shift, which has been under way, albeit gradually, for about a decade, he adds.

Ryder System Inc., the Miami-based trucking and logistics giant, is one of those straddling both sides of the fence. Ryder has fused its brokerage services with its “dedicated” trucking unit. The program operates under one contract with a uniform set of terms and conditions, and a single point of contact at Ryder, according to Steve Martin, the company’s vice president of dedicated.

Martin says Ryder’s model gives customers both flexibility and capacity assurance, depending on their situation. It will also have the effect of siphoning off supply that would normally be available to nonasset-based providers through the non-contractual, or “spot,” market. As a result, “running a business on the basis of spot market activity will become more challenging,” Martin says.

Not surprisingly, those on the other side of the debate—notably the nonasset-based providers—haven’t gotten the memo about the sun setting on their business. They note that the widespread capacity shortages that many have been warning about for five years or so have yet to materialize. “We’re not seeing the needle move very much” on supply constraints, says Chris Pickett, chief strategy officer at Coyote Logistics, a nonasset-based 3PL in Chicago.

Pickett says nonasset-based providers with the carrier contacts and network scale have the agility to quickly procure capacity during seasonal spikes such as in produce season, or in markets like retail and so-called fast-moving consumer goods (think toothpaste and toilet paper) that are staple items but where velocity of end demand can shift on a dime. “These are unpredictable and volatile markets, and it’s tough for a shipper to leverage asset-based carriers that operate on static schedules,” he says.

John G. Larkin, lead transport analyst at Stifel, an investment firm, says asset-light 3PLs will continue to play a vital role in optimizing fragmented networks on both sides of the transaction. Larkin added that shippers aren’t as concerned about the prospect of supply constraints as the conventional wisdom might hold.

“When capacity really does tighten to the point where shipments are left on the dock, then the asset-based carriers with brokerages might be more comforting to shippers,” says Larkin. “But we have been anticipating the ‘mother of all capacity shortages’ for a half-decade already, and the 3PLs still are shooting the lights out with growth way above the rate of freight growth overall.”

A nonasset-based provider’s load-matching skills could stand it in even greater stead during a prolonged period of tight supply, according to Valerie Bonebrake, who has worked for asset-based and nonasset-based providers, and now heads the 3PL unit at Tompkins. Perhaps for that reason, many shippers would rather work through 3PLs than go direct with the carriers even if they had the resources to avoid an intermediary, according to Bonebrake. “The nonasset-based 3PLs’ value proposition will not change as capacity tightens up,” she says.

Bradley S. Jacobs, founder and CEO of XPO Logistics Inc., a Greenwich, Conn.-based broker and 3PL, says the nonasset-based category has become bifurcated, with stronger players gaining share at the expense of weaker rivals. “There’s a massive market share movement from the smaller brokers to the larger ones. This isn’t surprising since the bigger ones have greater capabilities to offer,” Jacobs says. “When I ask customers what they value most, it’s always some version of lots of capacity, on-time pickup and delivery, and cutting-edge technology.”

Evan Armstrong, Armstrong’s president, says the leading 3PLs of the next 20 years will possess the broadest and most integrated logistics capabilities, expand their penetration into once-alien markets like less-than-truckload and intermodal, demonstrate network scale (he estimates that $300 million a year in purchased transportation is today’s price of entry to play with the big boys), and have the widest geographic scope.

Most important in what may become a long-lasting period of capacity shortages, successful middlemen will “contract with tactical asset-based providers as [capacity] is needed,” Armstrong says. The nonasset-based providers “may have assets where they are necessary to support customers, but it will be a more ‘asset-right’ versus an asset-based model,” he adds.