By Saba Pinard, April 2023The term "Third Party Logistics" (also known as 3PL or TPL) denotes the management of logistical activities by an external service provider acting on behalf of a company. Although 3PL is the most prevalent and well-known form of logistics provider, it is a highly paraded term used to designate externalized services. In order to correctly grasp the implications of externalizing logistical activities to a third party, it seems appropriate to discuss the origins of the term 3PL, the underlying subtleties of commonly known terminology and the different levels of logistics outsourcing.
Third-Party Logistics : the term vs the concept
The term 3PL is commonly attributed to Accenture, a consulting and technology firm, which was the first to give externalized services a specific name (and their very own acronym), promoting “3PL” as a distinct business strategy in the 1980s.
[1] It initially described companies providing logistics services such as transportation, warehousing, and distribution on behalf of their clients. However, over time, the definition of 3PL has expanded to include a broader range of services, such as supply chain management, customs brokerage, and freight forwarding, and the term gained general acceptance by the year 2000.
Obviously, the concept of outsourcing logistics services to third-parties is almost as old as trade itself. For example, the Silk Road (active from the second century BCE) heavily relied on externalized logistics to transport goods across vast distances, with third-party transport providers like camel caravans and river barge operators playing a crucial role in moving goods between different regions. Similarly, the Inca Empire established an extensive system of roads and bridges to transport goods across their empire, but they also built warehouses and storage facilities to manage their food and resources. These examples illustrate how externalized logistics have been a critical component of trade and commerce throughout human history and needn’t wait for a catchy marketing term to become popular. Succinctly, "3PL" is a term companies use to refer to a practice that has, in fact, existed since antiquity.
Overview of externalized logistics
The term “3PL” remains a useful way to describe a logistics provider’s specific level of involvement and to distinguish between different types of logistics providers. By extension, these types can be classified as 1PL, 2PL, 3PL, 4PL, 5PL, and even 6PL, each referring to different levels of logistics outsourcing
[2], with each level corresponding to a different degree of involvement and control by the customer. While certain vendors present the (N+1)PL as the upgraded version compared to the (N)PL, the number of “PLs” should not be seen as a measure of the quality of service provided. This categorization is vendor-driven and intends to give a sense of upgrade and novelty, which is not at all necessarily true. A 5PL is not intrinsically
better than a 4PL or 3PL.
In addition, as the logistics industry has evolved and the lines between the different types of logistics providers have become increasingly blurred, some have argued that the term “3PL” may be becoming less relevant. Although the categorization
is imperfect, it can still provide some insights on the varying degrees of logistic provider involvement.
[3]Types of externalized logistics and their characteristics
In understanding the spectrum of services offered in the industry of externalized logistics, it is important to underline that the boundaries between each category are often blurry: for instance, a 3PL company might also offer 4PL services, depending on its capabilities and the needs of its clients. You might find similarities in the range of services from one “PL” to the next, giving the impression that each level was shoehorned between the others for the sake of feeding the “PL story”.
- 1PL (“First-party logistics”): “1PL” refers to a company that manages its own logistics operations in-house, without outsourcing to a third-party provider. This term is not at all used in the world of logistics, as managing one’s own logistics operations in-house is (obviously) the default option. It’s the case for Amazon, for example, which uses its in-house logistics network to manage inventory, warehousing and delivery. The term’s utility exists almost exclusively as a means of differentiating it from the other logistics outsourcing models.
- 2PL (Second-party logistics): This term is not very common in the logistics world. 2PL providers are typically asset-based carriers like shipping, rail, or trucking companies that directly provide transportation services. They focus on moving goods from one location to another but do not offer comprehensive logistics solutions. For instance, the fashion retailer Zara, contracts its transportation needs to specialized carriers while maintaining control over its warehousing and distribution centers.
- 3PL (Third-party logistics): A 3PL is the first level of externalized logistics in which a part of the supply chain is outsourced. Unlike 2PL, a 3PL is entirely responsible for the management of the services it carries out. These include transportation, warehousing, picking and packing, inventory management and order fulfillment. 3PLs are usually contracted by businesses to handle various aspects of their supply chain operations. 3PL is the most widely used and well-known term in the logistics industry.
- 4PL (Fourth-party logistics): A 4PL is a logistics provider that manages the entire logistical chain on behalf of the company. Services may include logistics planning, coordination, and execution, as well as technology-enabled supply chain visibility and analytics. Acting as a single point of contact for all logistics activities, 4PLs are typically used by large companies that have complex supply chains and want to optimize their logistics operations. The term is also quite common in the logistics world.
- 5PL (Fifth-party logistics): 5PL providers offer end-to-end logistical management solutions, including logistics management, supplier management, demand planning, and other value-added services such as risk management and sustainability. They act as a data aggregator and provide their clients with real-time visibility into their supply chain. Companies that typically rely on 5PLs are those that have a need for supply chain visibility and want to optimize their logistics operations with cutting-edge technology and customized and integrated solutions.
- 6PL (Sixth-party logistics): 6PL is a concept that is still in development. The term isn’t widely used or recognized in the logistics industry, but the concept is gaining some momentum. 6PL moves into the realm of AI, also known as an AI driven logistical chain. 6PL providers offer highly sophisticated and integrated logistical chain solutions, acting as a strategic partner to the client in managing all aspects of the supply chain, from sourcing and procurement to final delivery. This level of service provider may also offer additional value-added services such as innovation management, product design, and advanced analytics. 6PLs provide strategic advice on how to improve efficiency and reduce costs.
- 7PL (Seventh-party logistics): There is currently no widely accepted or established concept of 7PL, the sole emergence of this term in the Google search engine illustrates that the “PL” categorization can be misleading businesses into believing that the progression from 1PL to 6PL represents a linear improvement in quality and that 7PL is superior to the other categories because it is new. Simply put, “7PL” is phantasmagoric marketing jargon.[4]
In summary, 1PL is a company's own logistics department, 2PL specializes in one or more logistics functions, 3PL provides a range of logistics services, 4PL manages the entire supply chain, 5PL focuses on supply chain optimization through data analysis and technology solutions, 6PL is a hypothetical AI-driven provider that manages the entire supply chain ecosystem and anything after that is, for now, irrelevant.
The increasing demand for externalized services
The popularity of externalized services, particularly 3PLs, has risen substantially due to several factors. One major catalyst was 2020’s lockdowns and social distancing measures, prompting businesses to outsource transportation and warehousing activities. This shift was fueled by the significant growth in the e-commerce sector, which experienced a remarkable 77.6% surge in February 2020, according to the Forbes Business Council. As a result, the demand for externalized logistics services skyrocketed.
[5] Even before the pandemic, external logistics providers were evolving in response to technological advancements and a growing emphasis on sustainability. This transformation reshaped their operations, boosting productivity and enhancing service offerings. Many providers began incorporating GPS tracking, warehouse management systems, and transportation management systems to optimize operations and deliver more innovative, comprehensive logistics solutions to meet client needs.
Fulfillment by Amazon has emerged as a game-changer in the world of externalized services and 3PLs, particularly since 2022. FBA has continuously adapted to the increasing demand in third-party logistics and specifically catered to the needs of online retailers. A key factor that made FBA so attractive to small and medium-sized businesses (SMBs) in the first place was its ability to simplify logistics processes and offer a cost-effective, comprehensive solution that previously was not easily accessible to smaller companies. By granting equal access to advanced logistics services, FBA has enabled SMBs to compete more effectively with larger enterprises. FBA's inclusive solution addresses warehousing, order fulfillment, customer service, global reach, Prime eligibility, and inventory management, which has further attracted businesses to outsource their logistics operations. As a result, FBA has not only reshaped the 3PL landscape but also set new standards for external logistics providers, encouraging them to innovate and adapt to the ever-changing demands of the e-commerce industry.
In light of FBA's transformative impact on the logistics landscape, it is crucial to understand the broader context of supply chain management and the appeal of outsourcing logistics operations. The added complexity in supply chains stems from factors such as globalization, expanding product portfolios, increased customer expectations for faster delivery and customization, and the necessity to manage multiple sales channels. This heightened complexity has driven businesses to seek specialized expertise to optimize their logistics processes, maintain cost-effectiveness, and remain competitive in the market. In response to these challenges, companies have turned to outsourcing logistics operations, with 3PLs emerging as a popular choice among the various "PL" services available. Consequently, it is essential for businesses to carefully analyze the advantages and drawbacks of partnering with 3PL providers, as they must be fully aware of the risks and benefits associated with outsourcing logistics operations to a third party.
Analysis of 3PLs
With the expansion of outsourced logistics services, it's essential to concentrate on the practical advantages and challenges related to using third-party logistics (3PL) providers. As 3PL is the most common term and these providers have experienced considerable growth, they will serve as a reference for assessing the overall impact of externalized logistics on businesses. Examining the various aspects of 3PL services can shed light on the potential benefits and drawbacks of outsourcing logistics operations.
The Benefits of Third-Party Logistics
A typical 3PL offers a wide range of services, including transportation, warehousing, and freight forwarding. The use of 3PLs has several benefits for businesses, such as potential cost savings, increased flexibility, data analytics and access to specialized knowledge and skills.
- Potential for cost savings: Businesses can avoid the upfront investment and ongoing costs of building and managing their own logistics infrastructure by outsourcing logistics operations to external partners. This is particularly beneficial for SMEs that may not have the financial resources to maintain their own logistics operations or who want to test the waters of a particular market without injecting important funds.
- Increased flexibility and scalability: 3PLs offer a range of services, allowing businesses to customize their logistics operations to meet their specific needs. For instance, a company can choose to outsource its warehousing and distribution operations to a 3PL while retaining control over its transportation activities. This enables businesses to respond quickly to changes in demand or supply chain disruptions, while also gaining access to specialized knowledge and skills that may not be available in-house. For instance, a small e-commerce startup can use a 3PL provider like Shopify to handle their warehousing and shipping needs, enabling them to scale their operations without investing in their own logistics infrastructure.
- Technology and data analytics: 3PLs use GPS tracking, warehouse management systems, and transportation management systems to optimize the use of assets and reduce waste. For example, a 3PL can use real-time data to track the location of a shipment, monitor inventory levels, and identify potential bottlenecks in the supply chain. This helps businesses to improve efficiency, reduce costs, and gain better visibility into their supply chain.
- Access to a global network of partners and suppliers: This is particularly useful for businesses that operate internationally or are looking to expand their operations globally. By partnering with 3PLs that have a global presence and local expertise, businesses can gain a competitive advantage and reduce the risk of supply chain disruptions in foreign markets.
In summary, the benefits of using 3PLs include potential cost savings, increased flexibility, access to specialized knowledge and skills, technology and data analytics optimization, and access to a global network of partners and suppliers. These benefits can help businesses improve their logistics operations, reduce costs, and gain a competitive advantage in their respective markets. However, it is important to note that there are also limitations and challenges associated with using 3PLs that must be carefully considered.
The drawbacks of Third-Party Logistics
Though outsourcing logistical operations has its benefits, multiple downsides must be carefully considered. These include:
- Loss of competence: This is a severe consequence of relinquishing control. By delegating critical logistics functions, companies may inadvertently relinquish control, reducing their internal capabilities. Consequently, maintaining in-house expertise can suffer, and employees become less familiar with logistics operations. This loss of competence poses challenges if a company terminates the 3PL contract and resumes logistics management internally, potentially causing supply chain disruptions and increased costs. Therefore, businesses must carefully consider the long-term implications of outsourcing logistics and maintain internal competencies while leveraging external support.
- Overall loss of control: Companies may have less control over the movement and handling of their products, which can result in an increased risk of damage or loss. This can be particularly problematic for sensitive or high-value products that require specialized handling or transportation. In addition, companies may have less flexibility over the timing and scheduling of shipments, which can lead to delays or missed deadlines. Overall, the company risks being less reliable and ultimately losing expertise. For example, in the late 1990s, Nike faced supply chain issues due to lack of visibility and control over inventory with its 3PL providers. This led to inaccurate demand forecasting, resulting in excess inventory, stockouts, and ultimately, a negative impact on Nike's profitability and brand reputation.[6]
- Cost: While outsourcing logistics operations can lead to cost savings for some companies, it may be more expensive in certain situations. For example, a 3PL provider may charge a premium for specialized services or equipment, resulting in higher costs than if the company had handled its logistics operations in-house. It is essential for companies to evaluate their specific logistics requirements and associated costs before outsourcing their logistics operations.
- Communication and coordination: Effective communication and coordination are essential for successful outsourcing of logistics operations. However, dealing with complex supply chain networks, multiple partners, and different time zones and languages can pose a significant challenge. To overcome this challenge, 3PLs must be compatible with their clients' IT systems to ensure seamless communication and coordination.
- Conflicts of interest: Since 3PL providers may work with multiple clients, they may prioritize the needs of a larger or more profitable client, potentially putting the interests of smaller clients at risk. Moreover, 3PL providers may have limited capacity during peak seasons, which can restrict a company's ability to fulfill customer orders in a timely manner. Therefore, companies must ensure that they have a clear understanding of the 3PL's service offerings, policies, and procedures before outsourcing their logistics operations.
Conclusion
In conclusion, 3PL represents a significant category of logistics outsourcing but has now evolved to be part of a broader categorization that includes 1PL to 6PL. However, it is essential to remember that this classification does not necessarily reflect the quality of service. Instead, businesses should focus on understanding their specific supply chain needs and selecting the most suitable logistics provider. By being aware of the varying degrees of provider involvement, businesses can make informed decisions and optimize their logistics operations to enhance efficiency and reduce costs.
Outsourcing logistics operations to third-party logistics providers (3PLs) can be an efficient way for businesses to save time and money. However, there are also challenges that come with relying on 3PLs. One major issue is the lack of visibility and control over externalized activities. The 3PL manages supply chain operations, which means the business may not be aware of every step in the process. This can result in delays or errors, leading to lost revenue and customer dissatisfaction. To mitigate these risks, some businesses diversify their 3PL relationships to minimize disruptions and improve reliability.
Despite the various "PL" services available, 3PLs remain a popular choice for companies seeking to outsource their logistics functions. To make informed decisions, businesses must consider both the benefits and limitations of 3PLs, ensuring they select the most appropriate logistics partner to meet their specific needs and support their long-term growth objectives. Thus, managing and overseeing 3PL relationships is crucial to ensure optimal operations.
Lokad’s take
The world of modern externalized logistics offers an unparalleled array of options for moving and storing goods. Virtually anything can be transported and warehoused in any location, at any time, and with advanced programming capabilities. However, all of these benefits come at a cost. With third-party logistics providers (3PLs), companies face a dilemma similar to the "hyperchoice" paradox: the abundance of options makes it difficult to discern the best choices. While selecting a single 3PL provider is relatively straightforward, revisiting the decision annually or so, the daily task of selecting among millions or even billions of possible combinations for each stock movement can be daunting.
Lokad provides a platform for end-to-end predictive optimization of supply chains, including all the logistical options as offered by 3PL. By leveraging advanced analytics capabilities, businesses can optimize decision-making and management of 3PLs, leading to reduced operational costs. Moreover, Lokad's platform provides a unified solution for supply chain optimization, streamlining data integration and reducing pressure on IT departments. This allows companies to efficiently manage their supply chain data, leading to improved coordination and communication with 3PL providers.
In the United States, many e-commerce businesses rely on Amazon's Fulfillment by Amazon (FBA) service for handling product storage, packaging, and shipping. Lokad helps these businesses take into account the long-term storage fees associated with FBA. Notably, FBA has a pricing structure that includes significant increases in storage fees after 6 months and 12 months of storing products in their warehouses. To take advantage of this pricing quirk, some e-commerce businesses strategically remove their goods from FBA just before these storage fee increases are triggered, and then immediately re-ship the products back to FBA for storage. This maneuver allows them to avoid the higher storage fees while still benefiting from FBA's services.
By leveraging advanced analytics capabilities, Lokad can help businesses streamline their data integration, optimize decision-making, and ultimately efficiently manage their supply chain data and improve coordination with 3PL providers. Lokad's approach to predictive optimization represents an innovative tool for businesses seeking to improve their supply chain operations and gain a competitive edge in the marketplace.
Notes
1. As stated in the Journal of Business Logistics in a 1998 article titled "Third-Party Logistics: A Definition" by Robert Lieb and Randy Slack
2. This classification of logistics providers is not attributed to a specific individual but rather emerged over time as a result of the evolution of the logistics industry and supply chain management practices. The terms have been normalized and used by logistics providers, supply chain and logistics professionals, academics and businesses seeking logistics services.
3. Alternative categorizations exist, primarily focusing on the types of services provided. For instance, outsourcing can be classified into four categories: manufacturing, information technology, knowledge, and business processes. The benefit of using the “PL” classification lies in highlighting the extent of involvement by a third-party service provider.
4. “8PL” and “9PL” will surely follow, but keep in mind that they most likely will be used and abused to feed the misconception that they are the best.
5. Additionally, the Armstrong & Associates report for 2021 shows that the top 3PLs generated a combined revenue of $827.2 billion in 2020, representing about 8.6% of the global logistics market.
6. Fawkes, S. (2004). The Nike Controversy. Stanford Graduate School of Business. This case study provides an overview of Nike's supply chain issues in the late 1990s, including the problems with the i2 software implementation.
