Third-Party Fulfillment Providers Face Tighter Market

When Kansas City, MO-based Innovative Fulfillment Solutions (IFS) opened for business in 1998, the third-party fulfillment start-up saw a huge opportunity in delivering product for Internet marketers.

And why not? Dot-com companies were flush with venture capital. Most i.merchants outsourced their fulfillment, preferring to invest in splashy marketing campaigns and online bells and whistles. Little wonder that, according to Little Rock, AR, investment bank Stephens Inc., the market for third-party fulfillment services was expected to grow 900% between 1998 and 2005, to $10 billion.

Then came the dot-com crash. “I didn’t expect the fallout to happen this quickly,” says Keith Milburn, owner of Innovative Fulfillment Solutions. IFS has lost three Web-marketer clients to bankruptcy; another is on “shaky ground,” Milburn says. That’s why last year IFS started to reach out to business-to-business companies for which marketing online is not a primary business. These firms now account for 60% of IFS’s sales.

As the story of IFS illustrates, third-party logistics firms are now competing for clients in a shrinking pool of e-tailers. According to Dallas-based Southwest Securities Group, an investment firm that tracks the third-party fulfillment industry, there are more than 85 back-end services providers in the business.

But “in the near future, the market probably won’t support more than five premier players,” predicts Tim Quillen, an analyst who covers fulfillment at Stephens. “There will be a lot of also-rans.”

Evidence of a glut is already showing in prices. Fulfillment companies now charge roughly $1.50- $3.50 an order plus $0.25-$0.50 for each item in the order, says Milburn, somewhat lower prices than a year ago.

Beware the dot-bombs Antony Lee, chairman of $100 million Greenwich, CT-based fulfillment provider New Roads, believes that many of the start-up fulfillment companies were naive in assuming they could make their fortunes fulfilling for dot-coms. “We were getting 5-10 calls a week last January from e-tailers, and we turned them down because they were inherently unstable businesses,” says Lee, whose five-year-old company was formerly known as Distribution Associates. Multi-channel marketers such as Abercrombie & Fitch and Restoration Hardware make up about 90% of New Roads’ business.

Frank DiMaria, president/CEO of Jacksonville, FL-based GATX e-logistics, says his company also turned away dot-com marketers as clients. “We didn’t want to get stuck with a losing business,” he says. Should a client go out of business, “you could liquidate the company’s merchandise, but that’s only after the banks most likely get their share. Besides, with liquidation, you’ll recover only pennies on the dollar,” says DiMaria, whose GATX e-logistics business, part of $400 million GATX Logistics, began last year.

So while the shakeout may have lowered fees, it also prompted some companies to add clauses in contracts, addressing the possibility of a client going under. For instance, some fulfillment companies now build cost recovery into their prices.

“There was a lot more trust 18 months ago between third-party logistics companies and their clients,” DiMaria says. But the volume and type of orders that rolled in from Web clients seldom resembled anything on their requests for proposals (RFPs), he says. “These Internet companies either couldn’t provide an accurate forecast or their line items looked nothing as advertised.”

DiMaria notes the trend now includes revenue-sharing to reduce both parties’ risk. Manufacturers looking to sell directly to the consumer, for example, are willing to forgo some sales in exchange for not having to build their own fulfillment infrastructure.

In short, third-party providers are taking nothing to chance. “We’re much more selective with whom we do business,” says Milburn, who notes that IFS now conducts more-stringent background checks with new clients, such as examining the business model and the client’s management team, as well as obtaining letters of credit from the banks.

It’s easy for fulfillment providers to blame failing dot-coms for their woes. But both Lee and DiMaria contend that at least some of the newer entrants into the field – particularly those that view fulfillment as an ancillary business – have only themselves to blame. “If you’re not singularly focused in this business you’re going to fail,” DiMaria says.

New Roads’ Lee agrees: “Just because you have a couple of conveyors lying around and have the ability to pick, pack, and ship doesn’t mean you can be a professional fulfillment company.”

It’s no surprise that third-party providers such as Lee and DiMaria would feel that way. Likewise, it’s no surprise that some catalogers that provide fulfillment services to other companies feel differently.

Several years ago, when he was CEO of Hanover Direct, Rakesh Kaul created Keystone Internet Services, a division of the multititle mailer that provides back-end services. Kaul describes third-party fulfillment as “an industry where the margins are very attractive and the bottom lines are twice that of selling merchandise.” Nonetheless, marketing and investment costs at Keystone contributed to Hanover’s red ink – and may also have contributed to Kaul’s removal from the company in November.

Multititle cataloger Fingerhut Cos. also began handling fulfillment for other companies, such as retail giant Wal-Mart’s online business, during the past few years. But Fingerhut has had its own financial woes lately, and as such, has scaled back its third-party operations, says spokesperson Ben Saukko.

J.C. Penney, on the other hand, is going full steam ahead with its third-party fulfillment division, J.C. Penney Logistics. The Plano, TX-based cataloger/retailer launched the unit last year, converting a Milwaukee distribution and telemarketing center to fulfill and take calls for clients such as Smith & Hawken’s Web business and Jenny’s, a division of Swiss Colony.

“We’ve never targeted the dot-coms per se,” says Al Bell, director of telemarketing and third-party logistics for J.C. Penney Logistics. “We wanted to target catalogers or retailers that were expanding. Of course, some of that business came from the Web.” From Bell’s perspective, since many dot-coms never accomplished the level of volume of, say, an Amazon.com, making up for the potential lost business is “not significant.” Bell expects that “for every dot-com that goes out of business there will be two or three more marketers expanding into multiple channels that need fulfillment services.”

Nonetheless the majority of fulfillment services firms will likely face tough times. Expect a shakeout in the first six months of 2001, DiMaria says, one in which “the men will be separated from the boys.”

Most catalogers, 96%, according to the Catalog Age 2000 Benchmark Report on Operations, handle fulfillment inhouse. Stand-alone start-up catalogers tend to fulfill everything in-house out of necessity while billion-dollar-plus companies can afford to build state-of-the-art distribution centers. So who is a candidate to outsource? GATX e-logistics president/CEO Frank DiMaria says that as a rule of thumb, you should be processing more than 10,000 orders a month before you consider outsourcing fulfillment; otherwise it won’t make sense financially.

What should marketers look at when shopping for a third-party provider? According to Antony Lee, chairman of Greenwich, CT-based New Roads, you want a fulfillment parter with:

1. A solid management team experienced in direct marketing outsourcing.

2. System capabilities that will suit your special needs.

3. The ability to customize its service to meet your exact specifications.

4. A sizable roster of clients, at least several of which are in businesses similar to yours.

5. Feasable economies of scale. Remember the company will be fulfilling your orders during crunch time.

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