Providers of the Lost Art, the Sequel

Sep 01, 2001 9:30 PM  By

A roll-up company consolidates a number of 3PFs into one

Third-party fulfillment (3PF) theory works well on paper, but what about in real life? The rationale behind 3PFs involves two basic concepts: (1) direct merchants may find it unwise to spend big bucks building a fulfillment infrastructure when 3PFs can provide competitive services that are in line with in-house operations costs; and (2) 3PF companies will be successful, given that they are operating in a cost-efficient environment where they have the advantage of economies of scale.

This paradigm says that direct merchants utilizing 3PFs will be free to concentrate on aspects of their business other than operations. They will also have the benefit of an operations cost structure that is variable instead of a variety of burdensome fixed costs, and they will be relieved of the high costs of periodic operations upgrades and/or expensive facilities expansion. In addition, direct merchants provide their customers with service that is equal to or better than in-house service.

According to the paradigm, potential clients will flock to the doors of 3PFs, demanding the opportunity to avail themselves of this incredible business opportunity. The 3PFs will be hugely successful, because operating in an efficient, shared-cost environment will yield large profit margins. Right!

The legend

Back in the mid-’80s, I was involved with a start-up women’s apparel and home furnishings catalog. The catalog began as a division of a larger company with excess operations and computer capacity, and because of that, all order processing and fulfillment was done in-house.

It was soon apparent that the catalog would not grow quickly enough to utilize all of the cost-draining excess capacity. We decided to help cover overhead by offering our excess capacity to other catalogers as Express Fulfillment Services (EFS). We had assumed that the paradigm was valid. As providence would have it, our first client’s relatively simple fulfillment requirements made it extremely profitable for EFS, which was off and running in the 3PF business.

In those days, there were a number of other companies providing 3PF services. These included Directel, Nationwide Fulfillment, DOSCO, and MarkeTech, all major players at that time, although none has survived. If the cost-effectiveness paradigm is valid, then where are these companies today?

I have idea why the other companies are no longer around, but I can tell you that in the case of EFS, a number of bad business decisions hastened the demise of the company. One was the decision not to be more selective about the type of client we pursued. Because we had clients with unique operating requirements, we were, in essence, running several different businesses and failing to receive the benefits normally associated with economies of scale.

Treasure map

To make the 3PF paradigm work in the real world requires that clients have certain characteristics:

  • Products as similar as possible (example: All clients selling only books and tapes)
  • Similar operations requirements for all clients (example: no clients with unusual packaging needs)
  • Minimal order seasonality
  • Similar reporting and other IT requirements

Of course, all clients having all these characteristics would be the best of all worlds, but this is the real world. In the case of EFS, two large clients (one a toy catalog, the other an upscale gift catalog) had a wide variety of products. Both had special gift-wrap and packaging requirements and both were highly seasonal, receiving 70% of their orders in the fall season. This was not a formula for success, and after a particularly bad holiday season, EFS was sold.

History lesson

What about more recent history? At the peak of the dot-com frenzy, demand for 3PF services increased dramatically, and pundits claimed that the 3PF industry was coming into its own. Dot-com companies typically preferred to concentrate on the technical, creative, marketing, and merchandising aspects of their businesses rather than on building a fulfillment infrasturcture. This created a flurry of activity for established 3PFs, and encouraged other providers to enter the market. These newcomers included some big-name direct marketers with extra capacity. (I’m sure these new-to-market companies discovered the paradigm, and just knew they had found the answer to their problems.)

Subsequent, highly publicized fulfillment problems may have done as much to set back the cause of all 3PFs as to bring the outsourcing of dot-com and catalog operations services into vogue. Today, when both established and start-up companies look at fulfillment outsourcing as an option, the problems that the dot-com companies had two years ago will act as deterrents to outsourcing.

These problems cannot be placed solely at the feet of the providers. In many cases, the start-up dot-coms were exploring new ground and truly did not know what to expect when they launched their business Web sites. In some cases, orders rolled in at a much higher rate then expected, but in most cases, orders did not come close to reaching projections. This cost the dot-coms money in lost and cancelled orders, and it cost the 3PFs in the form of out-of-control labor costs.

Regardless of the specific issue, the bottom line is that the news generated by the operational problems was not good for 3PFs in general. The likely result of this bad publicity was that the number of companies thinking about outsourcing declined. In addition to the negative impact of the dot-com debacle, 3PFs are now facing a slowing economy in which fewer new businesses are being launched and established companies are reluctant to make any moves until economic conditions improve.

The Buccaneers

Providers now on the scene that have catalogs or other direct marketing businesses of their own make up an interesting new category of 3PF. Examples of companies falling into this category are Spiegel/Hermes General Services, Bertelsmann Services, Inc., JCP Logistics, Access Logistics (Amway), and, more ominously, two firms that recently exited the 3PF arena — Fingerhut and Hanover Direct.

On paper it makes sense for a direct merchant with excess capacity to look at utilizing it to provide services to other direct merchants — the old “If we can do it for ourselves, we can do it for others” approach. In theory that is correct, but perhaps those companies still providing 3PF services for other firms should have a long talk with Fingerhut or Hanover Direct. It’s not impossible to juggle in-house business with external client demands, but it is a serious challenge for both provider and client.

And into the picture now comes another category of 3PF, the roll-up company. My definition of a roll-up company is one that rolls up or consolidates a number of 3PFs into one corporate entity. Greenwich, CT-based NewRoads is a good example of such a company. NewRoads’ approach to increasing the number of companies utilizing 3PF services is to be “bigger” than its clients, to be faster and better at processing than in-house operations can be, and to provide cheaper services than in-house operations can achieve.

Is utilizing 3PF services a viable option, and is the paradigm valid? In my opinion, the answer is yes. Outsourcing has been for years a common and successful option for such services as subscription processing, lettershop, printing, database management, and list services. The challenge for the 3PF community is to have some success stories upon which to build momentum and to maintain its stability. The rallying cry for 3PFs should be, “We are good at what we do, and we are here today, here tomorrow.”

Lew Waddey is a practice specialist with Spaide, Kuipers & Co. The firm provides outsource search services to the direct marketing industry, with offices in Pennsylvania, New Jersey, and Tennessee. Waddey can be reached at (423) 886-5255 or (610) 668-8297, and by e-mail at waddey@spaidekuipers.com.