Sound Bytes

O&F: What happened to precipitate the demise of third-party logistics providers such as JCP Logistics, who fulfilled their own products as well as products for other companies?

Lee: Historically, you have to go back and look at the direct industry. In the ’80s and early ’90s there was never really a large and viable outsourcing alternative available to direct marketers. Direct marketers generally grew and established their own operations and fulfillment infrastructure. There was never any outsourcer or outsourcing industry that grew up to support them properly. There’s a basic rule in outsourcing that generally, you have to be bigger and better than your clients at what you’re seeking to outsource, or they won’t outsource to you.

What the Internet did was turn virtually every company in the world into a direct marketer, even if they didn’t know it at the time. It gave rise to a much larger and growing need for operations and fulfillment, and hence, many people believed at that point that there would be a large evolving market for outsourced fulfillment. The early entrants into the field were people like Fingerhut. Fingerhut, Hanover Direct, and Damark were the early companies that said we’re very large direct marketers, we have expertise in the fulfillment and logistics area, and some of the world biggest companies are going to become Internet direct markers. Ipso facto, we are now in the third-party fulfillment of logistics business.

The model broke before they even shipped their first package. When you’re in the outsourcing business, and you’re a services company, your job is to solve the problems of your clients. Clients aren’t meant to solve your problems. Every one of the large catalogers that got into the third-party fulfillment business did so because they had a declining or not profitable core business cataloging. They had excess capacity that they shouldn’t have built in the first place–so they’ve made a mistake relative to their own infrastructure planning, and they sought to absorb their overhead and their high cost structure by bringing in clients to absorb their capacity and solve their problems.

The business models relative to outsourcing and cataloging are completely different. There was no history in the company for serving clients, clients realized that in fact, when resources got constricted at times of peak demand, obviously, companies like Fingerhut and Hanover would apply labor and resources available to their own shipments before that of their clients. Just as importantly, if a client grew, let’s say grew enough to warrant being in larger facilities, the board of directors and shareholders of the cataloger would not want to apply capital to a third-party business to build a whole new building when their core business is cataloging.

Every single large cataloger who got into the business has now quit the business because it was never the right business model. I know that because I got into the business myself, having owned then sold a catalog to Hanover Direct, and in 1994 suggested to Hanover Direct that they get into the third-party business that subsequently became Keystone. In working that model in the early days of Hanover, I realized that it wouldn’t work within the four walls of a catalog business. I then flew to see Fingerhut in ’96 to propose a slightly modified version of this plan, where you took the third-party business and you moved it into a separate company, outside of the core company. That didn’t work either.

O&F: Who will be the survivors going forward?

Lee: The only way outsourcing works in the direct industry–and the proof in the pudding is always in the eating, clients will either vote with their pocketbooks that I’m right or I’m not, it’s not speculation–is among the [outsourcing] pure-plays. All the larger early entrants were basically doomed to fail before they ever shipped their first package because the business model was wrong. I don’t want to cast dispersions on current entrants, but anybody with that model is battling against the historical tide.

O&F: What do companies see that is so attractive about the third-party fulfillment space that so many have decided to get into the business?

Lee: A year or two or three ago, many companies that were catalogers or direct marketers were in fact looking at that space–the number has dwindled significantly. The attractiveness is not in fact in the third-party business. The attractiveness to them is by charging other catalogs to enter their facilities, they reduce the overall cost of their facilities. They basically have excess capacity. If a company like Spiegel, which is a giant direct marketer, is sitting there with excess capacity, you have to first ask yourself why have they got excess capacity? They’re supposed to be filling it with stuff that they sell. Their decision to enter the business is in fact born out of a problem, and they go and find a client who solves their problem. But in solving their problem, they create a bigger problem for the client because there have been dozens and dozens of clients who have been literally tossed out on their rear or closed down, or at the last minute have to relocate, because suddenly, these companies realize that they shouldn’t have been in the business in the first place the moment they get into a problem with one of their clients.

It also happened last year with Stark Brothers, which was a division of Foster and Gallagher, who also tried this and had to quit the business. What amazes me is not that these companies get into the business, but how clients can continually go to them without understanding the history of every other company just like them that eventually ended up seriously impacting the business of their clients.

O&F: Obviously, these companies have to had built huge DCs all over the place, and now, they are leaving them vacant along with an enormous amount of equipment. What’s going to happen to all of the hardware that was accumulated in this big rush for the 3PL space?

Lee: The numbers as I see them indicate that in the five-year period between 1995 and 2000, there was a doubling of capacity in the direct infrastructure world, which means there is a huge amount of excess capacity in the marketplace. That is great news for a company like ours because we are growing very rapidly, we’re taking on many new clients, and therefore, our constant need for infrastructure is being satisfied, in a sense, out of the mistakes that other people have made. We can pick up infrastructure now much, much less expensively than we could some years ago. One never wants to benefit at the expense of someone else, but the reality is that infrastructure for us has become a far less critical issue relative to financing than it used to be. If you’ve managed to get your business model right, and now you’re in the market for infrastructure, than in fact, it’s there to be had.

I think like all markets, this particular marketplace will rationalize itself within the next two to three years, because the underlying business of direct marketing is still growing very rapidly. If you look at the results of the public retailers in the past few months, and results after results as they get published show that there’s been an unbelievable decline in same-store sales. And yet, if you look into the detail of the press releases, you’ll find that the direct divisions are actually doing very well and growing. As direct marketing grows, eventually, all these facilities will be absorbed, either by outsourcers like us or by companies that are fulfilling for themselves.

O&F: What specifically will enable pure-play third-party fulfillment providers such as NewRoads to maintain a viable business in the future?

Lee: The words third-party fulfillment contain the seeds of its own disaster within the words, because third party suggests that you’re on one side of some divide and your client’s on the other, and that’s not really a model that I think contains within itself long-term success and growth. We’ve changed the name of what NewRoads does, and I think we’ve helped organize a change in thinking in the industry, such that we don’t actually refer anymore to third-party fulfillment. We refer to business process outsourcing. Business processing outsourcing is very different from third-party fulfillment, because it’s the complete outsource of a business process on behalf of your client. If you are a business process outsourcer, you’re now in the same industry category or group as IBM and EDS and ACS and some of the largest, most respected outsourcing organizations in the world. What that tends to do to your company is heighten your standards. It tends to make you want to be better because you’re in different company and more is expected of you than what was expected from the old third-party fulfillers.

For us, the only way that you can grow and continually attract clients, and I guess more importantly, continually attract great talent to your own company, is to constantly be larger, and have better systems, and do the outsourcing better than any of your clients can do it for themselves. Because if you can’t marry to those very simple rules, than you won’t get any clients and you won’t grow.

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