an outsourcing decision on warehouse activities

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A Dutch trader in China:

an outsourcing decision on warehouse activities

Rijksuniversiteit Groningen

Faculty of Management & Organisation

Mentors:

Faculty of Management & Organisation:

Dr. M.J. Land Drs. D.F.F.R. Maccow

Xindao Shanghai:

G. Pleyte Author:

Jeroen L.J. van der Staay 1230220

August 2005

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Management summary

This research is conducted in order to test the intuition of Xindao’s management that their warehouse in Shanghai can be operated in a more cost-efficient way. In order to assist Xindao Shanghai in making a well-founded decision on outsourcing its warehouse activities, Xindao’s management has ordered a research to find out which alternative Xindao should pursue.

In order to test management’s hypothesis a research was conducted on both financial but also on non- financial factors of the possible alternatives for Xindao’s outsourcing decision (keep conducting the warehouse activities in-house or outsourcing them). Xindao’s management wanted two options researched: keep conducting the warehouse activities in-house and outsourcing the warehouse activities to a third-party logistics (3PL) provider. In order to make a viable comparison between the two alternatives the throughput data over 2004 on Xindao’s Shanghai warehouse were collected.

These data were used to obtain realistic quotations from five renowned third-party logistic providers (3PL providers). After the quotations were received a comparison was made with Xindao’s own annual expense of the warehouse over 2004. Also the differences among the quotations of the 3PL providers were analysed.

Next to financial aspects other, softer, issues were also analysed in this research. Grouped under non- financial factors, this research looked into the potential (dis)advantages of outsourcing. The different non-financial factors were identified by means of interviews and literature review. It was reviewed whether these non-financial factors would alter the conclusion reached solely on financial factors.

The comparison of the quotations of the selected 3PL providers with the Xindao’s annual expense over 2004 showed that outsourcing was financially more attractive for Xindao. The decisive factor was the fact that the actual number personnel is currently too high for normal operations. In order to be able to handle peak demand at all times, excess personnel are permanently available. This implies higher costs in comparison with outsourcing where the actual use of personnel will be charged to Xindao. Based on the throughput data on 2004, it can be concluded that outsourcing of Xindao’s warehouse activities will lead to a reduction in warehouse costs of between 25 to 50 percent.

Therefore the conclusion based on solely financial factors should be to outsource Xindao’s warehouse activities.

However, there are also several potential disadvantages of a non-financial nature to outsourcing Xindao’s warehouse activities. For one, outsourcing could result in a loss of control over warehouse operations. Also the linking of information systems of both parties may yield some problems because of the very real possibility that the systems do not mesh. Finally there is a risk of a leak of information to competitors, which is a serious threat to Xindao’s business in China.

Of course there are also a number of non-financial advantages to outsourcing. The most important one is that outsourcing the warehouse activities will yield a more agile supply chain. A number of factors support this conclusion. To name a few: the linkage between information systems of both Xindao and a 3PL provider, the simplification of communication with the warehouse and the focus on core competences.

The non-financial disadvantages were considered not to be powerful enough to alter the decision reached based on financial factors. Moreover there were a number of non-financial advantages that would urge Xindao to outsource its warehouse activities as it would provide Xindao with a more agile supply chain. Therefore the conclusion based on non-financial factors should also be to outsource Xindao’s warehouse activities.

Taking all the above into account it can be stated that outsourcing is indeed the more favourable option for Xindao with regard to its current warehouse operations. The conclusion of this research is that the intuition of Xindao’s management was correct and outsourcing is advisable.

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Preface

This rapport is the result of the research I have conducted for Xindao, a Dutch trader, in Shanghai and is also the final dissertation for my study Technology Management at the University of Groningen.

During six amazing months, I not only gained a lot of experience in the logistics branch, but also got to experience China, especially the city of Shanghai. China is an amazing country that balances on a very fine line between economic prosperity and overheating its economy as it experiences tremendous growth in a very short period. I am in awe of the way the Chinese government deals with the enormous challenges that it faces. The way the Chinese handle the transition of a communistic system to a more capitalistic one, the logistic problems of cities with a population well over ten million people and the liberalisation of more and more markets, have really impressed me.

With over one point three billion people earning an average salary of five hundred US dollars a year, the Chinese still have a long way to go. However there is no doubt in my mind that China will develop itself to become one of the economic superpowers of the twenty-first century.

During my internship at Xindao I had the pleasure to work closely with Mr. G. Pleyte who has not only taught me a great deal about logistics but also on how businesses, especially businesses in China, operate. I would like to take this opportunity to thank Mr. Pleyte and his wife for their care and support during my stay in Shanghai as they helped me getting around in a complete new metropolis on the other side of the world. On that note I would also like to thank Dr. M.J. Land and Drs. D.F.F.R. Maccow from the University of Groningen for their input and guidance during this research.

Finally I would like to thank my parents, Otto van der Heijden and Nicole Bolhaar who have taken the time to take a critical look at my dissertation and have helped me create the rapport you see before you.

Jeroen van der Staay Groningen, August 2005

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Chapter 1 Introduction & problem statement

This chapter will provide an introduction to the Xindao organization and present the logistic constraints it faces. Xindao is a Dutch trader that has sourced the production of its goods (over five thousand) to three hundred different factories in China. Xindao sells two different types of products, do-it-yourself products and promotional gifts & premiums to customers all over the world. Customers can choose to buy Xindao’s goods of the shelve or they can have products specially produced to their specific demands. Also it is possible for the customer to determine whether it wants to collect the ordered goods at a predetermined port or that the goods are delivered at its doorstep. Chapter two will further elaborate on these issues.

In this chapter, first the contributory causes and initial management question will be discussed, shedding more light on the causes for this research. Then an analysis of the problem Xindao is facing will be given. Next the goal Xindao has for the research will be given and the research question will be formulated. A conceptual model will be presented in order to visualize how the research question is going to be answered. Also a theoretical framework will be given to provide the basis on which the solutions can be built. Finally the methods and techniques used to answer the research question will be revealed.

1.1 Contributory Causes

In this paragraph the various contributory causes for this research will be discussed. Also this paragraph will demonstrate the necessity for this research within the Xindao organization.

In the 1970s and 1980s, the world witnessed the rise of a new phenomenon, the Asian Tiger. The Asian Tigers were national economies of Asian countries, more particular Taiwan, Korea, Singapore and Malaysia, that boomed thanks to government-led industrial policies and fast growing export markets. When combined with Japan's tremendous prosperity, the experience of the Asian Tigers led many to predict that Asian economies would soon dominate the world.

History shows us that things did not turn out that way. Japan's economy has collapsed into a decade- long recession and the economies of the other Asian tigers are struggling to keep their growth rate out of the red numbers. Meanwhile, China has emerged as a regional economic power. With rapidly growing industrial cities as Guangzhou, Shenzhen, Dalien, and of course Beijing and Shanghai, each with well over ten million people, China as an economical power is booming.

In spite of the fact that China is still gaining in popularity amongst Western corporations, moving to China does come with certain disadvantages. When in the mid-nineties of the last century a lot of Western corporations just started to move parts of their operation to China, the disadvantages were even more numerous than they are now. At the time one could not really speak of a business-friendly environment in China. This was to a large extent a consequence of the political situation in China. The communistic government did not make it exactly easy for the Western corporations to try to set up a business in China. There were a lot of rules and regulations that hindered Western corporations in their pursuit to outperform their peers who had maintained their production in the West.

The Chinese realized that they had something the Western companies wanted: cheap labour in a vast quantity. They did not mind the Western companies making huge profits using their cheap labour, but they wanted something in return; knowledge on how to run an efficient business and knowledge on new technologies. In order to guarantee that they would actually get this knowledge, every foreign company wanting to set up a business in China had to form a Joint Venture with a Chinese company.

However this began to change after China’s accession to the World Trade Organization in 2001, when China committed itself to gradually open up its market to foreign companies. And as a result of this new political and economical course, the Chinese export and therefore its entire economy has grown tremendously. However, at present there are still certain branches of industry (telecommunication,

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expedition & transport, infrastructure, energy and certain services) for which a Joint Venture is still the only possible way for a Western company to set up a business in China¹.

Mainly because of the fact that Western corporations have only recently gained access to the Chinese market, both China’s import and export have grown dramatically over the last decade. The timeline of the series of events that led to this explosion of international trade started in 1995, when China issued its first provisional regulations for foreign companies to set up China-based holding companies. Since then more and more foreign companies started to set up Joint Ventures with local Chinese companies in order to enter the Chinese market. In 2002, the Shanghai Municipal Government issued its own regulations encouraging the setting up of regional headquarters (RHQs) in Shanghai. Since then some eighty-six multinational RHQs and one hundred and thirty multinational R&D centres have been approved according to Shanghai’s vice-mayor Zhou Yupeng².

Presently China, with Shanghai as its main economic engine, is one of the world’s biggest trading nations. In 2004 China registered a record export figure of $593.4 billion, which represents a year-on- year increase of 35.4 percent. Import ballooned to $561.4 billion, a 36 percent increase compared to 2003. The trade surplus for 2004 was $32 billion, the highest trade surplus since 1998. With a foreign trade accounting for $1.15 trillion, China is ranked as the third largest trading nation in the world by volume, after the United States and Germany but ahead of Japan³.

Because of the abundance of cheap labour, China remains a country with a great potential for foreign corporations to conduct (at least a part of) their business. Although Chinese quality standards are not yet as high as Western standards for most products, it is sufficient for the intended purposes. This combined with far more attractive production costs any Western country could ever offer, makes China the place to be. Also, taking the enormous potential the Chinese market has into account, most Western corporations cannot afford not to be active in China.

Because China has only recently (1992) embraced a new vision that a market economy can be reconciled with the ideals of socialism, it is not more than logical that it is presently coping with a lot of problems that are a result of the transition from the old system to the new one. China’s main goal is to learn how to conduct business in an effective and efficient manner while at the same time offering the same level of quality of service only Western countries can presently deliver. There are a lot of obstacles that need to be overcome before China will achieve this goal.

Also a trend is visible in which (Western) companies are redirecting their focus to their core activities, outsourcing more and more important activities, not being core activities, in the process. Specialized companies have jumped at this opportunity to carry out the activities these companies want to outsource. Jennings, (1997) says the following on this topic: “The potential for outsourcing has moved on from those activities that are normally regarded as of peripheral concern to the organization such as cleaning, catering and security, to include critical areas of activity such as design, manufacture, marketing, distribution and information systems with almost the entire value chain open to the use of outside supply”. Xindao finds itself in a situation in which most of its competitors have already outsourced their logistic services while Xindao itself still keeps conducting a part of these services, the warehouse activities in-house. This situation has made Xindao wonder whether or not it should outsource this part of their logistic services as well.

Xindao Shanghai recognizes some of the symptoms of China’s national problems within its own company. There is little planning for the internal warehouse activities, although that is changing due to the introduction of a new Enterprise Resource Planning (ERP) program. ERP is a process by which a company (often a manufacturer) manages and integrates the important parts of its business. An ERP management information system integrates areas such as planning, purchasing, inventory, sales, marketing, finance, human resources, etc⁴. Also Xindao suspects that it employs to many warehouse workers (twenty-nine). This large number can partly be explained by the fact that Xindao conducts some additional activities such as stamping, labeling and packing in its warehouse but this is not considered to be a sufficient explanation.

1 http://www.hollandinchina.org/nl/algemeen/bedrijfsvormen.html

2 Shanghai Business Review, march 2005, p. 19

3 http://www.tdctrade.com

4 http://www.investopedia.com

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1.1.1 Initial management question

Since Xindao has already outsourced most of its logistic services (i.e. all the transportation activities of all of its goods), the only logistic activities Xindao can really exert influence on, are the ones that are conducted in its Shanghai warehouse. Because a lot of other (Western) companies in China have started to outsource activities they do not consider to be related with their core competencies, it is not surprising that Xindao’s management is wondering whether it might be wiser to outsource the rest of its logistic services as well.

As Xindao’s management wants to make a well-founded decision regarding this issue, it would like to have a research conducted on the question “whether or not it should outsource its warehouse activities”.

1.1.2 Different elements of the management question

The initial management question closely coheres with four essential elements. The first element that needs further explanation are logistic services. The second element that is actually are a part of the logistic services, is the warehouse activities. Then there are other logistic services besides the warehouse activities. And finally there is the element of core competencies. In the next paragraphs these elements will be discussed.

1.1.2.1 Logistic services

Many different definitions are used to explain what logistic service means. It is a fact however that the term logistic service is derived from the word logistics. This word originated from a military context, referring to how military personnel should acquire, transport and store equipment and supplies⁵. In the business community, the term is used to refer to how resources are acquired, transported and stored along the supply chain.

1.1.2.2 Warehouse activities

The warehouse activities comprise all the activities Xindao conducts in-house or has direct influence on. Activities like the (un)loading of the trucks, the internal movement of the goods and additional work on the different products, such as stamping, labeling and packing.

1.1.2.3 Other (outsourced) logistic services

Xindao does not manufacture its products in-house but has sourced the products to three hundred different factories, primarily located in three provinces around Shanghai (the Jiangsu, Anhui, and Zhejiang provinces). All logistic services that are related to the transportation of the manufactured goods from the factories to Xindao’s warehouse have been outsourced. The same goes for all activities that are required to get the goods from the Shanghai warehouse to their final destination.

1.1.2.4 Core competencies

Competencies are the skills, knowledge and technologies that an organization possesses on which its success depends. Although an organization will need to reach a threshold level of competence in all activities it undertakes, it is likely that only some of these activities are core competencies. Core competences according to De Leeuw (2000) are those competencies that have a big impact on customer value, distinctly different to the competitors (a unique advantage over the competition) and expandable. According to Prahalad and Hamel (1990) a core competence is communication, involvement, and a deep commitment to working across organizational boundaries. Xindao has many competencies but only two real core competencies: Xindao’s extensive network of suppliers together

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with the good long-term relations it has with its manufacturers, and the fact that Xindao conducts the QC inspection by itself.

1.2 Problem analysis

Now that the initial management question has been presented, it is essential to go further into the presumption that is implicitly mentioned in the management question posed by Xindao; that is the presumption that the logistic services are presently not organized in the most optimal way.

Xindao has known a period of rapid growth the last couple of years in which the total turnover for Xindao Shanghai more than tripled since 2001. A part of all these orders is directly transported from the factory to the Container Terminal. Then there is a part that is sent to the freight forwarder. The rest is transported to the warehouse first, before being transported to the freight forwarder.

During this period (from 2001 until the 1^st June 2005) Xindao rented an additional 960 square metres and expanded its floor space to a total of 3840 square metres. Because of contractual obligations Xindao was forced to make a decision with regard to the renewal of the lease on the warehouse during the course of this research. As it became apparent that the warehouse was not using its floor space very efficiently (see paragraph 3.1.1), the decision was taken to only renew the lease on three of the four buildings at the present warehouse facility and reduce the total amount of floor space from 3840 to 2880 square metres again.

Xindao’s main long-term objective continue to grow and acquire a market share that will be equal or bigger than its main competitors like Polyflame and the Mid Ocean Group who are the major players in the market of promotional gifts & premiums as they are seven to ten times bigger than Xindao’s. To become such a player Xindao Shanghai will have to cut its costs and increase its revenues. Over the last three years, due to a new impulse initiated by the newly installed European management, revenues have gone up by over 400%⁶ as a consequence of increased sales activity. A decrease of the logistics costs could contribute to the long-term goal to become one of the major players in the business even more.

The General Manager of Xindao Shanghai, Mr. P. Tornqvist and the Vice-General Manager, Mr. G.

Pleyte, both felt there was a lot of potential room for improvement in the Shanghai warehouse. And, as a reduction of warehousing costs would help achieve the desired growth of Xindao, they wanted a research conducted on whether or not Xindao should outsource its warehouse activities.

1.3 Research goal

The research goal was formulated bearing the initial management question mind as well as Xindao’s focus on costs.

“In order to ensure Xindao will take a well-founded decision on how to continue with its warehouse activities in Shanghai, this research aims to provide the necessary information and advice to aid Xindao’s top management in making this decision. The outsourcing decision will largely, but not solely, be determined by the possible reduction in warehouse costs”.

1.4 Research question

Based on both the demands of Xindao’s management in Shanghai and the limitations that were implicitly imposed by this dissertation, a research question was formulated. The demands made by Xindao’s management in Shanghai included, amongst other things, a focus on the Shanghai warehouse and an emphasis on costs. The limitations that were implicitly imposed by the research also included a timeframe of six months in which the research was to be completed. Haven taken all these factors into account, the following research question was formulated:

6 Xindao’s annual report 2004

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“Should Xindao continue to conduct its warehousing activities for its Shanghai warehouse in- house or should it outsource these activities?”

1.4.1 Sub questions

In order to be able to provide a clear answer to this question three sub questions have been formulated. The sub questions provide in-depth information regarding the elements mentioned in the research question. A chapter will be devoted to each of the different sub questions. The answers to the sub questions will eventually lead to the answering of the research question.

Sub question one

What effect do the different cost-factors have on the decision Xindao has to make whether or not to outsource its warehouse activities?

This sub question will give more insight in the financial aspects of the outsourcing decision. In chapter three both alternatives will be discussed with regard to their specific financial factors.

Sub question two

What effect do the different non-financial factors have on the decision Xindao has to make whether or not to outsource its warehouse activities?

Since next to financial factors there are also non-financial factors that can have a major impact on Xindao chapter four aims to identify and weigh the different non-financial advantages and disadvantages the outsourcing decision will have on Xindao.

Sub question three

What decision should be made with regard to the question whether or not Xindao should outsource its warehouse activities?

In chapter five both the financial and non-financial factors will be taken into account as a decision will be made whether or not Xindao should outsource its warehouse activities.

1.5 Conceptual model

This whole research is based on the question whether or not Xindao should outsource its warehouse activities. The conceptual model provides a visual depiction on the line of thought used to answer the research question. This conceptual model was designed using information from several financial reports generated by Xindao’s financial department as well as interviews and articles. These sources were of importance when the non-financial factors were categorized. The information from both sources was combined with the information that was yielded by interviews with the Vice General manager and Chief Operations Officer of Xindao Shanghai, Mr. G. Pleyte, who has been active in the logistic branch for over forty years now. As depicted in figure 1 the outsourcing decision is influenced by two different groups of factors: financial and non-financial. The financial factors usually have the biggest influence on the outsourcing decision. However there can always be very strong non-financial arguments that overrule the financial arguments. Of course the bigger the financial advantage, the stronger the non-financial arguments must be in order to do so. Both arguments will be discussed below.

1.5.1 Financial factors

Financial factors are very important factors to take into account when answering Xindao’s question whether or not it should outsource its warehouse activities. Financial factors have the advantage that they can be compared with each other relatively easy. Something that is not so easy when comparing different non-financial factors with each other. The direct cause for this research was in fact finance-

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related, as Xindao’s management perceived the costs for the warehouse activities to be too high.

Nevertheless Xindao had no hard data on competitors to base this assumption on.

In this research the financial factors related to both alternatives (i.e. to keep operating the warehouse activities in-house or to outsource these activities) will be analysed. Since the nature of the cost information differed considerably between the two alternatives, both were examined in a different way.

The cost information Xindao has available on its own warehouse is very concise (appendix 1). Since this is all the cost information there is, the costs for operating the warehouse by Xindao are reviewed per cost-factor. Five main cost-factors can be identified when looking at the warehouse expenditures;

the rent of the warehouse, repair & maintenance costs, staff costs, overhead costs and the costs of investments. Each of them will be discussed later in this report.

In order to obtain accurate cost information on the outsourcing alternatives first of all the throughput data on Xindao’s warehouse over the last year (2004) need to be determined. The throughput data consists, amongst other factors, of the number of cartons, the number of different lots, the number of 20’, 40’ and 40’ high cube containers (appendix 2). Since all this information is stored in weekly reports that are only available on hard-copy, all the throughput data first needs to be digitalized and combined.

Then it will be possible to have a number of different third-party logistics provider (3PL provider) make accurate quotations based on the throughput data. A 3PL provider is a company which supplies/coordinates logistics functions across multiple links in a logistic supply chain. The company thus acts as a “third-party” facilitator between seller/manufacturer (the “first party”) and the buyer/user (the “second part”)⁷. The cost information the approached 3PL providers could provide was more detailed and specified than the information Xindao could provide because they could make their calculations based on Xindao’s throughput data. Therefore the cost-factors used to examine this alternative differ from the ones used to analyse Xindao’s own warehouse expenditures.

Financial factors Non-financial factors

Conduct warehouse activities in-house

To outsource,

or not to outsource

Overhead Staff Repair &

maintenance

Investments Rent of warehouse

Picking cartons for QC inspection Rent of the QC area

Storage over one week

Overtime Labeling Receiving of the

goods

Tracking inventory Flexibility in

manpower Flexibility in floor

space

Simplifying communications

Reputation/

references

Leak of information on products & orders Linking the two information systems

Loss of control

Linking the two information systems

Focus on core competences Outsource

warehouse activities

Possible advantages of

outsourcing

Possible disadvantages of

outsourcing

figure 1: conceptual model

1.5.2 Non-financial factors

Besides financial factors there are also important non-financial factors that should be taken into account when considering outsourcing ones warehouse activities. The potentially important non- financial factors should be reviewed to see whether or not they reinforce or contradict the conclusion that will be drawn on a financial basis. Therefore the non-financial factors will be divided into potential

7 Lieb and Maltz, Third-party logistics industry: Evolution, Drivers and Prospects, 1995, p. 45

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advantages and disadvantages to the outsourcing alternative. The non-financial factors have been determined with the help of articles and documents found on the Internet as well as interviews with Mr.

G. Pleyte. The factors that were identified by both sources are introduced in the conceptual model figure 1.

1.6 Theoretical Framework

The theoretical framework will give the outsourcing decision on Xindao’s warehouse its place within the existing literature and also show which theories will be used during the course of this research.

As Xindao suspected that the warehouse activities were not organized in an optimal manner and therefore wanted a research conducted on its logistics services. The word logistics, as said before originated from a military context referring to how military personnel should acquire, transport and store equipment and supplies⁸. The Council of Supply Chain Management Professionals (CSCMP) has defined logistics as “that part of the supply chain process that plans, implements, and controls the efficient, effective forward and reverse flow and storage of goods, services, and related information between the point of origin and the point of consumption in order to meet the customers’

requirements”⁹.

It is of importance that the management of logistics is conducted in a way which maximizes efficiency and minimizes costs, as is underlined by the following quote from Watson and Pitt (1989).

“Management of logistics functions in modern organizations involves decision making for the complete distribution of goods and services in the marketing function with a view to maximize value and minimize cost”. In order to handle its logistics activities effectively and efficiently, a company may consider the following options (Razzaque and Sheng, 1998).

(1) It can provide the function in-house by making the service

(2) It can own logistics subsidiaries through setting up or buying a logistics firm (3) It can outsource the function and buy the service

Since setting up or buying subsidiaries (option two) is not a realistic option for Xindao because it does not have the resources for this, the first and the last options will be reviewed and compared with each other. Xindao wanted to know whether it should outsource that particular part of its logistic services that was still conducted in-house; the warehouse activities. This is a very common question for companies such as Xindao since transport, warehousing, inventory, value added services, information services and design and reengineering are typical services outsourced to a Third-Party Logistics (3PL) provider according to Andersson (1997), Christopher (1998), and Lieb & Randall (1996).

The previously named terms: Third-Party Logistics, outsourcing, and contract logistics generally mean the same thing (Lieb et al., 1993). Third-Party Logistics can mean almost anything from a one-time purchase of a transport service, to turnkey logistics systems for a whole firm according to Anderson (1998). Bergelund (2000) says Third-Party Logistics are “the services offered by a middleman in the logistics channel that has specialised in providing, by contract, for a given time period, all or a considerable number of the logistic activities for other firms”.

The decision whether or not to outsource such an important part of the company’s value chain as the warehouse activities should never be taken lightly. Especially since “the outsourcing decision can often be a major determinant of profitability making a significant contribution to the financial health of the company” according to Yoon and Naadimuthu (1994). Outsourcing can contribute to profits by enabling users to gain competitive advantage, adding measurable value to products, enhancing customer service, assisting in opening new markets, and providing dedicated resources (Foster and Muller, 1990).

9 http://www.cscmp.org

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The major reasons cited for usage of 3PL services include cost reduction, strategic reasons, process effectiveness and lack of internal capability (Sahay and Ramneesh Mohan). Xindao’s top management has indicated that the emphasis of this research should be on the financial aspect of outsourcing, but of course the non-financial aspects will also be analysed. For a research on outsourcing comprising only financial factors is not viable. Therefore this research will be divided into two parts: financial aspects and non-financial aspects. However, as requested by Xindao’s management, the financial aspects will have the most influence on the outsourcing decision. The financial factors will comprise both the cost factors that were identified in Xindao’s annual rapport of 2004 as well as the cost-factors that will be quoted by the 3PL providers. These factors will each be reviewed and estimations on future changes will be made.

Besides the question whether outsourcing is financially attractive, there are also certain potential non- financial (dis)advantages to outsourcing of the warehouse activities. According to Stalk and Hood (1990) the ability to be able to meet the demands of customers for ever-shorter delivery times, and to ensure that supply can be synchronised to meet the peaks and troughs of customer demand, is clearly of critical importance in this era of time-based competition.

Christopher (2000) suggests that companies that want to become more responsive and operate in an unpredictable environment where demand is volatile and the requirement for variety is high need to get more agile. “Agility might be defined as the ability of an organization to respond rapidly to changes in demand, both in terms of volume and variety”. Christopher (2000), also states that the truly agile supply chain has a number of distinguishing characteristics:

(1) The agile supply chain is market sensitive

(2) The use of information technology to share data between buyers and suppliers is, in effect, creating a virtual supply chain

(3) Shared information between supply chain partners can only be fully leveraged through process integration

(4) The supply chain must become a confederation of partners linked together as a network Christopher’s theory is used in this research because it discusses a number of non-financial factors such as the data flow within the supply chain and the integration of the supply chain which are issues that could provide Xindao with a competitive edge over its competitors. Also, in semi-structured interviews with Mr. G. Pleyte a number of non-financial factors (operating a Warehouse Management System, linking of the two information systems, simplifying communications and the focus on core competences) that are closely related to Christopher’s characteristics, were identified.

Christopher’s theory will be discussed in more detail in paragraph 4.1 where potential non-financial advantages are identified and reviewed.

1.7 Methods and techniques

This research will largely have a descriptive nature as it tries to give insight in the both the financial and the non-financial factors that will be discussed. Furthermore this research can be considered to be a company supportive research rather than a problem solving research. It is intended to create more insight for Xindao’s top management in order to enable them to make a well founded decision on outsourcing the warehouse activities.

In order to make a well-founded decision the research needs to be conducted methodically. The research needs to be based on data: data on the warehouse performance, data on costs and data on Xindao in general. Baarda & De Goede (2000) identify three different ways to obtain data for quantitative research which is applicable to chapters two and three:

(1) Use existing information

(2) Obtain data through observation

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(3) Obtain data through written or oral interview

For this research all three ways will be used to obtain the necessary data. As said before, a chapter will be devoted to each of the different sub questions. For each chapter different ways of data gathering are required. Below is indicated which method will be used in each chapter.

In order to get the information that is needed to make an analysis of Xindao and its internal warehouse processes (chapter two), data will be obtained through interviews and the use of existing information.

The existing information will consist of articles and rapports on China that describe the development of China as a country and economic power. It will also encompass internal documents on Xindao that will be used to shed light on supply chains and internal warehouse processes. Finally the needed data on warehouse processes will partly be obtained by observations in the warehouse itself.

In order to answer the first sub question (chapter three): what effect do the different cost-factors have on the decision Xindao has to make whether or not to outsource its warehouse activities, it is necessary to use relevant financial sources, such as annual budgets, year rapports and throughput data of the warehouse. This data will be obtained through the use of existing information as well as through semi-structured oral interviews. This throughput data will have to be assembled by merging all the individual weekly throughput rapports of 2004, since this information was not yet available.

The answer to the second sub question (chapter four): what effect do the different non-financial factors have on the decision Xindao has to make whether or not to outsource its warehouse activities, a number of different sources will be consulted. As this sub question has a qualitative nature the ways to collect data from Baarda & De Goede do not officially apply. However sources from which the needed data will be obtained will include review of literature and other documents concerning an outsourcing decision as well as interviews with Xindao’s management.

In order to answer the third sub question (chapter five): what decision should be made with regard to the question whether or not Xindao should outsource its warehouse activities, the answers to the second and third sub questions will be combined revealing the best alternative for Xindao.

Reliability, possibility to generalize and validity

According to Baarda & De Goede (2000) reliability is the dependence of research measurements on coincidence. In order to realise a high degree of reliability, coincidences must be prevented as much as possible. Therefore the data that will be collected on the warehouse, such as the throughput data and the cost data, will at least encompass one whole year. This way any seasonal influences will be made visible and can be taken into account. Furthermore the data that will be used in the research will be as up-to-date as possible in order to make accurate estimations.

Furthermore the 3PL providers will be asked to base their quotations on the throughput data of the most recent year of which the costs information is available. This way a viable comparison can be made between both the two alternatives as well as between the 3PL providers

The 3PL providers will be asked to quote their rates based on a framework which dictates which variables should be quoted and in which units the variables are to be quoted. This way Xindao can calculate the future costs for multiple scenarios and also it will shed light on what the differences in cost-structure between the different 3PL providers are.

The possibility to generalize conclusions of a research to other places and circumstances is an important part of the quality criteria of a research according to Baarda & De Goede (2000). This should be the case as the 3PL providers will be asked to make their quotations based on a framework. With this framework it is very easy to get quotations from other 3PL providers. It will be easy to compare the collected cost-data with Xindao’s annual budget.

According to Baarda & De Goede (2000), validity means that the indicators that are used to measure a term, actually represent that term. With the financial factors the data actually represent the underlying cost-factors.

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Chapter 2 Analysis of Xindao and its internal warehouse processes

2.1 Xindao

Xindao B.V. was founded in 1986, years before the massive influx of Western corporations into China really started, by three Dutch students of the Erasmus University Rotterdam. After they went to China where they wrote their dissertations, they started publishing a magazine called Reach that was intended to bring Chinese (trading) companies into contact with Dutch companies in order to sell their products in Europe. Within months they where approached by a Japanese-Chinese Joint Venture in measuring tapes and were asked if they wanted to be their European agent. Soon they realised that it would be even more interesting to do business for other Chinese companies as well. They decided to start a business and buy the products from these companies themselves and sell them in Europe.

Over time they expanded their business to the rest of the world.

In 1993 Xindao Hong Kong Ltd. was established as a first outpost for Xindao’s activities in the Fareast, China in particular. Hong Kong, at the time still part of the British Commonwealth, was for several reasons by far the best stepping stone in the Fareast for Western corporations. For one, the people in Hong Kong were already familiar with Western culture and the English language. This was due to the fact that Hong Kong had been a British Crown Colony until the 1^st of July 1997 when it returned into Chinese hands under the concept of “one China, two systems”. This scientific concept was put forward by Deng Xiaoping, a revolutionary elder in the Communist Party of China and de facto ruler of China from the late seventies until the early nineties. The concept means that on the premise of one China, the mainland will practice the socialist system, while the existing capitalist system and way of life in Hong Kong will remain unchanged for a long period of time¹⁰.Which leads to the second reason Hong Kong was the best choice for Xindao to set up an outpost: Hong Kong had a Western-friendly business climate as well as low tax-rates. Finally Hong Kong was selected because it is located at the very heart of the Fareast, close to most of the important Asian countries such as Japan, China and Taiwan.

Xindao recognized China’s enormous potential in general and the pulsing city of Shanghai in particular. And in 1996 Xindao made the giant leap to the mainland of China and established a representation office in Shanghai. All three of these entities (Xindao B.V., Xindao Hong Kong Ltd. and Xindao Shanghai) are part of the same Holding: the Huwest Holding. Because of Chinese rules and regulations and certain tax benefits the Shanghai office was officially set up as a representation office for Xindao’s Hong Kong office. Presently however, although all Xindao’s operations are conducted from the representation office in Shanghai the Hong Kong office remains the official basis for Xindao in Asia.

Since 1996 Xindao Shanghai has grown rapidly and at present it employs a staff of almost one hundred employees and also twenty-nine warehouse workers that are hired on a monthly basis. The Huwest Holding as a whole employs a staff of one hundred and ninety (excluding the twenty-nine warehouse workers).

10 http://www.fmprc.gov.cn/eng

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Huwest Holding

Xindao B.V.

Xindao Hong Kong Ltd.

Xindao Shanghai

figure 2: overview Huwest Holding

Xindao Shanghai is divided into two divisions, each with its own specific function; the Shanghai Sales Division (SSD) acts as a trader, the Holland Purchasing Division (HPD) acts as a buying agent for Xindao B.V. that is located in Rijswijk, the Netherlands. The customer can either choose to contact Xindao B.V. in the Netherlands (directly or through one of the Local sales offices) or it can contact the Shanghai Sales Division, depending on which way it would like its goods delivered (this will be explained in paragraph 2.2).

As was mentioned in the introduction Xindao’s products can be divided into two different categories.

The first category consists of do-it-yourself (DIY) products such as toolkits, bags and measuring tapes.

Historically Xindao is strongly represented in the measuring tape business since it was one of the first companies to export measuring tapes that were made in China to Europe. This explains why measuring tapes take up a relatively big part of Xindao’s DIY-product range. Through its contacts with these factories Xindao got involved in other product groups that were closely related to measuring tapes such as pliers, screwdrivers and wrenches as well.

The second category of products Xindao sells consists of promotional gifts & premiums. This category consists of products Xindao has have been divided into three different groups: soft wear (i.e. bags, hats, fleece blankets, inflatable items etc.), outdoor adventure (i.e. compass, pick nick, barbeque etc.) and indoor (i.e. household appliances).

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A good example is the Heineken Tooter which was especially made for Heineken as a promotional gift for the 2004 European Soccer Championship that was held in Portugal. But of course Xindao also sells other products, such as thermos flasks and wine-openers, as can be seen below.

It is important to realize that Xindao does not manufacture the products in-house. Because of its long presence in Asia, over twelve years now, Xindao was able to carefully select over three hundred different factories to source its products.

These factories either transport the goods directly to the Container Terminal in the Shanghai port, to the freight forwarder or to Xindao’s warehouse in Shanghai depending on whether or not additional work needs to be done on the goods. Either way a QC inspection of the goods is required because the Chinese manufacturers still have problems maintaining a constant level of quality. Even when a factory receives a repeating-order for several times and there have never been any problems before, it still happens quite regularly that the factory makes a mistake. For example it would not be strange that on a repeat-order for Heineken, the green colour on the Tooter Hat does not even come close to the typical Heineken colour. The constant attention during production and QC is a value-added service for Xindao’s customers and avoids that faulty products are shipped.

If goods are transported directly from the factory to the Container Terminal the QC inspection will be performed at the factory. Otherwise the goods will be transported from the factory to Xindao’s warehouse where additional activities like stamping, labeling and packing are performed. In this case the QC inspection will be conducted in Xindao’s warehouse as well. However, for big and important orders and also for factories with a history of slip-ups, a QC inspection will be conducted during the manufacturing process at the factory as well.

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2.2 Supply chain

As said before, the customer can either contact Xindao B.V. or the Shanghai Sales Division, depending on the way they want their goods delivered. If a customer wants the goods delivered on a Freight on Board (FOB) basis, which means Xindao fulfils its obligations to deliver when the goods have passed over the ship’s rail¹¹, it contacts the Shanghai Sales Division. In this case the customer is responsible for the selection of the ocean carrier, and all related matters. If the customer wants the required goods delivered at its doorstep it contacts Xindao B.V. Xindao B.V. then has the obligation to arrange for everything related to delivering the goods at the customer’s doorstep. Although in reality it has delegated most of the tasks (production and transportation) to third parties. Both order flows will be discussed in this paragraph.

First however, there are a few general remarks with regard to Xindao’s supply chain which are mentioned here:

It must be noted that the Xindao B.V. not only places orders with the Holland Purchasing Division on behalf of its customers, it also keeps stock in a warehouse in Doetinchem in the Netherlands. This way Xindao B.V. is able to instantly deliver fast running goods, whenever there is a request from a customer. Of course this fast delivery does come with a higher price tag since it normally takes twelve weeks from order to delivery of the goods in the Netherlands and: on average ten percent extra. When a certain product is almost out of stock or a rise in demand is suspected (e.g. Christmas) Xindao B.V.

will place an order with the Holland Purchasing Division that will arrange for the requested products to be shipped to Rotterdam. From Rotterdam the goods will be transported to Doetinchem. Xindao has outsourced its warehouse activities in Doetinchem to a third party, a company called Rabelink Doetinchem.

It should be noted that the Holland Purchasing Division only delivers to Xindao B.V. on a FOB basis just like the Shanghai Sales Division delivers its goods to its customers on a FOB basis. So in fact Xindao Shanghai delivers its goods on a FOB basis to all its customers including Xindao B.V. This means Xindao B.V. is responsible for the transport from the Shanghai port to the customer’s doorstep.

Xindao B.V. has outsourced all of the transporting activities to third parties.

It is important to determine who is responsible for the goods at any given point in the value chain, from factory to customer. If something happens with the goods, it is clear who will be held responsible for the resulting costs. The normal delegation of responsibilities that Xindao uses can be seen in figure 3.

Of course if the customer desires the responsibilities to be delegated in another way, Xindao will arrange for that as well. In general Full Container Load (FCL) shipments will be transported directly to the Container Terminal in the Shanghai port, provided no additional work has to be done on the goods.

The Less than Container Load (LCL) shipments usually go through Xindao’s warehouse, unless the warehouse is overloaded; then the goods are sent to the warehouse of the freight forwarder where they are consolidated. Xindao has a contract with a trucking company that will pick up the collected the goods in the Rotterdam port and transport them to Xindao’s warehouse in Doetinchem. Then the customer either arranges for the goods to be picked up at the warehouse itself or Xindao arranges for the goods to be transported to the customer, depending of course on the customer’s wishes.

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Factory

(China)

Xindao warehouse

(Shanghai)

Shanghai Harbor

Client

(Europe) Forwarder Res.

FCL Manufacturer Res.LCL

Forwarder Res.

Transporter Res.

Rotterdam Harbor

Xindao Warehouse

(Doetinchem) Transporter Res.

Transporter Res.

Xindao Hong Kong

Xindao B.V.

Caption

Please also note that Xindao B.V. is the only client Xindao Hong Kong has.

figure 3: responsibilities during transportation of goods for Xindao B.V.

It should be noted that all Xindao’s products are sold through both the Holland Purchasing Division and the Shanghai sales Division. In order to shed more light on Xindao’s supply chain both order flows will be analysed below.

2.2.1 Order flow for Xindao being a buying agent

The Holland Purchasing Division has one principal; Xindao B.V. It is important to realize that Xindao Shanghai and Xindao B.V. are two totally independent companies even though Xindao B.V. is the only customer the Holland Purchasing Division has. When a customer buys its goods through Xindao B.V.

it apparently prefers its goods delivered at its doorstep.

Customers that live in countries where Xindao has no local sales office can contact Xindao B.V. in Rijswijk (the Netherlands) directly. If the customer lives in a country where Xindao has a local sales office (figure 4) the customer can choose either to go through that office or to contact Xindao B.V. The local sales offices each consist of between one and four sales persons that are all are employed on a commission basis. They maintain the contact with the customers and also try to find new customers by going to fares, venues and to the companies itself. Customers that approach one of the local sales offices or Xindao B.V. in Holland directly can either buy from stock or place an order through Xindao B.V. with the Holland Purchasing Division in Shanghai. For the DIY-products around 50% of the orders are delivered from stock in Holland directly, the other 50% of the orders is passed on to the Holland Purchasing Division and has to be manufactured on demand. For the promotional gifts & premiums around 90% are delivered from stock directly, for the other 10% an order will have to be placed with the Holland Purchasing Division.

The order flow from the initial inquiry until the delivery to the customer for the Holland Purchasing Division has been depicted in the figure 5.

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figure 4: location Xindao’s local sales offices

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Overview order flow Holland Purchasing Division (buying agent)

Shanghai Merchandiser Xindao B.V.

Manufacturer

Xindao warehouse (Shanghai)

Container terminal (Rotterdam harbour)

Xindao warehouse (Doetinchem)

Customer

Container terminal (Shanghai harbour)

3. Quotes back price & delivery time 6. Confirms order

4. Confirm order

11. LCL (95%) 8. FCL (5%)

13. If goods are approved

14. Ships cargo to

15. Transports cargo to 2. Checks price & delivery time

16. Transports cargo to 1. Orders

9. If goods are rejected

10. If goods are approved Major

Change (10%) No

Change (20%)

Small Change

(70%)

QC Shanghai office checks goods

at factory

QC warehouse checks goods at warehouse

7. Checks on order

5. Quotes back price & delivery time

figure 5: overview product flow Holland Purchasing Division

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Clarification order flow Holland Purchasing Division

1. Xindao B.V. places an order with one of the merchandisers of the Holland Purchasing Division in Shanghai. This order can be placed either on behalf of a customer (with or without mediation by one of the Local sales offices) or on behalf of Xindao B.V. itself to replenish the stock in the warehouse in Doetinchem. Xindao places an order on the condition that the price & delivery time that Xindao has in the listing are still viable.

In this phase of the order flow the sales persons sometimes calculate very tight delivery dates (less than Xindao’s standard delivery time) for various reasons (for example to win an order from a client). This puts a lot of extra strain on the organization as a whole and the warehouse in particular. It must be noted that this problem lies outside the scope of this research as it is not related to the warehouse activities of Xindao Shanghai.

2. The designated merchandiser will then contact the concerned manufacturer(s) and will make clear what Xindao exactly wants. When it concerns a standard product the merchandiser will check whether the price & delivery time Xindao based its order on are still up-to-date. Often however, the customer wants to make certain changes and of course the merchandiser then needs to check with the manufacturer what effect the changes will have on the price & delivery time.

3. The manufacturer will quote back the price and delivery time for the new order to the merchandiser 4. If the manufacturer’s price & delivery time match with the price & delivery time Xindao B.V. based its order on, the merchandiser will confirm the order right away.

5. If the manufacturer’s price & delivery time do not match with the price & delivery time Xindao B.V.

based its order on, the merchandiser will quote back the new price & delivery time to Xindao B.V.

6. Xindao B.V. either accepts the new price & delivery time in which case it confirms the order or, if possible, it starts a new sequence of events by placing an order with another factory.

7. During the manufacturing process the merchandiser will check a number of times with the

manufacturer whether he is still on schedule and whether the quality standards are still met. In order to guarantee the promised quality standards the merchandiser will demand for example pre- and mid- production samples. Also, for difficult orders or important customers, he will send the QC inspection to the factory during the production phase to check if the quality standards are met and the production will be finished in time.

It must be noted that QC inspection at the factory is a costly business as QC inspectors usually need to fly to the factories. This is the reason why this is only done for big customers. However the definition of important customers is unclear.

8. The following step depends for a large part on the order size. In only five percent of the cases the goods are directly transported to the Container Terminal in the Shanghai port. This usually is the case when an order is big enough to fill one or more containers entirely and any additional warehouse activities can be conducted at the factory. In this case the QC inspection is conducted at the factory by the quality department of the Holland Purchasing Division.

9. If the goods are rejected by the QC inspection they will remain at the factory. Depending on the severity of the flaw the manufacturer and Xindao will decide whether goods will be repaired or new goods will have to be produced. Either way the goods will be checked by the QC inspection Department again at the factory.

10. If the goods are approved they are transported directly from the factory to the warehouse to the Container Terminal in the Shanghai port.

11. In most cases (95%) however the order is not large enough to fill up an entire container. In this case the manufacturer transports the goods to Xindao’s warehouse in Shanghai where, if necessary, any additional warehouse activities are conducted. In this case the QC inspection Department of the warehouse will check the quality of the goods as soon as the goods arrive. Again there are two

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possible outcomes; either the goods are approved if they live up to the set quality standards, or the goods are rejected if they do not meet the quality standards.

12. If the goods are rejected they are sent back to the manufacturer. Depending on the severity of the flaw the manufacturer and Xindao will decide whether goods will be repaired or new goods will be produced. The new or repaired goods will be transported to Xindao’s warehouse, where they will be checked by the QC inspection Department again. However sometimes Xindao has a dispute with the manufacturer on the rejection of certain goods. In that case the goods usually remain in Xindao’s warehouse until the matter is solved.

Since in this stage the QC inspection already received production samples that did pass the QC inspection, in theory this should never happen. However, for whatever reason, in real-life this happens quite a lot. Besides a delay of the delivery date it also means Xindao needs extra space to store these goods.

13. If the goods are approved by the QC inspection Department (whether it is the first or a later time).

The warehouse management will order one or multiple containers from the freight forwarder who will collect the goods at Xindao’s warehouse and transport the container to the Container Terminal in the Shanghai port.

14. There they will be loaded onto a container ship that transports the cargo to the Rotterdam port.

15. Once the container(s) are offloaded in Rotterdam they will be stored first in the Container Terminal.

There, they will be picked up and transported by truck to Xindao’s own warehouse in Doetinchem.

16. Depending on whether the order was placed on behalf of Xindao B.V. or a customer the goods will either stay in the Doetinchem warehouse or be transported to the customer.

2.2.2 Order flow for Xindao being a trader

Customers from all over the world can order from the Shanghai Sales Division directly. In general this division attracts the largest customers for Xindao. Also the customers of the SSD tend to customize their ordered products more than customers of the HPD. The order flow from the initial inquiry until the delivery to a port of the customer’s choice is depicted in figure 6.

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Overview order flow Shanghai Sales Division (trader)

Shanghai Merchandiser Customer

Shanghai Sales

Manufacturer

Xindao warehouse (Shanghai)

Container terminal (Designated harbour)

Customer

Container terminal (Shanghai harbour)

4. Quotation / Signs order back to client 5. Quotation / Signs order back to client 6. Quotation / Signs order back to client 7. Confirms order

8. Confirms order

9. Places purchase order

[60%] [40%]

16. If goods are approved

17. Ships cargo to

18. Client arranges his own transportation 2. Makes Inquiry 1. Makes inquiry

13. If goods are approved 15. If goods are rejected

3. Makes inquiry Major Change

(10%) No

Change (10%)

Small Change

(80%)

11. FCL (50%) 14. LCL (50%)

10. Checks on order

QC Shanghai office checks goods

at factory

QC warehouse checks goods at warehouse

figure 6: overview product flow Shanghai Sales Division

an outsourcing decision on warehouse activities

A Dutch trader in China: