THE WHEELS GROUP: EVOLUTION OF A THIRD-PARTY LOGISTICS SERVICE PROVIDER Michael Sartor prepeved this case under the supervision of Professor P. Fraser Johnson solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, do Richard Ivey School of Business, The University of Westem Ontario, London, Ontario, Canada, NGA 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@vey.uwo.ca Copyrigte 2004, Ivey Management Services Version: 2004-03-09 Peter Jamieson, president of Wheels Group, leaned back in his chair as he reflected with Doug Tozer, the founder and major shareholder of the company, upon the success of the Mississauga, Ontario-based company during the past 15 years. It was Wednesday, August 6, 2003, and Jamieson and Tozer were considering alternatives with respect to pursuing their goal of doubling the third-party logistics (3PL) provider's revenues over the next five years. In an attempt to identify potential opportunities and risks, Jamieson and Tozer had been working with the heads of the subsidiary companies. While the results of this planning exercise yielded a number of attractive opportunities for the company to pursue, after much debate, it seemed that the safest course of action was to focus the company's efforts upon growing its flagship subsidiary, Wheels International, and its non-asset-based business model. However, a potentially lucrative proposal presented by Jim Davidson, president of Wheels Dedicated, to expand the subsidiary's asset-based 3PL business continued to intrigue Jamieson an and Tozer. Davidson's proposal represented a significant shift away from the current business strategy of focusing on non-asset-based logistics services, and Jamieson and Tozer felt the company could not pursue expansion at both subsidiaries simultaneously. Consequently, they felt the time had come to firm up the company's business strategy. THE THIRD-PARTY LOGISTICS INDUSTRY While Canada's transportation industry was characterized by a high degree of government regulation during the early to mid-1900s, the end of the Second World War marked the beginning of a half-century transition to a deregulated industry in Canada. Progressive deregulation of the rail, air, trucking and ports sectors of the industry resulted in increased competition, lower market-based prices and an expanded range of transportation alternatives. One significant trend that emerged in North America following the deregulation of the United States and Canadian trucking industries in the 1980s was the evolution of the third-party logistics (3PL) industry. Initially, 3PLs were primarily engaged in supplying manufacturers with a limited range of transportation and warehouse storage services. However, with the advent of supply-side manufacturing strategies in North America and the increasing complexity of supply chains in the late 1980s, 3PLs began to capitalize on the opportunity to provide manufacturers with outsourced logistics solutions. In a 2002 annual survey of 66 of the largest (Fortune 500) manufacturing companies in the United States, 65 per cent of the companies reported using third- party logistics services, an increase from 38 per cent when the same survey was first conducted in 1991.' Exhibit 1 illustrates the growth in gross revenues. generated by firms in the U. S. 3PL market during between 1996 and 2002. The industries that have embraced 3PL services include the automotive, chemical, consumer products, electronics, computer, medical supplies and devices, retail and telecommunications industries. Exhibit 2 provides an estimate of the proportion of projected logistics budgets that will be outsourced by North American manufacturers during the period 2005 to 2007, and Exhibit 3, lists the activities most frequently outsourced to 3PLs. Although the 3PL industry had experienced dramatic growth since deregulation, the participants in the industry were highly fragmented and characterized by differing capabilities. Exhibit 4 lists the top 15 3PL companies in terms of their 2002 net revenues, along with an estimate o e of their current number of employees and a brief description of their service offerings. Participants in the 3PL industry were estimated to enjoy net margins of approximately five per cent on average. THE WHEELS GROUP OF COMPANIES Founded by Doug Tozer, Wheels Group commenced operations as a non-asset- based provider of highway and intermodal rail transportation services in 1988. By 2002, five subsidiary companies were operating under the Wheels Group banner: Wheels International, Wheels Dedicated, AIM Integrated, Wheels Pacific and Wheels Logistics. Head office supplied the operating g companies with shared support services such as administrative, financial (A/P and A/R), human resources, IT and quality initiatives, allowing the subsidiaries to focus on revenue growth and cost control. Exhibit 5 provides an overview of the Wheels Group's corporate organization. Wheels Group had annual revenues of approximately $100 million in 2002. Management believed that the company's success was driven by four key success factors: value-added customer focus, its non-to-light-asset strategy, deployment of a leading Web-based supply chain information system and continued enhancement of a people-centered culture. Exhibit 6 contains the Wheels Group's mission statement and general strategy statement. AIM Integrated, Wheels Pacific and Wheels Logistics AIM Integrated provided pickup and delivery trucking services (container drayage) for asset-based carriers engaged in rail and ocean transportation services whose customers needed their containers delivered beyond the marine ports or the end of the rail lines. In 2002, AIM was generating approximately five per cent of the Wheels Group's revenues. Wheels Pacific was a non-asset-based entity that focused on West Coast container transportation and management with services including container transloading, freight consolidation, cross-docking, brokerage services and warehousing for containers being shipped from the Pacific Rim into North America. Wheels Pacific targeted ocean carriers and major importers who were seeking a transportation solution to facilitate the movement of their products from coastal ports to inland destinations. Wheels Pacific represented approximately five per cent of Wheels Group's revenues. Wheels Logistics, which was started as a division of Wheels International, was being integrated into the parent company's operations during 2003 in an effort to enhance the suite of shared support services offered by the parent company to the subsidiaries. In particular, Wheels Logistics would provide supply chain analytical services to each of Wheels Group's subsidiaries. It assisted Wheels subsidiaries with customer route and load optimization studies for prospective customers, as well as logistics reporting, outsourced project implementation and management for existing customers. Wheels International Wheels International provided multi-mode (air, rail, ocean, highway) logistics services. In its promotional materials, the company proclaimed: "Whether you have 10 cartons, a full truckload or a plant full of equipment to be moved to a new facility. Wheels International will efficiently: i effectively move your freight." Revenues at Wheels International had grown from approximately $25 million in 1997 to approximately $70 million in 2002. Because of the importance of Wheels International to the overall company, Jamieson and Tozer personally oversaw day- to-day operations. Wheels International's non-asset-based business model involved providing customers with logistics solutions that employed the use of third-party transportation assets. For instance, Wheels International negotiated service agreements with customers and then subcontracted services with suppliers, such as trucking firms. While the company had traditionally focused on truckload and less- than-truckload services for irregular route logistics needs, it had been recently. leveraging its wide range of logistics services to offer more integrated supply chain management (SCM) solutions. The principle advantage associated with Wheels International's business model was that the subsidiary enjoyed a high degree of financial flexibility. Jamieson described Wheels International as a "positive cash flow business" that was not burdened by the costs of managing assets and debt. The lack of assets also meant that the subsidiary was unfettered by the complex utilization reporting maintained by asset-based 3PLs, and it was also characterized by a reduced risk of exposure to liability, given that it did not own any transportation assets and its suppliers operated their businesses under their own insurance policies and government authorities (carrier compliance). Jamieson acknowledged that non-asset-based 3PLs are often perceived as "brokers" who simply co-ordinate buyers and sellers of logistics services. He indicated that potential customers often regard asset-based 3PLs as being more capable of supplying logistics services than non-asset-based 3PLs. Jamieson thought these perceptions may manifest themselves in the higher valuation multiples attributed to publicly traded, asset-based 3PLs relative to non-asset- based 3PLs. As a non-asset-based company, Jamieson indicated that Wheels International sought to focus its strategy upon investing in people, technology and knowledge and information intangibles and management. He argued that the company's assets were primarily d was keenly aware of the importance of providing customers with an exceptional service experience. In this regard, the company was the first 3PL in North America to secure ISO 9001:2000 certification. Source: Company records With respect to the company's information technology strategy, Tozer pointed out: "Technology is the key to all our logistics solutions." The company recognized that many of its customers' enterprise management systems had poor logistical reporting, so Wheels developed three proprietary data mining and supply chain management software tools: Wheels Data Collection (WDC), Wheels Freight Audit (WFAT) and Wheels Automated Data Processor (WADP). The customized reporting generated by these software tools was used for customer cost benchmarking, carrier evaluations, performance measurements, freight auditing and payments, core root analysis and accessorial charges. Additionally, the subsidiary had invested a significant amount of money in CAST-dpm, a supply chain optimization tool that could be used to offer customers isochrome modeling of their transportation, routing and warehouse infrastructures. By leveraging its human resources, technology and a management philosophy of openly sharing information, management wanted to move beyond transactional- based relationships to create value-added strategic partnerships with both its customers and suppliers. For example, Wheels offered its True Partnership Program to customers who retained Wheels to manage entire supply chains. Customers who qualified for this program also enjoyed the benefits of Wheel's Open Book Approach, whereby Wheels would provide the customers with the actual costs associated with fulfilling the customers' logistics needs. Changes to business operations that resulted in cost savings resulted in shared benefits to Wheels and these customers. Similarly, while the relationship between a 3PL and a trucking company can sometimes be confrontational, Wheels International met regularly with the management of its key suppliers to openly share information about Wheels International's business strategy and logistics volumes. Wheels Dedicated Wheels Dedicated was created in 2001 to provide transportation and warehousing services to the automotive companies and their Tier 1 suppliers. Despite being a relatively recent corporate initiative, Wheels Dedicated enjoyed considerable success in its first year of operations under the leadership of its president, Jim Davidson, generating approximately 20 per cent of the Wheels Group's revenues by 2003. Jim's 37 years of experience in the transportation industry, coupled with an extensive network of professional and academic associates from the logistics industry, provided Wheels Dedicated with knowledgeable leadership. Wheels Dedicated's strategy was to focus on providing value-added transportation and warehousing related services in Ontario and the mid-central United States, as a "light-asset-based 3PL." The company sought to differentiate itself by leveraging its strong implementation and execution capabilities in order to provide its customers with low cost, customized dedicated logistics characterized by consistency of service (e.g., on-time deliveries). As a "light" asset-based provider of outsourced logistics services, Wheels Dedicated leased the trucking assets of owner-operators who operated their vehicles under Wheels Dedicated's insurance and government authority. The leases typically ran for a period of time equal to the term of the company's contract with its customer. These assets were employed by the company to provide logistics services to its customers on a dedicated basis. For instance, it supplied freight services between General Motor's (GM) Detroit and Oshawa plants. This business model represented a significant shift in philosophy for the Wheels Group, which had focused to date upon the non-asset-based provision of 3PL services. Jamieson observed: We have taken a right turn within the company by creating a light- asset division and putting trucks, trailers and warehouses on our balance sheet. Lots has been written about mixing asset and non- asset-based operations and that it's a recipe for failure. However, our approach has been to run the light asset side as a distinct standalone business. There are synergies at the head office level, but at the operating level it is separate from the rest of the company. The division is not now and will never be an irregular route carrier. THE CHALLENGE OF GROWTH Jamieson glanced at the commemorative plaque honoring the Wheels Group as one of the 50 Best Managed Private Companies in Canada and explained part of the reasoning behind considering a shift in strategy towards an asset-based model of 3PL activity: There are barriers to new trucking companies entering the 3PL to market due to such things as the inability to obtain insurance coverage, the increasing difficulty associated with attracting drivers and increasing costs around new security requirements after 9/11. Capacity is strained today even in a relatively soft North American economy. When the Canadian and U.S. economies start to improve transportation prices will start to rise. However, he explained that an asset-based provider needed to employ complex reporting systems to monitor metrics such as mileage, load weights, asset utilization rates, repair expenditures and schedules, fuel consumption and driver pay in order to ensure that revenues were maximized, while expenses and "empty miles" were minimized. Capital was required to lease assets and to acquire and operate the sophisticated asset management systems. A shift towards an increasingly asset-based model of 3PL activity would force Wheels Group to begin leveraging its unencumbered balance sheet. Jamieson estimated that the company could generate approximately $20 million in additional revenues for every $1 million it invested in expanding its asset base. The SCM Opportunity Wheels International had begun to experience some significant success in securing contracts to manage larger portions of customers' supply chains. This success was attributable to Wheels' efforts to shift the company's sales program towards a more consultative selling process whereby Wheels International sought to persuade corporate senior executives to consider how Wheels could reduce the prospective customer's supply chain costs. Jamieson noted: We find that senior executives are frequently well-versed on their costs of operations and manufacturing, but there is a void in the sense that there is little understanding of supply chain costs. Our selling cycle tends to be long, often exceeding 12 months, and it is consultative at the highest levels within the company. Dan Carruthers, a senior member of the sales force, agreed: One of our biggest challenges is communicating the advantages of conceptualizing outsourced SCM as a 'process' rather than as a "transactional' activity. It's not glamorous and it's typically a functional responsibility, but the supply chain makes up a significant percentage of overall cost and offers valuable business information and cost savings opportunities. Many companies don't recognize the opportunities in their supply chain. Success in this area was also based on Wheels' efforts to accelerate Wheels Logistics supply chain management (SCM) analytical consulting capabilities. Employing proprietary software to establish cost benchmarks, analysts from Wheels Logistics could demonstrate how using Wheels International supply chain solutions would reduce costs. This consultative analysis process, which included data gathering, modeling and supply chain design work, can cost the company $5,000 to $50,000, depending upon the size of the prospective customer. "We consider the consulting services to be a business development tool, but sometimes customers accept our optimized recommendations and do not proceed to have Wheels implement the solution," Jamieson noted with some frustration. Carruthers added that: "Wheels International was a transaction-based business until customers started asking for more information on their supply chains." Nevertheless, efforts in SCM appeared to be paying off. By managing customers' supply chains, Jamieson pointed out that Wheels International was evolving into a "fourth-party" logistics provider. For example, a recent consultation with a U.S.- based greeting card manufacturer resulted in Wheels securing the responsibility for major supply chain project. Wheels assumed responsibility for engineering and designing the manufacturer's supply chain, negotiating relationships with multiple warehouses and carriers, as well as co-ordinating the efforts of the carriers to facilitate the time-sensitive delivery of the customer's goods to 1,500 stores in the United States. Jamieson anticipated that Wheels International's revenues in this area could grow at an annual rate of 20 per cent in the near term. Jamieson regarded multi-national Fortune 500 companies that do not recognize a Canadian-American border within their North American operations as key target customers. Describing the Wheels Group companies generally, Jamieson noted that "a successful customer relationship will typically offer opportunities with little regard for geographic coverage." Both Jamieson and Carruthers agreed that expansion into the U.S. market, although potentially lucrative, was a formidable task. Jamieson noted that the company lacked credible mass in the U.S. market and that this hindered their ability to secure sales in the U.S. market. However, they both felt that their existing base of North American "transactional" customers provided a good base of leads to pursue increased SCM responsibilities. North American transportation management constituted 95 per cent of Wheels International's revenues, while international transportation management constituted the balance. Exhibit 7 subdivides the 3PL market into four major segments. Jamieson anticipated that the non-asset-based domestic transportation management sector for 3PLs would grow by 21 per cent per annum over the next five years, while the non-asset-based international transportation management sector for 3PLs would grow by 10 per cent per annum. The Dedicated Contract Carriage and Warehousing Opportunity Convinced of the potential offered by the light asset-based 3PL model, Davidson noted generally that "asset-based providers' revenues have been growing slightly faster than non-asset-based providers in the 3PL industry." He anticipated that that the dedicated contract transportation sector would grow by 20 per cent per annum, while the warehousing / value-added sector would grow 11 per cent per annum (Exhibit 7). To support its light-asset-based strategy, Wheels Dedicated leased truck trailers and warehouse properties, in addition to utilizing owner/operators instead of company drivers and company-owned tractor power units. By mid-2003, its asset base included 73 power units, 99 box trailers and 35 container chassis. Davidson wanted Wheels Dedicated to initially concentrate on less complex logistics services such as contract carriage, which could be implemented quickly in order to generate cash flow and establish positive customer relationships. Among the services Davidson envisioned the company offering its customers on a larger scale in the future were sequencing, sub-assembly and kitting. He observed: There will be a continuing focus on providing new value-added services that can effectively reduce the 'commodity' type services while increasing potential gross margins. For example, while transportation is an important standalone, it is a commodity service that will be subject to increasing downward pricing pressures When additional value-added services are consolidated with transportation as a more complete and/or complex offering, such as kitting, distribution and sequencing, competition is reduced, margins tend to improve and contract terms become more stable. It has been my experience that it is easier, quicker and more profitable o expand existing customer services and revenues than to sign new to customers. Although Wheels Dedicated was generating 95 per cent of its revenues from dedicated contract carriage and only five per cent of its revenues from warehousing and value-added activities, Davidson's plan to more deeply penetrate a limited customer base called for this ratio to shift to 65:35. He acknowledged that one of the key challenges to his growth plan was the lack of brand recognition, especially in the United States where a majority of the target customers were situated. Davidson regarded Wheels Dedicated's ability to penetrate the warehousing/value-added market as being directly related to its success in securing and successfully supplying dedicated contract carriage business. He continued, "This is a relationship-intensive business in which we are looking for long-term logistics relationships, not one-off deliveries." Davidson was optimistic regarding his company's prospects: "There is no dominant 3PL within this industry. The industry is still quite fragmented, with the largest player having just a three per cent market share." A potential advantage offered by increasing efforts to pursue the Wheels Dedicated growth strategy was t Wheels International could potentially utilize inter-corporate assets in order to service its own customers, in addition to sourcing transportation services from external asset-based carriers. In fact, the increasing shortage of trucking capacity had recently forced Wheels International to divert some of Wheels International's irregular route truckload and less-than-truckload business through Wheels Dedicated and AIM. By expanding this relationship, the Wheels Group would effectively shift its business towards an increasingly asset- based strategy that would have the effect of reducing Wheels International's costs and increasing Wheels Dedicated's utilization rates. However, pursuing this strategy would involve using Wheels Dedicated's assets for both dedicated transport and irregular route / one-way transport services. Efforts to leverage a single set of assets to address two different business models could prove to be overly cumbersome to co-ordinate, leading to a negative impact on each company's customer service, as well as alienating Wheels International's current suppliers whose available capacity was already in high demand in the market. Davidson pointed out that part of Wheels Dedicated's strategy was to locate operations personnel on site with the customer in order to facilitate communication and to minimize customer service issues. However, industry competitors had struggled to find good people in the industry, noting that: "Experienced logisticians are generally at a premium within the marketplace." Exclusive of any synergies that could be achieved by supplying logistics services expanding its base of external "dedicated customers," Jamieson estimated could generate sustainable growth at a rate of 18 per cent to 20 per cent per annum. to Wheels International, as a standalone business unit food that Wheels Dedicated THE DECISION Tozer and Jamieson had set an objective of doubling Wheels Group's revenues within five years. The question in front of the two was where management efforts and resources should be concentrated. A significant difficulty was the potential for conflict between Wheels International and Wheels Dedicated. Jamieson explained, The independently owned trucking fleets that supply services to Wheels International fear that Wheels Dedicated and its asset-based strategy threaten their continued viability within the Wheels Group of companies. However, what they do not realize is that Wheels Dedicated's fleet is operated for customers who want a dedicated carriage solution. Nonetheless, there is the perception amongst our suppliers that Wheels Dedicated is competing with Fleet owners and suppliers are particularly frustrated when they see our trailers rolling down the highway with 'Wheels Dedicated" emblazoned on the side. This is an added challenge in light of our efforts within Wheels International to create a partnership relationship with our suppliers. Tozer and Jamieson needed to make a decision on whether to concentrate on opportunities related to Wheels International or Wheels Dedicated. Jamieson turned to Tozer and said, "In order to meet our grow objectives, we need to decide where the best opportunities are for the company over the next five years and finalize our strategy."