It's a good time to be a third-party logistics company. The mood of the sector has improved considerably since this time last year.

First and foremost, growth is back-the 3PL market is up 6 percent, to an estimated $80 billion. The industry is achieving record profits. The stock market reflects this renewed vigor. For the last 12 months, the S&P is up 14 percent, and the DJ Transports are up 17 percent. In contrast, the basket of logistics companies is up 84 percent! (Hub Group is up 280 percent; Target, up 74 percent; TLC up 85 percent, among others). Clearly, the market believes these companies are poised for future growth.

What is driving this growth and opportunity in the 3PL marketplace? Part of the answer is a reviving economy and continued expansion of logistics outsourcing. But in addition, there are substantive changes occurring below the radar. This article outlines seven mega-trends that manufacturers, retailers and others who buy 3PL services should consider as they construct their global supply chains.

Mega-Trend Number One:
Lean logistics and continued reduction in inventory levels

One key metric of logistics efficiency is the inventory/sales ratio, which measures the level of inventory companies require to support their annual revenues. Last year, the U.S. inventory/sales ratio fell to a record low of 1.38. This year, the number has dropped even further, down to 1.32!

Over the longer term, logistics spending as a percentage of GDP has dropped even more significantly. In 1981, this metric stood at 16.2 percent. Today, it has fallen nearly 50 percent, down to 8.5 percent. Over the same time period, inventory carrying costs have dropped 60 percent, versus a 20 percent decrease in transportation costs. The key driver has been the reduction in inventory levels.

Who are the 3PL beneficiaries of this mega-trend? Those companies that help their customers to operate with lower warehousing, inventory, and supply chain systems costs are all emerging as big winners. For instance, KN Lead Logistics won the Nortel outsourcing contract by promising major reductions in the cash-to-cash cycle and other balance sheet improvements. Similarly, Unicity has delivered significant value for companies like Maytag by developing and executing supply chain strategies to reduce the number of warehousing locations for Fortune 500 companies in Canada. These "lean logistics" leaders will continue to drive supply chain value for their customers.

Mega-Trend Number Two:
New technologies like RFID are finally happening

The conventional wisdom about logistics technology falls into one of two camps: it's revolutionary or it's over-hyped. The reality is that moderate adoption is indeed happening. The U.S. Defense Department has been using RFID since 1991, with the first Gulf War. I just returned from Kuwait, and saw one of the warehouses where RFID is being used for military logistics. This new technology is indeed being deployed.

In the past year, several initiatives have come to fruition. Just last June, Wal-Mart announced the top-100 mandate for January 2005, followed by full adoption for Wal-Mart's 10,000 and the Defense Department's 43,000 suppliers. Today, Wal-Mart has successfully launched an April pilot project, with eight major suppliers and one Texas distribution center serving seven stores. Meanwhile, leading supply chain software provider Manhattan Associates generated 4 percent of its last quarter's sales from RFID, based on five new customers. With a sales pipeline of 50 prospects for its RFID applications, Manhattan Associates expects to see significant growth in this category.

Innovative 3PLs are leading the way. 3PL pilot projects have emerged in several areas-DHL for Metro in Germany, Exel for the House of Fraser in the UK and China, and Trenstar for Coors. While it is undoubtedly true that format wars will complicate adoption, there is no question that RFID is happening, and will open doors for smart 3PLs.

Mega-Trend Number Three:
China is growing at least 10% annually and revolutionizing global logistics

The explosion in the Chinese manufacturing market has major implications for the global logistics arena. As China grows some 10 percent annually-official estimates are slightly lower, but construction in Shanghai alone is up 40 percent over last year-the ripple effects are being felt worldwide. Chinese exports are up 35 percent annually, and imports are up 40 percent. As a result, cargo volumes for the Asia-California shipping lanes have risen 8 percent. However, due to a shortage of capacity, ocean rates have soared by over 40 percent. This impact is being felt more dramatically in certain sectors. For instance, steel mill spending tripled in the last year! As a consequence, China now consumes 30 percent of the market.

The China phenomenon will have massive implications for 3PLs who are focused on manufacturing and industrial sectors. Already, most 3PLs are scrambling to ensure a major foothold in this market, either through acquisitions, start-ups, or joint ventures. This pressure will only increase in the coming years.

Mega-Trend Number Four:
NAFTA is another high-growth market, closer to home

While China has captured the headlines, the convergence of NAFTA markets has created significant opportunities for North American logistics providers in both Canada and Mexico.

Over the past decade, U.S. exports to Canada have grown at 10 percent annually. Last year, over 10 million trucks crossed U.S.-Canada borders, as the U.S. imported $211 billion from Canada and exported $161 billion. Similarly, truck crossings on the U.S.-Mexico border grew from 2.8 million in 1995 to 4.4 million in 2002, as both exports to and imports from Mexico more than doubled over the same time period. As U.S. companies continue to expand trade with NAFTA neighbors, and as security regulations create increased complexity in terms of compliance, cross-border services will provide expanding opportunities for innovative logistics companies.

Logistics companies that are particularly well-positioned are those focused on lean logistics. As cross-border transit times become more reliable, logistics firms that eliminate excess inventory and provide high-velocity logistics solutions will become increasingly valuable.

Mega-Trend Number Five:
Regulatory changes promote both simplification and complexity

Regulatory changes are creating two sets of dynamics. On the one hand, deregulation initiatives are promoting simplification. President Ronald Reagan's death reminds us of the history of deregulation. In 1981, the Interstate Commerce Commission stood at 11. This entity was eventually eliminated by Reagan, and replaced by a much weaker Surface Transportation Board. Ongoing deregulation will continue to facilitate competition.

On the other hand, the regulatory environment is also marked by expanded complexity. Supply chains are only beginning to adapt to the 24-hour rule for trucks, and its equivalents for other modes. Security mandates will add to the regulatory requirements companies will need to meet. As a result, regulatory changes will ultimately fall on the shoulders of 3PLs, who will become security partners as well as supply chain partners for their customers. 3PLs that can adapt to this regulatory environment will succeed, just as innovative trucking firms prospered in the years following motor carrier deregulation in the 1980s.

Mega-Trend Number Six:
The Consolidation wave continues

The logistics market witnessed a massive wave of consolidation in 2000-2001. Mega-mergers combined the firms of Deutsche Post-AEI-Danzas, UPS-Fritz, Kuehne & Nagel-USCO, and Exel-Mark VII. After a brief pause in 2002-2003, the pace has quickened. In the past few months, we have witnessed the following:

• Ozburn-Hessey's acquisition of Lanter Logistics-to consolidate the warehousing marketplace

• PBB's acquisition of Clarke Logistics-to solidify their Canadian/

  cross-border position

• Reliant Equity's acquisition of Air-Road-to build on the company's leadership position in the U.S.-Mexico transportation management marketplace

• DHL's acquisition of SmartMail-providing a high-growth, North American post office logistics service offering for the German logistics giant

• TPG's acquisition of Wilson for over $200 million-adding a Scandinavian freight forwarding base to TPG's global logistics operations

• Exel's acquisition of Fujitsu's logistics arm for $46 million-providing Exel with a strong beachhead for Japanese market expansion

• Exel's acquisition of Tibbett & Britten for over $600 million-consolidating Exel's contract warehousing and logistics leadership within both North America and the UK

This wave of consolidation will continue. It will be fueled by growing customer demand for one-stop-shop solutions, new technologies, and deep-pocketed buyers. The private equity marketplace stands at a record level of capital, with $120 billion in money on the sidelines. As this capital seeks a home, we may well see $12 billion invested in the supply chain sector over the coming five years. Meanwhile, strategic buyers like UPS are sketching plans to deploy a significant portion of their $2 billion in annual free cash flow within the logistics sector.

The implications for logistics companies are significant. As smart money flows into the most successful sectors, it will become harder for most independent 3PLs to succeed without aligning with a partner.

Mega-Trend Number Seven:
Mid-market companies must offer niche services to compete successfully against global giants

While the preceding trends may appear to pose challenges to mid-market logistics firms, plenty of opportunities still exist. The most successful mid-market 3PLs are developing successful strategies to dominate attractive niche markets.

For instance, reverse logistics is a $35 billion annual market. This service involves the management of reverse flows of product throughout the supply chain. Mass merchandisers see typical return rates of 4-15 percent, while cataloguers see 18 percent returns.

Similarly, service parts logistics has become an important part of the supply chain for high-technology and telecommunications companies. This service revolves around rapid fulfillment of high-value parts, typically through critical parts warehousing located near airport facilities for next-flight-out execution capabilities. USCO built a service parts logistics capability for Sun Microsystems in the late 1990s, ultimately driving from breakeven to $40 million of EBITDA in less than five years on the basis of these and other differentiated services.

Other niche services include the convergence of warehousing with packaging (as represented by Power Logistics, which Exel recently purchased) and the convergence of financial services with logistics (embodied by UPS' expansion of trade financing capabilities).

Ultimately, the smartest 3PLs will seek out new niche markets to dominate in the coming years.

Sidebar: TNT Logistics Ups Its Ante With Strategic Partners

Few people are better positioned to comment on the evolution of 3PLs than Jeff Hurley, Managing Director and COO of TNT Logistics. Since graduating from Michigan State in 1979 (BS, Urban Planning), his whole career has been in the sector.

From his current perspective in Jacksonville, as part of the giant worldwide TPG Group (2003 sales, euro 11.9 billion), he sees a future where customer requirements will move into a new realm of expectation. "Customers used to outsource because of convenience or to avoid labor situations or so as to not have to invest in buildings and infrastructure. Now, they view us as having a core competency in managing logistics and supply chain issues. Increasingly they regard us as a partner in their business."

What does that mean in real-world terms? Hurley points to the re-implementation of a distribution center for after-market parts in Tennessee. "We were struggling with quality issues and efficiency issues, working seven days a week, and still it wasn't flowing right. We and the customer committed to having dedicated resources that would do nothing but work on this project. For three months, the customer, the site manager and a local engineering team looked at the order process and the decisions used to put inventory in the facility.

And the result? "When we started, there wasn't enough room in one facility so we had to put a second one online. Through improvement processes we've closed the second warehouse and have surplus capacity in the one existing facility. There have been marked improvements in errors per million, productivity has improved 30 percent, and we're not working seven days a week anymore. All of our ten primary metrics are green-when we started, seven were either yellow or red."

For the customer, this translates into both lower logistic costs and reduced inventory overhead on the balance sheet. "Now they're ordering from the supplier based on the replenishment that is taking place in the facility and what customers are ordering, not just making big buys because they can get a cheaper price."

Even bigger changes wait in the wings. In order to get more complete control over the in-flow of parts from different suppliers en route to the final customer, TNT anticipates taking a more active role in the procurement side of their customer's business. "For example, say we currently set up a job to have two days inventory in the building, but because of inefficiencies in the supply chains of the different vendors, we'll have five days of materials. But since our customer is in control of the sub-contractors' shipping schedules and not us, there's not much we can do about it. Maybe in the future we'll actually own inventory and operate more like a contract manufacturer."

For an automobile customer (TNT customers include BMW, General Motors and American Honda), they could mean doing sub-assembly work. "Say we become our customer's provider of interior door panels. We would take the parts-the arm rest, the window regulator, the door lock-and assemble the finished door. We'd schedule all components to our facility and execute purchase orders to own the material. That way, we can control the flow of material and exercise the discipline of having the right inventory in our facility to maximize the utilization of space and to get efficiency from our labor force. Then we'd deliver the finished door to the manufacturer." In this model, TNT would effectively be in the automobile component business, making working capital outlays for inventory procurement and realizing profit on the sale of completed door panels.

"Customers are challenging us to come up solutions," concludes Hurley. "But it takes two to tango. In lots of cases we can suggest a solution, but they can't be implemented unless the customer is 100 percent motivated to make changes."