Growth and Structure of the Third-Party Logistics Industry
In these challenging economic times, it may be difficult to think of industries that achieve meaningful growth irrespective of the economic cycle.
Historical trends, however, suggest that the third party logistics (“3PL”) industry has been able to accomplish just that. During the last recession, gross revenues for the domestic industry grew 17.8% from $65.3 billion in 2001 to $76.9 billion in 2003. By comparison, GDP growth for the same period of time was 4.1%.
The value proposition and cost savings offered by 3PL providers tend to be sought by customers both during periods of economic growth and contraction. At the peak of the economic cycle, 3PL providers help address their customers’ capacity challenges by economically sourcing transportation when trucks and drivers are scarce. Outsourcing frees customers to focus on their core business and drive out costs in their supply chain.
These benefits are an especially strong incentive for customers to consider supply chain strategies in partnership with 3PL providers when facing a tough economic environment.
State of the Industry and Growth Drivers
Despite current and historical growth rates, we believe industry growth has yet to hit an inflection point. Demand for extreme efficiency of inventory and working capital management continues to drive reliance upon third parties for assistance with managing operations across multiple geographies and with many suppliers.
Once economic weakness recedes and transportation demand again escalates, logistics costs will rise quickly. Significant capacity exits during this downturn and a continued driver shortage imply a future need for sophisticated solutions, which will position 3PL providers for even more rapid rates of growth.
Another key driver of growth, in our view, will be increased outsourcing of 3PL functions by middle market companies. Most middle market manufacturers, wholesalers, and retailers lack the sophisticated internal controls necessary to address logistics challenges and (particularly in today’s fuel environment) can no longer take transportation and supply chain costs for granted.
Historically, smaller companies were relatively slower at adopting and implementing outsourcing as a strategic solution. By contrast, 3PL providers have significantly penetrated the Fortune 500 sector.
74% of the domestic Fortune 500 used at least one 3PL in 2007 and today, the three domestic automotive OEMs each utilize more than 30 3PLs. Small-to mid-size companies’ need for greater efficiency in their supply chains is expected to drive even more robust 3PL industry growth rates over the next decade.
Providers to this customer segment stand to benefit as middle market companies tend to have a lower switching rate and offer slightly greater profitability.
Market Participants and Industry Structure
The 3PL industry remains very fragmented with several thousand industry participants and a continued stream of new entrants that are attracted by the high industry growth rates. The broader selection of providers in the marketplace has empowered customers to be selective and manage the number of providers that they use.
Acquisitions enable 3PL providers to secure add-on offerings to further penetrate customer relationships, realize growth in new geographies, and diffuse customer concentration. This strategy has been observed in the marketplace as several notable transportation industry participants have utilized acquisitions as a means for repositioning their service offerings, adding capabilities, and entering new segments.
With new small companies continuing to enter the market and extremely large providers continuing to grow rapidly, a barbell dispersion effect has taken place. It is estimated that the top 10 providers generate approximately two-thirds of aggregate industry revenue in North America. The vast majority of the remainder is made up of companies under $50 million of revenue.
Given the notable disparity between small niche players and large players, providers that exceed this revenue threshold with differentiated service offerings are scarce and highly sought-after acquisition targets, particularly by private equity buyers looking for a platform investment.