EXAMINING THE DRIVERS FOR FINANCIAL PERFORMANCE OF THIRD PARTY LOGISTICS: A PRELIMINARY STUDY OF 3PL COMPANIES IN MALAYSIA
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1 EXAMINING THE DRIVERS FOR FINANCIAL PERFORMANCE OF THIRD PARTY LOGISTICS: A PRELIMINARY STUDY OF 3PL COMPANIES IN MALAYSIA by Wong,W.P., Soh, K.L., Chong, C.L. School of Management, Universiti Sains Malaysia USM, Penang, Malaysia ABSTRACT Third party logistics companies are playing an increasingly important role in transportation nowadays. The effectiveness and efficiency in shipping and delivering of goods or services to customers are often reflected through the financial performance of their companies. It is therefore important to understand what are the antecedents of financial performance for 3PL firms. This question is becoming more relevant now due to the changing global environment that greatly affects 3PL financial performance. This paper specifically examined what are the internal and external drivers of financial performance of 3PL firms in Malaysia. This question is greatly relevant to Malaysia because the logistics sector has been identified as one of the key drivers in attaining the aspirations of the New Economic Model (NEM). The new thing to this research is it includes the environmental forces using Porter s Five-Forces model of industry competition, in addition to the internal driver that is the extent of different functional involvement in business operations that would ultimately affect 3PL financial performance. This research will also examine the mediating effects of operations strategies on the relationships between the antecedents, i.e., internal and external drivers, with financial performances. The contribution of this study will be two-folds. Firstly, managers will be able to know what are the drivers that affect the financial performance of 3PL in Malaysia in today s challenging environment. Secondly, by exploring this context that is drivers-strategies-performance, managers will better understand the relationships among drivers, strategies and performance, and ultimately, they will be able to better align their strategies according to their needs to further strengthen the financial performance of the firm. KEYWORDS Third Party Logistics, 3PL, Drivers, Strategy, Financial Performance INTRODUCTION With the globalization of companies and the consequent competitive pressures, there has been an increasing dependence on the ability of companies to deliver customer adapted products, all over the world, quickly and on time (Sohail & Sohal, 2003). The increase of competitive pressures will tend to increase innovation and incentives to meet consumer demands effectively. Instead of being stuck in the high cost and unsatisfactory innovation of managing logistic operation by themselves, many companies choose to outsource some or all of their logistics activities to specialist firms (Wu Bing & Liu Zhongying, 2008). As such, third party logistics is developing and playing an important role in transportation which is shipping and delivering. There are challenges where customers find themselves in an environment of reduced cycle times, expect a higher level of reliability and emphasize on damage-free products (John J. Coyle, Edward J. Bardi, C. John Langley Jr, 2003). Based on Bask (2001), third party logistic can be found in the relationship between interfaces in the supply chains and third-party logistics providers. In such cases, logistics services offered ranges from basic to customized ones, of a shorter or longer term relationship, and with the aim of effectiveness and efficiency. To ensure efficiency, advanced technologies are used to acquire instantaneous feedback from customers and markets. The assumption is performing logistics companies are those that perform financially well at least in the longer term. Therefore the logistics companies published their financial data (annually and quarterly) to inform clients and to attract new ones. Firms with good financial performance for the longer term are perceived as good companies. Financial performance is defined by the financial and market measures to evaluate the companies efficiency and effectiveness, such as growth rates in market share, growth in annual sales, growth in return on sales and growth in return on assets (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008).
2 The changing global and local environments are presumed to affect financial performance as well. It is therefore important to measure performance to reflect the changing environment and strategies (Kennerley and Neely, 2003). As such, this study intends to include the environmental forces using Porter s Five-Forces model of industry competition and the extent of the participation by the different management function in the planning of businesses that would ultimately affect 3PL financial performance. At the same time, this research is to allow the 3PL industry to keep abreast of new trends in achieving good financial performance. With a well-thought-out plan for the trends, a 3PL can better prepare itself to receive early warnings about the trends that will create opportunities and threats. With the increasing outsourcing of logistics to 3PL, the logistics industry has attracted many players. This has created intense competition within the 3PL industry. Successful firms are usually identified as having performed financially overcoming the external environment and the optimal use of its internal resources. This study will investigate the internal and external drivers that ultimately contribute towards the financial performance of 3PL firms. The environmental forces will be analyzed using Porter s Five-Forces model, and at the same time, the effects of operations strategies towards the relationships between drivers and performance will be examined. Specifically, this paper aims to address the following two questions, which are What are the internal and external forces that influence financial performance of 3PLs? and How does strategy (e.g., functional involvement) influence financial performance of 3PLs?. The paper will proceed as follows. Next section will discuss briefly some past works that had been carried out on drivers, strategy and performance. This will then lead to the crux of the paper which is the development of a theoretical framework to examine the subject matter. The proposed framework will be undertaken in our future research study, through examining the context from the perspective of Malaysian 3PL companies. The findings from the future research study will be helpful to managers in understanding what are the factors or antecedents that affect financial performance and how strategies leverage it. Drivers THE DRIVERS, STRATEGY AND PERFORMANCE LINKAGES The drivers on performance can basically be grouped into two types, namely internal and external drivers. Internal drivers comprised of functional involvement which is the extent of the participation of the executives from different functional areas in the overall strategic formulation and planning for the company (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). External drivers or forces of the environment can be categorized into five components which are potential entrant, bargaining power of customer, bargaining power of supplier, substitutes and rivalry among industry. Potential entrant is defined as forces that keep new entrants out, providing a level of protection for existing competitors (Porter, M.E., 1985). It would be any company or people who might enter the industry (Harold Hopkins, 2008). Bargaining power of customer is the degree to which customers exercise active influence over pricing and the direction of product development efforts (Porter, M.E., 1985). Bargaining power of supplier refers to the degree to which they can exert influence over the profits earned by the firms in the industry (Porter, M.E., 1985). Suppliers would be the companies that sell the rivals components and those who provide labor, mainly engineers (Harold Hopkins, 2008). Substitutes are the products or services fulfilling the same functions as one industry s products but not being produced by another firm in the same or different industry (Harold Hopkins, 2008). Rivalry among industry refers to the competitions that occur in the industry. In most industries, competitive moves by one firm affect other firms in the industry, which may incite retaliation or countermoves (Porter, M.E., 1985). Strategy There are basically two types of strategy undertaken by a firm, which are low cost and differentiation. When a company emphasizes on low cost strategy, the company competes by being the lowest cost service provider (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). There is a measurement that is called Cost Performance Index (CPI) which is a key indicator used to analyze cost/schedule performance data reported (David Christensen and Kirk Payne, 1992). On the other hand, in differentiation strategy, the company differentiates its services from its competitors services in areas such as quality, speed, flexibility, and etc. Cost may not be the major strategic focus here (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). Alfred M. Pelham (1997) claimed that groups of customers are considered differentiated if their needs and buying motives are different. An example of differentiated customer groups would be end-users and original equipment manufacturers. Products are considered differentiated if customers perceive significant differences in the features and benefits of competitive products. An example of differentiated products would be diagnostic monitoring equipment compared to undifferentiated metal bolts.
3 Firm performance The performance of a firm can be assessed through cost, differentiation and financial perspectives. Cost performance refers to current cost and price position of the company in relation to its main competitors for the primary service (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). S. Meeampol and S.O.Ogunlana (2006) claimed that cost performance is based on the owners perception towards the actual construction cost paid to contractors as compared with the planned construction cost. For instance, in a 3PL company, if the actual payment to contractors is less than the planned cost, the project is adjudged to be successful. Differentiation performance refers to the current service differentiation position of the company relative to its main competitors for the primary service (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). Hambrick and Lei s (1985) results indicate that customer and product differentiation are significant contingency variables in the strategy performance relationship. Financial Performance is measured by financial statements of the listed companies usually contain a wealth of information that is a variety of financial ratios playing different roles for interpreting the company s financial performance (Yanxia Jiang, Lida Xu, Huacheng Wang, and Hui Wang, 2009). Their linkages Many researchers had investigated the conceptual and theoretical development of operations strategies by identifying the framework which could aid the selection of the most appropriate strategy that is consistent with the competitive strategy of the company (David Walters, 1999). However, Ward et al. (1995) have explored and focused on the specific relationship between competitive environment factors and operations strategy. The participation of different management functions in the formation of strategy internally, referred to as functional involvement, may also influence the choice of the company s operations strategy (Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung & Xiande Zhao, 2008). Simultaneously, Dagmar Recklies (2001) noted that the external forces of environment (i..e Porter s Five-Forces Model) has become an important tool for analyzing the industry structure of an organization in relation to its strategic processes. Linking strategy to performance measurement, some literature review reveals that the context-strategyperformance relationship has been a popular research topic in the area of business strategy in the last two decades (Hill 1988, Lawless and Finch 1989). The main logic in most of the research in the area is that environmental change requires strategic response, and that performance is an effect of strategy choice (Iskra Dukovska-Popovska and Harry Boer, 2008). Other research (Parnell 1998) has also explored the influence of performance on strategic change. Next, we will proceed to develop the theoretical framework to analyze 3PL financial performance. Our model is based on the theoretical underpinnings of past literature. THEORETICAL FRAMEWORK The basic model was adapted from Baofeng Huo et al. (2008). We added in the external drivers by integrating Porter M.E. forces. We further advocate that, operations strategy will mediate the relationship between the drivers and performance. Figure 1 shows the proposed theoretical framework.
4 FIGURE 1 THE PROPOSED THEORETICAL FRAMEWORK External and Internal Environments Operations Emphases Operational Performance Finance Performance Internal Environment Functional Involvement Cost Performance Financial Performance Service Performance External Environment Potential Entrant Customer Low Cost Supplier Substitutes Differentiation Rivalry among industry
5 The relationship might be better understood by examining the following research hypotheses. H1a. 3PL experiencing higher functional involvement will have an increased low cost emphasis. H1b. 3PL experiencing higher functional involvement will have an increased differentiation emphasis. H1c. 3PL experiencing higher functional involvement will have better cost performance H1d. 3PL experiencing higher functional involvement will have better service performance H2a. 3PL facing more operational challenges will have an increased low cost emphasis H2b. 3PL facing more operational challenges will have an increased differentiation emphasis H2a. 3PL facing higher competition potential will have an increased low cost emphasis H2b. 3PL facing higher competition potential will have an increased differentiation emphasis H3a. 3PL facing higher existing competition will have an increased low cost emphasis. H3b. 3PL facing higher existing competition will have an increased differentiation emphasis. H4a. 3PL facing higher indirect competition will have an increased low cost emphasis. H4b. 3PL facing higher indirect competition will have an increased differentiation emphasis. H5a. 3PL pursuing a low cost emphasis will have better cost performance H5b. 3PL pursuing a low cost emphasis will have poorer service performance H5c. 3PL pursuing a low cost emphasis will have better financial performance H6a. 3PL pursuing a differentiation emphasis will have poorer cost performance H6b. 3PL pursuing a differentiation emphasis will have better service performance H6c. 3PL pursuing a differentiation emphasis will have better financial performance H7. 3PL achieving better cost performance will have better financial performance H8. 3PL achieving better service performance will have better financial performance The above model will be tested in our future research using a questionnaire survey and personal interviews from the 3PL companies in Malaysia. We intend to separate our sampling pool into high and low performance groups of 3PL providers. The 3PL providers will include those of air freight, sea freight, land freight, warehousing and transportation services. The fitness of the model will be tested using path analysis technique. REFERENCES Alfred M. Pelham (1997), Market orientation and performance: the moderating effects of product and customer differentiation. Journal of Business & Industrial Marketing, Vol. 12 No , pp Baofeng Huo, Willem Selen, Jeff Hoi Yan Yeung and Xiande Zhao (2008) Understanding drivers of performance in the 3PL industry in Hong Kong, International Journal of Operation & Production Management, Vol. 28, No. 8, pp Bask, A.H. (2001), "Relationships between 3PL providers and members of supply chains a strategic perspective", Journal of Business and Industrial Marketing, Vol.16, No. 6, pp Christensen, David S., and Kirk Payne. (1992), CPI Stability Fact or Fiction? Journal of Parametrics 10:27-40 Dagmar Recklies (2001), Porters Five Forces - Management Tools and Models - Management Portal, David Walters (1999), Marketing and operations management: an integrated approach to new ways of delivering value, Management Decision 37/3, Hambrick, D.C. and Lei, D. (1985), Toward an empirical prioritization of contingency variables for business strategy, Academy of Management Journal, Vol. 28 No. 4, pp Harold Hopkins (2008), Applying Michael Porter s extended rivalry model to the robotics industry. Industrial Robot: An International Journal 35/ Hill, C. W. L. (1988), Differentiation versus low cost or differentiation and low cost: a contingency framework. Academy of Management Review, Vol. 13, pp
6 Iskra Dukovska-Popovska and Harry Boer, (2008), Manufacturing Strategy Configurations, Contingencies and Performance. Presented at the Euroma 2008 Conference. John J. Coyle, Edward J. Bardi, and C. John Langley Jr. (2003) The Management of Business Logistics, A Supply Chain Perspective, 7e. Kennerley, M. and Neely, A. (2003), Measuring performance in a changing business environment, International Journal of Operations & Production Management, Vol. 23 No.2, pp Lawless, M. W. and Finch, L. K. (1989), Choice and determinism: a test of Hrebiniak and Joyce s framework on strategy-environment fit. Strategic Management Journal, Vol. 10, pp Parnell, J. A. (1998), Performance s influence on strategic change: A longitudinal assessment. Scandinavian Journal of Management, Vol. 14, No. 1/2, pp Porter, M.E. (1985), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York, NY. S. Meeampol and S.O.Ogunlana (2006), Factors affecting cost and time performance on highway construction projects: evidence from Thailand. Journal of Financial Management of Property and Construction Volume 11, Number 1, pp3-20 Sohail, M.S. and Sohal, A. (2003) Third party logistics services: a Malaysian perspective, Technovation, Vol. 23, No. 5, pp Wu Bing and Liu Zhongying (2008) Decision-Making in optimizing the contract of the third party logistic. Yanxia Jiang, Lida Xu, Huacheng Wang, and Hui Wang (2009), Influencing Factors for Predicting Financial Performance Based on Genetic Algorithms. Systems Research and Behavioral Science. Syst. Res. 26,
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