Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I've followed XPO Logistics for years and then the spinoff with GXO, which has always been a very interesting subject for me to understand. To frame the interview, what I've come to understand over the years is how important client relationships are, especially in contract logistics, which are very sticky contracts and a low churn business. I'd love to dig into this and hopefully learn a lot from you. As a first question, could you start by telling me what your role was at XPO and GXO and how it evolved?

I've been in the logistics and transportation business for probably 25 to 30 years. I've worked for the major players out there. I started my career with UPS, spending many years with them on the operations side as well as the sales and solution side. I've also worked with big players like DHL, GXO, and XPO, as well as having a couple of private equity stints where I had equity shares in some smaller 3PLs that we turned around and did transactions on.

So, I've covered the spectrum of large companies and small companies in the space, both private and public. Most recently, with GXO, I was Vice President of Strategic Accounts. I worked directly with GXO's very large enterprise companies on a global basis and reported directly to the Chief Commercial Officer, who at the time was Bill Frame. I'm very familiar with the contracts, services, caveats, and pricing.

Even with the company I'm with today, right here on my desk, I'm working on an 11-year contract with a major company for about $100 million. I can walk you through all the details on the commercials, KPIs, the whole nine yards. So with that, feel free to ask away.

What defines a strategic account? You mentioned you were responsible for strategic accounts. What was the difference between a strategic account and a normal account? How much did this represent in terms of the client pool of GXO?

GXO is one of the major players in the industry, similar to DHL and NFI, where I am today. These large 3PLs are quite similar across the board. When I was with DHL and GXO, the main difference was just the logo on my shirt, business cards, or email signature. Everything else, from salesforce to the services offered, was remarkably similar. The culture and strategy might vary slightly, but overall, they are quite alike.

A strategic account is one with brand recognition, like Clorox or a well-known product like a Stanley Cup. Internally, it would be an account with multiple sites across the country or internationally, representing at least $20 million in revenue per year. That would be on the smaller side, but typically, it would be around the $40 to $50 million range if they had multiple sites.

So, $20 million per site?

Correct, at least.

What proportion of the business would strategic accounts represent compared to smaller accounts?

For a company like GXO or DHL, strategic accounts represent a significant portion, at least 40% to 50%, if not more. For these operations, the minimum revenue threshold is about $10 to $15 million per year to even consider an RFP. Anything smaller, we would typically pass on, as it wasn't worth the time to pursue.

We tried to avoid the multi-client space as much as possible. At GXO, we had the capability if needed, especially for a large strategic customer with an immediate need. We might place them in a multi-client environment as a favor, but we tried to minimize that.

What is a multi-client contract?

In the 3PL space, you have contract logistics, where you set up a dedicated facility for a customer, like a 500,000 square foot warehouse.

Multi-client means multiple clients share the same facility. Got it.

Exactly. It can be complicated due to lease expiration terms that may not align with all customers' contract terms. However, there are advantages, such as sharing equipment, resources, and labor, which provide economies of scale when multiple customers are in the same building.

This might sound like a basic question, but why would you turn away from contracts worth less than $10 to $15 million per year? I understand that larger contracts offer bigger returns, but how about the defensibility of the business when dealing with smaller, more challenging clients?

It's about return on investment. My time is limited, and larger deals, like a $30 million per year, five-year contract, are typically longer-term. A $20 million per year, five-year contract is more worthwhile than an $8 million contract for two or three years. You spend the same amount of time selling, negotiating, and implementing. The larger deal offers a better return on investment, making it worth pursuing. Larger deals are often with strategic customers, and as you mentioned, they are sticky. These relationships can last 10, 15, or more years. The customer I'm working with now has been with us for about 25 years. We continue to grow with them as their logistics partner. We prefer these over smaller, transactional contracts that change providers every three years, focusing more on cost than the value a 3PL can offer.

Why are smaller contracts in dollar terms also shorter in duration?

Smaller deals often involve customers who are less financially secure or not well-established in the market. They might be in a growth phase and hesitant to commit to contracts longer than three years because they can't forecast that far ahead. So, they opt for three-year deals to minimize risk.

If companies like you or DHL don't take these smaller accounts, who does?

There are many smaller 3PLs that thrive on this type of business. The market is flooded with them. In Southern California, a major 3PL market due to its proximity to the ports, you might find 10 to 15 different 3PLs within a five-minute drive. They operate in the smaller space, picking up two or three contracts and maintaining a portfolio of about 10 customers. They are content and can service these clients well, accepting the transactional nature and contract flow.

How does a small 3PL become a dominant player in the market?

There are two ways to grow. One way is like NFI, which has been around for over one hundred years and has grown over time. That approach takes a while. The other way is through acquisition. For example, GXO acquired smaller mid-sized 3PLs and grew into a large company. They expanded by acquiring companies and merging them under the XPO banner at the time, and then under GXO. Acquisition is a fast and rapid way to grow your customer and revenue base.

How do you approach clients and source contracts? Is it solely internal, or do you work with brokers? What are the different channels?

That's a really good question.

Even though this is a large-scale business with contracts like the one I'm working on, which is a couple hundred million dollars over time, much of this business is based on relationships and trust. The people we deal with need to trust the company, but ultimately, they're working with people. My network, for instance, includes connections with hundreds of companies, including the C-suite, senior executive teams, operations teams, and procurement teams. I have a robust network of people I've kept in contact with and built up over the years. They trust me and my reputation, knowing I won't position something in an RFP or negotiate a contract we can't service. Trust and relationships are crucial.

Many companies issue RFPs, and nearly every bid we pursue and contract we sign goes through an RFP process. This is standard in the industry. Companies bring in three or four providers they trust and know can execute the services. These providers bid, and the process narrows it down to one or two players before making an award and negotiating the contract. It's a competitive engagement, but you need an organization with capabilities like GXO, DHL, or others to be invited to the table. It's very much about who you know and relationships.

So it's mainly RFPs pushed by potential clients.

Correct, exactly.

And you're saying that every client does this?

That's correct. Many of them have financial accounting principles they must follow, and they need to have a competitive bid cycle with multiple vendors for these engagements because the contracts are substantial, around $20 million a year. The consequences of making a mistake are enormous. If your supply chain provider fails, shuts down, or can't execute and gets into a backlog situation, resolving that is a nightmare. It could potentially shut down an entire business. Just having one or two distribution centers that are backlogged or down can severely impact customer experience, whether you're shipping to retail customers or end users through an e-commerce platform. That type of negative experience can go viral, causing immense harm to your business. Therefore, they must make the right decision, which is why, even with existing relationships, they still go through the RFP process to vet providers.

How do you approach an RFP from a client outsourcing their logistics activities for the first time versus someone who already has a provider that is not GXO, and you're competing for it?

It's a very challenging task. Many customers who insource believe they have a lot of control over their operations. They may have their own facilities with long-term leases or even own the facilities. Sometimes, we've purchased the facility from the customer as part of the bid. Real estate considerations are important, and convincing them to let go of this critical element of their business to another entity is very difficult. Trust is crucial. They need to trust me, the negotiator, and my company, which will execute the business for them. Without trust, it won't happen.

For companies that haven't outsourced their supply chain, the success rate is very low, less than 10%. It's a significant hurdle to overcome.

It's interesting because if you look at GXO's investor presentation, they talk about a massive untapped market where a very small percentage of logistics activities are outsourced. They're selling this to the investment community as a massive opportunity. But you're saying the success rate of capturing business from those who have in-house logistics is very low.

I've noticed GXO is also exploring robotics and automation. They've released videos about humanoid robotics, claiming they could have robots operational in facilities within a couple of years. However, I don't foresee humanoid robots in warehouse operations for at least 10 years due to numerous safety concerns.

Most automation in the industry today operates separately from humans. While we have some cobots that interact with people, technologies like AutoStore and goods-to-person systems involve robots moving in a designated field. Humanoid robots would need to interact with humans directly, which remains unproven. These robots are bulky and awkward in their movements. Watching them transfer boxes between conveyors, they move slowly.

The cost of these robots and their maintenance is high. For the same maintenance cost, I could hire five warehouse workers who would work five times faster, maintaining the same cost structure. Labor scarcity doesn't justify investing in robots that would increase costs two to three times. The infrastructure, systems, and ROI aren't in place yet. GXO's promotion of humanoid robotics as the future of warehousing seems more like market hype for investors.

The contract I'm currently working on includes automation and robotics, but not humanoid robotics. It's more static technology, which is efficient, effective, and offers a return on investment. It reduces the need for two or three people, and over a 10-year agreement, it will likely pay back within three to four years, involving about $15 million worth of investment.

Regarding the TAM question, you're suggesting that only 10% of logistics operations that haven't been outsourced could potentially be captured by players like GXO?

I don't see many insourced operations being outsourced for the first time. Out of the last 10 engagements I've been involved in, not one has been an insourced operation transitioning to outsourcing.

If you check Google Maps, especially in the Southern California area, more towards the Inland Empire, which is a major logistics hub, you'll notice that most warehouses are run by 3PLs. Companies like Walmart run their own DCs and aren't likely to outsource. They initially outsourced but then insourced. Target sometimes runs their own distribution centers. However, customers like Home Depot and Lowe's do not. I operate 3PLs for Lowe's and Home Depot. Walmart has enough critical volume to insource, reducing the margin typically given to an outsourced provider. I don't foresee this market dynamic changing anytime soon.

So who is the ideal target for you?

We have a couple of target profiles. One is large-scale, multi-site opportunities with major CPG providers like Archer Daniels Midland or Procter & Gamble. These companies may not have insourced operations and rely on outsourcing. They offer long-term contracts and consistent, reliable revenue, although margins are tight. These are our stable growth customers. We're currently working on expanding operations for two major food companies, involving 10-year deals with five-year renewals. These are large-scale, steady operations that we value.

Another target is middle-market companies that are growing and expanding. They might want to transition from smaller 3PLs to a more reliable provider with geographic coverage, professional operations, and access to automation and systems for business continuity. We're looking for middle-market companies willing to outsource or already outsourcing, with one to five sites across the country, typically in the 300,000 to 400,000 square foot range. These should be stable businesses, as we place a high importance on credit checks.

What percentage of your business is from the large, stable companies like Walmart versus the smaller, growing companies?

I would say we're probably about 50% stable companies. That's similar to what I see at DHL and GXO. It's around that 50% mark, maybe slightly less. We also have smaller companies in the mix. So, I would say the strategic large accounts are at least 50% in that range.

What would prevent these large accounts from insourcing, like Home Depot, for example? If they're stable and not growing or adding warehouses, why would they give you this margin instead of keeping it in-house?

Sometimes it's a balance sheet issue. They don't want to take on the liabilities and assets of buying a large-scale building that they may not be able to flex in and out of in the future. They want to keep that off their books. It's often a financial play. They can also change providers by leasing and bringing in different providers.

We often see larger, more strategic accounts taking the lease on the building, but we operate the labor, systems, and processes inside. That's one type of contract we structure. This way, they take the margin off the real estate aspect, still only on a lease, so they report it as a lease, not an owned asset. We operate inside, reducing employee liabilities. Plus, we use our expertise, knowledge, flexibility, and network to service them. We have several contract types with our customers.

For example, we're dealing with a home products company, like Home Depot or Lowe's. We have a building of about 700,000 square feet. They're insourcing by consolidating and moving everything into one of their buildings. We're working with them on this transition because they're a long-term partner, and we'll continue doing business with them in other areas.

Okay, it does happen. So, if a client who's never outsourced logistics is unlikely to do so, it's fair to assume that most of your opportunities come from clients already outsourcing their logistics operations. Given that it's a sticky business, can you explain the challenges in winning a contract from a competitor?

Sometimes it's very sticky, and sometimes it's not. For instance, a three-year contract without automation can lack stickiness. We try to incorporate value-added services into our commercial terms, which really enhances stickiness on the contract logistics side. If it's just about storing pallets temporarily and then shipping them to a retail distribution center or a store, that's not very sticky. Clients can change and transition within a couple of months after awarding business, switching providers and cutting 5% to 10% off their revenue. This often happens if the provider becomes complacent during the term and isn't saving them money, or if it's a cost-plus agreement with no motivation to reduce costs. We see this frequently.

The companies we're interested in are those with insourced business that are growing and bursting at the seams. This is crucial for transitioning from an insourced model to an outsourced situation, or for outsourcing expansion while keeping the main operation insourced. I've worked with companies in Southern California that started importing from Asia and have insourced operations, but they can't contain their business within one building anymore. They don't want the risk of acquiring a second building elsewhere, so they outsource that part while keeping the main operation insourced. We gain business like this, but it's a competitive landscape. Many players offer similar services and operations, and we aim to take business from companies like DHL and GXO. It's the nature of the industry, and we compete against each other frequently.

You mentioned value-added services as a source of stickiness. Could you elaborate on that?

The more complex and elaborate the services rendered within a warehouse operation, the better. GXO excelled at this with Disney, one of their major customers. At one point, they had operations across five sites nationwide, handling a wide array of tasks.

All the facilities included embroidery operations. For instance, if you ordered a stuffed animal or backpack from disney.com and wanted it personalized with your child's name, it wasn't Disney that embroidered it; it was GXO. They also offered screening for product customization, steaming to remove wrinkles, and engraving for items like watches. If you wanted a watch engraved with initials, GXO handled that, not Disney.

They provided numerous value-added services, including gift wrapping. GXO was adept at creating these services, which are highly sought after in the industry. It's challenging for a customer to switch providers and give up that experience and expertise. A lot of this knowledge resides in human minds, knowing how to execute tasks to Disney's quality standards.

Setting up such systems is complex. Orders must be integrated with embroidery machines, requiring skilled personnel to operate them. These machines have multiple computer-controlled pins, adding to the complexity. Ensuring every order is perfect is crucial because a single mistake can offset the profit from several orders. It's challenging for a traditional 3PL warehouse operator to provide these services.

Didn't DHL also offer similar services?

Absolutely, DHL would manage it, but a smaller or mid-range 3PL might not have the capabilities.

Another example is on the tech services side. I'm working with a TV company right now that deals with returns of faulty TVs. Currently, they bring those TVs in, send them to a repair provider, who then repairs them and sends them back to the distribution center to be restocked or replaced. We are now positioned to actually repair those in our warehouse operation, which is unusual for a warehouse. But that's what we're going to do, and we'll train technicians on how to test and repair TVs, even high-end ones with screen issues. This approach significantly reduces costs in their supply chain. There's a lot of value in doing this within warehouse operations. The return never leaves the four walls; we repair it and can put it back into inventory almost immediately, saving time and money.

Another thing that creates stickiness in contracts is automation. The company I'm working with is investing $18 million in automation and wants to amortize that over time. They're amortizing it over eight years of a 10-year contract. Sometimes, with a five-year contract, we amortize over eight years, with a three-year tail on the amortization schedule. If the customer wants to leave, they must pay for the extra three years of capex, acting as an exit penalty. This creates stickiness and incentivizes renewal for another five years, keeping the customer longer.

Okay, this one's obvious. But for the others, like embroidery or repairing the TVs in the warehouse with GXO technicians, is the challenge more on the tech side or finding the right talent? What makes it difficult for a smaller 3PL to do it?

Many other 3PLs aren't willing to bring in technical people. The systems are a big part of it, especially integrating with the WMS. That's crucial. You integrate the Warehouse Management System with the customer's ERP and business systems on the back end to control the order flow.

Is this integration something that GXO does?

Absolutely. Typically, your warehouse management system (WMS) is integrated with the customer on both the inbound and outbound sides. When they have containers on the water coming into the ports, GXO or whichever 3PL is involved will be aware of that through the system. They'll know when those receipts are arriving and exactly what inventory is there. It gets put into inventory, and the WMS manages that inventory. This allows the customer to always know exactly what is in the warehouse.

This relates to your KPI question. Inventory accuracy within those four walls is typically about 99.9% accurate, so the customer knows precisely what is there. All orders that come in through the customer's system are integrated into the WMS. The warehouse, throughout the day, receives those orders, whether they're waived or in real-time. The WMS dispatches people to pick those orders, process them, bring them into the packaging areas, and process the packages. Tracking numbers are then assigned, and this information goes back to the WMS, giving the customer visibility into every aspect of the flow.

The system is heavily integrated with the customers. When you add technical services like repair or embroidery, all of that must be tied into the same system because the information needs to flow seamlessly to those operations. For example, if an operator needs to pick a baseball cap, the system manages that flow to the embroidery area. The operator scans the barcode, verifies the order, sees what needs to be embroidered, keys that in, and goes through the process, including quality control checks. From there, it moves to the shipping department. There's a lot of integration involved, and from a system standpoint, you don't want to change that because redesigning it can be very costly.

What KPIs do you put in place to ensure you cater to customer needs? What do customers ultimately care about, and how do you ensure that? What KPIs do you follow to measure the efficiency of the warehouse?

There are a number of KPIs, and typically, we see several layers of KPIs within the contracts we work on. There are usually four or five primary KPIs, known as breachable KPIs. These are critical because if a vendor or provider, like a 3PL such as GXO, NFI, or DHL, breaches these KPIs and cannot rectify the issue within a specified cure period, the customer can terminate the contract and find another provider. These KPIs are crucial.

Typically, we see financial KPIs at the outset, such as cost per unit or a budget if it's a cost-plus contract. The KPI is a certain percentage above or below the budget. As long as you're within that percentage, considering volume and budget, you're fine. If you exceed that, you need to realign. This acts as a cost control mechanism.

KPIs are usually spread across inbound processes, starting from the initial receipt. When a truck arrives, it's important to measure how long it takes to receive the inventory into the system and store it for orders. This is critical because delays affect the customer's ability to place orders and the company's ability to recognize revenue. We refer to this as dock to stock, measuring the time from when it hits the dock to when it's stocked, typically within 24 hours.

Once in inventory, two important metrics are inventory accuracy and shrink allowance. Inventory accuracy ensures the system matches the physical stock in the warehouse, preventing issues like picking errors or visibility to non-existent inventory. Shrink allowance measures how much inventory is lost or damaged, whether from leaks or accidents like a forklift damaging a TV screen. The 3PL should minimize property damage or loss.

On the outbound side, we typically see two KPIs. That's going to be order accuracy. So when it's going through, how accurate is the order? In other words, If I ordered seven widgets and 10 speakers, does it have seven widgets and 10 speakers in the order? How often have we received a package at home that was wrong? It doesn't happen that often because we put those quality checks in place on the outbound side and those KPIs are in place.

And then also order to ship. How long does it take once an order is received at the warehouse until it actually ships out the door? And that's critical because you don't want orders coming in and it's taking two or three days to pull the product off the shelf and get it out to the customer, because then you also have transit days. Whether it's going to a retail DC, it has a time window that has to be delivered within or if it's going direct to consumer, you're expecting it within a day or two. So that's very, very critical on the outbound side. These are the typical KPIs we see in almost every contract we establish.

They're the same with DHL. Did you find them almost the same?

Yes, all of them are pretty much the same.

When you look at different types of contracts, like cost plus or fixed variable, is there a difference in stickiness between the two types?

I wouldn't necessarily say there's a stickiness factor to the type of contract. There's definitely a trust factor that goes into cost plus that may not be necessary for fixed variable. Fixed variable is more of an arm's length transaction, whereas cost plus involves trusting that the 3PL will execute its fiduciary duty to the plan and follow through with what they promised regarding the budget.

Hypothetically, a 3PL in a cost plus contract might be inefficient and incur more costs because the more costs they incur, the more margin they make. That's the challenge there, so there has to be a huge trust factor. The contract I'm working on, which I mentioned earlier, is a cost plus. We've been their provider for 25 years. They trust us, knowing we work with integrity and good moral character.

We have KPIs around those financials. The first KPI is always a financial KPI, and we have some guardrails around it too. I don't think there's a stickiness factor between the two because the contract type and billing are just results of the activities. The activities create the stickiness; the billing is just a financial mechanism.

So GXO had cost plus and fixed variable contracts. Did DHL operate differently, or is this an industry standard?

No, it's fairly industry standard. I see a lot of fixed variable contracts as the go-to for more transactional engagements. The more partnership-driven, longer-term engagements are typically cost plus.

I would say maybe 20% to 30% of the contracts are Cost Plus, while 70% follow a fixed variable model.

Why is this the case?

It's just that procurement people at these companies don't like cost plus because it's hard to sell internally due to the perception that the provider could drive up costs to increase profit margins. There's a trust factor involved. Sometimes executive teams and procurement teams on the customer side aren't structured that way and don't like to do business that way. It depends on the customer you're working with.

On the fixed variable side, you'll have fixed expenses like facilities and warehouse management systems infrastructure in the fixed component. The variable aspects, like seasonality, make labor the transactional part.

What's the main difference between DHL and GXO? You have insightful perspectives, I guess, since you've worked with both them.

It all boils down to culture, doesn't it?

Yes, please elaborate on that. I find it fascinating. You can't read this in an annual report.

Yes, exactly. It boils down to culture. DHL is a great company. What I loved about them was that I traveled the world extensively with them, and they had operations in almost every country. It didn't matter if I was in Sao Paulo, Brazil, Singapore, or Brussels, Belgium. When I was in a DHL building, I couldn't tell which country I was in. They treated their employees with respect and ran their facilities identically, regardless of location.

They made everything seamless while respecting local cultures. For instance, in Brazil, they provided uniforms and transported employees from the favelas to the warehouses daily. They even catered to local events like football matches, shutting down operations to watch the game. It was expected and loved by the employees. The consistency in facilities was remarkable.

On the other hand, GXO had a colder, more corporate culture. It changed significantly from when it was XPO. XPO was similar to DHL, catching up in many respects. However, after the split to GXO, the culture changed over the next two years. Brad Jacobs brought in people like Eduardo Luciano, whose job was to drive down costs and increase margins, creating a difficult cultural environment. The focus shifted to quarterly reports, often at the expense of customer satisfaction. They would cut management staff, replacing them with less experienced personnel to reduce costs after contracts were signed. This approach upset many customers, and the last two years were challenging for me. The corporate culture reversal was a significant issue, leading to my departure. My reputation in the industry is crucial, and when the company started affecting my customers negatively, I couldn't tolerate it any longer.

That's very interesting. How accessible was the management team? Would they listen when you raised concerns about decisions not being right for the customer? How much leeway did people on the ground have to make the right decisions for the customer?

Once it split to GXO, I would say there was very little to none. It was all about making the numbers for the corporate report, and that was it. If you challenged that in any way, you were removed. The company had five different division presidents, and I think within two years, we went through 12 different division presidents for those five divisions. They would bring in people, and they wouldn't be there after six to nine months because they would step up and say something, and it was like, nope. Or they would refuse to do something they didn't agree with, and then they were gone. So it did change, and that was unfortunate. I know it looks good from a market standpoint, right? They're reducing costs and really squeezing the customers and everything else, but it's not necessarily sustainable all the time. And that's the challenge they face.

A lot of people were let go if they challenged things or pushed back. The focus shifted from being on the customers and employees to being on the market. That was basically it.

If you had to put all your savings into one contract logistics company and forget it for the next 10 years, where would you put it?

Well, I love the company I'm with today, but it's a privately family-held company, and we're all one big family here, so I'm very happy where I'm at. But if I were to choose between DHL and GXO, there are pros and cons to both. DHL is a very methodical beast. It's big and continuously moves like a big machine, going in the same direction. It's very bureaucratic with lots of layers, but they seem to take care of their customers and have a very good internal corporate culture.

GXO does some very innovative things. They push the envelope on technology, even though sometimes it's more hype than reality. But they do push the envelope on technology. There is a lot of backing and strength behind the brands they acquired and the GXO brand itself. But if I had to personally put my money into one, I would choose DHL because of its cultural aspect. I went to Claremont Graduate School, Peter F. Drucker Masatoshi Ito Graduate School of Management. There was a quote that said, "Culture eats strategy." It's so true. The culture of the company is what drives its innovations and everything the company is about.

GXO has the strategy, the mechanical mechanisms, and the corporate structure, but they don't have the culture like DHL does. DHL thrives on that and does very well. So if I had the choice, I would choose DHL.