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e-Procurement – Fastest Return on e-Commerce Investment?
a report by
T h o m a s S l a i g h t and A l N o r m a n
Vice President and Principal, AT Kearney
New software solutions have recently emerged to help corporations streamline their procurement processes and save billions of dollars a year in the process. As more organisations scramble to develop strategies that speak to the demand side of e-business – selling to other businesses or to online customers – these solutions are working quietly to improve the supply side. Although the term e-procurement scarcely existed more than a year ago, it is now a market that is predicted to grow from US$187 million in 1998 to US$85 billion by 2003. Analysts estimate that companies can save up to 30% a year on procurement costs by automating their procurement process using the Internet. Research groups maintain that e-procurement can turn 10% to 20% of procurement expenses directly into pre-tax profit. Business magazines are including e-procurement in the big wave that will hit businessto-business (B2B) e-commerce, and even the computer magazines have concurred. PC Week asserts that more software companies are entering a market that many users now see as the fastest return on an e-commerce investment. Investors are also signalling their interest in e-procurement. Ariba Technologies, Commerce One and Tradex are three e-procurement software pioneers taking full advantage of Wall Street’s euphoria. In May XXXX, the move towards eprocurement software and systems developers was a slow-moving trend; by mid-June XXXX it had erupted into a fully-fledged race. Ariba Technologies’ stock price almost tripled in its first day of trading. Initially priced at US$23, it began trading at US$61 the following day and doubled again one month later. Wall Street is attracted to these pioneers because it considers them safer bets than their Web-based retail counterparts. Companies are attracted to e-procurement because of its potential to save time and money – something accomplished by improving supplier selection and relationships, and the efficiency of processing transactions.
Evaluating the Promise
The question now is how companies should evaluate the promise of e-procurement, and how executives should ration their investment dollars and management time towards the ‘buy side’ rather than the ‘sell side’ of the Internet. Also, how they should choose between players when some early entrants are already leaving the business or are being bought out by more aggressive competitors. The answers lie in two areas that have garnered much publicity in recent months: 1. Internet purchasing; and 2. downward auctions.
Internet Purchasing
Internet purchasing allows a company to place orders faster via the Internet. Rather than wait for the right people to approve an order, then wait for the procurement staff to push paper requisitions out to suppliers (a process that can take weeks), employees order what is needed from a pre-approved list directly from their own computers. They buy products online, depositing their purchases into virtual ‘shopping baskets’. The order is routed through an internal approval process, and then sent electronically to the supplier, leaving a clear audit trail in its wake. It also leaves procurement professionals free to concentrate on more strategic aspects of procurement, such as negotiating contracts and managing suppliers. National Semiconductor is one of several firms flaunting the advantages of Internet purchasing and can boast a purchase order (PO) process that used to take 14 days now takes only one day. The cost savings can be just as compelling. At Texas Instruments, the cost to process a purchase order dropped from US$49 per PO to less than US$5 when processed electronically. Pacific Telesis’s costs plummeted from US$78 per PO to US$0.50. Internet purchasing also helps companies harness
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e-Procurement – Fastest Return on e-Commerce Investment?
‘maverick’ purchasers and get a handle on a previously poorly managed spend. Research has found that, last year, a typical company purchased as much as 30% of its indirect goods and services from non-contracted suppliers, and that these products ended up costing an average of 20% more than necessary. Internet purchasing helps rein in these rogue buyers. The system is easier to use and more difficult to circumvent because it dictates approved suppliers and products.
Downward Auctions
transportation costs and financial risks began to shrink, and it became less important for companies to be close to their suppliers. Today, Eastman Kodak sources electronic components for its digital cameras from South-East Asia and Toyota depends on bumpers for its vehicles from Indonesia. These are an example of just two companies that have learned that having access to suppliers worldwide creates its own set of problems. If the Internet provides a company with access to 10 times the number of suppliers, it stands to reason that this creates a tenfold increase in the workload needed to analyse and negotiate purchases. The solution lies in a new process called downward auctions. Downward auctions replace traditional ‘round one’ negotiations with suppliers, in which companies shuffle through a process of mailing out requests for information (RFIs), followed by requests for proposal to potential suppliers. Eventually, this process weeds out around 80% of the suppliers. Some are eliminated because they are not qualified. Others are eliminated because the buyer does not have the
A decade ago, a senior purchasing executive at Eastman Kodak proudly announced that more than half of his suppliers were located within 40 miles of the company’s main plant in Rochester, New York. During the same period, Toyota was admired for having concentric rings of suppliers located around Toyota City. When the value of suppliers was measured by the shortness of their supply chain, these were powerful images. Such images blurred early in the 1990s, as
Box 1: Case Study – Downward Auctions Slash Costs and Time
With eyes locked on computer screens, and fingers poised over keyboards, 85 suppliers in cities throughout North America waited patiently for the opening round of an AT Kearney downward auction. The goal was to win contracts with Sprint, a leader in global communications. Four hours later, 15 of those 85 suppliers had cleared the final hurdle for winning US$50 million in telecoms services. Sprint had contracted nearly US$60 million worth of services for only US$50 million – saving 17%, well beyond the 12% it was accustomed to saving using traditional sourcing methods. In another auction, Visteon Automotive Systems put nearly US$150 million in supply contracts for printed circuit boards onto the action block. For 90 minutes, the company was an active partner as 17 suppliers from Europe, North America, Latin America and Asia bid against each other to win the contracts. In a downward auction, prospective suppliers use a password and a standard browser to gain access to Web bidding sites. Once online, the supplier can see the prices being bid – whether it is for telecoms equipment or printed circuit boards – but they cannot see the names of the other organisations involved in the bidding. Unlike target pricing, in which a customer sets an initial price for a commodity, suppliers bidding online set the market price for the technologies being sourced. Kim Marslender, an interior systems purchasing manager with Visteon, said the online action gave Visteon a much more accurate and timely sense of market prices, though market price is not the only determining factor in a sourcing decision. “We initially sent out requests for information to over 90 printed writing circuit board suppliers around the world,” Marslender told Automotive News, “from the information that they submitted, we narrowed the field down to those suppliers who could meet our rigorous quality, performance and technology standards.” Prior to the auction, Visteon’s suppliers were required to attend a half-day session to learn what Visteon expected. Following the bidding, the suppliers were audited and company purchasers made follow-up factory visits.
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resources to conduct negotiations and find out whether or not potential suppliers are qualified. In a downward auction, the competition remains open to all qualified suppliers. New suppliers, geographically remote suppliers and economically hungry suppliers alike can meet the buyer online to negotiate prices and terms. A case in point is USbased Visteon Automotive Systems, an after-market electronics equipment supplier that held its first parts auction in August. Awarding nearly US$150 million in supply contrac ts for printed circuit boards, Visteon expected its Asian electronics suppliers to be ‘hungry’ and slash prices in order to cope with struggling economics – it wasn’t disappointed. (see Box 1) The suppliers have whatever timeframe the buyer decides, be it one hour, two hours or three days, to bid their best prices or their best terms. What used to take weeks or even months to accomplish now takes just a few hours in an online auction. The buyer chooses a supplier that meets its needs, and then goes into next round, face-to-face negotiations. Downward auctions are well suited to selection criteria other than price – delivery time, quality and financing options, for example. They are particularly effective for companies that want to source globally because they alleviate many of the difficulties inherent in conducting business over long distances.
The main reason for the price differential is that more suppliers can participate, making the entire purchasing process more competitive. Also, auction participants can clearly see how far they are from the ‘best’ price and adjust their price accordingly. For example, if a machine part supplier has done everything necessary to prepare for an online auction – the product categories have been studied, the cost structures are understood, there have been discussions with management and what is thought of as a highly competitive bid of US$45 is entered. During the auction, the supplier witnesses a competitor lower its bid to to US$42. In a traditional sourcing scenario, the supplier would simply lose the price competition. In an online auction, he may elect to undercut the US$42 competitive bid in order to win the business. Furthermore, in a traditional sourcing process, suppliers – knowing that the contract will be awarded some time in the future – tend to build in a pricing hedge against uncertainty. In a downward auction, suppliers are more willing to accept a lower margin, knowing that the contract award will be immediate. The sense of immediate feedback, the fact that suppliers can see how far they are from the best price, and the excitement of the auction event give downward auctions a clear advantage over the traditional paper process.
... employees gain greater control over their own purchases, while employers reduce their operating costs by benefitting fully from their negotiated contracts and volume discounts.
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Consider the case of a manufacturing firm that sourced a metal component through a global network of 30 suppliers. The company encountered problems with language and distance, and it had difficulty determining which suppliers were truly price competitive. When it turned to online bidding, language ceased to be a barrier because the bidding was conducted in writing using standard format. Distance became irrelevant because buyers could participate from their offices, homes or even hotel rooms – wherever their personal computer (PC) happened to be. The fast pace of online bidding can cut one-third off of the time from when an RFI is issued until the product is ordered. By trading online, buyers can also obtain lower pricing from suppliers, 5% to 10% lower than using traditional sourcing methods.
The Means May Have Changed, but the Methods Have Not
The Internet does not offer a complete solution for fixing a fragmented procurement organisation. e-Procurement may change the means that companies use to source their materials, but it does not change their methods. Companies still need to survey the marketplace to ensure that they are getting the best products and services for their money. As always, they must analyse their supply markets, their internal spend and demand, determine their business needs and negotiate new agreements with new suppliers. Essentially, a company must remain focused in eight areas to support its procurement activities (see Figure 1):
e-Procurement – Fastest Return on e-Commerce Investment?
Figure 1: A Total Procurement Solution
Areas to Address: 1. Procurement and Supply Strategy Who are the best suppliers? How can I get the best deals? 2. Procurement and Supply Organisation How can my supplier support me more effectively? What are my suppliers doing differently?
1 2 3
Strategic Sourcing Supplier Management and Development Day-to-day Purchasing Information Management Human Resources Performance Management
What else is happening in the supplier community? 3. How much do I spend on what? How do I minimise transaction costs? Am I getting the prices promised? Are my users complying?
1. 2. 3. 4. 5. 6. 7. 8.
procurement and supply strategy; procurement and supply organisation; strategic sourcing; supplier management and development; day-to-day purchasing; information management; performance management; and human resources.
– Boise Cascade Corporation (office supplier) and CompuCom Systems, Inc. (PC technology). This information has become useful in negotiating and managing terms of its trade agreements. Other companies use the same type of data to negotiate with their suppliers. In purchasing laptop computers, for example, one company draws on information about its past purchasing practices to determine the number of purchases it should make of each computer model, average delivery time from the shipping dock to the employee’s desk, and average total time to first-use by the employee. Unlike the paper process, tracking this information is fast and easy, and its value increases over time., particularly in evaluating the performance of both the supplier and the company. Furthermore, e-procurement is beginning to incite price competition among suppliers. By its very nature, e-procurement gives suppliers access to information they have never had before, the kind of information that allows them to become more knowledgeable about their market and their competitors’ products. An example is an automotive manufacturer that has set up an online procurement system to allow its computer suppliers to price their products daily. One day, Computer Supplier A is overstocked on a specific kind of laptop and decides to reduce the price in order to move them more quickly. Immediately, the automotive manufacturer’s
Changing the Dynamics of the Relationship
The argument in favour of e-procurement is that employees gain greater control over their own purchases, while employers reduce their operating costs by benefitting fully from their negotiated contracts and volume discounts. There is also a larger argument that goes beyond cutting costs and saving time, and that is the ability to gather good information and then use it. Through e-procurement, the buyer can rapidly assemble a vast store of information on its suppliers. No more days spent backtracking through a wealth of paperwork in order to discover a supplier’s volume or performance. Today’s informed buyer wields power, demanding more value in products and services. John Hanock Insurance and Financial Services, Inc. was among the first to realise this potential. The company uses its e-procurement system to quickly collect performance data on two of its major suppliers
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procurement system, which has been programmed to buy the lowest-priced laptop, begins buying up the laptops. Computer Supplier B’s competitors note that the lower price is shifting demand to the Supplier A and may decide to match or beat Supplier A’s price. Essentially, the buyer has constructed a demanding pricing relationship with its suppliers that drive the its costs down. The same level of competition can take place when negotiating delivery times.
What Should Be Done?
decided not to proceed with an e-procurement strategy because most employees did not have the basic PC skills necessary to make online purchases. Integrating online procurement software with an organisation’s existing enterprise resource planning systems is not always a smooth process. A recent survey taken at the National Association of Purchasing Management’s Annual Conference found widespread unhappiness with current eprocurement tools. The result, cited in Internet Week, revealed that some 40% of the 212 respondents complained they had to use more than one system to perform even the most basic purchasing and contracting tasks. Another 86% complained that they wanted a single-entry search engine for comparison shopping, but only 25% of the programs offer it. One-third of the purchasing managers commented that they could not easily place orders against a master contract, even though 94% said they wanted to do so.
Few senior managers would argue the need to respond to the changes taking place in procurement brought about by the Internet, but many hesitate to move because of the uncertainty – confounded by acquisitions among the software developers, as well as a proliferation of new products and new companies entering the market. Although it may be some time before the market ‘shakes out’ completely,
By its very nature, e-procurement gives suppliers access to information they have never had before ... that allows them to become more knowlegeable about their market and their competitors’ products.
e-procurement is here to stay and all companies need to approach it in steps. The first step is to develop a tailored e-procurement strategy that takes into account the industry and the competition. A good strategy will highlight the firm’s own skills and competencies and the organisational changes that will be necessary to implement the strategy. A primary consideration will be in choosing an e-procurement system that will work with initial systems, suppliers’ networks and legacy applications. This will play a major role in what e-procurement software is chosen. For example, John Hancock decided to purchase Netscape BuyerXpert, because the software works hand-in-hand with the company’s legacy and supply chain systems, and with its electronic data interchange networks. Ford is working with Interlisys to forge connections with between 3,000 and 5,000 suppliers globally. The system is expected to be operational in 2001. By the same principle, a closer look may reveal that not all organisational capabilities are able to support an e-procurement system. This was the case for an oil and gas company that, after researching its options,
The Stakes are High – Know the Players
Discussing the steps to implementing an e-procurement strategy raises questions about which e-procurement products will perform certain functions and work with certain systems. A quick look at the major players helps answer this question. While the biggest players in e-procurement have existed for a while, many others did not even exist prior to the e-procurement revolution.
Conclusion
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The widespread belief among analysts is that B2B trading is the next wave of the e-commerce revolution. e-Procurement is still a relatively immature industry that is struggling to gain a following. Until recently, neither the software applications nor the technologies have been available to make e-procurement a viable commodity. Even the success of the much-touted supply-side pioneers, – particularly those mentioned in this article – have been small when compared with the swift ascent of the online retail leaders. This is destined to change, however, and soon, as more companies recognise the advantages of purchasing online. s