by Malcolm Wheatley

How to Know if E-Procurement Is Right for You

Jun 15, 200314 mins

At its peak in March 2000, the stock price of e-procurement software vendor Ariba reached $183. In May 2003, it traded at $3. Another e-procurement vendor, Commerce One, saw its stock peak even higher—an eye-popping $330. Its shares, too, have recently become but a shadow of their former glory at just $2—and that’s after a reverse 1-for-10 split in September 2002. Without that, the shares would be trading at 20 cents.

But while the stocks of once-high-flying e-procurement companies have come crashing to earth due to excessive expectations, the dotcom bust and the vagaries of the market, e-procurement itself is quietly booming. Studies by AMR Research show that 17 percent of the companies that don’t yet have sourcing and procurement applications plan to implement them in the next year. “This is the highest percentage of any packaged applications category in the market today,” says Pierre Mitchell, vice president of research at AMR. “That is a market growth of 12 percent, up from $1.7 billion in 2002 to $1.8 billion in 2003.”

Explaining e-procurement’s allure isn’t difficult. After a rocky start, it’s finally delivering the goods. The software has matured; there’s a critical mass of suppliers to buy from; internal systems—front and back—are better equipped to deal with e-procurement. The list goes on. Today it’s possible to buy almost anything electronically.

Which is not the same as saying that everything should be bought electronically. Deciding whether to invest in e-procurement applications—whether or not your business can benefit from electronic sourcing and purchasing—it turns out, is a much more difficult call. Pens, paper clips and copier paper are one thing. Complex, made-to-order engineered components are quite another.

The Questions You Must Ask Yourself

E-procurement implementations often simply facilitate the catalog-based buying of indirect materials such as office supplies. The ROI of those implementations is invariably good. Rarely, however, are they earthshaking. Savings on office supplies can only boost a bottom line so far.

Moving beyond this stage—from calendars and Post-its to direct materials (the stuff that goes into your product) and the various services that a company buys, such as consulting, auditing or janitorial services—is hard. If a company makes large purchases of strategically important raw materials or components, it usually does so in multimillion-dollar deals. These are often negotiated over weeks and months, arranging for supplies for up to a year ahead. In such environments, runs the argument, e-procurement adds little value. It may even get in the way.

But e-procurement can deliver more than just lower prices. Indeed, the net impact of its other characteristic deliverables—better productivity, faster processing, greater visibility, the elimination of maverick, or unplanned, ad hoc buying—can have a much higher ROI than what can be achieved by shaving a few pennies off price.

“The bottom line [on e-procurement] depends on your company and what it’s buying,” concludes Scott Elliff, president of Capital Consulting and Management.

Elliff suggests that a CIO evaluating the pros and cons of e-procurement ask himself the following questions.

  • Is the value of the spend high or low?
  • Is the product or commodity highly substitutable or not?
  • Is there a lot of competition or a little?
  • How efficient are your internal processes?

Rather than rushing to automate for automation’s sake, those are the sorts of factors that require consideration.

Choosing the E-Procurement Meal That Works For You

1 Fast Food: Keeping It Simple.

At Applied Industrial Technologies, price negotiation remains in the hands of the product managers in charge of each category. The focus of the company’s e-procurement is on making internal processes more efficient through the paperless processing of orders, receipts and invoices. An internally developed inventory management application gathers requirements from more than 400 Applied service centers across Canada, Mexico, Puerto Rico and the United States, and then sends them to suppliers via EDI.

This isn’t rocket science, but it meets the needs of the $1.5 billion distributor of industrial components that stocks 2 million different items, including bearings, motors, pumps, valves, couplings and the other highly substitutable building blocks of manufactured products. And those blocks are provided by suppliers competing in an intensely price-sensitive market. Applied CIO Jim Hopper eschews newer technologies like XML in favor of tried-and-trusted EDI because, as he says, EDI “has been around for 20 years, works and is very cheap for us to administer. There’s a ton of people who know EDI intimately but only a handful who know XML that well.

“We’ll do EDI with anyone that has the capability,” adds Hopper, “and help them to get that capability if they haven’t got it.”

Similarly, Webasto Roof Systems, a $300 million subsidiary of Germany-based automobile roof and thermo systems manufacturer Webasto AG, has been adopting e-procurement strategies to make its internal process more efficient, while keeping sourcing decisions and price negotiations offline.

CIO Mike Thibideau credits e-procurement with reducing inventories by 15 percent, generating $1.5 million of cash flow and reducing annual inventory carrying costs by $180,000. All that, and the system is still only 30 percent implemented.

Using technology developed by enterprise system vendor QAD, Webasto’s 150 direct material suppliers download all the information they need to know to ship the parts and materials for Webasto’s sunroofs and convertible tops.

“Because all they need is a Web-browser, it’s less intrusive than EDI, and less expensive—especially for the supplier, who doesn’t have to pay anything,” says Thibideau.

Armed with knowledge about future requirements, he explains, it’s much easier for Webasto’s suppliers to fill those requirements just after parts are used and not before, hence the inventory savings. For example, suppliers of items as diverse as glass and electronic control modules can now log on to see how Webasto’s production schedule affects demand for the parts they produce. Suppliers can then compare the inventory Webasto is holding to the minimum and maximum levels the company preset, and decide for themselves when to ship a particular part and how much of it to ship.

2 The Full Banquet: E-Everything.

At the other end of the spectrum are businesses, such as Reliant Pharmaceutical, that have gone whole hog, seeking savings from items where compressibility and substitutability make that possible, and settling for internal efficiencies where it isn’t.

Reliant decided in 2002 to buy everything electronically—from janitorial supplies to the products that it sells. It’s true that the relatively straightforward nature of its business made this easier; the drugs it sells are manufactured by pharmaceutical giants such as Novartis and Lilly, thereby eliminating direct materials as such. Even so, says Reliant CIO Ron Calderone, “100 percent of our purchases now go though Ariba: lodging, travel, office supplies, sales literature, the products we sell, you name it.”

Previously, for Reliant to process a typical purchase order required 21 “touches”—approvals, logging, classifying and the like—and took between one and three months to move through the system. It was also difficult to enforce any consistent company purchasing policy, and Reliant’s back-office system provided very little procurement information with which to leverage price concessions from suppliers. In the first year of its Ariba implementation, says Calderone, 10 percent of Reliant’s purchases were electronic, contributing to an ROI of 65 percent. He estimates the second year ROI will be 400 percent.

3 ¿ la Carte: Picking and Choosing Among E-Procurement Strategies.

Moving to emulate Reliant’s comprehensive levels of e-procurement may seem daunting. In fact, it’s easier than it first may appear. The traditional distinction between direct materials (those that go into the finished product) and indirect materials (those that don’t) often obscures more than it illuminates. More enlightening are those factors that apply to both direct and indirect materials: substitutability (where one widget is as good as another) and compressibility (squeezing suppliers to force them to lower their prices). In short, if you can put it in a catalog and describe it through standard parameters, then you can source it electronically.

Take items such as pumps, motors, switches, electronic components and valves. Those are clearly direct materials, but they also exhibit high levels of substitutability and compressibility. One manufacturer’s motor or pump is likely to be very similar to any other one that meets your specifications, and therefore your suppliers are likely to be competing on price.

Bill Lawson, CIO at electronic instrument and motor manufacturer Ametek, reckons that asking Elliff’s questions at his company has resulted in an average 20 percent savings. His company now sources 12 commodity groups of substitutable and compressible items (among them machine tooling, electrical supplies and computer hardware) through an Oracle Exchange e-procurement portal. “We have access to around one and a half million SKUs [inventory items] through catalogs maintained by our suppliers,” says Lawson. Even so, apart from obvious items such as electronic components, bearings and adhesives, which meet the substitutable and compressible criteria, Lawson is leery of embracing e-procurement for direct materials too quickly. The reason? Through direct negotiation, buyers can at present get a better deal, especially when grouping different items together into a single buy. “At the moment, we believe that direct material and components are best handled though relationships between our purchasing people and our suppliers,” Lawson says. “The more important the item, the more true that is.”

For example, Ametek uses a lot of copper wire—around $12 million worth a year. Large and carefully negotiated deals with suppliers might embrace many months of supply, right across the couple of dozen or so wire gauge sizes that the company buys. In reality, purchase orders for wire are releases against a prenegotiated contract, at stipulated prices. That kind of sophisticated agreement requires the personal touch. A catalog-based buy, oriented around a single catalog item, would not allow for the same critical degree of elasticity and would lock Ametek into a potentially disadvantageous spend.

But even here, e-procurement is beginning to encroach on the buyers’ preserve of finding and negotiating with suppliers.

“We certainly engage in a lot of Internet activity to locate and qualify suppliers, although I wouldn’t necessarily characterize that as e-procurement,” Lawson says. “We might even hold an electronic auction. But after that, the transactions would be releases against a contract.”

Some companies go even further toward using e-procurement for everything they buy, although again, the objective is often improved efficiencies, leaving sourcing decisions and price negotiations to the experts. At ImagePoint, which designs, manufactures and puts up outdoor signs for retailers such as McDonald’s, Pizza Hut and Taco Bell, e-procurement already embraces both direct and indirect material spend but not yet services, says Vice President of Information Services Steve Hammond. Aluminum, steel, fasteners, wood, plastic sheets—everything that goes into constructing ImagePoint’s signs has been sourced through software from SupplyWorks since early 2002. Indirect materials—everything else, in fact—utilized the Web-based buying tools supplied by specialist indirect material suppliers, such as Granger, Insight and Staples. The incentive for moving direct materials onto SupplyWorks, explains Hammond, was better productivity in the buying department that allowed buyers to do what they ought to do—buy better, not shuffle paper.

Instead of printing purchase orders then faxing or mailing them to suppliers and then finally chasing the suppliers for order confirmations, ImagePoint’s procurement requirements are fed directly from its elderly enterprise system into the SupplyWorks system.

“The time that our purchasing agents used to spend chasing paper is freed up so that they can now spend more time working and negotiating with existing vendors, and qualifying new ones,” says Hammond. “Their jobs used to be transaction-based. Now they are performing a higher value role.”

Already, that higher value role is delivering a bottom-line benefit. The company is on track to achieve a 10 percent reduction in its annual purchase spend of $32 million. It is, points out Hammond, “a very sizeable return on our investment.” In addition, the plan is to grow the business by 6 percent to 8 percent this year, but without hiring any more purchasing agents. Previously, the size of the business and the purchasing function pretty much moved in lockstep.

The New Tools

E-procurement used to be about dealing with low value, repeatable items that clog up your purchasing function,” says Prasad Hedge, a partner with Denali Consulting. “Over the past couple of years, the tools have started to become more collaborative and not just transactional.”

MSX International, an $800 million business specializing in providing supply chain management and procurement services to the global automotive industry, is using newly available collaborative technology from Commerce One to buy items and services as varied as printer cartridges and contract labor for its automotive customers. The company issues RFPs (accompanied by CAD drawings and specifications), solicits bids and responds to suppliers’ requests for additional information—all over the Web.

“It’s the electronic equivalent of a bidding conference, using the Web to interact with a greater number of suppliers,” says Troy Gazette, director of IT platform strategies for MSX. Answers to suppliers’ questions can be broadcast to the entire pool of vendors, or not, depending on the automotive customer’s own preferences.

Applying optimization technology to procurement is another area that is hotting up, especially with multi-item lots. “Run a buy through an auction, and you might get an 8 percent savings. Run that same buy through an optimization engine, and you’ll get another 8 percent,” asserts John Fontana, a principal with sourcing and supply chain management company Tigris Consulting.

One of the beauties of optimization, he explains, is that it frees both buyers and sellers from the straitjackets of fixed bundles of goods or services against which bids are solicited. That means that online buyers and sellers can now do something they once couldn’t. Sellers can bid for selected parts of lots, or include in their offering nonstandard terms such as volume discounts, extended price validities or other goodies not explicitly covered by the bidding terms. Buyers, for their part, can evaluate those bonuses. In one sense, it’s the answer to Ametek’s problem of moving its wire buying online. Instead of forcing bidders to bid for every one of the couple of dozen wire gauges the company uses, bidders can bid to their strengths and sweeten those bids with volume discounts, or fix them for a period of time. It doesn’t sound too difficult, but in practice, disentangling the merits of a dozen suppliers’ different bids is surprisingly challenging—which is why companies have usually opted to enforce standardization in the first place.

Both Procter & Gamble and Bayer have recently deployed optimization technology from CombineNet that allows suppliers to submit these so-called expressive bids and buyers to evaluate them. The optimization involved, says Dennis Begg, Procter & Gamble’s associate director of purchase innovation, “is a combination of linear programming and mixed-integer programming, coupled to a very efficient solver.” (A solver is a piece of software that works out difficult calculations.) Boiled down, for those that can remember Economics 101, it’s similar to applying the law of comparative advantage to everyday purchases.

“Auctions are a zero-sum game,” explains Begg, “but by allowing suppliers to bid to their own strengths, and squeeze out their own inefficiencies, expressive bidding adds value.”

Tom Phalin, director of logistics procurement at Bayer, has a straightforward endorsement of the bottom-line benefits of expressive bidding. Last year, the company sought expressive bids for its Nafta ocean-going freight business. “We weren’t very confident that we’d see lower prices at all,” he says. “But in the event, we reduced our ocean freight costs by 15 percent, signing contracts with 11 separate steamship companies.” This year, Bayer is repeating the process on a global scale.

The E-Procurement Future

Today, both the technology and the buyer’s expectations have matured to the point where e-procurement can genuinely be used to source things other than catalog-based indirect goods. Direct materials, and the services that companies buy (see “At Your E-Service,” Page 61), are now real options for mainstream businesses—and not just for the few companies whose business models and operations lend themselves to it.

To manage expectations of an e-procurement effort, it’s important to remember that the ROI will come only partly through lower purchasing prices. The rest of the return will come from efficiency improvements within the buying process. And the job of moving those improvements from the theoretical to the practical often falls upon the CIO.