Every business is a purchaser as well as a supplier, with many routinely processing hundreds of buying activities daily. Typically, purchases represent 50 to 90% of a company's cost structure - making procurement strategy and execution a critical lever for effective supply chain operations and superior business profitability.
Electronic commerce offers exciting new possibilities for businesses to improve their performance on this important "upstream" supply chain activity, both for indirect or support items and, increasingly, for materials that are direct components of the products and services that businesses make and sell.
As in many areas of e-commerce, the wide variety of alternatives can be confusing. This article outlines some of the major recent developments in e-procurement and the important strategic and tactical choices that companies need to make in order to answer these questions and to take full advantage of new "buy" side e-commerce developments.
This part addresses how e-procurement can be used to Leverage Volume, including leveraging volume through outsourcing.
About This Article
This article will appear on this site in five parts. Each part will contain links to the preceding parts.
Part 1 discussed the Benefits of e-procurement and included examples of major corporations that are pursuing e-procurement.
Part 2 discussed the potential Efficiency Gains of e-procurement, including relationships and processes that are necessary to obtain these gains.
Part 3 discussed how e-procurement can Broaden the Supplier Pool, including the pros and cons of this approach to procurement.
Part 5 will discuss how e-procurement can Improve Process as well as How to Get Started with e-procurement.
Objective: Leveraging Volume
- Online auctions can yield major savings.
- You first need to have a strong understanding of your usage, requirements, and other factors in order to obtain the benefits.
- Price is rarely the only criteria for selecting suppliers, so be sure to consider multiple factors that are important to you.
Leveraging Volume Discussion
Achieving lower prices is a major objective of any buyer, of course, and a straightforward way to drive prices down and obtain increased supplier attention is to leverage total purchasing volume through Internet-based auctions. In a way, these are the e-procurement equivalents of traditional requests-for-proposal and price bidding techniques that purchasing departments have used for years: Bundle your volume together, and make it a winner-take-all proposition. Now, however, they can occur in real time with a worldwide supply base bidding interactively and with visibility of other supplier bids, until a winner emerges.
As consumers, we are all familiar with auctions, in which the buyers continue to bid up the price for a given item or service until only one buyer remains. Technically, e-procurement uses "reverse auctions" or "downward auctions," where the bidders are the suppliers and prices continue to fall until only one bidder remains, who then has the right and obligation to supply the requested goods or services at the low bid price.
The initial entrant in this field, FreeMarkets, Inc., began five years ago with an auction for plastic parts for Frigidaire refrigerators, a commodity category in a mature market niche where you might have expected that the lowest possible price was already in effect. FreeMarkets obtained savings of about 15% within about 3 hours, and a new business was born. Since then, over $7 billion in auctions have been completed for major corporations and even one state government. Perhaps the most dramatic indication of the potential importance of e-procurement solutions is that FreeMarkets now has a stock market capitalization of $2.5 billion as a newly public company, down significantly from the Internet frenzy last year, but not bad for a company with about $40 million in revenues over the past year.
The level of activity generated in these auctions is often very impressive. Recently, for example, the ebreviate.com unit of consulting firm A.T. Kearney assisted a Fortune 500 company with $75 million in telecommunications services expenditures. Sixty-two qualified suppliers from 3 different countries submitted over 700 competing bids during the course of the auction, and the client saved about 18% versus its prior cost level.
Anyone who has participated in an auction for antiques or art or other merchandise knows that the environment can become emotionally charged and that bidding sometimes exceeds rational or sustainable levels. While significant improvements in price can be obtained, buyers need to be careful since it doesn't do any good to accept a low bid submitted online by a supplier only to find out later that they don't have the capability to deliver the volume and quality you need.
Indeed, the most important activity in these reverse auctions is the work that occurs before the auction actually takes place. You may need to pre-qualify suppliers who have the capacity, quality levels, and track record to serve your business, and invite only that select group to participate in the auction event. Do you really want anybody with a Web browser to be able to bid for your business?
In addition, without a strong knowledge base of what your company purchases, from whom, at what prices, and for what uses, it is nearly impossible to derive the full value from e-procurement and other "upstream" supply chain initiatives.
Many companies still don't really know these basic facts about their internal operations. Decentralized corporate structures and the autonomy given to individual business units have often resulted in an inability to take full advantage of business-to-business e-commerce. In many consulting projects, the first, and arguably most valuable, task performed is "building the fact base" that can later be used to develop and implement improvement programs - an arduous task that often involves piecing together information from a dozen disparate, incomplete, and inconsistent data sources. In e-procurement, and auctions in particular, it is critical to know how much volume you have and how much you can realistically commit to the winning bidder.
Finally, the price of individual items is often only one consideration in determining the most appropriate supplier for your business. Other price-related considerations such as payment terms, warranties, shipping and duties, as well as non-price factors such as lead times, product innovation, and access to new technology may be equally or more important than unit prices alone. While auction providers can increasingly accommodate these additional factors, determining the overall "leading" bidder in a real-time auction environment can quickly become very difficult or impractical.
Leveraging Volume Through Outsourcing
An auction format is only effective if you have significant volume that can be leveraged in order to gain attention and price discounts from the marketplace. For many smaller and medium-sized companies, the level of purchases of specific categories of goods and services is unlikely to be adequate to command superior pricing through an auction.
To address these situations, yet another variant of e-procurement has emerged — an outsourcing or intermediary approach. Here, in effect you turn over your spending requirements for office supplies, electricity, MRO, or other business needs to a third party who bundles it together with the volume of other small and medium-sized companies to create enough volume leverage to attract superior pricing from suppliers. While consortium or group buying has been in existence for some time — your health insurance plan uses it to get better prices for doctor visits, pharmaceuticals, and other items, for example — bringing it to e-commerce is a new development.
ICG Commerce is one of the new players in e-procurement that uses this approach, among others, with some notable successes. Smaller customers can potentially save anywhere from 5 to 25% on the cost of factory supplies, administrative services, packaging, and related categories, and major companies can utilize the ICG Commerce staff of procurement experts and its e-procurement technology to drive ongoing procurement improvements. Major oil company Sunoco recently announced that it was turning over its nearly $1.4 billion in purchases to ICG, for example.
Conclusion of Part 4
As the old saying goes, "be careful what you ask for, you might get it." Before committing your volume to an auction, a third party, or some other variant, it is important to understand your company's willingness to live with the results. At what point would you be willing to change suppliers — for a 1% improvement, a 25% improvement, or under no circumstances at all? What if a supplier who you don't know much about, or are not entirely comfortable with, wins the auction event? Sure, you can choose not to give them your volume, or you can use the auction purely as a way to reduce the prices and margins of your incumbent suppliers without making a change at least for a while. But without your commitment to live with the results, suppliers will quickly recognize that it is just a paper exercise, and may not continue to participate fully and openly.
This is part 4 of a five part series on e-procurement.
Part 1 was The Benefits of E-Procurement
Part 2 was The Efficiency Gains of E-Procurement
Part 3 was E-Procurement Can Broaden the Supplier Pool
About the Author
Scott A. Elliff is Founder and President of Capital Consulting & Management, Inc. (CCMI), offering high-quality analysis, practical advice, and fresh perspectives to help clients achieve bottom-line improvements in profitability, effectiveness, and market position.
Mr. Elliff has sixteen years experience consulting to a wide range of Fortune 500 and other companies, with particular expertise in supply chain management, including product development, forecasting, procurement, scheduling, manufacturing, transportation, logistics, inventory management, and customer service. He has written and spoken widely about these topics in a number of industry conferences and publications.
CCMI can be found on the Web at www.CCMIservices.com.
Mr. Elliff can be reached at (703) 370-2607 or by e-mail at scott_elliff@CCMIservices.com. All materials CCMI 2001.