Executive
Summary
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.