The New Money Makers

Reengineer your purchasing and supply management department. Do it well and save big. Do it so well, you turn around and offer your services to the outside world. Enter not only a more sophisticated profession but a whole new industry

Procurement reengineering is not only saving companies millions of dollars, but for a few stalwart pioneers it's also making money. After developing their own internal, world-class procurement systems and processes, companies as diverse as IBM and Wells Fargo Bank have decided to pass the experience on to others  for a tidy fee, of course.

If it worked for me it can work for you is the mantra of the new procurement services providers. Given their individual success stories  huge savings in transaction costs and more efficient supply chains  the companies are betting others will want the same experience.

To fulfill such aspirations, IBM and Wells Fargo have created separate units focused exclusively on procurement services, from simple consulting to full technology implementation and even hosting of the purchasing system.

The first to enter the space was IBM, which undertook a massive internal procurement reengineering in the mid-to-late 90s. The success of the endeavor  an astonishing $9 billion in procurement cost reductions reported by its most recent annual report  fostered, in part, a decision to offer procurement consulting and other services to clients. Similarly, Citibank, Chase, American Express and Wells Fargo also derived bottom line benefits from procurement reengineering and are seeking to market their newfound expertise. At its core we're seeing outsourced purchasing and strategic sourcing services.

They're entering the market with the likes of Commerce One and Ariba. In addition, they're positioning themselves in the market by offering their expertise and buying clout to organizations to help them sort through the thousands of e-marketplaces and digital trading exchanges popping up like mushrooms on the Internet. In the metals space alone, more than 70 trading portals are competing for critical mass, each hoping to land on top once the inevitable shake-out slims the field. Others, with a consortia twist, include the pharmaceutical buying site launched by Pfizer, Bristol Myers and Upjohn, in addition to the planned automobile trading bazaar sponsored by Ford, General Motors and DaimlerChrysler. Meanwhile, diverse companies from application supplier SAP to powerhouse innovators like Intuit and Microsoft either have procurement service offerings in place or on the drawing board.

What's going on here? Simply competition for what Forrester Research projects will be a $2.7 trillion B2B trading market by 2004. Everyone is driven by the theory that pulling off a small piece of the procurement pie will yield a revenue stream big enough to grow some real numbers  given the volume of transactions expected to occur, explains Laurie Orlov, research director for e-business applications at Forrester Research.

While Orlov doesn't dispute the motivation to create a procurement services enterprise a la IBM and Wells Fargo, she questions the fit for some companies. At the end of the day, do these companies have any core competencies in procuring anything other than for themselves? she asks. Just because they've had great experiences reengineering their own procurement processes doesn't automatically translate into a great value proposition for others. That said, if they can provide real value to buyers and suppliers, there's a lot to be said in their favor.

On Their Own
The return on investment (ROI) for procurement reengineering is substantial, as much as 300 percent over the lifetime of a system. Indeed, companies can expect to reduce their overall spend by 10 percent to 25 percent and more, adding up to huge bottom line benefits. For example, the average purchase order processed manually costs between $75 and $200. Automating procurement processes reduces that cost to between $10 and $40. (Note: the preceding metrics were pulled from iSource's pilot issue.)

Getting there, in terms of reengineering systems and processes, installing requisite software and building the IT architecture, is the tough part. Hence, the desire of IBM to carry other companies on its broad shoulders. The Armonk, N.Y.-based technology services company attacked its own sourcing inadequacies in the latter half of the last decade. We completely redesigned procurement  the process, organizational structure, methods and systems  with the objective of a centralized view of procurement worldwide, recalls Javier R. Urioste, director of strategy, policy and international operations at IBM Global Procurement in Somers, N.Y.

IBM's internal consumption included just about everything a company could consume  roughly $44 billion of stuff, from the components used in its products to desks, chairs, fax paper and travel services. By consolidating procurement processes and strategies, Urioste says IBM identified $9 billion in cost reductions, savings it has filtered into its operating statement.

The IBM procurement story is well known. In brief, the company established an SAP engine for procurement, adding a large number of tools and applications to this infrastructure to manage the process from the requester's ability to order online through virtual catalogs to suppliers that were pre-approved and paid automatically. Suppliers were vetted carefully for quality, and measured for efficiency, resulting in a reduced number overall, but an increased number of core suppliers.

IBM's Web-based general procurement system screams integration. Direct and indirect goods are ordered at the desktop, with the relevant data routed for approval where required. The system processes these requisitions, transmitting the purchase orders directly to suppliers within the core group. The suppliers, in turn, create e-invoices that are matched with orders. Payments are made and ledgers are updated with virtually no human intervention. We look at it as a complete req-to-check (requisition to check) system, Urioste says.

The success of the new system, in terms of both direct and indirect spends, has been dramatic. Purchase orders previously took 30 days to leave the house; today they're dispatched instantly, many of them over the Internet (about 45 percent of the volume, at present). And 95 percent of procurement is paperless, roughly $13 billion in business transactions with 12,000 suppliers. Process failures  employees not using the procurement system properly  are close to zero; internal surveys indicate a satisfactory rating of 89 percent; and an external survey of 1,000 worldwide suppliers rates IBM's procurement system number one among customers. Five years ago, a similar survey rated us in the middle of the pack, Urioste notes.

Given what we've been able to accomplish internally, we debated whether or not other companies might benefit if we created a separate commercial facility, he adds. Then United Technologies Corp. came knocking.

Like IBM, Hartford, Conn.-based UTC, a multinational manufacturing concern with a $14.5 billion spend on products and services annually, had a decentralized general procurement system. (See the story of how UTC transformed their purchasing and supply processes in more detail on page 66 of this issue: e' Marks the Spot.) The company's new vice president of supply management, Kent Brittan, had met IBM's former chief procurement officer, Gene Richter, who explained what IBM had achieved through its internal process reengineering and the centralization of procurement. Kent came down the road from Hartford and began meeting with us, says William Schaefer, vice president of procurement services at IBM Global Services in Raleigh, N.C.

We had this benchmarking session where we explained what we had done in procurement and how we got there. He was impressed and asked us, upon further discussion, if we could do the same for UTC. Although IBM didn't realize it at the time, it not only was on the verge of a new service offering, it had its first customer on tap. Thanks to UTC and Kent Brittan's interest and prodding, a new core service and potential profit center was born at IBM  third party strategic outsourcing of purchasing.

Schaefer was asked to lead the new procurement services effort  a parallel organization that IBM had developed internally. Strategic sourcing personnel were imported from Urioste's group on a shared basis to handle day-to-day customer transactions. Schaefer established a separate accounts payable organization and leveraged the systems skills and architecture of IBM Global Services. More than 100 people directly report to him today, although he has access to hundreds of others within the expansive company.

Today, IBM Global Services, which accounted for a tidy $30 billion of IBM's $80 billion in revenues last year, is UTC's de facto purchasing department. The unit processes requisitions, places orders with suppliers and reconciles invoices; responds to questions from both requisitioners and suppliers; trains new and current users; maintains systems and provides upgrades and continually analyzes opportunities to leverage buying volumes.

Volume purchase savings aside, IBM offers users the ability to track spends to monitor expenses more closely. Maverick buying is reduced, as is inventory, since the system tracks and solves delivery delays. The system also ensures that the right corporate cost centers are charged for the appropriate expenses, and that accounting procedures are followed consistently. Once a company realizes where and how it is spending its money, it can reduce unnecessary and wasteful spends, Schaefer says.

IBM offers customers the choice of three service offerings. The first tier is simple consulting, i.e., assessment of the opportunity. The second tier is more substantial, involving assistance in the installation of technology to meet procurement objectives. The third is the full magilla  procuring on behalf of the company, as in the UTC example. We've unbundled the pieces to make them accessible to all companies, Schaefer says.

At present, UTC is IBM Global Service's only client in the third tier and its most advanced outsourcing client. The unit is servicing more than a dozen companies in the first and second tiers, and several are evolving toward third-tier placement, Schaefer says.

The price depends on the tier and the client particulars. While Schaefer declined to reveal the revenues reaped by IBM's procurement enterprise, he says its growth rate is in the triple digits. Without a doubt, procurement services is one of the fastest growing areas within our Global Services unit, he says.

There's also a starburst' effect produced by the fact that this effort touches so many other parts of our business, dragging other service revenues with it. Not only is this a strategic and important part of IBM, our experience to date indicates it will be a long-term generator of revenue.

Banking On It
Wells Fargo Banks is also in the procurement outsourcing game. Following in the footsteps of Citibank, Chase, Amex and other financial institutions hawking similar services, Wells Fargo is launching two procurement offerings, one for small businesses (under $10 million in annual revenue), and the other for middle-market and larger companies. The difference: The latter is a full-breadth hosted procurement environment linked to companies' ERP systems.

Like IBM, Wells Fargo reengineered its own procurement system before deciding to establish a separate outsourcing business. The bank expects to have 5,000 internal users, 20 suppliers representing 80 percent of purchase transactions, and 100,000 transactions overall going through its internal procurement system by the end of the year. Everything from deposit stubs and checkbooks to desk chairs and unique banking forms are currently automated and online.

As for Wells Fargo's new service offerings, the first went live July 20. We've developed a small business' portal on our site that includes online purchasing of indirect materials as an option, explains Wendy Quast, vice president and product strategy manager at the bank's San Francisco headquarters. We'd helped many of these sole proprietorships get online anyway. They asked us for help with their purchasing needs, and we've complied.

Customers have the ability to use a Wells Fargo debit or credit card to place orders directly through the procurement system, which uses software by San Mateo, Calif.-based PointSpeed. Suppliers on the system include Barnes& for books, PC Mall for personal computers and software, Online Office Supplies Co. for office supplies and Airborne Freight Corp. for shipping. The lure? Deeper discounts on products, Quast replies.

We've got the power of a large block of buying power and one-stop shopping via a shopping cart' system, all of which translates into cost savings for users.

The site aggregates total spends per month and breaks these down into pertinent categories based on the customer's wishes. Moreover, if a company uses Wells Fargo's online tax preparation service, their business spend is automatically exported into relevant tax forms without manual intervention or duplicate keying (expected by first quarter 2001).

Best of all, the service is free to the bank's customers. Says Quast, We don't look at it as a profit center per se, but as a way to offer customers the services they want. However, we do have different revenue sharing agreements with the various suppliers, based on sales volume. The agreements are proprietary.

The bank's second offering is more robust, given the target market. For that, it plans to charge subscription fees to customers and service fees to suppliers. A company opting for the outsourcing effort is given the ability to electronically search through various buying catalogs, create purchase requisitions, have these transactions routed through the appropriate approval channels, if any, and then sent on to the supplier(s) selected. We've identified suppliers that we've had experience with internally and have strategically sourced through ourselves, says Brenda Smith, vice president and eBusiness Manager in Wells Fargo's Denver office.

Our goal is to create a community of buyers and suppliers, wherein we are the overseer. We're looking at this holistically, from sourcing through transactions to payment and then, finally, into the customer's accounting system. Wells Fargo will manage suppliers, she says, tracking purchase orders against deliveries to measure shipping times, product returns, partial orders, etc. all the areas that cause headaches in the purchasing process, Smith adds.

The bank has installed buying software, hosting the community behind its secure firewalls. Indeed, the security aspect of the system is one of its major attractions. Our customers believe we're a trusted source for electronic transactions, which in many ways is a bank's core competency, says Smith. We're already trusted to do online banking and have processed electronic invoices for years. And we are used to integrating into our commercial customers' legacy, ERP and accounting systems. This is simply an extension of that.

The service kicked into gear this October via several pilot tests. It's expected to be unveiled nationally in the first quarter of 2001. While some may think it odd for a bank to take this route, given our reputation, security and the experience we've gleaned from our own internal purchasing reengineering, it makes total sense, Smith asserts. When you add the financing element (Wells Fargo plans to offer equipment leasing services), we believe we've got a compelling value proposition.

Skinning a Similar Cat
Obviously, not every company that has reaped financial rewards from procurement reengineering is branching off into a commercial outsourcing enterprise. Eli Lilly & Co., for example, which estimates it has saved $300 million since introducing a centralized, automated purchasing system three years ago, is content to remain a pharmaceutical concern. We may join an electronic marketplace like (hosted by Pfizer, Upjohn and other large pharmaceutical companies), but I doubt we'd get more involved in procurement services beyond our own system, says Patrick James, Eli Lilly chief procurement officer.

Radio Shack has taken a different route. Its procurement system for direct materials, including finished goods and components is, indeed, a profit center, but not in the traditional sense. We've cleaved purchasing from the company and made it a separate subsidiary called A&A International, says Mark Yamagata, executive vice president of A&A International LLP.

A&A is a for-profit company, with its own profit and loss statement and balance sheet. It has but one primary customer  Radio Shack. The purchase order comes from Radio Shack electronically to the suppliers with which A&A International has contractual agreements. A&A International then receives a commission on these products, paid for by the parent company.

Here's the kicker: More than 7,100 Radio Shack retail shops spread across the United States have the option of buying from local suppliers. Indeed, only 35 percent of the company's spend routes go through A&A International. What gives? The bottom line is that we have to be competitive, says Fred Rigdon, A&A International controller. If we aren't competitive, and I include in that more than just price but things like delivery time and support service, our customer has the option to go elsewhere.

Picking the Winners
eProcurement analysts have some reservations about the different value propositions. They're unproven models, says Orlov. No one to date has successfully implemented a procurement environment for customers, or come close to cornering the market.

The only procurement outsourcing business Orlov gives a shot at success is IBM's. They've got the technology background, the right partnerships (IBM recently announced an agreement with Ariba and supply chain supplier i2 to procure direct materials) and oodles of cash, she explains.

Gilles Belanger, global partner in charge of supply chain consulting at Chicago-based accounting firm Arthur Andersen, is equally bullish on IBM. They'll survive, but they need to build more of a fulfillment capability, Belanger says. Right now they don't have a fulfillment network in place, or trading partners to support that, particularly on the direct-purchase side. Indirect is easy, but when you offer direct-purchase services, which involve more quality control issues, it's a different ballgame.

Ultimately, the service providers will need to help customers plan purchases to need, i.e., develop a replenishment strategy, Belanger says. Advertising a 15 percent savings in procurement is terrific, but what happens when that flattens out, as it will? he notes. Providers must evolve from helping customers get materials cheaper to getting cheaper materials at the right time on time.

Orlov is particularly pessimistic about the procurement services touted by banks. What gives them the idea they're procurement experts? she says. Why on earth would a small business go to a bank to buy its office supplies? Why not, which makes its living selling office supplies? Sure, banks have a nice, secure infrastructure for protecting transactions, but lots of companies do.

Nevertheless, she rates Wells Fargo's chances greater than those of the larger banks. They're fleeter of foot from a technological standpoint and not nearly as lumbering as Citibank and Chase, Orlov says. When I look at them I see the dance of the elephants'  except they don't know the steps.

As for Radio Shack, the analysts are split. Belanger believes A&A International eventually will spawn a B2C (business-to-consumer) model that, in effect, competes against Radio Shack franchises. A&A already is supplying the stores, so the next logical step would seem to be supplying customers. If that happens, and the B2C option is cheaper, it could create serious friction, he argues. (Yamagata says A&A International has no such plans.)

But Orlov sees the model as a great way to run a company, she says. Here they've developed a way to provide optimal service in procurement, spinning it off and then basically giving it incentive to find the least expensive supplies. That makes their parent a leaner, meaner entity and the procurement function more efficient. Were they to take the next step and procure on behalf of other customers, it would be a more compelling model than what the banks are doing. (Yamagata says the company is considering this possibility, but only for customers that don't compete against Radio Shack.)

Down the road, of course, comes the inevitable shake-out separating the winners from the whiners. Like everything else on the Internet, Step One is always the glut, Step Two is the serious slimming, says Orlov. Right now, it appears we're ramping up fast to the glut.

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