eProcurement Takes on the Untamed Supply Chain

Purchasing and supply management professionals entering the virtual marketplace as buyers discover that you can still reduce your supply base and enter into online procurement

On the surface, it might seem like a tug of war. First came supply base rationalization and the mandate to achieve supply chain efficiencies by decreasing the number of suppliers. Now e-procurement and online marketplaces come along, and you are supposed to leverage the Internet's search capabilities and give your company access to an expanding roster of potential new suppliers.

Reduce and expand at the same time? Next thing you know, you'll be leaping tall buildings, too.

Actually, purchasing and supply management professionals at companies entering the virtual marketplace as buyers are finding that e-procurement can support supply base rationalization. As long as their focus remains on rationalization as a strategy and on e-procurement as a tool to facilitate that strategy, companies achieve a smaller supplier base, reduced maverick spending and long-term relationships with strategic suppliers.

The Mantra
Supply base rationalization has been the mantra in purchasing and supply management since the mid-1990s. The goals of rationalization include reducing administrative costs associated with numerous suppliers, streamlining purchasing processes and improving control over inventory.

Rationalization strategies of recent years have met with some degree of success, according to a 1999 report by KPMG Consulting, titled, Global Supply Chain Benchmarking and Best Practices Study: Phase II. The report, prepared in conjunction with the Massachusetts Institute of Technology, showed that 42 percent of responding companies in a cross-industry survey had trimmed their supplier base by zero to 20 percent over the previous two years. An additional 13 percent reported supply base reductions of 20 percent to 60 percent during the same period. 75 percent of respondents indicated they made 80 percent of their purchases from fewer than 100 suppliers. Rationalization strategies appear to be producing closer relationships with a smaller number of strategic suppliers.

Compared to supply base rationalization, e-procurement is a Johnny-come-lately. In fact, although the business-to-consumer model has been hogging online bandwidth since the mid-1990s, the market for e-procurement solutions is only just now taking shape.

eProcurement is, to some extent, an extension of Electronic Data Interchange (EDI), which promised to eliminate the need for paper invoices, thereby reducing transaction costs and cutting turnaround times. But EDI required substantial upfront investment that discouraged smaller suppliers from signing on. On the other hand, the low initial cost of Internet-based procurement  whether through electronic catalogs, virtual marketplaces or online auctions is attractive to companies of all sizes. As a result, buyers have access to a greatly expanded number of potential suppliers, whether for maintenance, repair and operating (MRO) items listed in electronic catalogs; transportation services posted on an online spot exchange; or commodities sold through online auctions.

Indeed, the KMPG report indicates that at least some buyers are taking advantage of the Internet to identify new sourcing options. According to the study, 37 percent of responding companies had actually increased their supply base by up to 20 percent over the past two years, and an additional six percent had seen supply base growth of 20 percent to 40 percent in the same period. The study cites decreasing transportation costs, generally lower tariff barriers and less governmental intervention as possible factors contributing to this countertrend, but the authors also mention the continued globalization of the marketplace combined with the increased information flow across and within global regions at a significantly lower cost.

The potential benefits of the virtual marketplace appear to be at odds with the goals of supply base rationalization. But purchasing and supply managers at several companies implementing e-procurement systems make just the opposite assertion  that e-procurement can and does support ongoing rationalization strategies.

The Bigger Picture
Ted Ramstad is something of an evangelist for e-procurement systems as part of supply base rationalization. Ramstad, group director for global supply management at Dallas-based Perot Systems, a worldwide provider of information technology services and e-business solutions, says e-commerce supports the rationalization process because it permits companies to get a broader snapshot of the market and to be more strategic in their sourcing.

Bruce Beavis, vice president for strategic sourcing at the Philadelphia-based US Filter, is putting that principle into practice. A subsidiary of French Vivendi Water NA, the company has recently undergone a period of acquisitions and currently offers goods and services ranging from water purification and treatment products to the design, construction and operation of water plants and the manufacture of equipment for those plants and water-distribution systems.

With such a diverse buy spread over six divisions and more than 400 sites throughout North America, Beavis has made supply base rationalization a priority. He estimates the company achieved a 10 percent reduction in its supply base in 1999, and now US Filter is targeting further 30 percent reductions for both 2000 and 2001. We really see e-procurement as the enabling vehicle that helps us do that, Beavis says.

Using different types of e-marketplaces to rationalize spending, US Filter is focusing its electronic initiatives on two areas of procurement: MRO supplies and mission-critical chemicals.

In the MRO segment, US Filter's goal is to shift control of supply selection from end-users to purchasing managers who can negotiate pricing, delivery and other terms upfront. The company has been using purchasing data warehousing to get a better picture of its spend and its key MRO suppliers. By midyear, 10 such suppliers were set to make their catalogs available to US Filter employees online through Datastream's iProcure system, a hosted (that is, third party-operated) electronic marketplace. US Filter staff, regardless of their location or the size of their facility, can log into iProcure and purchase MRO products from approved suppliers.

Says Beavis: What I want to have is a controlled marketplace where our employees log on with one set of passwords. They can see 25 of my national contracted suppliers. When they log on, all that contracted pricing is reflected with no questions. And because a lot of these suppliers have overlapping distribution, we can put in motor, Baldour, 5 HP' and pull up the same motor from three or four distributors. By having multiple suppliers that can supply the same item, we can essentially shop our national contracts simultaneously and electronically for this item. The key here is that Beavis has his purchasing team's specifically selected suppliers in the system, creating more management control than ever over this strategically sourced supply base.

For its chemical needs, the company's goals include reducing its supplier base, as well as establishing a preferred-supplier hierarchy, according to Ronald MacReynolds, strategic sourcing manager at US Filter. To accomplish these goals, the company turned to e-marketplace SupplierMarket, which specializes in hosting reverse auctions for built-to-order direct materials. US Filter selected six chemicals (caustic soda, hydrochloric and sulfuric acids, bleach, chlorine and sodium bisulphite) for its initial auctions, based on their high dollar value and their wide use throughout the company's facilities.

MacReynolds wrote the RFQ for each of the six auctions, stating the specifications of the chemicals sought and the terms, including the period of the contract, units to be bid (gallons or tons) and the locations where the products would be used. He then contacted SupplierMarket.com, which collected additional information from US Filter; prequalified suppliers to ensure they had the infrastructure in place to handle the requirements set forth in the RFQ; and administered the bidding, which took place in April. The only cost to US Filter was the time necessary to prepare the RFQs, while SupplierMarket.com says its collects a commission of 2 percent to 4 percent of the final bid from winning suppliers.

The results: In addition to saving US Filter more than $980,000, or about 8.5 percent, on the purchase of the six chemicals, the auction helped the company identify strategic suppliers. US Filter was successful not only in reducing costs but also in moving forward with our strategy of reducing the supplier base and establishing a preferred supplier hierarchy, MacReynolds says. The terms of the auctions provided for a two-year relationship with the winners, after which US Filter anticipates putting the items out to bid again, with the expectation that more suppliers will be willing to participate in the next auction. In the meantime, US Filter is posting another five chemical bids and is examining which additional raw materials, finished products and services could be sourced through reverse auctions.

No More MavericksPerot Systems' Ramstad says companies should also view e-procurement as a tool that contains the supply base by reducing, if not eliminating, maverick spending. An e-procurement system can reduce off-contract buying by channeling purchases to a fixed set of suppliers. The key is ensuring that internal customers buy into the new system, according to Alan W. Daniel, procurement tools manager at Dallas-based Texas Instruments Inc.

Texas Instruments, a global semiconductor company and a leading designer and supplier of digital signal-processing solutions, first began looking at supply base rationalization in mid-1998. Since then, the company has reduced its MRO suppliers from about 5,000 to 750 through a process of evaluation that focuses on overall performance indicators, including price, quality and delivery. The company expects to channel 90 percent of MRO purchases to 200 or fewer suppliers by the end of this year.

Daniel emphasizes that e-procurement is just one tool the company uses to meet its supplier rationalization objectives. Texas Instruments uses both electronic catalogs hosted by key suppliers and American Express purchasing cards. As we consolidate suppliers and choose the right suppliers, we pick the procurement tool based on what is the best tool to connect the user with the supplier, Daniel says. Electronic procurement is a piece of the overall purchasing strategy. It's not the strategy in itself. Think of it as an enabler.

As is the case at US Filter, end-users at Texas Instruments place orders from approved suppliers' electronic catalogs directly through the Internet, channeling a substantial portion of transactions to a reduced number of suppliers. Six of Texas Instruments' suppliers currently have electronic catalogs available to the company's employees, but already more than a third of the company's purchasing transactions are made through the e-procurement system provided by Intellisys.

Despite this success, Daniel warns that e-procurement will only help a company contain maverick spending if end-users find the electronic purchasing process easy to navigate. The main reason for maverick spending is that the process by which someone needs to acquire something is so difficult that they go around the system, he explains. The real point of these e-procurement tools is that they need to be easy to use.

Bringing Suppliers On Board
In addition to end-user buy-in, purchasing managers implementing e-procurement as part of a rationalization strategy must also make sure suppliers are willing to participate in the new electronic systems. To many suppliers, e-procurement may sound like one more way for buyers to squeeze lower prices out of them. The knee-jerk reaction among some suppliers may be resentment and refusal to participate in e-marketplaces, according to Bill Sheehan, vice president for business development at SupplierMarket.com. To ease such reluctance, Sheehan points out to suppliers the benefits of participating in the SupplierMarket.com reverse auctions, including access to more open information about competitors' bids than is typically available in an offline bidding or negotiating process, the opportunity to find better matches for the supplier's current capacity, and potential exposure to new customers. Suppliers can also take comfort in the fact that only about half of SupplierMarket.com's auctions end with the lowest bidder winning the tender. The other half go to suppliers who offer better quality and geographic or other advantages. This is not a beat-up-the-supplier.com' price game, says Sheehan.

Peter Dunning, president and CEO of FacilityPro.com, touts the benefits that suppliers and buyers enjoy through e-procurement. Two-year-old FacilityPro.com provides end-to-end procurement solutions for MRO supplies and services in the highly fragmented facilities-management market. We are trying to reduce the amount of friction in the supply chain between the buyers and the suppliers, Dunning says. If we can reduce the process costs on the procurement side and on the selling and fulfillment side, everybody wins.

For their part, buyers must bear in mind the total cost of ownership of products or services they are sourcing through e-marketplaces, as well as the benefits of a stable relationship with suppliers, according to Barry (Keith) Baxter, a business process consultant at eBreviate, an EDS CoNext company that provides e-procurement solutions, including online auctions. Price is what brings suppliers to the short list and subsequently to the table to talk, Baxter says. But I don't think that [e-procurement] will ever replace the ability to build relationships with key suppliers over longer periods. There has to be some stability in the supply base.

Chuck Lileikis, acting vice president for corporate procurement at Lockheed Martin, agrees that implementing an e-procurement system does not preclude forming close, long-term relationships with suppliers.

Bethesda, Maryland-based Lockheed Martin is a $25 billion aerospace, electronics and energy-management company. In March, Lockheed Martin signed a memorandum of understanding with Boeing, BAE SYSTEMS and Raytheon to create an independent enterprise that will develop an Internet trading exchange for the global aerospace and defense industry. (Similar online consortia have been announced in the automotive, retail sales and other industries.) CommerceOne will be the solutions provider for the exchange. But even before the announcement, Lockheed Martin had implemented a supply base rationalization program that has brought the number of suppliers among its 17 divisions down from about 80,000 to near 37,000. The company also had a target to transmit 95 percent of its transactions electronically by 2001.

Lileikis says that the upfront work involved in setting up any e-procurement system requires that a company work with suppliers to bring them into the trading exchange. But even as it shrinks its supply base, Lockheed Martin will continue to work on a long-term basis with suppliers, both to coordinate design improvements and to ensure that parts and services meet Lockheed Martin standards, many of which are based on government requirements.

Beavis of US Filter also believes that e-procurement will strengthen his company's long-term relationships with suppliers. e-procurement, he says, generates savings that can be shared. It allows me to become a low-cost customer to serve. I would cheerfully be the most profitable customer of many of my suppliers and get the best service by costing them the least. To me, that's a huge win-win.

eProcurement is still in its infancy as an industry, and companies are moving into e-marketplaces as buyers at varying speeds. As supply chain professionals seek ways to integrate e-procurement into their purchasing strategies, they need to avoid being dazzled by the technology and focus on e-procurement as one more tool in their arsenal. People don't need an Internet strategy, says Sheehan of SupplierMarket.com. People need a business strategy, and part of that is how they leverage the Internet as a tool consistent with their overall strategy.