The Analyst Corner: Sourcing

Sourcing is an area where knowledgeable technology investments can lead to a solid return on investment. With the market growing, companies are placing their bets on this sure winner.

Sourcing is an area where knowledgeable technology investments can lead to a solid return on investment. With the market growing, companies are placing their bets on this sure winner.

[From Supply & Demand Chain Executive, June/July 2004] Like the sound of the starting bell at the horse races on a balmy day, the January announcement of the Ariba/FreeMarkets merger excitedly shot e-sourcing consolidation out the gate at breakneck speed. Beyond market consolidation, the pace of activity in the enterprise-wide e-sourcing space is clipping along well due to several interesting issues.

The previous economic crisis, globalization and advances in Internet-based sourcing make strategic sourcing a critical business initiative for 2004, according to the leading information technology (IT) research firms. Additionally, a recent Wall Street Journal special section entitled "Adventures in Cost Cutting" highlights how important total cost management currently is to corporate America. In fact, some contend, minus layoffs, only healthy strategic sourcing practices successfully lead organizations toward better management of their costs.

Certainly leading-edge organizations know the formula: Correctly place core strategic sourcing steps, followed by plugging in robust technology. The result means effective strategic e-sourcing will dramatically reduce transaction costs, increase market transparency, and instill discipline and consistency into the sourcing process.

"The past three years have highlighted the importance of supply management to overall business success," comments Tim Minahan, senior research analyst with Boston-based Aberdeen Group. "Unable to grow revenues, companies were forced to develop strategies to rein in costs and to maintain profitability. Increased globalization also required companies to develop strategies to leverage new markets — without impacting service levels or increasing risks. Leading enterprises have found that supply management, in general, and strategic sourcing in particular, offers the largest and most direct opportunity to achieve these goals."

Toeing the Morning Line

Last year Boston-based AMR Research estimated the sourcing software and services market to be approximately $1.6 billion for 2002, and predicted that it would reach $1.9 billion by the end of 2003.

They were pretty close to the mark. The sourcing software and services market for 2003 ended up at $1.86 billion, and AMR projects this market to round off at $2 billion by the end of this year, representing a compound annual growth rate (CAGR) of 7 percent. This is consistent with AMR's prediction that the e-sourcing market will grow an average of 5 percent a year through 2008.

"This is a healthy growth rate for e-sourcing," says Pierre Mitchell, senior analyst with AMR Research. "And, again, the [enterprise resource planning (ERP)] players will be driving a lot of this growth."

Mitchell highlights the ERP position in the market by pointing out that SAP took the No. 1 spot in e-sourcing license revenue from Ariba last year. SAP's 2003 license revenue was $250 million compared to Ariba's $100 million.

The lion's share of e-procurement and e-sourcing revenue still comes from application software licenses (37 percent) and implementation costs (38 percent), according to AMR's latest research. And application hosting/subscription revenue has gone from just 6 percent in 2001 to 10 percent in 2003.

AMR Research also predicts e-sourcing and contract management applications' revenue growth will continue to out-strip the other application areas of buy-side content management, indirect procurement and direct procurement. The 2003 to 2008 CAGR for contract management is 20 percent, and e-sourcing is 15 percent. None of the three other application areas even exceed 2 percent CAGR, with direct procurement actually showing a minus 2 percent.

Making the Call

Of course, the big news about e-procurement and e-sourcing players was the Ariba/FreeMarkets merger this past January. Though license revenue was off the first quarter of 2004 (not unusual for a newly merged organization), Ariba's acquisition of FreeMarkets bolsters its position in the market for online business software services.

"In the spend management space," says Aberdeen's Minahan, "the $493 million merger between Ariba and FreeMarkets is the equivalent of combining the New York Yankees and the Boston Red Sox: The deal looks very good on paper, both for the combined franchise and its customers. And it's bound to ignite a flurry of merger and acquisition (M&A) activities as rivals move to strengthen their rosters.

"Over the past two years, each company struggled to fill gaps in its bullpen and deepen its bench strength," adds Minahan. "Ariba has been taking steps to build a services organization to bolster its spend category and process expertise, as well as to identify high-margin revenue streams. FreeMarkets has worked to develop an extended sourcing application both to prove itself as a software provider and to retain customers looking to transition to a broader self-service sourcing suite. Their union accelerates these strategies."

The merged company can claim 200 sourcing customers and combined revenue of $360 million based on 2003 year-end results, making it the leader of the spend management software and services business. In addition, the combined company has 400 sourcing experts, including strong coverage in emerging markets in Eastern Europe and China. Together the companies manage $40 billion of spend per quarter and 25,000 sourcing projects per year.

Additionally, Minahan suggests, "Success in the sourcing and spend management markets will require a hybrid delivery model, which incorporates a self-service application platform combined with category-specific market intelligence and process methodologies. The union accelerates Ariba's category management strategy and enhances the company's ability to offer procurement services on a full business process outsourcing (BPO) basis, or as adjunct services designed to extend enterprise implementations of third-party procurement and sourcing applications.

"The value of the deal will be determined by how well — and quickly — the combined company can execute," concludes Minahan.

The analyst community together says Ariba customers benefit from advanced category expertise, global sourcing support and enhanced negotiation functionality. FreeMarkets' customers gain a broader integrated application suite that combines strategic sourcing and procurement execution capabilities. And, AMR's Mitchell points out that most leading-edge companies have tended to use Ariba and FreeMarkets.

But not to be blinded by the glare of the Ariba/FreeMarkets merger, several other players are doing exciting things, too.

If you now include the Ariba/FreeMarket merger in the top-tier e-sourcing pool, the top players (SAP, Oracle, PeopleSoft and now Ariba) control more than half of the e-sourcing market. "Functionality-wise the three ERP players look very similar," states AMR's Mitchell, "with SAP and Oracle probably having the strongest industry adoption of procurement and e-sourcing modules. PeopleSoft has great sourcing functionality, too, but is challenged in being able to truly offer professional services."

In fact, the greatest drawback of the traditional ERP players is their inability to come on strong with a professional services component to their offering. The combined technology and professional services offering of the Ariba/FreeMarkets deal should be a competitive win against the traditional ERP players.

Since strategic enterprises continue to view e-sourcing as the foundation of a larger total cost management (TCM) strategy, the process functionality of future systems must be based around strong negotiation capabilities, collaboration, document management, project management, demand management and analytics. "As providers attempt to build out around these key requirements, overall value of a system to today's customer can only improve," says Aberdeen's Minahan.

Though not surprising, the big players are gaining on these requirements better than anyone else in the market. However, other players continue to have their specialties.
A.T. Kearney Procurement Solutions will be sloughing off its application development area and will use supplier UGS, now a private company originally owned by
EDS (A.T. Kearney's parent company). A.T. Kearney Procurement Solutions will stick to its professional services offering, letting UGS take care of the software component. Like FreeMarkets and ADR International, A.T. Kearney has a clear edge in strategic sourcing professional services but has struggled with staking a prominent claim in the e-sourcing market. As AMR's Mitchell has often said, "Consultants should stay out of the packaged applications business and major in what they're good at."

On the other end of the spectrum, Emptoris, with great software functionality, is struggling with its direct sales model but sowing potentially healthy seeds with its indirect business model by partnering with the likes of Capgemini and IBM. Another encouraging note for Emptoris that could help revenues is the latest release of their supply management software.

Strategic sourcing services are the very reason that Verticalnet recently acquired Tigris. With combined revenues of $6 million in the first quarter of this year, the numbers are down, but this duo can now reflect a nice technology suite with great professional services. AMR Research predicts they will bring in $25 million in 2004 revenue, down from $30 million last year, due to the typical challenges of synchronizing two newly merged organizations.

On another front, B2eMarkets recently closed a major deal in Europe with a government agency, obtaining more exposure in the public sector vertical. And Frictionless Commerce continues to do well in the financial and utilities verticals with both its indirect and direct model.

With D&B's revenues flat to down in e-sourcing services, Austin Tetra becomes its major competitor with a model that's similar but more economical. And in the public sector, Silver Oak Solutions dominates. ICG Commerce is doing well in business process outsourcing — the "hot" issue in the market today.

Last year, the analyst firms suggested that while i2 and Manugistics do well in the market with component supplier management, they could build out more functionality in e-sourcing. i2 is succeeding in this endeavor, but Manugistics appears to be in the same spot as it was last year.

And on the other end, there are those providers that needed to improve on their component supplier management functionality, and Agile acquired Tradec for just this purpose. More improvements are to be made in total cost modeling, but this functionality is coming-of-age for them.

As stated earlier, users want to see greater connectivity between order/demand management, product lifecycle management and sourcing. Continue to watch i2, Agile, Polydyne, RiverOne, Demand Management and MatrixOne for this. If you look outside the United States, LeftBrain, a Geneva, Switzerland-based organization, creates connectivity between these core supply and demand chain functions. The exciting aspect is that players are more sensitive than ever before about combining these critical areas of the supply and demand chain.

Zycus continues to be recognized as the leading player in spend data management for the sourcing space. Ariba acquired Softface this past March in order to improve on this functionality.

Other analysts recognize that Archimedian Software, Mindflow Technologies, Diligent, Global eProcure, B2eMarkets, Perfect Commerce, MatrixOne, Moai Technologies and Procuri's strength continues to reside in the request-for-quote, -proposal and -information (RFX) bidding events and bidding analysis. Mindflow, Diligent and Procuri continue to have strong footprints in specific vertical markets, realizing great partnering opportunities with providers whose strength is in the strategic sourcing professional services area. For a low-end, quick hit reverse auction environment, Iasta can be an experience for the first-time user who wants to dabble.

Winner Takes All

If the ideal merger can create hybrid sourcing and spend management delivery models — ones that incorporate self-service application platforms and category-specific market intelligence and process methodologies — then are we finally getting the well-bred racehorse?

AMR Research and Aberdeen Group tell us that corporations want three things from enterprise-wide e-sourcing solutions: 1) total cost compliance, 2) e-sourcing connectivity and visibility into the demand management tools already in place, and 3) true strategic sourcing aggregated from the technology.

The Ariba/Freemarkets union got us back to the racetrack to bet on solid delivery in the e-procurement and e-sourcing arena. But strategic organizations are not willing to gamble. When they put their money down today, they want the promise of a winner. Strategic sourcing continues to be the one area in corporate America where true total cost management can be effectively managed. More than ever, the providers are required to ante up.

As they say at the tracks: "And they're off &"