Value-Chain Report

Dec. 21, 2004
Internet-based procurement systems hold promise, but pose challenges.
Question: What do corporate "mavericks" and Alaskan bears have in common? Answer: Both can be controlled with a little help from Internet-based procurement technology. That little tidbit is one of the more curious findings I came up with recently while reviewing a stack of background material on electronic procurement -- or "e-procurement" -- that has been collecting on my desk for the last several months. Rather than prolong the suspense, I'll jump right into the explanation: The mavericks in question are employees who, when they need something in a hurry, deal with suppliers of their own choosing rather than channel their purchases to pre-approved vendors who are under contract to sell products at a negotiated price -- a price that typically includes a volume discount. Maverick buying is a common phenomenon in the sourcing of maintenance, repair, and operations (MRO) items -- including office supplies, computer equipment, maintenance supplies, and a variety of other materials that a manufacturing company uses but which do not go into its end products. A report by Boston-based Aberdeen Group estimated that MRO supplies typically account for about 35% of a manufacturer's external expenditures -- and that as much as 40% of a company's MRO outlays can represent maverick buys. Obviously, not all MRO items are going to be covered by negotiated supplier contracts. It's unlikely, for example, that many companies would bother to wheel and deal to get reduced prices on pencils, paper clips, or toilet paper. But, for higher-value items, curbing maverick purchases -- and thereby increasing volume and leverage with selected suppliers -- can translate into price reductions of 5% to 10%. And those are savings that drop directly to the bottom line. A key point in all of this is that enterprise-wide e-procurement systems can help to keep would-be mavericks in line by simplifying the requisition/purchase of MRO items and dramatically shortening the transaction processing/fulfillment cycle. Simplifying The System A study by Grainger Consulting Services, a unit of W.W. Grainger Inc., found that Internet-based procurement systems, integrated with ERP and other business systems, can reduce the procurement cycle by 70% or more -- from five to 10 days down to just two days. Rather than relying on purchasing staffers to thumb through numerous dog-eared catalogs and then deal with suppliers, well-designed e-procurement systems can quickly locate a preferred source (if there is one) and zip the transaction along. There are other benefits as well. Grainger Consulting, which conducted its study for SAP, found that use of a business-to-business e-commerce system typically reduces ordering costs by one-third. Moreover, the study team projected that on-hand inventories of MRO items -- and, hence, inventory carrying costs -- would likely be reduced by 25%, since shorter fulfillment cycles reduce the temptation to overstock. W.W. Grainger, a $4.3 billion-a-year distributor of MRO supplies, keeps its industrial customers stocked from its 527 branches and distribution facilities in North America. It sends out more than 2 million copies of its printed industrial-supply catalog annually, but has also made the leap to the age of e-procurement. Grainger now offers an online catalog featuring more than 200,000 products that are typically kept in stock. Last November it launched a new service -- FindMRO -- to handle "spot" buys (unplanned purchases that aren't reflected in corporate contracts) where the source may be unknown to the buyer. The FindMRO service, which combines Internet, phone, and fax options, has access to a much more extensive database covering 12,000 suppliers and some 5 million products. To use the service, which is accessible with a standard browser, customers must first open a line of credit with Grainger, which handles the sourcing and fulfillment. In some cases, Grainger's sourcing specialists will conduct online searches to find items that aren't already in its database. "In effect, we become the customer's industrial personal shopper," explains Ron Paulson, FindMRO general manager. "We'll get back to the client on price and delivery within 24 hours." E-procurement Explosion Internet-based procurement is still a relatively new phenomenon and manufacturing firms have only begun to tap the potential it holds for cost reduction and other efficiencies. In large companies, full-blown e-procurement solutions can take a year or longer to implement -- with costs escalating into the $1 million to $2 million range. But the projected savings are expected to far outweigh the costs -- and that prospect has caught top management's attention. Before long, the volume of business-to-business transactions conducted over the Internet could dwarf the volume of business-to-consumer transactions by a factor of as much as 20 to 1, the Aberdeen Group estimates. And consultants at A.T. Kearney estimate that the world's 100 largest companies alone will be doing $400 billion in business-to-business transactions over the Internet by 2002. In a study that explored the procurement practices of more than 160 large corporations in 28 countries, A.T. Kearney found that, from 1998 to 2001, those companies planned to increase their external spending via the Internet by a whopping 1,000%. Released last October, the study projected that, within two years, Internet-based transactions would account for 25% of the external expenditures of many companies, compared with less than 2% last year. That startling growth curve prompted Tom Slaight, an A.T. Kearney vice president, to predict the demise of "the traditional procurement function," while the strategic component of procurement becomes elevated to the status of "a boardroom level competitive weapon." Supporting those conclusions were these study findngs:
  • Fully 76% of the CEOs in the participating companies foresaw procurement strategies contributing to shareholder value. (Three years earlier, only 12% had that vision.)
  • Over the next two years the surveyed companies expect to decrease their procurement headcount by roughly 25% -- eliminating personnel now required for traditional transaction processing. Content Management Key For firms planning to install e-procurement systems, buying a software package is only the first step. Integrating it with other IT systems can be a daunting task. Another challenge that must be resolved, particularly with respect to MRO supplies, is how to handle "content management" -- namely, creating and updating searchable catalogs containing descriptions and pricing information about various suppliers' products. One approach is to create the electronic catalog in-house, entering relevant data on various purchased items and structuring it in a way that simplifies searching and comparison shopping. This can be a time-consuming effort, especially for firms that deal with thousands of purchased items from numerous suppliers. Creating a catalog -- and reformatting supplier-provided data -- might require five or 10 full-time permanent employees, advises Terry Welty, marketing vice president at TPN Register, a joint-venture business-to-business service created by GE Information Services and Thomas Publishing, which publishes the Thomas Register of American Manufacturers. The task might be simplified by requiring all suppliers to provide their MRO product data in the same electronic format -- but such an approach is likely to encounter resistance, especially from smaller vendors who haven't gotten beyond the paper catalog stage. Moreover, the buying organization still has to gather the data, standardize it, and cope with such issues as data quality and ongoing maintenance, Welty points out. And suppliers who have the capability to provide the requested electronic format will likely "mark up their prices to cover the cost of their front-end labor." Another option is to subscribe to an electronic marketplace service -- an outfit like TPN Register, for example -- that specializes in content and contract management. "True electronic marketplace service vendors will handle the entire supplier engagement and acquisition process and host all supplier catalog content on behalf of the buyer and the supplier," explains a white paper prepared by TPN Register. "Suppliers need only provide their catalog data once, and the data can be repackaged and supplemented with contract-specific information for each new buying customer that joins the service. . . . Each buying organization has its own 'virtual' private catalog that combines seller's product data with that buyer's negotiated pricing (and contract terms)." Of course, there's an even simpler route: forego attempts to create a master catalog and require purchasing staffers to navigate online, from one supplier-hosted Web site to another, looking for the right item at the right price. But this approach hardly constitutes a savvy e-procurement strategy and isn't likely to reap the cost savings that many have envisioned. "Large corporate buyers with numerous contracted suppliers don't have time to visit each supplier's Web site to comparison shop," says Welty. "And most suppliers aren't able to display negotiated prices for each buyer or enable buyers to track their procurement expenses." Finding It Fast Clearly, companies must deal with a good many issues in developing e-procurement strategies -- including one that we've been barely touched on here: finding new suppliers or locating items that have never been purchased before. Which brings up that Alaskan bear that I mentioned early on.... During a phone conversation, Ron Paulson at FindMRO shared an anecdote about one of his service's clients -- a fellow who was working on the Alaskan pipeline and was worried about being attacked by wild bears. "He needed bear repellent," Paulson says. "We found a source of supply and had it delivered to him in about three days." The incident underscores a key point about the benefits of electronic procurement. It is not always a question of reducing costs and securing lower prices, Paulson points out. "Sometimes, it is more about availability -- and how soon they'll get the item."
    John H. Sheridan is a senior editor with IndustryWeek and IW Growing Companies.
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