Sun shines by combining two supplier strategies
Portal, reverse auction strategies drive communication and competition in the supply base
By David Hannon -- Purchasing, 5/6/2004 2:00:00 AM
Sun Microsystems, like a lot of high-tech companies, spent much of the mid-1990s outsourcing its manufacturing operations to electronics manufacturing services providers in the U.S. and abroad. The strategy was aimed at reducing costs but also increased the complexity of Sun's supply chain and made it more difficult to communicate supply and demand issues to suppliers throughout the tiers. The increased outsourcing and greater cost pressures from Sun's executives also left buyers concerned about the impact on its existing supplier relationships. It was a conflict of cooperation and competition, and balancing the two through a down market would be the biggest challenge facing Sun's procurement organization in the new millennium.
"As we outsourced more and more of our manufacturing, we found the ability to communicate with our supply chain partners became more important," says Kurt Doelling, vice president of supplier management and worldwide operations strategy. "We had gone from building 100% of our systems internally to building about 10% of our systems internally in a span of three years. That drove the need to communicate better with our supply chain partners. When we built everything internally and a plan changed, we could put the changes through our material requirements planning [MRP] system and the next day all the component suppliers would know about the plan changes. But now [after outsourcing most of its manufacturing] when we run changes in MRP, we send the plan changes to contract manufacturers building systems for us. Then they have to send the plan changes to their suppliers who may be building boards, and the board makers send the changes to the component suppliers. What used to be a one-step process suddenly has several steps or tiers in it and if you weren't really careful, those changes can take three or four weeks to get down the line."
At the same time, purchasing at Sun was being pressured by senior management to reduce costs and explore online reverse auctions. But the purchasing staff had serious concerns about the impact of reverse auctions on Sun's relationship with its rapidly dwindling supply base. Purchasing was being asked to reduce the number of suppliers, increase communication with the tiered supply base and reduce its costs using a technology unfamiliar to many buyers.
Communication
In an effort to minimize the negative impacts of the more complicated supply chain, Sun established its eOperations initiative with two primary goals. First, increase the effectiveness of supplier communication in the more complex, multi-tiered supply chains. Second, develop stronger partnerships with Sun's existing supply chain partners while making them more competitive for contracts.
The first thing Sun needed was an infrastructure to foster communication directly with its diverse supply base. Some suppliers were EDI-proficient and moving on to XML while others were not so advanced and needed a tool that worked only with a browser. To address these various levels of e-enablement, Sun created a portal framework that made it very easy for all suppliers and buyers to access the tools and information they needed. Information available on the portal is classified into several categories. There is public information targeted at companies that might want to be Sun suppliers. There is also information for existing Sun suppliers such as terms and conditions for doing business with Sun and specific contacts. And there is supplier-specific information like purchase orders and forecasts.
The entire portal framework was completed in about 18 months. Today, 40 suppliers use 18 different applications available through the portal, from demand planning to supplier performance to logistics tools. Before the portal, Sun used 27 different demand replenishment programs alone. With the portal in place, that number was reduced to three: one for raw materials, one for finished goods, and a third program called Supplier to Customer for shipping directly from a supplier to a customer without using a distribution center.
"We needed to provide planning information to suppliers at various levels with this system," says Doelling. "For example, a disk drive supplier wants to know how our plans for disk drives are changing, even though they are not selling the drives directly to Sun, but to a contract manufacturer. With the portal, they can still benefit from direct access to our plans, rather than wait for the information to filter through tiers."
A 30-day demand horizon report is available through the portal and updated several times throughout the day so suppliers cannot only use Sun's planning but also see how Sun is ordering its parts against that plan. The result has been a 50% reduction in inventory and a $500 million reduction in costs. Suppliers can make supply decisions well before Sun even places its orders.
"The demand horizon report gives suppliers the information they need to be more responsive both on the up side or the down side," says Doelling. "They don't have to wait for the plan to change because they can see that demand is coming in faster or slower than the plan and adjust their schedules to meet that change. We really ended up taking a lot of inventory out of the supply chain in aggregate instead of just moving it back to the suppliers."
Setting strategy
But by early 2000, with the portal strategy well on its way, Sun's purchasing organization was also getting a lot of pressure from CEO Scott McNeeley to reduce material costs through online reverse auctions (or dynamic bidding in Sun-speak). Sun's buyers were concerned that this strategy would conflict with the communication-based strategy that the portal was promoting to its suppliers.
"We kept saying reverse auctions would affect our supplier relationships negatively, but [McNeeley] kept the pressure on until we tried it," says Doelling.
Sun's first auctions targeted semi-custom parts such as custom cables and printed circuit boards. The advantage of the semi-custom parts is they can be specified clearly and easily, but there is not a broad market for them, so buyers can create a market and see greater margin reduction. Doelling says the commodity-type parts may be in a market where the margins are much thinner and the level of savings from a reverse auction would not be as high. Sun saw an eye-opening 30% savings on its early events using the FreeMarkets reverse auction tool.
The savings spoke for itself and the reverse auction strategy became a core tool for Sun buyers. But Doelling explains that "internal acceptance was difficult because people felt exposed, like they were putting supplier relationships at risk." To drive the most effective use of this tool across the organization, Sun recruited five "market makers" who could help buyers identify good targets for reverse auctions and work toward a successful result. Sun also set up an online checklist with several simple questions to help buyers determine if the market or commodity is suitable for a reverse auction.
The company moved about 20% of its spend onto reverse auctions fairly quickly. Over the next two years, it grew to 25%, or about $1 billion a year, which "seems to be about the right range for us," according to Doelling. Sun has piloted various other tools, but still uses FreeMarkets for most of its auction events. The spend areas targeted have included both direct and indirect areas such as freight, travel services, and call center services. In terms of number of events, Sun does more auctions with indirect and MRO than on direct, but from a total dollar level, direct is much larger.
The use of reverse auctions has not changed Sun's supply base dramatically (outsourcing manufacturing took care of most of that), but has increased the competition among existing suppliers. Doelling notes that there have been successful events with as few as three bidders. Sun has also pushed the use of reverse auctions into its supply base, actually holding events for tier one suppliers in areas like disk drives and memory while consulting with lower level suppliers on events for areas like packaging.
"We did have one supplier refuse to participate in an early auction event," Doelling reports. "And we have heard some people say that after a while, suppliers start to like the reverse auctions, but that has not been my experience. It's a transfer of margin from them to us so why should suppliers like it?"
House rules
In an effort to drive both internal compliance with the reverse auctions and minimize the negative impact on suppliers, Sun established some house rules on the use of reverse auctions. For example, in some of the early bidding events, Sun saw some suppliers become too aggressive and bid so low they could not meet the specifications in the contract. This strategy could produce major headaches down the road when the supplier fails to deliver and the contract has to be re-bid. Today, suppliers are much more familiar with the use of reverse auctions, but Doelling cautions there are still some rules to live by. Sun typically will not award an entire contract to a single supplier through an auction, but bids multi-source contracts with suppliers bidding on a certain percentage of business.
"Integrity is rule number one," he says. "Buyers should only invite suppliers that they would do business with in a non-auction environment and never use the auction as a benchmarking exercise. Second, things that are inadvisable in traditional sourcing are every bit as inadvisable in online events. We've all heard stories of a buyer finding a new low-cost supplier in a foreign market through a reverse auction that ended up shutting down the company's production lines. You would never source like that in a traditional environment, so you should not do it in the dynamic bidding environment. You need all the same qualification steps that you normally go through."
Doelling cautions that the resources targeted for the qualification process are often what get new auction users into trouble. A streamlined process does not mean that up-front work can be reduced—in fact, the up-front RFP work might take longer in an auction environment. "If you're negotiating terms of a contract after it's been awarded, you have no leverage," he says. "You've got to make sure you do it up front."
The savings gained in the first online reverse auctions typically produce one of two reactions by senior management, according to Doelling. Some managers or CFOs may see the level of savings and assume that buyers had not been doing an adequate job and punish those buyers. "Of course, if you do that, the results of your next event will probably not be quite as impressive because the buyer will not want to get the same treatment," says Doelling. "But if you reward those people that get you those results, the future events will continue to produce savings. Honestly, dynamic bidding produces similar results no matter who the buyer is, unlike traditional contract negotiations."
The future expansion of reverse auctions at Sun will likely focus on indirect spend areas and the integration of online bidding to Sun's ERP system. Sun is also keeping an eye on some of the new add-on technologies like optimization tools and scorecard tools, which may help expand the use of auctions into areas where they are not used today.
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