Big OEMs prefer private platforms

But public e-markets will carve out a role.

By -- Purchasing, 3/22/2001

In the past two years, big manufacturers have been experimenting with many of the e-sourcing and e-procurement technologies being offered through third-party (public) electronic marketplaces and trading exchanges. Now, it appears, they're taking the best of these technologies and going private.

This growing preference for private e-trading platforms is not quite a backlash against public e-markets, which are typically hosted by third parties and entice manufacturers to source with a variety of their member suppliers. But it does represent a shift from late 1999 and early 2000, when public online trading exchanges were being hyped heavily.

In fact, the level of direct procurement activity through independent online trading exchanges is nowhere near the level of expectations set about a year and a half ago. A recent reader benchmark study by PURCHASING Magazine finds only 16% of purchasing pros claiming to have joined a public trading exchange of any type. Among the 74% who say they don't participate in e-markets owned by third parties, only 22% think they might in the near future. (Complete survey results appear on pages S1-S6 of this supplement).

Bad assumptions

A problem is that large numbers of public trading exchanges have been built on the misguided assumptions that-

• Price is always the most important factor in manufacturers' procurement decisions, and

• Manufacturers are willing to sacrifice hard-won cooperative supply relationships on the altar of lower pricing.

PURCHASING 's benchmark reader study finds only 12% of purchasing pros doing reverse e-auctions at this time and only 4% participating in the types of e-markets that offer NASDAQ -style anonymous matching of buy and sell offers.

Dave Cotteleer, manager of planning and control, Harley-Davidson Motor Corp., speaks for many when he says: "[Electronic] auctions run counter to our strategy. We have an aversion to them and they won't play a role in our use of B2B exchanges."

Preferred suppliers

Public e-market makers also seem to have underestimated the sophistication of many manufacturing companies' supply management organizations in terms of their-

• General market expertise,

• Knowledge of the global supply base, and

• Progress in establishing strategic trust-based relationships with a select few critical suppliers.

The reality is that most OEMs in the U.S. have spent the last decade or so rationalizing their supply bases. They've explored suppliers' technology roadmaps, measured supplier performance from a total cost perspective, identified the most promising long-term supplier partners, and set up collaborative relationships aimed at designing better products and driving costs out of the supply chain.

Sun Microsystems, a computer manufacturer based in Palo Alto, Calif., is a case in point. Long before the B2B e-commerce frenzy began, Sun had already established relationships and set up initiatives with key suppliers for critical commodities. Sonia Syngal, director of procurement strategy for Sun, says the manufacturer spends 95% of its direct material budget with 40 established suppliers. So when public exchanges told Sun it could reach new suppliers, the manufacturer asked a simple question: Why? "There isn't a magical list of suppliers that we don't know about," says Syngal.

IBM takes a similar position. Pat Knight, vice president of strategy, transformation and procurement for the Armonk, N.Y.-based computer maker says the company has spent years cultivating strategic relationships with core suppliers and is not about to start from scratch using public electronic trading exchanges. "We now have a clear view of our supplier relationships," says Knight. "That's why we are where we are, and why we can't jump on a brand-new business model."

Toledo-based Dana Corp., a large automotive supplier, holds a seat on the supplier advisory council for Covisint, the mega online public trading exchange for the automotive industry. But, Doug Grimm, the company's vice president of global strategic sourcing, says Dana has so far used Covisint only for collaborative design efforts and has spent virtually no dollars there.

John Fontanella, senior analyst for B2B marketplaces at AMR Re-search in Boston, remarks that, "If you're a buyer, you've got qualified suppliers and you don't want to open up and purchase from unknown suppliers." Austin Whitehead, research director for Gartner in Stamford, Conn., agrees, noting that: "Companies understand the value of online information, but they want to work with trusted partners."

Big promises

Beyond their overemphasis on simple price discovery mechanisms and their under-emphasis on offering tools to cultivate strategic supply relationships, purchasing execs say third-party public trading exchanges have demonstrated other shortcomings as well. The worst offenses-

• They've been too aggressive, promising capabilities they can't deliver,

• They've failed to create an appropriate comfort level around security and privacy of critical data,

• They've been sold frequently as "free" to buying organizations, a pitch that falls on highly skeptical ears, and

• They've been criticized by suppliers for their propensity to aggregate and to "commoditize" sellers, forcing them to be comparable where real differentiation exists.

"A lot of public marketplaces went out and offered the world," says Whitehead. "They covered the biggest issues, but they didn't deliver."

"We found, in some cases, a lack of e-readiness," notes Dana's Grimm. "The inability to get a catalog up and running from a supply base was an issue in 2000." As well, Grimm says Dana, which might have turned to a public exchange for certain MRO supplies, was disappointed to find that standards offered for communicating with suppliers and manufacturers were not being widely used.

Perceived insecurity of critical data is another big issue for public trading exchanges to overcome. AMR's Fontanella says many public trading exchanges took painstaking steps to make sure that data would be protected, that both OEMs and suppliers could feel comfortable about the security and privacy of their information. "The good public exchanges took extraordinary security precautions. They know the value their client places on security," he says.

But Gartner's Whitehead says there's no way of completely securing data in an open-exchange environment and suggests that the creators of public exchanges may have underestimated most companies' willingness to risk the potential exposure of their data to competitors.

"Until now," he says, "companies have always had human intervention. They could say, 'We can't give you that.'" But regardless of the technology in place, Whitehead says companies participating in public e-markets face a risk that "somebody is going to get [their data]."

"If there were a breech in a file exchange or in development plans, it would be devastating to our company," remarks Harley Davidson's Cotteleer.

Likewise, Syngal says Sun Microsystems simply could not be convinced that its data could be protected from competitors and says the company's suppliers share similar concerns. "We spoke with our suppliers, and what we saw [on the public exchange] was the sharing of highly proprietary information with our competitors."

Adds Kevin Carroll, Sun's vice president of supply management: "There are certain things a company does in terms of aligning itself with a supply base and the information passing back and forth is confidential." While e-market makers promise complete security, Carroll says, "In the end they have enough information to build a directory on you. You have to think about that."

IBM's Knight says the company searched unsuccessfully for proof that its data would be secure in a public exchange environment. "Anyone who will host an exchange will have to demonstrate security and privacy," says Knight. "Whoever will deliver needs to understand that buyers and sellers must have regard for security and privacy."

No free lunch

Too often, as well, the business model for public exchanges has been to offer e-buying functionality "free" of charge to buyers, and to charge suppliers a commission on every sale-a small percentage that supposedly pales in comparison to the amount they would spend to make a new sale the old-fashioned way. But purchasing pros are, by nature, a skeptical bunch, especially when someone offers something for free.

Says IBM's Knight: "[Net] marketplaces are a tough sell to a procurement person. Very rarely have I found much that is free in my experience."

Jack Shipe, UNISYS 'director of business effectiveness for global procurement, says much the same thing: "Nothing is free. Any time you inject a third party into a purchasing process, there's guaranteed to be incremental costs somewhere."

What's more, Harley Davidson's Cotteleer says he's seen no real evidence that suppliers are realizing large bottom-line cost savings from their participation in e-markets. "This is the big pitch from some companies. They say suppliers can get so much more efficient and, 'Look at the savings they've generated!' But I've been shown no empirical evidence supporting these claims."

Going private

But while large manufacturing companies have largely shunned public electronic trading exchanges, they're still hot on many elements of the technology for e-buying and e-sourcing because they recognize that online connectivity with suppliers can streamline procurement processes, allow for online inventory management, improve communications, and drive costs out of the supply chain for good.

Gartner's Whitehead suggests that manufacturers may have joined public e-markets as "a cheap way to learn the major issues" in B2B e-commerce. But, ultimately, he says, "People wanted to go back to a steady state. They experimented, and then asked, 'How can I use this technology to continue doing business the way that I did before? Which is to say, to work with strategic suppliers."

The result of this thinking is that many manufacturers are now busy assembling the best e-commerce technologies into private electronic platforms for working with and managing transactions among their preferred supply bases.

IBM, for example, has the IBM Supply Portal, which connects the computer maker with 24,000 first- and second-tier suppliers. IBM set up the portal with Ariba and i2, and uses it for all of its procurement. Through the portal, IBM takes quotes, conducts graphic interchange, and handles supply-demand forecasting, purchase orders and invoices.

Knight says the private marketplace allows IBM to work securely with its suppliers. It can negotiate with them, create contracts and POs and collect invoices-functions that, Knight says, could not be accomplished with preferred suppliers in a public-exchange format.

Dana Corp. is developing its own private electronic trading exchange as well. At present, it purchases non-production or indirect materials through an Ariba-powered exchange, but this is only a start. The strategic vision, Grimm says, is to have an aggressive private exchange network setup by 2005 with e-sourcing capability that will also handle data aggregation, financial systems, etc.

Grimm says Dana will purchase the necessary tools from FreeMarkets to set up online purchasing for both direct and indirect goods and services. The company is also setting up an online inventory portal called SupplySolution, which will provide suppliers with real-time online access to Dana's parts inventory. "This is so we won't have to prompt them every minute of the day," Grimm says. The goal is to have 100% connectivity with tier-one suppliers, 32% connectivity with tier-two suppliers, and probably less than 10% connectivity with tier-three suppliers. "It will help us get to just-in-time manufacturing sequences and parts delivery," Grimm says.

Sun Microsystems has developed a private trading platform using a variety of technology providers, including FreeMarkets, Commerce One and Ariba. The company hasn't purchased software for the private exchange, but has negotiated limited-term contracts with FreeMarkets, which is hosting the platform.

Sun uses its six-month-old exchange to buy direct materials, including printed circuit boards, disk drives, cables and mechanical enclosures. The company also is using the exchange to purchase some MRO items. Syngal says Sun uses dynamic bidding to make better sourcing decisions, drive robust RFPs, connect with strategic trading partners, and participate in online bidding events. Already, she says, the company has conducted $400 million worth of business through its trading platform, reaching targeted savings goals of 20%.

Harley-Davidson remains in the decision-making stage. Cotteleer says any exchange activity will most likely be private and will be directed at the tier-two MRO area.

UNISYS is yet to be sold on the benefits of e-trading exchanges at all. Shipe says the Blue Bell, Pa.-based information services company and computer parts manufacturer is involved in neither public nor private online trading exchanges at this time, and the reason, he says, boils down to cost. "If we wanted to go to an exchange, I think we'd look at exchanges for office supplies, MRO-related products," says Shipe. "But we've found that the incremental cost of participating in an exchange like that is prohibitive, both for private and public."

And Shipe certainly has a point. AMR Research predicts that private exchanges will represent a huge market for suppliers during the next four years, acting as a funnel for an estimated $58 billion in aggregated spending. But to get there, OEMs will spend an estimated $8 billion for the software applications necessary to set up the exchanges. Larger companies can spend between $35 and $40 million to set up a private trading exchange. Midsize companies might spend $5 to $10 million.

A role for public

Even if they don't offer the sorts of strategic sourcing opportunities that major manufacturers say they're seeking, public online trading exchanges are not likely to go away, analysts say. Indeed, the two e-business models are expected to coexist, simply playing different roles.

"It might appear that it's a battle, that people are thinking it's going to be an either/or situation," says AMR's Fontanella.

He and other analysts believe that smaller manufacturers will use public online marketplaces as a way to quickly gain marketing exposure and to obtain functionality they couldn't otherwise afford.

They say public ex-changes will also offer larger companies the ability to find new suppliers when old business relationships break down, source for new product lines, make spot buys, and obtain pricing information against which to benchmark their existing long-term supply relationships. As well, Fontanella believes that larger companies will occasionally turn to public exchanges to focus on specific markets that they might not be able to access through their private exchanges.

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