Web ordering, auctions will play limited role

The real payoff will be in e-sourcing and integrated information systems.

By -- Purchasing, 4/5/2001

When manufacturing companies saw how much they could save using e-procurement tools for MRO and office buys, they quickly started looking for ways to apply the same tools to their processes for buying production materials (often referred to as "direct spend").

Then-just as quickly-they hit a wall. Reason: "When e-procurement was introduced, [many of] the major players intended it to be used only on the indirect side," explains John Christensen, leader for the B2B practice at Deloitte Consulting, San Jose, Calif. "It was only when the demand arose on the direct side that they began looking at ways to expand the technology."

Jeff Zaniker, a partner with Accenture (formerly Andersen Consulting) says that automating procurement processes for manufacturing materials, components and subassemblies raises "a whole different set of issues that require different approaches and different capabilities."

For example, he notes that when people think of e-procurement, they tend to focus on transactional functions, such as shopping carts. "While these make sense for the indirect side, they are less appropriate on the direct side, due to the nature of the products being purchased," he says.

Tim Laseter, a vice president with Booz-Allen & Hamilton, McLean, Va., agrees. "Catalog procurement, for example, is very popular on the indirect side, but not on the direct side, because most direct materials are not cataloged items," Laseter says. "Even if direct materials were cataloged, I doubt catalog ordering would become popular on the direct side, because users would have to find a way to integrate the system into their various production planning and inventory systems."

E-auctions

Some manufacturing companies are successfully deploying electronic auction tools in their production purchasing processes, especially as the technology model has expanded to encompass total cost calculations rather than price only.

Tom Meisel, e-procurement manager, for Kingsport, Tenn.-based Eastman Chemical Co., says "On the direct side, we have purchased coal, some industrial gasses, and some chemical intermediates via reverse auctions." To conduct its auctions, Eastman uses ChemConnect, a third-party provider, for some events as well as an internal site, EastmanMarketplace.com, which is powered by Moai technology.

"In both cases, we are careful to use only pre-approved suppliers," emphasizes Meisel. "This is an ethical issue as much as anything. We don't want a supplier involved that is ultimately incapable of getting our business, allowing that supplier to bid lower than approved suppliers may be able to bid. We tell all of our suppliers in advance of an auction that all participants are approved and capable of getting our business."

To date, Eastman has conducted four or five exchange transactions using ChemConnect technology. "Exchanges have presented more of a challenge than we originally expected," admits Meisel. "For example, in posting a 'request to buy' on an exchange, we need assurance that material coming in will meet our quality requirements. We have been working with ChemConnect to address these quality issues."

Eastman also purchases large quantities of propane via another exchange, operated by Altra. "We have found this exchange works easier, because there is a lot of liquidity in this marketplace," notes Meisel. "There are enough buyers and sellers involved to create a very liquid exchange."

Another company involved in reverse auctioning for direct materials is Texas Instruments Inc., Dallas, Texas, which has been enjoying the benefits of indirect materials e-procurement for the past two years. "We are using the same philosophy on the direct side as we have been using on the indirect side," says Alan Daniel, procurement tools manager. "Once we understand the procurement process in terms of both current and future needs, we select e-procurement solutions that will maximize effectiveness of the process."

One of TI's strategies is to use the Internet to conduct online auctions for raw materials with qualified, preferred direct material suppliers. "We view these sourcing arrangements as long term, such as for a year's worth of volume, not for spot buys," explains Daniel."

Lennox Industries Inc., Carrolton, Texas, began using reverse auctions in mid-2000 on the direct side. "We purchase all of our ferrous metals this way," reports John Ireland, director, corporate materials.

Another company exploring reverse auctions for direct materials is Rohm & Haas, Philadelphia, Pa., where e-procurement strategies are part of a company-wide, global e-business strategy. "We have created a global e-transformation team, developed at the highest levels of the organization, to look at all of our global business processes and see how we can link our e-business initiatives to these global business processes," says Joe Pawlikowski, procurement manager, North American Region, for the company's Performance Polymers Business Group.

One initiative Rohm & Haas is using in the procurement area is the concept of "corporate trading rooms," operated by both ChemConnect and ChemMatch. "These are neutral e-marketplaces where we can conduct reverse auctions and other sourcing initiatives," says Pawlikowski. Rohm & Haas is actually involved in two different kinds of reverse auctions, which Pawlikowski describes as the "club" approach, where customers are allowed to select who is invited to participate in the auctions; and the "Wild West" approach, which is a spot market where customers can engage in price discovery and then work their way toward deals with a wider range of suppliers.

Web order entry

Another direct-side e-procurement initiative at Eastman Chemical involves ordering direct materials from suppliers who offer the capability through their Web sites. "There is some truth to the claim that using this technology doesn't add much value," agrees Meisel. "All it does is replace the phone or fax, and that doesn't save much time. In fact, this is one channel where we don't anticipate much in the way of cost savings."

Still, Meisel says there are two good reasons for forging ahead anyway. First, he says, there are minor benefits to the technology. "It saves a little time compared with the phone, because you don't end up chatting with the customer service rep about things like the weather. You can place orders 24-7. You can also track your orders, get product information, obtain Material Safety Data Sheets, and so on, all without having to place calls to customer service departments." Second, Eastman has made a conscious commitment to be a leader in the chemical industry in promoting e-business. "One way we can express this commitment is to work with suppliers in any way possible on e-procurement initiatives," he explains. "When suppliers notify us that they have Web ordering capabilities, we see it as a step toward moving them closer to full e-enablement."

The real opportunities

But while reverse electronic auctions and Web order entry can be useful in direct materials procurement, observers say the real benefits will come in the area of highly integrated and automated supply chain management.

"E-procurement on the direct side is really about collaborative tools for supply chain and data management," explains Zaniker. "These are tools that allow trading partners to work together to wring out supply chain inefficiencies. Examples include collaborative design, collaborative planning and collaborative manufacturing."

Laseter agrees. "Reverse-auction providers have already made a lot of headway into the direct-materials side," reports Laseter. "However, I have seen estimates suggesting that only about one-third of raw materials would be applicable for reverse-auction activity. E-sourcing is really about using the Internet to improve the strategic sourcing process," he says. "The focus here is not on price negotiations or transactions, but rather on how you go about developing strategies, conducting research, and engaging in design collaboration between and among companies. With emerging tools, multifunctional teams can collaborate on a global basis without ever having to meet face to face."

Along the same lines, massive opportunities exist for creating systems where production schedules and changes can be shared back and forth between customers and suppliers.

Public vs. private

Public trading exchanges are one model seeking to establish a big role in e-commerce relating to direct production materials. "These create hubs that allow participants-both customers and suppliers-to interact with each other, regardless of what kinds of different systems they may each have in-house," Laseter says. "They can share information because the exchange provides the translation mechanism."

But Laseter notes that "some companies have been reluctant to join these exchanges, because the fees can be high and companies also have some privacy concerns." In fact, it seems that quite a number of manufacturing companies may prefer the benefits of industry-led semi-private exchange networks. "Here," notes Laseter, "a handful of host companies [in an industry] implement software to create an exchange. A potential drawback to this approach is that it usually requires a big investment."

Still, the benefits of these investments seem to outweigh the potential disadvantages. "Most of our clients tell us that, until standards are in place and a good system is available on the direct side, they will continue to get involved with industry consortiums-private verticals-on the direct side," says Christensen.

One company finding success in this area is Rohm & Haas, which has become involved in an exchange in which participants link their transaction systems (from purchase order to payment) with their suppliers and customers. Rohm & Haas, as well as many of the other largest chemical companies in the world, are founding members of an independent, online, supply chain e-hub called Elemica, which links member companies on the transactional side, allowing them to conduct business with one another. "Once you contract with a supplier, you can conduct the transactional activity via Elemica," says Pawlikowski. Along the same lines, Rohm & Haas is involved in proprietary order transactions, using MySAP.com as its internal e-business ERP platform. "We route our orders through Elemica, which forwards them to our suppliers," he explains.

Production management systems

Communicating directly with suppliers on a daily basis to share production forecasts and schedules, engineering change notices, advanced shipping notices, etc. is probably the area with the greatest automation opportunities on the direct materials side of things. Some companies are even looking forward to systems that will integrate all systems in the supply chain-from order entry to payment.

Texas Instruments is investing in this challenging area of sharing information back and forth with its direct materials suppliers. "In the past two years, we have focused on MRO and other indirect materials, because the amount of work involved in these non-value-added PO transactions has been significant," notes Daniel. "Relatively speaking, the actual transactions involved for direct material are not as time-consuming as on the indirect side, either for us or for our suppliers. What does consume time, though, is the back-and-forth sharing of information." This involves detailed information between TI's ERP system (which is used to run the factory), and the supplier's system (which it uses to acquire parts, build products and supply TI).

Examples of information sharing include: TI's information on its production schedule, both parties' information on inventories, back-and-forth reporting metrics, and supply chain forecasting and supplier commitments. Daniel elaborates on the fourth: "We share detailed forecasts with suppliers," he explains. "After suppliers view these, they need to give us commitments, which we then load into our system and make the proper adjustments. These adjustments are ongoing, not a one-time event."

Currently, this back-and-forth transfer of information is handled largely via e-mail and spreadsheets. "These are not tied into our ERP system or our suppliers' systems," notes Daniel. "It still requires a person pulling information from the system and then using the 'fat finger interface' [typing the information] to turn it into an e-mail or spreadsheet."

TI's goal is to implement a system that can access information directly from its system and from supplier systems and share this information back and forth without the fat finger interface. "Some providers have the technology to move data back and forth between buyer and supplier, but the real challenge remains to be able to connect it directly to everyone's system," he adds.

TI could wait a couple of years until such technology is in place at other companies, and then play catch-up. However, the company prefers to adopt a leading-edge strategy. "It may involve some pain, but the benefits of being one of the first are greater than the possible challenges we will face," Daniel says.

AT & T, Basking Ridge, N.J., is another company that understands the benefits of linking processes electronically. "While indirect materials e-procurement is easier to do than direct, it doesn't get at the major issues," explains Debra Bell, chief procurement officer for AT & T, Supplier Management Division. "Buying direct goods has real impact on the strategic part of the business."

AT & T has had discussions with suppliers about their existing interfaces with AT & T and how these might change in the future in a Web-enabled fashion. "There is some complexity involved," admits Bell. "It's more than just the transactional activity involved in buying something." E-procurement of direct material has at least two additional challenges. One is linking up various business processes that are outside the procurement area, such as forecasting, planning, inventory and logistics. "That is, it involves more than just re-engineering the procurement process," notes Bell. "It involves re-engineering other processes."

A second challenge for AT & T relates to engineering activity, information and subsequent change orders. "This is especially prevalent in the configured-goods area," she notes.

Despite the challenges, AT & T has been moving forward in this strategy and anticipates rolling out a direct goods e-procurement solution by late 2001. "We will be procuring direct goods via a Web-enabled means, taking into account the necessary business processes as well as engineering activities," says Bell.

Potential savings? They're difficult to calculate at this point. "First, you can't estimate savings until you know your existing costs," explains Bell. "We have heard savings estimates of 20% to 40% as a result of minimizing inventory levels, reducing product cost via streamlined communications and planning paths, etc. However, since we already have some very sophisticated processes in place, we expect to see a lower level of savings," she notes.

Another company actively exploring opportunities in this area is Lennox Industries. "We have had EDI relationships with about 30 of our trading partners since the late 1980s," reports Ireland. "We communicate our anticipated needs to them and then firm them up as our actual demand materializes." Currently, though, the process is not a two-way street, where suppliers come back with advanced shipping notifications. "In addition, we are not using the system for invoicing, funds transfer, or other activities," adds Ireland.

In January 2000, though, Lennox's board issued a directive to take a new look at the company's e-commerce initiatives and create long- and short-term strategies, both for B2B and B2C. "Since I am in charge of direct materials, my initial focus is on B2B for direct materials," continues Ireland.

To move in this direction, the materials department met with its most significant trading partners and asked them for their input in terms of what was of value to them. "We want this initiative to be win-win," explains Ireland. The department also brought in representatives from other internal departments to discuss the features and functions they would like to see to optimize B2B. Departments included accounts payable, billing, customer service, etc. "We then created a strategy that will provide us with what we need to create these linkages and be able to transmit information effectively and efficiently."

Under the system, Lennox will generate forecasts and demand. This information will be forwarded online and on a real-time basis to participating suppliers. "The suppliers will use the information to schedule their shops, based on our needs," continues Ireland. Subsequently, suppliers will send back advanced-shipping notifications, which Lennox will use for payment of freight bills and also to generate receipts back at the point of use. "We will then report actual usage-a backflush of the bills of materials," he continues. At the end of each month, the system will be able to generate invoices on behalf of the internal users and forward this information to the payables file, which will then authorize electronic payment to the suppliers.

"We have already brought in our internal auditors to make sure we have an appropriate paper trail or alternate trail, to make sure they are comfortable with what we are planning to do," adds Ireland. "We hope to have the system up and running with five or six suppliers in beta phase by the end of the year."

Recommendations

When it comes to applying new technology to the direct materials spend, Laseter cautions that, "there are a lot of providers making a lot of promises. Be careful with your investment. Make sure you make the right investment at the right time in order to get the greatest payback."

One company that looks at provider offerings carefully is Eaton Corp., Cleveland, Ohio. "All of the providers say they offer savings in the procurement area," explains Stan Mickens, vice president of global procurement. "It can get confusing unless you have a model to which you can refer. When we get calls from providers, we first ask how they could fit into our operational and strategic plans."

Eaton plugs potential providers into different "boxes" to assess how well their offerings might meet the company's needs. "We look at hard savings and soft savings," reports Mickens. "We also look at the type of sourcing being impacted-whether it is tactical sourcing or strategic sourcing. For example, we may find that one provider offers hard savings in the tactical sourcing area." Eaton also "filters" providers through several features: pricing, engineering collaboration, productivity and supply chain management.

The future is now

Why is it so important to become involved in e-procurement on both the indirect and direct sides of the spending coin? "We see it as a requirement to maintain our competitive advantage," says Meisel. "We don't feel that companies really have a choice in the matter anymore. If you're not involved, you're going to get burned. Some companies say they plan to take a 'wait and see' attitude and get involved in the future. The problem is that, by the time you make the decision, you're already behind, because it will take at least a year or two to get up to speed once you make the decision. Things don't change overnight."

Jonathan Krum, general manager, procurement, for Bethlehem Steel, Bethlehem, Pa., agrees on the importance of moving ahead, despite the apparent challenges. "Right now, there are at least three things standing in the way of e-procurement on the direct side," he says. One is that the process will involve a complex model that will need standards, which are not yet in place. "A second is the technology tangle," he adds. "We are still waiting for a breakthrough model." Third, there are currently too many players, many of which will need to fall away. "We need to see a consolidation," he explains.

Despite the challenges, Bethlehem has no intention of being left behind as progress is being made. "We continue to create pilots in order to stay abreast," explains Krum. "We are also conducting in-depth analyses on a number of existing tools."

Krum says it's only a matter of time before significant progress is made in addressing the challenges of automating direct-spending processes. "Today, capital markets, in the form of money, move around the world at light speed," he explains. "This has been enabled by standards to which everyone agrees. I believe that goods and services can also be shot around the world just as effectively, once the standards are in place." This needs to be done via exchanges as well as directly among companies, according to Krum. "As a buyer, I want to see a business model that allows me to use exchanges and work directly with specific suppliers with whom I have good relationships." Krum also sees a time in the near future when a shakeout of the industry will occur.

"When the standards are in place, when the technology tangle is resolved, when the shakeout has taken place, and when the breakthrough model is introduced, we will be in a position to ramp up quickly, because we have been staying abreast of the changes as they occur," he adds. "We are waiting for that 'breakthrough' model to emerge, and we have our radar screen up so we will be able to recognize it quickly."