E-Sourcing's Next Wave

A growing number of businesses expect big savings from supplier-relationship management

InformationWeek Staff, Contributor

March 15, 2002

12 Min Read

Delta Airlines Inc. executives are glad they didn't call a halt to a critical procurement technology project last year, even as the economy fell into recession and IT budgets came under scrutiny. By the end of a troubled year for a very troubled industry, Delta had lost $1.2 billion. But the airline saved $65 million in the final three months of 2001 on its annual $9 billion in overall spending, thanks to a suite of supplier-relationship management tools that went live in October. "That's a big savings for us. It keeps things running just a little longer before the checkbook goes empty," says Rick Plasket, general manager for supply chain for the Atlanta airline. No one knows how long it will take Delta to get back in the black, but Plasket says the airline is just starting to slash costs using supplier-relationship management software from B2eMarkets Inc.

Delta used B2eMarkets software to get a handle on spending, Plasket says.

Delta joins a growing number of companies that expect big savings from taking their procurement operations to a new level of sophistication and automation. First-generation tools for automating procurement helped companies buy low-cost, non-strategic items, such as paper clips and pens, at the lowest price via electronic catalogs. Supplier-relationship management software is designed to manage the end-to-end contract buying of high-priced, high-value, strategic goods and services, including direct materials, which are the parts and materials used to manufacture products, and indirect materials, such as heavy machinery and factory equipment. Such spending accounts for about 80% of manufacturers' procurement costs, but only in the last few months have applications become robust enough to support contract buying of big-ticket items.

The timing is right for businesses struggling out of the economic slump but wary of the extent of the recovery, says Tim Minahan, Aberdeen Group's VP of supply-chain research. "Companies don't want to be caught flat-footed again," he says, "and this is one of the few ways to capture costs and get control over them."

Supplier-relationship management applications let companies issue requests for price quotes or proposals and execute non-catalog purchase-order-based procurement. They include built-in analytics tools to automate the evaluation of suppliers on criteria such as product quality, performance, reliability, and price, as well as to monitor internal compliance with procurement policy--all without having to manually create and run reports. These packages will lead the overall procurement market to more than double in size by 2003, to $9 billion, predicts Aberdeen Group. Vendors are primed for the pickup. This month, Ariba Inc. and Arrow Electronics Inc. will debut SRM tools, the Spend Management Suite and the Connectivity Dashboard, respectively. Commerce One Inc. and SAP, which previously partnered to deliver procurement applications, began offering separate SRM applications in January. Oracle shipped its 11i E-Business Suite procurement module earlier this year. PeopleSoft Inc. is set to ship SRM tools next month.

Without the built-in analysis these tools offer, it's hard to find out exactly how procurement dollars for strategic supplies are being spent, says David Heppenstall, associate director of global purchasing systems for Procter & Gamble Co. "This isn't the easy stuff, like office supplies, which are a lot of transactions but not a lot of dollars. These are the big opportunities," he says. The consumer-goods maker uses SAP software to buy high-tech equipment used to test the quality and safety of its products, as well as parts for factory equipment and facility maintenance. Until it began deploying an early version of the software, called Enterprise Buyer Professional, in late 2000, P&G had failed to adequately address more than $8 billion in annual spending for strategic indirect goods.

The company had negotiated contracts to receive lower prices for these supplies, but rogue spending was common. "For some R&D equipment and supplies, we had vendors going around telling employees they could use their company credit cards and get quicker delivery, but they didn't tell them they were selling at list price," Heppenstall says. P&G also didn't have a handle on how many suppliers had contracts to provide the same parts or equipment to different divisions or locations without offering a volume discount. And the company had never been able to track spending for which a contract hadn't been negotiated, and for which numerous suppliers were used, to see if it could save money by signing a single corporate contract at a better price.

The situation has improved in the divisions where P&G has implemented the SAP tools. The Cincinnati company realizes savings of up to 30% on items for which it previously hadn't negotiated contracts with any suppliers. When analysis of buying patterns showed that numerous divisions bought the same items from different suppliers--none of which had a contract with P&G--the company leveraged the buying power of all those divisions to negotiate discounted contracts with vendors that now are preferred suppliers.

"SAP's analytics make it pretty simple for us to spot trends in our spending where some kind of sourcing activity could help us leverage our spending power," says Heppenstall, who's evaluating the new SAP supplier-relationship management applications. P&G is midway through its deployment of Enterprise Buyer Professional and expects to provide all divisions with access to the SAP tools by the end of 2003. These SRM products are the first procurement tools to offer such in-depth analytical capabilities, Gartner analyst Karen Peterson says. Previously, procurement tools offered only general data query and reporting tools or weak analytics that prevented most companies from building a strategic-sourcing plan based on an accurate picture of their procurement without hiring expensive business process consultants, so problems such as rogue spending and ineffective use of buying power persisted.

Delta faced a situation in which many departments functioning autonomously at its hub, Atlanta's Hartsfield International Airport, were individually contracting for strategic supplies and services. "The left hand didn't know what the right hand was doing," Plasket says. "Technical people, engineers, tactical people, line supervisors, all were doing sourcing, signing contracts, and managing purchase orders."

Once Delta installed the B2eMarkets software, the airline quickly began to get a handle on its spending. One immediate benefit of the software's analysis tools was that Delta realized that it wasn't exploiting its buying power for a critical and costly service--securing contracts with hotels for pilots, flight attendants, and other employees. Hotel contracts may not be considered a strategic buy for every company, but with an average of 8,000 flight staff needing lodgings every night, it is for Delta. With that realization, Delta began to negotiate contracts aggressively rather than accept set-price services. Following negotiations with hotels all over the United States, Delta saved $11 million on rooms in the last three months of 2001 alone. It used B2eMarkets software to manage $900 million in spending during those three months, and, says Plasket, "in our evolution of strategic sourcing, we're still gaining momentum. By no means are we starting to slow down."

Delta's and P&G's experiences point out that very few companies have visibility into their spending, analyst Peterson says. Visibility is essential for highly critical purchases where price is only one factor in choosing a supplier, and a supplier's performance, delivery commitment, and quality records may be even more important. Companies may find that while they're better off centralizing information about procurement, they're not necessarily better off centralizing procurement. Companies can continue buying locally while formalizing the relationships local branches have with local suppliers or with local subsidiaries of large suppliers to take complexity and shipping costs out of the supply chain and more easily hold suppliers accountable for failing to meet contract obligations.

Analytical tools can also help companies make sure suppliers are honoring negotiated discounts, analyst Minahan says. It's common for companies to aggressively negotiate discounts based on the amount of business they do with a supplier, but too often, they don't have the tools that let them see when that discount is being adhered to. Such analytics are particularly valuable when multiple suppliers for a particular item are involved. If a manufacturer is, say, 100 pieces away from getting a discount with one of its secondary suppliers, it might prefer to place the next order with that supplier rather than with one with which it's not as close to getting a discounted price.

Companies buy few strategic goods or services using electronic catalogs, and previous procurement tools didn't have the ability to automate contract buying and negotiation. Managing the purchase-order process used for high-value goods at most companies today is labor-intensive, requiring procurement personnel to match contracts and purchase documents without the help of automated software tools.

That's been a problem at Dutch Railways NS, a $2.5 billion railroad company in Utrecht, the Netherlands. Ten percent of its spending is allocated for labor and services, but the labor office handles purchase orders manually, which causes a lot of errors due to problems with invoice mismatches. The company is upgrading to version 7.1 of Ariba Buyer, which has been enhanced to manage purchase-order-based procurement, and deploying Ariba Sourcing and Ariba Contracts, part of Ariba's new Spend Management suite. In the next 18 months, the suite will let the railroad manage half its $1.5 billion in annual spending, including labor and other strategic items, says Gijs van Rooijen, the railroad's procurement program manager.

Ariba's sourcing tools will let the company publish its requests for bids to its key suppliers online and help the railroad manage the process of selecting preferred suppliers using criteria such as supplier quality and performance, Van Rooijen says. Once a preferred supplier has been selected, Ariba's Sourcing and Contracts applications will help the company negotiate a contract electronically and then automate the process of buying from the contract. When a procurement manager issues a purchase order, it will be automatically linked to the appropriate contract and, once approved, will be transmitted electronically to the supplier.

ITT Industries Inc., a $4.8 billion engineering and manufacturing company in White Plains, N.Y., is investigating Commerce One 5.0, a new suite of applications that includes analytics, sourcing, contract management, and procurement tools, to begin automating the process of requesting proposals from suppliers for the tens of millions of dollars the company spends each year on materials and parts used in finished products. For example, the company might be able to negotiate a single contract for roll steel with a large producer that would let local operations issue a purchase order whenever they needed to take delivery.

The tools also would let the company have its primary suppliers manage the inventory of their products at ITT's facilities by allowing the company to specify maximum and minimum inventory levels and providing suppliers visibility into the company's current inventories. It's all part of a continuing plan to automate ITT's $900 million in annual spending for goods ranging from critical factory machines to PCs and office furniture. ITT has channeled about $35 million in spending on strategic items such as production machinery and a $500,000 order for office equipment through Commerce One's Enterprise Buyer Desktop software, which ITT deployed last year when it connected 50 U.S. operations with 28 of its most important suppliers.

The software has saved the company as much as 5% on contract items by eliminating rogue spending, and another 13% on spending for items for which ITT previously had no contract but has identified a primary supplier, says Tom Restaino, manager of E-business for ITT's shared services organization. But it hasn't been easy. "Historically, the company has grown by acquisition, and divisions and locations are diverse and autonomous," he says. "Getting everybody rolling in the same direction is difficult. But success will breed success."

Manufacturers' Services Ltd., an electronics manufacturer in Concord, Mass., with $1.52 billion in sales last year, plans to enhance electronic-catalog buying with automated negotiation and contract-management modules. Catalog buying is common in the high-tech industry, where more than 9 million commodity parts and suppliers are cataloged by vendors such as i2 Technologies Inc. But such companies also need to purchase custom-designed electronic components and strategic indirect materials such as manufacturing machinery. So Manufacturers' Services is testing i2's supplier-relationship management application to help it request bids from potential suppliers, negotiate contracts, and execute purchases from the contract, says John Boucher, VP for global supply-chain management.

Boucher estimates that better contracts and tighter controls on spending will help the company save about 10% of the $1 billion a year it spends for direct materials and strategic indirect goods. "These tools let us do things we couldn't do before," Boucher says.

Deploying supplier-relationship management solutions isn't without pain. Mark Steele, VP and director of purchasing and supply management at Kennametal Inc., a $1.8 billion-a-year Latrobe, Pa., metalworking tools and engineering services company, says one of the most daunting challenges he ever faced was cleaning the company's procurement data while Kennametal was building a data warehouse to manage spending. The same challenges await those using a packaged SRM tool.

Companies have to create and assign consistent codes to be used for their spending categories, but traditionally, many strategic parts and services they purchase may have gone under a variety of code numbers. Some companies decide to skip the process of cleaning up old data and start fresh with new codes when they install SRM packages. But there's a drawback: They forfeit the ability to use SRM tools to analyze historical spending activity until they have enough new procurement activity to be useful.

Whichever method a company uses, it must ensure employee compliance. Kennametal's Steele says some employees and procurement managers tried to subvert the company's old procurement system. Steele found that employees may not have known there was a company contract for what they were buying, or they may have preferred to deal with a trusted local supplier rather than the contract supplier. "Categorizing our spending correctly will create additional opportunities we can't see right now," says Steele, who adds that his company has been able to negotiate more favorable contracts with close to half of its 800 largest suppliers since building the database. "In many cases, we didn't realize how much we bought from a vendor," he says. "We were able to go to many of them and say, 'In order to retain that volume, what are you going to do for us?'"

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