Strategic Sourcing: Getting your hands around direct materials procurement
New e-procurement applications can provide a competitive edge
By Sidney Hill, Jr., Executive Editor -- Manufacturing Business Technology, 1/1/2001 7:00:00 AM
When he agreed to test a new e-procurement system, Robert de Neve expected the normal efficiency boosts and cost-savings that come from automating manual processes. Now, roughly six months later, de Neve sees his company's procurement processes becoming a strategic weapon.
de Neve is vice president and general manager of the OEM Systems Division of PRI Automation, a $300-million-a-year supplier of equipment used in semiconductor manufacturing. The OEM Systems Division, based in Mountain View, Calif., makes robotics and other automation systems that are used primarily for the careful handling of the wafers on which semiconductors are mounted.
Since last summer, de Neve's division has been purchasing select production-related components through an Internet-based procurement service. "Initially, we were sold on the concept of saving money by eliminating errors in the procurement process," de Neve says of the decision to try the service. "But as we started working with it, we saw additional benefits."
Those benefits include a sharp reduction in the time it takes to build prototypes, which is a critical exercise for all suppliers of semiconductor manufacturing equipment. Prototypes are built so customers can compare competing designs before selecting a supplier for a specific product. And de Neve says, "Delivering your prototype first can be the difference between winning or losing a competition in which millions of dollars in revenue are at stake."
By expanding the use of this e-procurement service, de Neve expects PRI Automation to establish a reputation for delivering prototypes quickly. He also expects to further impress customers with the quality of those prototypes as the new e-procurement service fosters the purchase of components that fit together and work correctly the first time around.
This service is designed specifically for companies that want to buy or sell production-related components-which in industry lexicon are known as direct materials-over the Internet.
A market blossoms
Up to now, e-procurement has revolved around using the Internet to purchase office supplies or parts used in maintenance and repair operations-the so-called indirect materials. Such initiatives have proven to be tremendous cost savers, with some early adopters reporting 300 percent returns on their investments in the first year. But that may be just the beginning when it comes to the benefits that can be derived from e-procurement.
As PRI Automation has learned, manufacturers can actually capture a competitive edge by purchasing the right set of direct materials over the Internet, which is why that process is sometimes referred to as strategic sourcing. It also is why strategic sourcing is destined to become a widespread business practice.
"The market for strategic sourcing software and services will be in the $2.5-billion to $3-billion range by 2003," says Pierre Mitchell, e-commerce research director for Boston-based analyst firm AMR Research. Mitchell expects this market to blossom as more companies realize that strategic sourcing applications can help them identify and develop relationships with suppliers they can rely on to support a build-to-order manufacturing style.
Strategic sourcing applications enable the automatic generation of requests for quotes (RFQ), as well as transmission of electronic copies of those RFQs to a selected group of suppliers. But their most valuable characteristic may be the ability to support real-time collaboration between trading partners on critical factors such as product designs.
Some industry experts say strategic sourcing represents the third generation of e-procurement. Companies like Ariba, Mountain View, Calif. and Commerce One, Pleasanton, Calif., ushered in the first generation of e-procurement with the introduction of systems designed primarily to automate the execution of purchase orders for standard products selected from catalogs. In addition to speeding up such transactions, these systems gave procurement managers the ability to control costs by establishing and enforcing rules about who could purchase certain items, and which suppliers they could purchased those items from.
The movement to trading exchanges, which also has been led by Ariba and Commerce One, is considered the second generation of e-procurement. Trading exchanges have enabled companies to secure lower prices for goods either by aggregating their buying power with other companies to gain volume discounts, or by pitting suppliers against one another in processes known as reverse auctions.
A new set of vendors
In a reverse auction, the buying company posts the items it wishes to purchase on an electronic messaging system run by an exchange operator. Suppliers that have registered with the exchange then offer to sell those items to the buyer at specified prices. In most cases, the supplier offering the lowest price wins the business.
Mitchell says first- and second-generation procurement systems quickly became popular with buyers because of their potential to produce quick savings, "but these systems have very little strategic impact on a business."
In the near term at least, analysts expect the strategic sourcing space to be populated by a collection of smaller vendors offering what might be considered point solutions rather than the handful of large vendors that have dominated the e-procurement arena. Ariba has entered the strategic sourcing space by purchasing SupplierMarket.com, an Internet-based direct materials e-procurement service.
Following the purchase, which took place last June, SupplierMarket.com was renamed Ariba Sourcing. It is now part of the Ariba Commerce Service Network, which is a broad-based platform of technology and services for conducting business-to-business electronic commerce. The key feature of the Ariba Sourcing service is a capability called Smart Match that provides buyers an instant list of suppliers that have demonstrated the capability to deliver products that comply with the specifications contained within the buyer's RFQ. Ariba Sourcing also provides capabilities for generating RFQs in addition to hosting online auctions.
The other large vendors that offer e-procurement functionality include RightWorks, San Jose, Calif.; Peregrine Systems, San Diego; and Oracle Corp.; Redwood Shores, Calif., as well as Commerce One. These vendors all claim to have direct materials procurement or strategic sourcing capabilities, but they continue to devote most of their resources to developing large business-to-business trading exchanges. And so far, most of the transactions taking place on those exchanges involve the purchase of indirect materials.
A natural migration
This situation has left an opening for a host of new e-procurement players. The new market entrants include a number of recent startups, as well as some vendors that have migrated from other application spaces. "We are seeing vendors from various application classes converging around strategic sourcing," AMR's Mitchell says. "That includes suppliers of product data management (PDM), as well as vendors that offer tools for building private trading exchanges."
The strategic sourcing space is a natural migration point for product data management vendors because they are experienced at helping trading partners exchange the type of data-specifically engineering drawings and bills of material-that is needed to complete transactions involving direct materials. The PDM vendors that now offer strategic sourcing solutions include Parametric Technology, also known as PTC, of Waltham, Mass., Digital Paper, Arlington, Va., and Agile Software, San Jose, Calif., which now refers to itself as a supplier of collaborative product commerce applications.
The recent startups that have entered the strategic sourcing space include BlackHog, the Sunnyvale, Calif., company that operates PRI Automation's e-procurement service, as well as SupplyWorks, Bedford, Mass, and Moai Technologies, which is based in San Francisco.
Each of these vendors approaches strategic sourcing from a slightly different angle, but they all provide some capability to link their products to backend systems that contain product-related data, which is the essence of a strategic sourcing application.
BlackHog is not only focused on providing strategic sourcing capabilities; it also is devoted to building solutions specifically for companies that make complex capital equipment.
BlackHog owes its singular focus to its three founders, all of whom are former executives with companies that manufacture capital equipment. Jeff Donnelley, the president and (CEO), says BlackHog's e-procurement service addresses the issues he found most frustrating while working in various sales and marketing positions within the semiconductor equipment industry.
Eases frustration
"The procurement process was always a source of frustration," he says, "because it was slow and error prone and it affected my ability to meet commitments to customers." The obvious solution was to automate the process, but Donnelley says BlackHog went a step further.
"We spent hundreds of hours talking with buyers and suppliers, trying to understand the types of information they handle, and who they communicate with," Donnelley says. "We also found out what forms or spreadsheets they used to organize information. In essence, we took every manual process that had been taking place between companies over the years and put them into a Web-based collaboration and communications system."
BlackHog calls its service Clear Link. The developers' familiarity with the semiconductor equipment industry is evident in the way the service is designed, according to de Neve. "They designed this service exactly the way I would have," de Neve says. "It was built by buyers for buyers."
The PRI Automation buyers that use this service work in front of a computer screen that de Neve says resembles a cockpit. "When you log on, the system gives you a list of alerts that tell you what items you need to order," he says. At the bottom of that list are two buttons labeled, Create RFQ and Create Order.
Clicking the Create RFQ button sends the user to a master list of PRI Automation's suppliers. The buyer then selects the suppliers that they want to receive a specific RFQ. They also attach any supporting documents they wish to send, such as engineering drawings or terms and conditions, before sending the transmission. The RFQ is then posted to a secure Web page on the Clear Link network that can only be accessed by suppliers approved by PRI Automation.
When suppliers respond to an RFQ, buyers can easily see any proposed changes because the system highlights anything that differs from the original transmission. Donnelley says that feature makes it easier for buyers to compare quotes from various suppliers. Once a supplier is selected, the buyer can click the Create Order button to begin converting the quote into an actual order.
A foolproof system
Currently, PRI Automation is using the Clear Link service solely to purchase pre-production parts. That represents roughly 20 percent of the parts purchased by the OEM Systems Division. But de Neve says the division will be using the service for 80 percent of its purchases-including purchases of production parts-within the next six months.
"This system is foolproof in terms of eliminating errors that used to hinder quality or delay delivery of products," de Neve says. "But the benefits don't end there. We expect to improve the efficiency of our entire supply chain. We expect our business to double over the next several years, and we will be able to accommodate that growth without doubling our staff of buyers. We also will be able to get by with fewer quality engineers as our scrap rates go down and the quality of our products go up, because we will be buying parts that fit better and work better."
Grove Worldwide, a manufacturer of construction cranes and aerial work platforms based in Shady Grove, Pa., turned to Digital Paper, its existing PDM supplier, when it decided to streamline its direct materials procurement process. Digital Paper offers an application called docQuest Market that allows buyers to pull engineering data from their company's backend systems to create RFQs on the fly. This application helped Grove Worldwide shorten the time it takes to assemble RFQs from more than two weeks to less than three minutes.
The first step in this transformation was converting more than 5,000 existing paper documents to electronic files, according to Dieter Radamacher, Grove's director of procurement. Once that was accomplished, the docQuest Market application provided the capability to transfer copies of those files, as well new files created in Grove's computer-aided design (CAD) and enterprise resources planning (ERP) systems, directly into an RFQ template.
Once an RFQ is assembled, it can be posted to a secure Web site for suppliers to review. At that point, Grove's buyers can hold discussions about any aspect of the RFQ with individual suppliers via e-mail.
In addition to shortening Grove's entire procurement cycle, this system has enabled Grove to reassign 12 people who were responsible for maintaining paper drawings and three others who were devoted to creating paper RFQ packages. The system also allows Grove to present its RFQs to a larger number of suppliers, but Radamacher says Grove is not interested in subjecting suppliers to an auction process.
Expanding possibilities
"We want to expand our universe of potential suppliers," Radamacher says, "but we are going after value in that regard. We won't select suppliers based solely on price. We want to make sure that anyone we do business with has all of the qualities of a good supplier, including the ability to consistently deliver quality products on time."
Moai Technologies sells software that gives companies options for how they want to secure components. They can hold simple reverse auctions in which they seek the lowest possible price, or they can engage in "structured negotiations" with a set number of suppliers whose bids will be judged on criteria other than price.
"Our focus is bringing the negotiation process to the Internet," says Matt Miller, Moai's CEO. "The first iteration of that was the simplest form of negotiations-the reverse auction. That works well for simple commodities, but it doesn't work well for strategic raw materials."
Miller says Moai's software, which is called Live Exchange, is designed to let companies build private trading exchanges. He also says the software is becoming popular with companies that "want to model the way purchasing managers negotiate."
Typically, these negotiations start with a purchasing agent sending an RFQ, via e-mail, to a select group of companies that supply a particular item. The RFQ will also include a notice of the date and time that the buying company will accept bids for that business, along with a Web address and a user name and password that let each supplier access a special bidding page.
"There may also be a half-hour phone session with each supplier, explaining how to insert prices and other terms on the bidding screen," Miller says. The actual bidding lasts about two hours. During that time, buyers can funnel all communications into a special Moai application that generates a score for each supplier.
Does price really matter?
When the bidding starts, each supplier is asked to submit a price, and those suppliers that submit an acceptable price will be asked to continue to the second round. At that point, other criteria, such as adherence to product specifications listed in the RFQ, come into play. Miller says the buying company typically assigns a certain weight to various factors, "and a supplier's credibility, based on past experience, usually carries a lot of weight.
"Cost is typically no more than 60 percent of the criteria for buying," Miller adds. "The real objective is providing a means of engaging in structured negotiations." Part of that is providing access to product-related data and allowing trading partners to collaborate in real-time.
SupplyWorks also offers a platform for building trading exchanges. But Jeff Herman, the company's CEO, says SupplyWorks is focused exclusively on building exchanges that can solidify relationships among existing trading partners. "We assume that direct materials procurement involves long-term business partners," Herman says. "And the emphasis is on streamlining the day-to-day execution of those relationships, not constantly replacing them with someone whose price is slightly lower."
To that end, SupplyWorks is encouraging companies to link its SupplyWorks Max e-procurement package directly to their supply chain management applications and enterprise systems. With that type of integration, Herman says, companies could automatically convert their production plans into procurement plans. They also would be able to share planning data with their suppliers.
Ultimately, Herman envisions SupplyWorks customers building trading hubs that allow suppliers to log in and not only find out how much of a given component customers need, but also exactly when they plan to use each component. Access to that information would let the suppliers know whether they need to take extra measures to deliver a complete allotment of a given product by a certain date, or if they can stagger the delivery without disrupting customers' manufacturing schedules.
"When you communicate strictly by purchase order, your supplier doesn't gain that knowledge," Herman says. "We would like to create an environment without purchase orders that enables the sharing of that knowledge.
"Think about what customer relationship management [CRM] applications have done on the front end of manufacturing organizations," Herman continues. "They have allowed companies to build relationships with their customers. We want to do the same thing on the backend, enabling companies to build better relationships with their suppliers."
A farewell to 'buy-side'
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