Is B2B 4 U?

Given this mixture of intense competitive pressures, a turbulent marketplace, and widespread managerial hesitancy, what is the best way to begin moving forward toward making a decision about your company’s e-procurement strategy?

As always, one way is simply to look at the business case for e-procurement at an organizational level. It is worth noting that, for one thing, the return on investment for e-procurement tends to be much greater than any of the business improvement revolutions—business process reengineering, strategic sourcing, activity-based costing, ERP—that have preoccupied organizations for the past decade.

To understand why the return on investment for e-procurement can be so significant, it is first important to understand the sheer dollar magnitude of procurement-related activities in the average company. Doing this for indirect materials—office supplies, maintenance and repair parts and services, travel planning and booking, and so on—is much more straightforward, of course, than the infinitely more complex activities of the modern supply chain, which will be examined in more detail later.

There are at least two good ways to put your procurement spending in perspective. The first is simply to look at the percentage of total revenue that your company spends on non-production purchasing costs. Using this approach, the Center for Advanced Purchasing Studies estimates that the average company tends to spend 40% of its revenue on non-production purchasing, depending, of course, on the industry.^[24] W.W. Grainger sets the figure slightly higher, averaging nearer 60% of total expenditures.^[25] That means that for every dollar a firm earns, between 40 and 60 cents is spent on maintenance, repairs, office materials, and employee services.

Although a huge amount of money, these figures simply reflect the prices paid for goods and do not take into account the significant transaction costs associated with those purchases in terms of labor, time, and delays. In reality, price is neither the only nor the major component of cost to an organization when estimating procurement spending. In fact, a recent study by Group Trade concluded that although leveraging your buying power through online e-markets might reduce the price paid by 10% to 20%, the real value to the company—up to 70% of total savings—comes from savings realized through reducing transaction costs.^[26]

This tends to be one of the most pressing problems with large-scale procurement, generally. The fact is, without accurate, real-time decision support tools that can help a company to understand the underlying costs of the process—transaction costs, vendor delivery or quality issues—firms (and individual departments) far too often focus exclusively on price, many times at the expense of broader “value creation” opportunities. It is usually true in any endeavor: you get what you pay for, and a focus on price alone often results in ultimately higher costs because of unpredictability or poor supplier performance. This is particularly true in maintenance and direct material purchasing situations where certainty of the right materials, delivered at the right time to the right place, can be far more valuable than a lower price per high volume or per item. Too often, companies suffer through devastating delays, shutdowns, or recall situations simply because they have bought in bulk or for price (as many manufacturers have found to their frustration with recent purchases from unknown sellers completed through online exchanges). Equally, from a supplier’s perspective, adding value through quality services is much more profitable and predictable than a price race to the bottom.

More important, of course, is what level of savings organizations themselves can expect to make by eliminating slow, inaccurate, and costly paper-based processes. These savings are best measured in terms of transaction costs, which include things such as lost discounts and “maverick” buying, hours spent in supplier relationship management, time and labor hours spent in the paper-based order generation, requisitioning and approval process, quality assurance, returns, capital cost of warehouses’ excess inventory, carrying costs that come as a result of disconnected replenishment channels, shop-floor downtime from items needed but missing, and so on. These are the types of savings that should be measured into the equation to get an accurate picture of the scale of improvements that can come from fully automating this procurement process.

Looking at these transaction costs themselves provides a second way of gauging relative procurement costs. Even today, the vast majority of purchasing transactions of indirect materials is done in varying combinations of telephone (still used by 85% of companies), faxed orders (used by 65% of companies), or face-to-face discussions with suppliers (50% of companies). Using these slow and labor-intensive (if personal) methods, the average transaction cost tends to be somewhere between $80 and $110 for each order. The Aberdeen Group sets average indirect transaction costs at $107 per order. British Telecom set its average pre-e-procurement transaction cost at $80.^[27]

Although prices can be driven down through better vendor management, adherence to discounts, and the reduction of maverick buying, the big savings come through greatly reducing these transaction costs. To understand the scale of what automating your procurement process can do, consider data offered by those who have initiated strong e-procurement programs:

• British Telecoms claim to have cut their average transaction cost from $80 to $8 dollars on a volume of $1.3 million in transactions.^[28]

• The Aberdeen Group reports that e-procurement systems have dropped the average transaction cost for the companies they surveyed from $107 to $30, with a corresponding drop in average cycle time from 7.3 days to 2 days.^[29]

• IBM says that they cut the average cost of generating an order from $35 to less than a dollar.^[30]

• Raytheon Systems are predicting a reduction in the cost of their purchase orders from $100 per piece to less than $3.^[31]

• Microsoft reduced direct purchasing costs from $60 to $5, and claims to have reduced its purchasing department from 29 to 2 full-time purchasing employees.^[32]

• Companies report reducing transaction costs by as much as 75% over traditional phone or fax-based ordering.^[33]

• The Wall Street Journal sets the average cost of a paper-based purchase order at $150 and an e-commerce PO at $25.^[34]

These figures are especially impressive given that most e-procurement systems are still in their design infancy and involve only indirect goods. Companies have seldom integrated these systems well into their direct production purchasing processes—an area of enormous savings yet to come.

As astounding as the improvement in transaction costs appear, they are borne out by corresponding return on investment (ROI) figures. According to the Aberdeen Group, within the first full year of deployment, companies have been able to realize more than a 300 percent return on investment through Internet-based e-procurement systems.^[35] A study completed by Deloitte Consulting last year found that of over 200 organizations currently involved with e-procurement projects—with average implementation costs of between $2 and $4 million—reported savings averaged 9% over the first two years.^[36] A similar study by W.W. Grainger set an average ROI for buying companies installing e-procurement systems of between 245 and 400 percent. And although sellers showed much smaller returns of between 10% and 15%, through moving online, they were able to increase their sales by an average of 300%.^[37]

Few businessmen can be unmoved by figures like these, and yet many believe that the most significant long-term savings will come not from greater efficiency alone, but also from freeing up procurement employees from the drudgery of day-to-day transaction processing, and refocusing their talents on strategic sourcing activities. And, because of the nature of an all-inclusive e-procurement system, one of the most important benefits to be realized with automation of the procurement process is that, for the first time, an organization will be able to accurately track costs for labor, error reconciliation, lost orders, maverick buying, and delays in the process. One of the most telling revelations coming from the myriad of studies being done on this subject is that, incredibly, very few companies can provide accurate figures for money lost through noncontract or maverick buying, or calculate with any reasonable level of accuracy the volumes of spending per vendor on contracts that might allow them to negotiate improved terms or discounts. Large companies seldom can identify their suppliers across the entire enterprise or break down with any precision the nature of their spending with key suppliers or by operating divisions.

In short, companies that have invested strongly in e-procurement have not only found a significant return on their investment, but have come a long way in being able to get an accurate grasp on where and why they spend.

Finally, whatever the exact numbers, it is worth keeping in mind that savings from procurement costs can be applied directly to the bottom line, which in effect makes them more valuable than two to three times that amount in revenue growth alone. In fact, according to some studies, a 10% reduction in procurement costs can result in up to a nearly 50% rise in profit margin.^[38]

However we measure the potential savings, though, it is quickly becoming obvious that e-procurement is a viable and valuable new way of doing business, and although still in its early days, promises to be something that will soon be adopted by companies large and small. In this book, then, we work under the premise that not only can e-procurement be a valuable new opportunity for most organizations in the coming years, but that with the relentless push by software companies, powerful market creators, and government, the wide adoption of e-procurement is virtually inevitable. Accordingly, we will explore in this book the various important aspects of this new economic and business phenomenon in order to understand what it is and why it is important, and to help companies just beginning to anticipate the shift toward online purchasing to be able to move more quickly toward an e-procurement initiative—from strategy through implementation.