Chapter 7 Procurement and Outsourcing

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Chapter 7Procurement and Outsourcing

• Qi Xu
• Professor of Donghua University
• Tel [phone]
• E-mail xuqi_at_dhu.edu.cn

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Outline
Case FreeMarkets Online
Section I
Section II
Procurement
Outsourcing
Section III
Section IV
Section V
3
FreeMarkets Online

• FreeMarkets is an online market making firm that
  enabled industrial buyers to link up with their
  potential suppliers in a live electronic bidding
• The end result of such interaction among a
  network of suppliers was procurement cost savings
  of about 15 for the buyers
• The company was founded in 1995 and was on the
  verge of breaking even in 1998
• It was expecting to receive commissions and fees
  of nearly 6 million for arranging procurement of
  200 million worth of industrial components and
  parts

4

• FreeMarkets????
• 95??????,???Meakem?
• ??????????????,?????????6000????????
• ???????????????????????????????,?????????????????
  ????????????,??????????????????
• FreeMarkets???????????

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The Move to B2B Commerce
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B2B is Huge...
Source Forrester Research, Inc.
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Highly Fragmented

• Most product categories are highly fragmented,
  with numerous suppliers each offering different
  level of quality, service and pricing options
• Buyers incur significant cost in the actual
  purchase process
• A buyer must invest internal resources to manage
  the process of collecting, analyzing and acting
  upon all the information in the market
• In addition to purchase price companies spend
  over 10 in additional procurement costs
• On the suppliers side, there are significant
  costs in using the manufacturing reps
• These commissions range from 4 to 7 of purchase
  price

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How Does FreeMarkets Online Create Value for its
Customers?

• Consulting/Purchase outsourcing
• Distribution Intermediary
• Network Enabler/Software Provider
• Putting together specs, drawings, lot sizes,
  documentation and RFQs????
• Identifying potential savings opportunities
• Identifying and qualifying suppliers
• Educating and training buyers
• Conducting the Competitive Bidding Event (CBE)
• Providing post bid analysis and support

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How Does FreeMarkets Online Create Value for its
Customers?

• Consulting/Purchase outsourcing
• Distribution Intermediary

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Traditional B2B Trading Exchanges
11
Internet Based B2B Trading Exchanges
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How Does FreeMarkets Online Create Value for its
Customers?

• Consulting/Purchase outsourcing
• Distribution Intermediary
• Network Enabler/Software Provider

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Which suppliers benefit from this model?

• Low cost, quality suppliers will benefit as they
  drive competition out of the market
• The FreeMarkets model would be beneficial for
  large more efficient suppliers
• It will also provide opportunities for a host of
  small suppliers, especially if they are located
  overseas

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The Revenue Model

• A hybrid of service fees and sales commissions??
• FreeMarkets charged monthly fee from the buyer
  based on the size of the market making team
  dedicated to the event
• Winning supplier paid sales commissions this was
  paid in installments as suppliers shipped
  products
• ????????????,?????????????????

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Problems with the revenue model

• Buyer side
• FreeMarkets invests substantially in a project
• Consulting revenue is independent of the value
  created
• Does not lead to another intensive purchasing
  study for the customer
• Gross margin on consulting is about 22
• Supplier side
• FreeMarkets does not represent the supplier
• FreeMarkets success depends on their ability to
  identify many potential suppliers
• Suppliers pay commissions to the company that
  reduced their margins

16
Vertical vs Horizontal Focus?
??????????

• Vertical
• Advantage FreeMarkets can capitalize on its deep
  knowledge of supplier industries
• Disadvantage Hard to scale-up
• Horizontal
• Advantage Ability to generate multiple contracts
  from one buyers
• Disadvantage FreeMarkets does not bring much
  expertise to the transaction

17
By the end of 1998

• FreeMarkets was pursuing the horizontal market
  expansion
• In 2000, the company started licensing its
  software

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The company went public in 12/99...
Freemarkets Stock Price
19

• ?95????97??,?????15????????38?????????,??40???????
  ??7000????????,?????1?????43???????

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Where is FreeMarkets today?

• For the three months ended in 3/31/01
• Revenue totaled 33M
• Net loss(???) totaled 43.7M
• For the three months ended in 12/31/01
• Revenue totaled 44.8M
• Net loss totaled 2.8M

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E-Marketplaces The Initial (95-99) business model

• The e-marketplace concept started as a new way to
  procure products.
• E-marketplaces
• Expand everyones market reach
• Generate lower price for the buyers
• Cut operational costs for buyers and suppliers
• Automating the procurement process will reduce
  processing cost per order from as high as 150 to
  as low as 5 per order
• Focus on liquidity
• Transaction fee paid by the suppliers
• Serve as a virtual distributor

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Consider Instill Corp.

• Instill.com focuses on the food service industry
  and provides an infrastructure which links
  together operators, i.e., restaurants,
  distributors and manufacturers. This
  e-marketplace provides value to its customers by
  offering not only procurement services, but also
  forecasting, collaboration and replenishment
  tools.

23

• Instill.com?????????,?????????????????????????????
  ??????????????????

24
Consider eSkye.com

• In the alcoholic beverage industry, eSkye has
  tailored an offering that provides the supply
  chain with real value. eSkye now links retail
  stores, distributors and suppliers providing
  visibility into a supply chain where little data
  existed. eSkye adds value by automating the
  ordering process for the retailer while providing
  product flow information to distributors and
  suppliers.
• ?????,eSkye??????????????????,eSkye???????????
  ?????,?????????????????eSkye????????????????,?????
  ?????????????

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E-Marketplaces???????

• Private e-Markets ???
• Consortia-based e-markets ???
• Content based e-markets ???

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Evolving Market Types
???????

• Private e-Markets
• Valuechain.Dell.com (Dell), eHub (Cisco)
• IBM, Sun Microsystems and Wal-Mart
• These companies use the marketplace to improve
  supply chain collaboration
• Providing suppliers with demand information and
  production data

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Evolving Market Types

• Consortia-based e-markets
• Covisint (automotive) Trade-Ranger (oil)
  Omnexus (chemicals) e2Open and Converge
  (high-tech)
• Objective of the consortia is
• Aggregate activities and use the buying power of
  consortia members
• Provide suppliers with standard systems that
  support all buyers and allows suppliers to reduce
  cost

• ??????,???????????
• ??????????,??????,?????????

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Evolving Market Types

• Content based e-markets.
• Focus on Maintenance, Repair and Operations (MRO)
  goods
• These are components that are not part of the
  finished product or the manufacturing process but
  are essential for the business
• Examples include lighting, office supply,
  fasteners,

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E-marketplace Examples
Independent VerticalExchanges (IVX)
Independent Horizontal Exchanges (IHX)
Private Trading Exchanges (PTX)
Consortia TradingExchanges (CTX)
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A Framework for eProcurement(1)

• Type of Component
• Strategic Components
• Part of the finished product
• Not industry specific company specific
• Examples PC motherboard and chassis
• Commodity Products
• Can be purchased from a large number of suppliers
• Price is determined by market forces
• Examples Memory unit in a PC
• Indirect Material
• ??????????,????????????

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A Framework for eProcurement (2)

• Level of Risk
• Uncertain Demand (Inventory risk)
• Volatile(???) market price (Price Risk)
• Component availability (Shortage Risk)

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(e.g.) Risk Commodity Products

• Can be purchased either
• in the open market through on-line auction, or
• through the use of long term contracts to supply
• Long term contracts guarantee certain level of
  supply but may be risky for the buyer
• Inventory risk, shortage risk or price risk

???????????
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Analysis about Framework for eProcurement

• (1) Indirect Material
• Typically low risk and hence the focus is on
  content based hubs(????).
• The objective is to use an MRO-hub that
  specializes in unifying catalogs from many
  suppliers
• Examples MRO.com, Grainger on-line catalogs

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Grainger

• W. W. Grainger has been selling industrial
  supplies for 72 years
• In 1995 Grainger established Grainger.com, an
  on-line catalogue for more than 220,000 products
  from 12,000 suppliers
• In 1999, Grainger experienced revenue growth of
  102M through its internet channel
• The MRO supply industry is growing at a rate of
  3-4 a year. From 1996 to 1999 Grainger internet
  sales grew 32 a year and 20 in offline due to
  customers that were lured to Grainger from the
  web site

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• Grainger???????72?
• 1995?,Grainger???Grainger.com,???12000???????22000
  0??????
• 1999?, Grainger????????1.02????????
• MRO??????????3?4??1996?? 1999?,Grainger????????
  ??32,??20???????????Grainger???

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Analysis about Framework for eProcurement (2)

• (2)Strategic Components
• Typically high risk components that can be
  purchased from a small number of suppliers
• The objective is to use private(???) or
  consortia-based(???) e-marketplace.
• The focus is on an e-marketplace that allow
  collaboration with the suppliers

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Analysis about Framework for eProcurement(3)

• (3)Commodity Products
• Products go directly into finished goods
• High risk
• Many potential options to choose from
• Long Term Contracts
• Buyer and supplier commit to certain volume
  (called the commitment level)
• Supplier guarantees a level of supply for a
  committed price
• Flexible, or Option Contracts
• Buyer pre-pay a relatively small fraction of the
  product price up-front, in return for a
  commitment from the supplier to satisfy demand up
  to a certain level (called the option level)
• The buyer can purchase any amount up to the
  option level by paying additional price for each
  unit purchased
• Spot Purchasing

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A Framework for eProcurement A Portfolio(??)
Approach
???????????????????
Option Level

N/A
Inventory Risk (Supplier)
H L
Inventory Risk (Buyer)
Price, Shortage Risks (Buyer)
Commitment Level
L H
??????
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E-Procurement The reality

• Companies conducting greater than 20 of
  procurement transactions online have reduced
  their transaction processing cost by nearly a
  third (Hackett Benchmarking)
• ????????20????????????1/3(??????)
• Product savings and process cost improvements
  effect operating cost by 10 (Credit Suisse First
  Boston Technology Group)
• ?????????????????????10

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E-Procurement The reality

• To capture this benefits purchasing organization
  needs to invest heavily in
• Changing internal procurement processes
• Integrating e-marketplaces in internal systems
• Purchasing B2B applications software
• Paying e-marketplace transaction fee/subscription
  fee

Source Forrester Research
41
Positive Aspects of Trading Exchanges (Companies
who use exchanges)

• Reduce costs or labor (31)
• Better access to products/vendors (24)
• Increase speed or efficiency (29)
• Access to more customers (21)

Source AMR Research
42
Positive Aspects of Trading Exchanges (Companies
who plan to use exchanges)

• Reduce costs or labor (43)
• Better access to products/vendors (26)
• Increase speed or efficiency (23)
• Access to more customers (10)

Source AMR Research
43
Negative Aspects of Trading Exchanges (Companies
use exchanges)

• Security trust (17)
• Start Up cost (5)
• Loss of face-to-face relationships (12)
• Lack of standards (5)
• Immature technology (5)
• Integration issues (7)

Source AMR Research
44
Negative Aspects of Trading Exchanges (Companies
who plan to use exchanges)

• Security trust (16)
• Start Up cost (15)
• Loss of face-to-face relationships (11)
• Lack of standards (6)
• Immature technology (6)
• Integration issues (4)
• Pricing pressure (6)

Source AMR Research
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Strategic Alliances
Section I
Section II
The third Party Logistics
Section III
FreeMarkets Online
Procurement
Section IV
Outsourcing
Section V
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How to Capitalize on the real Business
Opportunities?
Outsourcing ...
functions
operations
ORGANIZATION
TECHNOLOGY
TM -46
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Outsourcing

• An easy way to increase profits

What is outsourcing?
48

• What is outsourcing?

• The phenomenon that appeared in the late 1980s
  was outsourcing, which means turning over a
  firm's operations, or perhaps other functions to
  a vendor for a specified time - generally, at
  least for three years.

TM -48
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Why Outsoucing?

• Outsourcing has become an option that most CIOs
  need to consider to satisfy their management that
  their operation is being run efficiently,
  effectively, and economically

TM -49
Dr. Chen, The Trends of the Information Systems
Technology
50
The Driving Forces Behind Outsourcing

• Two drivers
• focus
• on core business
• value
• Shareholder

TM -50
Dr. Chen, The Trends of the Information Systems
Technology
51
Outsourcing As an Economic Strategy

• Core competencies
• Which sources are less expensive
• How much control is needed

TM -51
Dr. Chen, The Trends of the Information Systems
Technology
52
Examples of outsourcing

• Nike, Cisco, Apple outsource most of their
  manufacturing
• Each could focus on research, marketing
• Nike ????????????????,?????Nike?90?????????20?
• Cisco????????????,????56?????????
• Apple????70????

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Examples of outsourcing(Cont)

• Each has gotten into trouble
• 2001 Nike reported unexpected profit shortfalls
  due to inventory problems
• 2000 Cisco had to write down billions in
  obsolete inventory
• 1999 Apple was unable to meet customer demand
  for new products

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Outsourcing Benefits and Risks

• Benefits
• Economies of scale reduce manufacturing costs
• Risk pooling demand uncertainties are
  transferred
• Reduced capital investment
• Focus on core competencies
• Increased flexibility
• Risks
• Loss of competitive knowledge
• Conflicting objectives
• Flexibility vs. long-term, stable commitments,
  etc.

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• Consider the IBM PC example.

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IBM Global Services Value Framework
WHAT SHOULD I DO ?
HELP ME DO IT
MANAGE ITFOR ME
BUSINESS
Outsourcing Services

Business Consulting Services

• Outsource Management, Operational and Support
  Processes
• Finance Accounting
• Human Resources
• Procurement
• Customer Care
• Infrastructure
• Servers
• Web Hosting
• Network
• Desktop
• Storage
• Groupware
• Disaster Recovery
• Security
• Application Management Services
• Custom Legacy
• Packaged

• Human Capital Solutions
• Customer Relationship Management
• Financial Management
• Supply Chain Operations Management

• Strategic Change
• e-business Integration
• Transform and Operate Solutions

Integrated Technology Services
IT
56
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IBM, A Business In Trouble
1993

• Individual business strategies
• Brand erosion
• Becoming irrelevant
• Fragmented marketing investments
• Lack of marketing expertise
• Lack of marketing management system

58
Network Development
Relationship Development
Client Experimentation
Learning
Promoting
Capability Development
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1997 (Re-) Introducing the Business Dimension

• Internet rise to prominence
• "Browser wars" dominate
• IBM recognizes the opportunity for another
  perspective Helping businesses do
  real business, using Internet
  technologies. Defines positioning as
  "e-business"

60
A Framework for Outsourcing

• Reasons for outsourcing
• Dependency on capacity
• Dependency on knowledge
• Product architecture
• Integral products components are tightly
  related
• Designed as a system
• Not off-the-shelf components
• Evaluated based on system performance
• Modular products independent components

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A Framework for Outsourcing (Fine Whitney)
Product Dependentknowledge, capacity Indep knowledgeDep capacity Indep. knowledgecapacity
Modular Outsourcing risky Outsourcing opportunity Outsourcing can reduce cost
Integral Outsourcing very risky Outsourcing option Keep internal
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• ????????????25???,?????????,????????,???????????
  ?????????
• ???????????????,???????????
• ????????????????????,????????????,70??????????
• ???????????,?????????????????

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QA