Managing Your Spend
New strategies, reengineering, and powerful technology enable companies to revamp sourcing and procurement.
Honeywell’s Federal Manufacturing and Technologies (FM&T) business unit, which operates the Kansas City plant for its client, the National Nuclear Security Administration, committed to move 15 percent of the dollars spent on direct and indirect procurement at the Kansas City plant to online procurement. The plant makes sophisticated electronic and mechanical components for the U.S. defense system.
Honeywell FM&T wanted to shift from transactional buying to strategic sourcing that focuses on establishing long-term relationships with suppliers.
Seeking an e-sourcing and e-procurement solution, Honeywell FM&T elected to build a platform that included sourcing, procurement, and supplier management solutions from Ariba Inc., Sunnyvale, Calif.
The payoff was significant and swift: in the first nine months after implementing the sourcing solution FM&T processed $24 million in purchasing, realizing savings of more than $3 million. Purchase price savings averaged 14 percent, and the mean cycle time required to complete the sourcing process was cut by two weeks.
With significant benefits such as these within reach, it’s no wonder that companies increasingly try to build core competence around spend management, aggressively pursuing savings that can be realized by more effectively managing their spend.
Today’s flat revenue numbers are increasing the urgency to do so, says Doug Blossey, vice president of product management for Ariba. Spend management encompasses the full scope of procurement, including sourcing, analysis, procurement, and payment, he notes.
Spend Management 101
While there’s some disagreement about whether it’s called spend management, procurement, or purchasing, most observers agree that it includes several key components:
Sourcing— “This means choosing the suppliers you want to do business with, and putting a deal in place,” explains David Clary, senior vice president of solution delivery for ICG Commerce, a procurement services provider based in Jenkintown, Pa.
Supplier enablement— During this step, the buying organization enables itself to do business with the supplier. This may involve putting a contract in place, having the supplier site a person in the plant, or establishing electronic connections between the supplier and customer, Clary says.
Purchasing or procurement— This component involves placing orders with suppliers and processing transactions.
Settlement— The step of paying the suppliers’ invoices closes the overall procurement loop.
While some companies develop strategic sourcing capabilities, and others zero in on the procurement processing step, integrating the entire purchasing package is a key to breakthrough achievements.
“It’s crucial to combine the overall solutions, to have a closed loop process around the strategic sourcing enablement process and tie procurement to the back-end processes,” Blossey says.
This may involve bringing together the purchasing organization with accounts payable, notes Bill Schaefer, vice president of procurement services for IBM Global Services, Research Triangle Park, N.C. “The entire process needs to be set up with a common set of objectives and measurements, and a common underlying infrastructure,” he says.
In a traditional organization, “where accounts payable and purchasing report to two different management chains, there can be tremendous inefficiency and dislike of each other,” Schaefer says. When the purchasing and payment process are seamless and integrated, “it runs much smoother. Fewer backend reconciliation problems occur, and costs and efficiencies improve.”
Four Keys to Success
To do a top-notch job of procurement, a company needs to have four things in place, Schaefer says:
1. A sound sourcing and procurement strategy. “This is not just the tactical view, but a strategy tied to the company’s core business—what it’s trying to produce, what it wants to do in-house vs. having its suppliers do, and how it will support that through the procurement process,” he says.
2. A strong set of organizational and people skills. “Traditional procurement organizations have been very bureaucratic or administrative, pushing paper through the procurement process,” Schaefer says.
ICG’s David Clary agrees. “Until maybe 10 years ago, most purchasing people were order takers and transaction processors,” Clary says. “These buyers took orders and got close to the suppliers to make sure that they delivered goods and supplies on time, so that the buyer didn’t look bad. That was the name of the game—not looking bad.”
Today, he observes, procurement professionals are typically more highly trained, more specialized in such areas as analytical model building, negotiating skills, problem solving, general management, global trade, and international logistics.
In addition, according to Schaefer, purchasing professionals are moving away from acting as generalists and administrators to serving as professional sourcing experts, often with specialized focus. Today’s state-of-the-art procurement organizations process much less paperwork, and are becoming electronic.
3. Common processes and governance. “In any company there are typically many internal business units, areas, or pockets that think they’re different from everybody else,” Schaefer says. Nonetheless, “there’s a need to operate as a whole company in a consistent fashion.”
Reengineering processes and operating in a consistent way throughout the organization is “one of the difficult but fundamental things that have to happen” in order for companies to more effectively manage their spend, Schaefer notes.
4. The enabling technologies. Many new applications are available today in the e-procurement space. But bear in mind that implementing e-purchasing tools should take place after processes are reengineered, Schaefer recommends. “You can’t start with the technology. If you do, you’ll just automate bad processes,” he says.
The Power of e
“E-procurement is nothing more than the ability to transact electronically with your suppliers,” says ICG Commerce’s David Clary. “That has been going on for two or three decades in the form of EDI.”
But the advent of the Internet opened things up. “The majority of Fortune 500 companies have invested in e-procurement tools of some sort,” Clary says.
In 1995, the dream of e-procurement was that the software was the silver bullet that would eliminate many procurement and accounts payable positions. But the expectations were unreasonable.
“E-procurement tools have not necessarily solved these problems,” Clary says. But companies have gotten much smarter about where and how to use them.
E-procurement may have been thought of as a web requisition and catalog tool originally, Ariba’s Doug Blossey notes. But companies now recognize that it “focuses on capturing spend in the most effective manner.
“E-procurement tools allow you to capture the spend—whether services, indirect, MRO, or production goods—so you can catch systematic demand signals and manage to them,” he says.
Giant corporations such as IBM already realize great benefits from e-procurement. IBM buys nearly 95 percent of its $40-billion-plus purchases a year electronically, according to Schaefer. Ninety-nine percent of its spend goes through the procurement process. “We’ve virtually eliminated maverick buying,” he says.
E-Procurement by the Numbers
E-procurement works for smaller companies, too. It is “a valuable tool regardless of the type or size of company involved. It can squeeze costs out of procurement regardless of the setting in which it is applied,” according to a monograph from Tompkins Associates, Raleigh, N.C.
Look at the math. “In a paper-based system, the cost of procurement is significantly higher than most people realize,” according to Tompkins.
“For example, the average administrative cost of a simple purchase order is between $75 and $125. E-procurement uses refined business processes and supplier relationships supported by technology to automate processes, eliminate paper, and reduce errors, and it can ultimately cut the administrative cost of a PO by more than 75 percent.”
Thus the cost of a purchase order can be cut from, say, $75 in administrative costs to $18.75. It’s no wonder that e-procurement tools are on many companies’ wish lists.
The maturity of today’s technological tools varies by category, with solutions in some areas far more developed than others.
“A lot of e-procurement applications started in the middle of the process, with procurement,” Schaefer notes. As a result, e-procurement application offerings have matured and consolidated. There is new activity on both ends of the procurement process—sourcing and settlement—he says.
An Emerging, Immature Market
“The e-sourcing space—the tools and applications that are electronically enabled—is an emerging, immature market,” he explains. “A lot of niche providers are doing specific tasks, such as spend analysis.” While e-sourcing is still in the early stages, Schaefer predicts that tools “will get better and better. E-sourcing is one of the hot focus areas.”
E-settlement is also seeing activity. The enablement of suppliers, however, can be an obstacle to automating payment, he says. “Many companies have bought a system and find that, 18 months to two years later, they have only a few suppliers that they’re doing business with electronically.”
The data obtained through various e-procurement tools will lead to improved supplier management, notes Clary, thanks to “the ability to measure the supplier, determine whether it’s charging you the prices you’ve negotiated, is delivering on time with few defects, and the ability to rapidly put in place a performance improvement program with suppliers.”
Applying such data to supplier management for most companies is still in the future, Clary says. “Many companies are just getting up to speed on e-sourcing and e-procurement.”
The e-procurement space is a dynamic one that promises to change as much in the next five years as it has in the past. “We’ll see a convergence of e-sourcing output and tools with e-procurement output and tools,” predicts Clary.
Take the foam trays used by a chicken processing company as an example. Its purchasing professionals would traditionally identify potential suppliers of the foam trays, put out and receive bids for the next six months’ supply of trays, and select two suppliers to serve the United States.
The deals with the suppliers would be captured on the back end, so that as orders are placed and deliveries are made, purchasing processionals would be able to manage the suppliers—monitoring service levels as well as prices.
Additionally, by integrating supplier management capabilities, an alert can be issued at a trigger point indicating that it’s time to re-source or renegotiate the contract.
Finally, Clary predicts, “on an ongoing basis, the executive vice president of procurement or supply chain can see who the company is spending with, and be able to evaluate units, plants, or buyers who are out of compliance.”
Hearth Technologies Heats Up E-Procurement
Hearth Technologies, a manufacturer of leading fireplace brands headquartered in West Lakeville, Minn., decided it wanted to ease into e-procurement rather than plunge all at once into a multi-million dollar program.
To prepare for e-procurement options—which it had been exploring for some time—Hearth Technologies developed a detailed value stream map of procurement at each of its three manufacturing plants.
“We knew that e-procurement alone would not fix our challenges,” explains Joel Mickelson, Hearth Technologies’ procurement director. So the company sat back and examined its current processes at the plants, two of which had been acquired.
“We looked at how they bought things, and identified seven to 11 categories of spend per plant,” he notes. “We then looked for opportunities for immediate improvement. The value stream mapping revealed, for example, that plant procurement staff was spending a lot of time following up on purchase orders. They were managing all purchase orders, rather than managing purchase orders by exception.”
The procurement team also created a future state map, and identified what would be required to get there. For example, one goal was to have vendors manage inventory levels, sending the material to the line for manufacturing when it’s needed. Another goal was to manage by exception, “so that we’re not looking at Advanced Shipment Notifications, but rather looking at places where we don’t have an ASN,” Mickelson says.
Among the options that Hearth Technologies explored was a hosted e-commerce Internet service from SPS Commerce, based in St. Paul, Minn.
“We thought of it almost as tuition money,” Mickelson explains, “our chance to break into electronic procurement and electronic commerce with our suppliers,” at minimal risk and cost.
Additionally, a number of the manufacturer’s suppliers were already using SPS.
“We decided that, because of SPS’s flexibility and service, this would be the best choice for us,” Mickelson says.
The first step of implementing the SPS solution involves electronically sending purchase orders and receiving invoices and ASNs. The second phase will involve production scheduling and production activity, with suppliers doing more vendor-managed inventory activities.
In addition, Mickelson says, “we’re looking at a suggested purchase order in the second phase that gets our buyers out of the process of doing the faxes, e-mails, and calls every morning to set up the next day’s shipments.”
A core cross-functional Hearth Technologies team—representatives from procurement, accounts payable, and IT, plus involvement from receiving and production—worked with an SPS Commerce technical engineer this summer to work with the future state map. “We set up a Gantt chart of process change,” Mickelson says, and put in place the process for issuing purchase orders electronically.
Hearth Technologies held a supplier conference, bringing in one third of its most critical 100 suppliers. “We heard a full spectrum of responses from our vendors. A couple were a little concerned,” Mickelson says. A potential concern—the cost of using the web-based system—was addressed at the conference by SPS representatives, who explained that the spend would not be much more than the cost of using an Internet provider.
“That was acceptable overall among suppliers,” Mickelson says. Some larger suppliers had their own system in place that they wanted to roll out to their customers. “SPS has expertise in mapping information from the hub ERP system to the supplier’s systems,” he adds. “It can be faxed to them, they can go to a web site, or have that information mapped directly into their order entry system—it’s the supplier’s choice.”
While Hearth Technologies didn’t make using SPS Commerce an option, “we didn’t tell them ‘it’s our way or the highway,'” Mickelson says. “We explained that this is something we have to do, and that it needs to be implemented across the board—we can’t afford to have a 98-percent acceptance rate. And we said that we would work with suppliers to do what it takes to get implemented.”
The company is moving into phase one this fall, bringing four vendors on board the first month. After adding another four a month for the first several months, the company will then ratchet up the process, bringing 12 suppliers a month on board. The entire phase one process is expected to take about seven months. Then it’s on to phase two.
“This will give us a good step into learning about the electronic trading of information,” Mickelson says. “If we continue to grow according to our plan, I see additional opportunities in the future,” such as using reverse auctions where appropriate.
Hearth Technologies’ move into e-procurement has been facilitated by strong commitment from the materials and purchasing managers at each of the manufacturing plants, as well as from top management. The company made the decision that turning to e-procurement was a strategic move, rather than one that would be judged simply by immediate ROI, Mickelson explains.
“We have backing from the president and CFO, and we are willing to use this move into e-procurement as tuition money to see how e-commerce works on the supply side.”
Crown Cork & Seal Keeps the Lid on Costs
Crown Cork & Seal, manufacturer of cans, plastic bottles, and containers, purchases raw materials and support materials for 60 manufacturing facilities in the United States. The company has explored e-procurement options for the past several years.
“We were looking at a way to reduce our costs,” says Dan Donaghy, Crown Cork & Seal’s vice president of procurement.
A large e-procurement initiative targeting information technology, led by the IT department, was well under way when ICG Commerce called on the procurement operation. ICG Commerce is a procurement service provider that aggregates the buying power of its customer base, then negotiates pricing and service with suppliers in different categories. Customers can purchase these goods and services through ICG Commerce’s proprietary web-based purchasing tool, RealExchange.
“ICG’s value proposition showed us an immediate savings,” Donaghy says. Because the Internet was the enabling technology, the procurement operation felt that it could test the e-procurement concept without interfering with the IT study that was also underway.
Using the ICG solution “was low risk,” Donaghy says. “There was no new hardware involved to speak of, we wouldn’t be bumping heads with the other initiative, and ICG Commerce could guarantee us a saving.”
However, “we were somewhat cynical,” he says. So the company tested the concept where it was already achieving good results, piloting use of the solution with a leading office supply vendor with whom it was already doing business.
In addition, it was an area of minimal risk. “We knew that the corporation wasn’t going to go down based on whether or not we got ballpoint pens,” Donaghy notes. The pilot, implemented at company headquarters, took place in January 2001, targeting pre-approved items.
“It was a no-brainer,” Donaghy says. The company was able to realize substantial savings thanks to ICG Commerce’s negotiated deals, and “users were just as happy with the new approach as they were doing it the traditional way,” Donaghy says. The next step was to have the plants purchase pre-approved office supplies through the ICG solution. Plant procurement personnel training was done by teleconference, 10 people at a time.
The pilot went smoothly. Soon, the company expanded from pre-approved office supplies to the vendor’s entire catalog. “All the paperwork disappeared,” Donaghy recalls. “Thousands of transactions occurred on the computer, and we got a bill at the end of the month. Life was wonderful for a couple of months.”
When the company expanded use of the e-procurement solution beyond the plant office and into the storeroom, however, problems began to crop up. While office supply purchases could generally take place without human intervention, that wasn’t always the case with purchases of items such as electric motors, bearings, air compressors, or wires and clamps. In addition, plant personnel were concerned about having to deal with specific vendors.
Communication Solves Problems
Communications with the plant were key to heading off potential difficulties, Donaghy says. “We’d have monthly teleconference meetings with five or six plants and ICG.” Sometimes a vendor was brought in as well. The teleconferences served as problem-solving sessions, with other plants, ICG, and vendors working together to resolve issues.
In addition, plant personnel who can find a source less expensive than those in the ICG network are encouraged to bring those to the procurement team. “If, at the plant level, they have a more cost-effective solution, we’ll carry it to ICG Commerce first and find out why it doesn’t use the supplier. Second, we’ll honor their solution.”
Crown Cork & Seal and ICG Commerce analyze purchasing data to understand what is not bought through the system and why. The manufacturer uses the information to show plants how much spend they’ve lost by not using ICG-approved vendors. It can also now demonstrate to vendors how much money they’ve lost by not participating in the ICG network.
Since the e-procurement solution was implemented in the spring of 2001, Crown Cork & Seal plants now do online purchasing of such things as office and MRO supplies, packaging materials, industrial supplies., and energy. Return on investment was achieved in 90 days, with Crown Cork & Seal saving between 12 and 23 percent on purchases in implemented categories.
And Crown Cork & Seal’s Purchasing Department is able to invest its time in sourcing and procuring strategic materials such as metals, coatings and resins.