Gartner
Procurement teams can exploit e-sourcing techniques to create efficient and manageable sourcing processes. But buyers must not be seduced by the lure of low prices, nor hypnotized by the idea of reverse auctions.
What You Need to Know
E-sourcing exploits technology to improve business performance. It offers considerable advantages over paper-based tendering and will rapidly become the accepted way of managing procurement processes. But management teams should spurn “quick win” value propositions based solely on reverse auctions. Instead, they should introduce comprehensive change management programs to raise the status and visibility of sourcing activity and embrace the process improvements made possible by e-sourcing.
Analysis
Electronic sourcing (e-sourcing) is the term used to describe the various electronic systems and services that can support organizations soliciting and evaluating tenders.
The process of inviting and evaluating tenders allows buyers to seek value for money by testing the market for competitive offers. This kind of procedure is becoming more important, because an increasing percentage of costs in many industry sectors is spent with external suppliers, rather than internally. As globalization and competitive pressures increase, buyers can find potential suppliers that will compete to offer better value for money. In an economy where many sectors are experiencing deflation, it makes good business sense to test the market regularly.
But the tendering process is expensive. Even quite simple invitations to tender take time and are likely to demand the creation of multidisciplinary sourcing teams. Buyers need to invest substantial resources to assess the performance of incumbent suppliers and define requirements for new contracts. They also need to research and engage the attention of potential suppliers and receive and evaluate their bids.
Since the procurement team is usually seen as just a cost center, procurement managers rarely have the resources to run effective tender processes for all the contracts coming up for renewal. As a result, some contracts will simply be allowed to “roll over.” In a deflationary market, this may lead to the buyer paying more than the current market price, because the contract price has been fixed at some point in the past.
Procurement professionals have been aware of these issues for a decade, yet few management teams have launched the radical change management programs that would be needed to tackle them. The advent of “e,” with the sudden interest it engendered in business-to-business processes, put procurement in the spotlight and promised to address tendering issues through a set of technologies that became known as “e-sourcing.” The element of e-sourcing that attracted most attention was the reverse auction, a way of using relatively simple Web technology to provide an environment for electronic bidding.
Reverse auctions have highlighted technology’s ability to help transform the tendering process. A reverse auction is a Web-based bidding event that takes place at a fixed time and has a fixed duration, typically two hours. During this period, pre-qualified suppliers submit their bids, which are plotted on a “scoreboard,” often projected onto a wall in the procurement team’s office. As the team gathers round and lower and lower bids are received, the atmosphere is often like that at a sporting event, especially during early, pilot stage reverse auctions. Comments and applause fill the room and the tension mounts until the time is up and the bidding closes, often to a round of cheering, leaving the procurement team to decide which bid will win the contract. But the excitement and exuberance, so common during early pilot events, often fade quite fast, for a number of coldly practical reasons.
Reverse auctions are fast, decisive and exciting – and that has become a problem in itself. Many managers cannot think about e-sourcing without thinking of reverse auctions, yet the true value of e-sourcing lies more in the work that precedes the event. This includes generating the requirements specification, distributing and managing electronic requests for quotations and requests for proposals (eRFQs and eRFPs), and managing the transparent interactions with suppliers.
Gartner research shows that the use of reverse auctions actually declines as managers become more sophisticated users of e-sourcing. The reverse auction is a tool that can deliver value in relation to certain categories of goods or services. But for other categories, it is not the right mechanism. As e-sourcing matures, the number of reverse auction events will increase, but the proportion of e-sourcing exercises culminating in reverse auctions will fall dramatically. Gartner believes the use of reverse auctions will reach a peak during 2005 and then stabilize, being used in less than 10 percent of e-sourcing events for Global 2000 enterprises (0.7 probability).
Reverse auctions are appropriate when:
- Supply consistently exceeds demandThere is no need for a strategic relationship between buyer and sellerThe goods or services are easily describedAll potential suppliers meet common standards and service levelsThe financing of the contract is straightforwardThe decision about one commodity does not need to be seen as part of a broad procurement portfolio.
Reverse auctions are less effective when:
- Demand consistently exceeds supplyA strategic relationship is needed between buyer and sellerOffers involve markedly different deliverables or service levelsDeal financing is an integral part of the supplier selectionProcurement decisions about one specific commodity need to be seen as part of a broad portfolio of expenditure.
In a typical e-sourcing pilot, the procurement team may start off skeptical and apprehensive about the possibility of negative reactions from suppliers. The decision is often taken to pilot the new techniques with some relatively unimportant indirect supplies. Much effort goes into planning and preparing detailed specifications, and new suppliers are evaluated and invited to bid through a reverse auction.
When the first auctions take place, they often yield spectacular savings, compared with prices from established suppliers – early pilots may show cost reductions of 20 percent or more. Financial planners then start dreaming about the huge savings that will be available as all suppliers in all categories of procurement are subjected to the new miracle tool. Fired with enthusiasm, the team hopes to repeat the savings seen in the pilot exercise when reverse auctions are brought to bear on more important materials. But it doesn’t work out like that. When reverse auctions are extended to cover more significant materials, the price reductions seen in the pilots are not achieved. In some extreme cases, the prices in the reverse auction may even be higher than those currently paid. As a result of these disappointments, despondency sets in.
There are several important lessons to be learned from this familiar sequence of events.
- Never make assumptions about the savings to be made from e-sourcing based on extrapolations from early e-sourcing activities. Pilot auctions tend to yield spectacular price reductions because procurement teams try the technique out on “unimportant” categories of goods, which have usually had little attention for years. These items have, after all, been selected as being unimportant.Be wary about creating wrong expectations by publicizing the lowest prices bid in reverse auctions. Many procurement teams end up awarding contracts to suppliers that were not the lowest bidders, for a variety of perfectly good reasons. No organization should run a reverse auction under a set of rules that compels it to give the contract to the lowest bidder.Remember that reverse auctions are not a panacea. And they are only one part of what e-sourcing has to offer.
There are real dangers if an e-sourcing program focuses too heavily on lower prices. The principal value in procurement is the relationship – particularly for strategic supplies – and the price paid is only one component of this relationship. The actual value of the relationship may exceed the “price value” in many different ways, some of them impossible to capture in reverse auction algorithms. These may include “extras” provided by the supplier. But they may also include factors such as having first refusal when materials and personnel are in short supply or enjoying the ability to influence the direction of R&D work.
When it comes to the most important direct supplies, it may be impossible to achieve lower prices than current contracts. If the justification for an e-sourcing program has been based entirely on lowering prices – and not on the consistency, efficiency and manageability it brings to the tendering process – the team may lose heart and the sponsor will certainly lose confidence. Program sponsors should see price reductions as a bonus, over and above the key objective of improving procurement processes.
Unfortunately, negative experiences with pilot programs are all too common, and may prevent many organizations from exploiting e-sourcing’s full potential. The real value of e-sourcing lies in its ability to provide an efficient, consistent and manageable tendering process. To achieve this, management teams should develop long-term change management programs that focus on key business deliverables. Objectives should include a reduction in the number of “roll-over” contracts and an increase in the number of tenders each buyer can handle. It will probably take the program team at least four years to achieve the transition from paper-based tendering to electronic tendering, and program sponsors should be prepared for this. But the benefits are well worth fighting for, as the use of electronic tendering for the exchange of information between buyers and potential suppliers is significantly better, in every respect, than any paper-based mechanism.
It is important to see the change management program as a knowledge-based initiative, where the analysis of experiences with one category of goods will provide lessons that can be applied to other categories. The procurement team should create and nurture a multidisciplinary center of excellence for e-sourcing to make sure that the acquisition and sharing of knowledge are at the heart of the program. If the company is responding to electronic RFQs and RFPs and reverse auctions initiated by its own customers, this center of excellence should incorporate sales and marketing specialists, to provide a complete view of the process.
Finally, the program team should recognize that not all buyers will be willing or able to take to the new regime with equal enthusiasm or commitment. The team should work with those buyers that are most willing to change, who will then emerge as role models and advocates for the new techniques within the procurement department.
The use of electronic RFQs and RFPs offers such overwhelming benefits that e-sourcing will grow rapidly. By late 2006, these techniques will be part of the procurement cycle for at least half the materials expenditure of Global 2000 enterprises (0.8 probability).
Key Issue
How will successful enterprises select, deploy and manage ERP II solutions to minimize risk and achieve optimum ROI?
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