Introduction
Towards the end of 1999, many were predicting a massive swell in demand for B2B solutions in 2000, but all predictions were somewhat humbled as the world waited to see if all the computer systems would survive the Y2K bug and therefore, retain their faith in the promise of the digital age.
The Year 2000 arrived without a hitch and this left many business managers wondering whether the money they had spent had been necessary at all. This scepticism was shared by none other than Tito Mboweni, who turned on the old banking system just to satisfy his curiosity and discovered that it was still working fine. This fingering uncertainty should have heralded a new era of business, as opposed to IT, led business systems projects. Supposedly the business cases would be harder scrutinised, the ROIs measured and heads ‘rolled’ should the ROIs not be met.
Sadly, it appears that in the mad rush to find work for the Y2K inflated IT departments, eCommercc has become the thing all businesses should be doing, just as they all did ERP. The question that does not appear to be being answered in the mad rush to do eCommerce though is whether the eCommerce intervention is in support of the businesses’ strategic objectives, or whether the organisation intends to change its strategic objectives in order to do eCommerce?
As this forum provides only a limited opportunity to address the impact across the organisation as a whole (Buy-side, Sell-side and In-side) this paper will look only a the Buy-side implications of eCommerce, what is often referred to as eProcurement. Unlike the eProcurement systems however, this paper will address the entire ‘Procure to Pay” cycle within the paper itself and will not require any partnering or outsourcing!
It is a fundamental belief that technology decisions should be taken in line with the business processes they are intended to support and that business processes should only exist to take the oranisation closer to its strategic objectives. Any process that is not in support of the organisation’s srategy should be removed or
re-engineered. This being said it is therefore important to understand at the outset what the business issues are behind the opportunity that is eProcurement.
What are the business drivers behin procurement?
Organisational procurement differs widely from consumer procurement. Keynes’ Supply and Demand Curves” illustrates one of the core differences in Figure I.
Figure 1: Keynes’ Supply And Demand Curves
To summarise briefly, the graph assumes there are two distinct drivers in supply and demand: Price and Quantity. The theory states that the higher the price is for an item, the lower the Demand will be for that item, yet the greater the incentive to suppliers to Supply the item. Conversely, the lower the pace for an item the greater the demand will be for the item, yet there will be less supply of the item, due to its low price. Generally, and this is where capitalists depart from socialists, the market will determine what the equilibrium (e) price (p1) and quantity (q1) is for an item.
Due to this dynamic, the suppliers in the consumer market place tend to focus more on Supply than Demand, carrying out market research to determine what the wants are in the market place and delivering products to satisfy those wants and using marketing strategies to increase the amount of want there is for their products. In the Business to Consumer (B2C) market therefore. Supply leads Demand. In the B2B market, the buying organisation determines what its needs are on the basis of the type of goods or services it manufactures or delivers and demands these items from the supplier base. Because it is very difficult for suppliers to predict what the buyer’s requirements are going to be, unless they are in a strategic partnership, most B2B suppliers produce on the basis of what has been demanded by the buyers. It therefore follows that in B2B, Demand leads Supply.
This is a critical differentiator as it means that in B2B the buyer has more power than in B2C, as, in B2B, the buyer buys only what he needs, while in B2C the buyer buys what he wants. The desire shifts the balance of power. When considering eB2B this is a crucial dynamic to understand. It is the reason why so many eB2C players failed to make the transition to eB2B and is behind the reasons why eProcurement is so far failing to meet the customers’ expectations.
Many of today’s eB2B solutions are based on the eB2C model of displaying a large number of catalogue items detailing the product range of a group of suppliers and having the buyers surf the site. The key problem this creates is that this model is useful when the buyer has determined the need, but is not sure how to fulfil it:
(I need a shirt, but I don’t know which one I want). Browsing, both in the physical and virtual sense, helps the buyer arrive at a buying decision. In the organisation though the buyer has a limited degree of choice around how best to meet a need and very seldom is this based on the wants of the buyer, but more often the needs of the organisation. As the want is therefore predefined, there is no need to browse.
The buyer will just select against a predetermined list of what he is allowed to buy.
Few of today’s eB2B solutions operate in relation to these drivers.
What is the business issue that e-procurement seeks to address?
Organisational procurement has three distinct phases as shown in Figure 2.
Figure 2: The Components of Procurement
Sourcing is about establishing the best possible arrangements for the supply of bought in goods and services. The primary objective of sourcing is to find items of the best quality, at the best price, from suppliers who consistently supply correctly (right time right place). Once that has been accomplished the people in the organisation that need these items can then buy off the supply contracts (on-contract) that have been negotiated. Finally, the organisation must pay for the items.
Number of Transactions / Number of Suppliers Organisational spend will typically match the profile in Figure 3.
Figure 3: Organisational Spend Profile
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Figure 4: Typical Organisational Buying Process
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Many organisations today have realised that approximately 80% of the procurement effort is committed to only 20% of the procurement value and that this procurement represents goods and services that are not strategic to the organisation’s core business.
Additionally, as this spend is consumption and not production driven, it needs to be managed very lightly in order to ensure that the organisation’s expense objectives are met. This usually results in a process somewhat like the one in Figure 4. KPMG did a study on behalf of VISA and the typical activity based cost for this process is about R350. See hltp://www.visa.com/pd/comm/intl/purchasing.html.
Considering that one may be placing orders for lower than this amount, many organisations have seen this as a means to reduce costs to the organisation.
Inherent in this process however is the fact that it is cumbersome. As a result of this many buyers in the organisation will by-pass the process in order to have their needs met quicker. This off-contract buying is referred to as maverick buying. The implications of this are two-fold:
1. Research has shown that when bought off-contract, items on average cost 30% more than the contracted price arranged by the procurement department; and
2. The contracted price would have been negotiated on the basis of a commitment of procurement volume. By buying off-contract the organisation will not meet its volume commitments and will be prejudiced when negotiating the next time. More recently suppliers have opted to go for volume rebates to ensure maverick buying does not expose them, but this is cumbersome both for the supplier and buyer.
One of the other issues that arise is that due to the complicated nature of the process, many organisations seed the buying responsibility to the sourcing staff. This leads to the trained sourcing staff spending more time on the non-value adding activity of buying and less time on the value adding activity of sourcing. This increase in workload often results in the suppliers taking advantage of the distraction and sneaking up their prices.
The final business issue relates to the organisation’s buying power. Many larger corporations do not have a complete picture of how much they buy from a particular supplier. In many cases the different business units in the organisation are buying from the same supplier at different prices. Organisations therefore need to be able to have a complete picture of everything they buy from which suppliers, across the organisation.
In summary therefore it can be said that eProcurement seeks to target an organisation’s Low Value / High Volume spend, to reduce process costs, eliminate maverick spend, to allow the main buyers to focus on sourcing and to increase the organisation’s buying power.
What do today’s e-procurement systems offer?
The current eProcuremcnt systems target two key areas. The first of these is the buying process and the other is sourcing.
Buying Process
The diagram in Figure 5 details which areas of the buying process are accommodated in eB2B systems.
Figure 5: Scope Of Present Day eProcurement Systems
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The main target in the buying element of eProcurement is process inefficiency. Often the organisation has complicated authorisation routines, based on order value, budget and the commodity that is being bought. As these checks and balances tend to be binary, that is, they can only be Yes or No, they lend themselves to computer intervention, as this is how computers think. Theoretically, the computer will always be there loo, not in a meeting or on leave and therefore if the requisition meets with agreed criteria then the order should be created immediately.
More than that though, it can route the requisition through the process, eliminating the need for the requisitioner to chase around a building to get a requisition signed off. Coupled with emerging technologies like WAP and SMS, the lapsed time on authorising a requisition can be decreased dramatically. Typically though, the role players in the process remain the same as does the cycle tune of the process.
The reason for this is that the controls that are in place cannot he abandoned. Yes. the computer system can route the requisition for approval, but the approver needs to apply just as much time to the approval as he did before. This makes process cost reduction very difficult, as 80% of the costs relate to the role players and their responsibilities and only 20% to the interaction costs, the area where costs are saved.
Reducing the process cost is complicated further by the ENID Factor. The ENID FActor postulates that every organisation has a little old lady called Enid who does many of the repetitive tasks associated with this type of process. Ultimately, while one can reduce the activity-based cost of a particular process by removing Enid this cost saving is only passed to the bottom line if Enid is fired. This is not so easy in present day South Africa. More to the point though practically. It is very difficult to reduce this process to such an extent as to free up an entire resource. This is because, as stated the role players stay the same. While certain efficiencies can be created, saving 10% from ten people’s work load does not add up to 100%. just as getting nine women pregnant at the same time will not result in a baby a month for nine months.
The other challenge is that the eProcurement systems target a limited area of the “Purchase to Pay” cycle. The R350 referred to ny KPMG relates to the entire defined process in Figure 4. This decreases therefore the overall capacity of the e Procurement systems to deliver effective savings.
Sourcing
Exchanges address the sourcing issue. An exchange is an electronic repository of supplier information including supplier master details such as name, address, nature, etc. and supplier product details. The idea is that, when linked to the buying process computer system, the exchange will deliver up to the buyer the range of products that the buyer is allowed to purchase. This begs the question as to why then the buyer needs authorisation for the transaction? The way in which an exchange achieves this is detailed in Figure 6.
Suppliers will load an electronic version of their catalogue onto the exchange. This usually requires the intervention of a specialised organisation, such as Logtech or Starnode, that will charge the supplier for the service. This is currently between R8 and R15 a line item. This may sound like a lot, but to produce a printed catalogue of high quality currently costs about the same and is outdated very quickly. The exchange operator will generally come to some arrangement with the supplier over maintenance.
The exchange operator will then set up individual catalogues for each buying organisation, with its range of suppliers and contract arrangements. In most cases a duplicate copy of this information is stored at the buying organisation to improve system response times. It is important to note that the structure of the exchange makes it highly unlikely that one particular buying organisation could become privy to the buying information of another organisation.
The exchanges, while they seem impressive, only exist because the buying process computer systems require them 10 exist. It is somewhat of a self-fulfilling prophecy. Theoretically, if an alternative system were proposed, such as the suppliers providing the catalogue information to the buyer directly, the exchange would have little reason to exist. While there is a justifiable set-up charge for the creation of the catalogues, the exchanges provide little additional, or sustainable value. As they all currently charge some form of ongoing transaction fee the question that must be asked is what are they doing for their transaction fee?
The exchange operators claim to offer two sustainable value-adders: vendor searching and auctions.
Vendor searching is compelling for a buyer as it enables them t0 quickly find a list of suppliers for a particular product. The problem lies in the fact that this functionality does not come as standard with the buying system. Remember, the buyer can only access his own catalogue directly. Additionally, while useful, it is difficult to attach a great deal of value to this service, as most good buyers know the best suppliers through those supplier’s marketing efforts or have access to industry supplier lists, most of which they receive free.
Reverse auctioning is an area receiving a great deal of attention and an entire presentation could be done on this issue alone. The short answer is that most industry experts, apart from the ones working for the vendors, are somewhat sceptical about the benefits of this functionality. It is important to remember that price is only one element of concern to the buyer. Total cost of ownership (TCO) goes further and it is TCO what concerns the buyer. Reverse auctioning can also create resentment in the supplier community and is not conducive to strong supplier relationships. While this is not so important for non-strategic procurement, one must remember that an auction will only provide the buyer with the best possible price available on that particular day. The vagaries of supply and demand will result in differing prices based on time of day, week, month and year and a variety of other factors. Other issues include the fact that large supplier may continually under-price in order to drive out smaller competitors, ultimately creating a reduced supplier base and higher prices in the long term. It is interesting to note that recent research carried out by the Chartered Institute of Purchasing and Supply in the UK found that in 60% of the cases the incumbent supplier won the auction. Does this mean that the buyer was paying too much for the item in the first place, or does it mean that the bigger suppliers are shaking out the smaller suppliers? This is unknown. Finally, it is sobering to also remember that in a reverse auction the price can also go up!
Figure 7: Expected Benefits of eMarketplace Participation Forrester
In June 2000 Forrester published research on what companies were expecting to achieve from eMarketplace participation. That research is detailed in Figure 7. What is interesting to note is that 65% of these benefits can be ahieved through the implementation of a Strategic Procurement Policy the adherence to procurement best practices. This does not necessarily imply the implementation of any new Technology.
THE VISION OF THE eB2B VENDORS
Figure 8: The Vision Of The eB2B Vendors
All the eB2B vendors are aiming for a situation in which their systems can address all the areas in Figure 8 for the “Procure to Pay” process, but the reality is that they are all a long way from that. Many issues still need to be addressed, some legislative and some from restrictions placed on them by other industries.
On the legislative front, government still has a way to go on creating the necessary legal frameworks for eB2B. An emailed purchase order is still not a legal document, exposing the supplier to fraud. The VAT regulations to do not accommodate electronic invoices or self-billing.
The eB2B vendors are also hampered by the controls on the banking system limiting their ability to close out the process and so are heavily reliant on the banks.
The question that naturally follows is whether there is a system available today which goes further to addressing this issue?
THE PURCHASING CARD (PCARD)
The PCard has the following pre-requisites:
1. The buying organisation needs to first go through a supplier rationalisation process to reduce the number of suppliers it has.
2. Each of the suppliers must then be enabled 10 accept the PCard. This involves the implementation of specific software at the supplier and the agreement on the supplier’s part to pay a merchant fee to the bank. This is usually between 3.5% and 8%.
3. The buying organisation needs to inform the bank about which employees will be using the PCard what they can buy and what value.
4. The bank needs to issue the PCards to the buyers. The bank does not necessarily supply a physical card. Just the card number will suffice.
5. The buying organisation needs to buy a particular piece of software proprietary to the PCard system.
Figure 9: PCard Process
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Once the above has been done the PCard works in the following way:
1. The buyer will phone, fax or email a Purchase Order to the supplier, along with the PCard number.
2. The supplier uses the Point of Sale (POS) software to connect to the bank to obtain authorisation for the transaction.
3. The bank will check that the user of the card is allowed to purchase from that merchant and whether the amounts are within the tolerances set by the buying organisation.
4. If approved, the supplier will then deliver the goods.
5. Once the supplier has delivered and as long as he has a signed delivery note, he then captures the line item detail of the transaction into the POS software and sends it through to the bank.
6. Four days later, the bank will settle the supplier directly into his bank account.
7. At month end, the bank consolidates all the transactions and sends an electronic statement to the buying organisation.
8. The buying organisation uses the proprietary software to break the information down for analysis and distribution to the PCard holders. The buying organisation has seven days in which to repudiate any transactions.
9. On the seventh day the amount is direct debited from the buying organisation’s bank account.
There are the following benefits to the supplier:
1. While the supplier is effectively exchanging his settlement terms with the buyer with a merchant fee to the bank effectively a 3.5% / 4 day settlement term, what he does get is assured payment. Most suppliers are more concerned with being paid within the terms agreed than with the terms themselves.
2. He does not need to send an invoice. The statement from the bank is currently before the Receiver to attain certification as VAT evidence.
3. A locked in relationship with the buyer.
4. Reduced collections costs. Collections costs can be as high as R80 per invoice – R40 per invoice on average.
There are the following benefits to the buyer:
1. consolidated billing. This reduces the payables cost of the organisation.
2. Empowerment of staff. Instead of checking every purchase the buyer is free to transact within predefined limits and only the exceptions are managed.
3. All the benefits of strategic purchasing… reduced maverick spend, greater negotiating power, improved supplier relations, etc.
4. Actual reduced process cost as whole role players are removed.
5. Better management information.
There are however limitations to the PCard’s use. The two charts in Figures 10 and 11 illustrate this. Assuming the buyer currently enjoys a settlement term of 60 days from statement, the supplier will have been financing the buyer for this period. The supplier is now paid within four days of delivery, although he pays for this in the form of a merchant fee.
Figure 10: PCard Impact On Buyer NWC (1)
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The buyer sees his settlement term reduce from 60 days to seven days. This should theoretically be accommodated by the process cost savings he enjoys, but to what level?
At some point the impact on his net working capital is going to exceed his process cost savings. The chart in Figure 11 illustratrates this.
Figure 11: PCard Impact On Buyer NWC (2)
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Note: The gradient of the “Impact” line is a function of the Average Accounts Payable (AAP). The higher the AAP the steeper the line and therefore the lower the transaction value at which the benefit is lost.
While this does not negate the use of the PCard it illustrates the importance of understanding what the process cost savings are likely to be and at what point the PCard ceases to provide benefit.
Sadly, if the banks had enough vision they might realise that by re-pricing the product and adding certain key functionality, not major changes, then the PCard would be a powerful procurement tool for an organisation’s entire spend and it would compete even more effectively with the eProcurerncnt vendors.
In Conclusion
It is essential that any organisation that is interested in eCommerce gains a deep and extensive understanding of what the impact is likely to be on the organisation. The only way to do this is for the organisation to be in touch with its strategy and thereby have clear goals and objectives of what it intends to achieve.
When looking at eProcurement the organisation must begin by firstly ensuring it understands what its strategic objectives are in relation to procurement, how procurement aligns with and supports its wider corporate strategy and that its procurement processes are already world class and in line with international best practices. Once it has achieved this then it is in a position to seek out technology solutions to enable those business processes. It could literally save the organisation millions of Rands.
References
• DT Lobley, Applied Economics Made Simple, (1983)
• Forrester.com
• Harvard Business Review
• Tradewins.co.za