A lot of companies are realizing significant savings by using e-procurement tools to purchase indirect materials like office supplies, computers and light bulbs. The real money, however, is in direct materials - the raw materials and components that companies use to make their products and that comprise about 60 percent of the cost of goods sold. More importantly, direct materials are the competitive lifeblood of manufacturers. Not having the right product at the right time doesn't mean just a lost sale, it means closing down a production line and possibly missing crucial days in getting a new product to market.

Supply-chain changes in recent years have only increased the criticality of this process. As global businesses have shifted away from vertical integration, their suppliers, including contract manufacturers, have provided more and more of the value of finished goods. Short product life cycles, constrained materials and increased customization make it increasingly important to select the right suppliers up front and to effectively manage supplier relationships.

Despite these pressures, the most pervasive analytical tool in use today by purchasing professionals is the spreadsheet, according to a report by Scott Alaniz and Elaine Shuffield, analysts at Stephens Inc., Little Rock, Ark. And while most large companies have automated some aspects of their direct materials process with electronic data interchange (EDI), manufacturers and suppliers continue to rely heavily on phone, fax and e-mail for communications.

The lack of automation is largely because direct materials purchases can be very complex. Products often have custom features that are not easily cataloged and requests for information or quotes frequently are multi-layered and must be accompanied by blueprints and detailed specifications. In addition, unlike indirect materials where buying decisions are almost entirely based on price, direct materials buyers must take into account many other factors, such as lead times and delivery performance.

"With direct materials, companies are not just concerned with buying things but with synchronizing the flow of parts and materials so they can keep their plant running efficiently," says Jeff Herrmann, president and CEO of SupplyWorks, Bedford, Mass. "It really is a supply-chain problem, and it relates to managing the entire flow of parts and materials from multiple tiers of suppliers into the plant."

SupplyWorks Max is a web-based direct procurement solution that unifies purchasing with supply-chain applications, he says. "Most companies have some sort of ERP that does manufacturing planning, and they explode a bill of materials and generate requirements as to what materials and parts they want to have on hand on any given day. But the question is how do you communicate that to your suppliers and how do you collaborate with suppliers to optimize the flow of materials into the plant, and how do you manage that process over time? We have integrated all three of those pieces - execution, collaboration and management - in one application."

The SupplyWorks solution is a hosted model accessed with a PC and browser. Other vendors, like Atlas Commerce, Malvern, Pa., are providing software in a private exchange environment. Atlas MetaSource is deployed on the vendor's Metaprise PE Platform, which connects trading partners.

"When you look at where companies are having challenges dealing with direct materials, it is not in the way they issue a purchase order," says Dan Tiernan, Atlas co-founder and senior vice president of corporate strategy. "That works OK. It's in the way they have moved from being vertically integrated to outsourcing production. Now they have a bunch of different company systems to deal with, a lot of points of information that are not synchronized. ERP is good for keeping track of inventory and production schedules internally, but a lot of that information needs to be shared and synchronized across these networks. So our concept was to create an e-hub, a community of businesses where that information could be shared and where trading partners could cooperate. Before the marketing people got involved, we originally called ourselves Atlas Cooperative Commerce Solutions."

In varying degrees, these emerging solutions enable companies to: automate the request for information and request for quote processes, conduct online auctions and bids, optimize supplier selection by weighing and analyzing supplier responses against user-established criteria, negotiate terms and conditions, execute agreed-upon contracts, and share schedules and exception information. In many cases, purchasing events and supplier performance are captured and archived to create a bank of knowledge that can be used in future sourcing decisions.

E-marketplaces, which once looked like the most promising answer for direct materials procurement, also have a role to play, though not the leading one previously envisioned.

Potential Benefits
These emerging solutions are important because even a small improvement in direct materials purchasing can have big benefits. Alaniz and Shuffield estimate that the 326 manufacturing companies in the S&P 500 spent $1.3tr on direct materials in 1999. If only half of that spend could benefit from strategic sourcing applications and if the savings realized were only one-half of 1 percent, they say, the annual bottom-line benefit still would total $3.3bn.

Many contend that one-half of one percent is extremely conservative. Several vendors in this area report that customers are realizing total cost savings of 15 percent to 25 percent, and manufacturers are making similar claims. Owens Corning, for example, recently announced that it had saved 17 percent using online reverse auctions with selected suppliers enabled by software from PurchasePro, Las Vegas, Nev. Analysts point out, however, that these double-digit savings usually come in the first year and are then maintained, perhaps with much smaller incremental improvements, in following years.

Reducing the sourcing cycle time is as important as lowering product cost. "We see cycle times being reduced on the order of 50 percent to 75 percent," says Richard Waugh, co-founder and executive vice president of B2eMarkets of Rockville, Md. "Companies can go from an average four-month cycle to a one-month cycle, and with some less complex items, can achieve a very rapid negotiation cycle of a couple of weeks. This allows them to capture compound savings by doing more in a shorter period. Going from one month to four months, based on the time value of money, means you are saving more money faster."
B2eMarkets' Strategic eSourcing Management is an end-to-end sourcing solution that provides a collaborative platform. The company emphasizes that it builds intelligence within the enterprise through its ability to capture, retain and share e-sourcing experiences.

The ability to reduce cycle times also helps companies improve their margin, particularly with products that have a short life cycle. "What happens in the high-tech area is that when a new product is introduced, most of the demand comes very early in the product cycle," says Terrence Austin, executive vice president for communications and high-tech at Manugistics, Rockville, Md. "If sourcing is not done effectively, you can get caught taking too much time to ramp up to volume so you have a period of real shortage at the early stage of the cycle, exactly when you can make the most money. After two or three months, as the product matures, the margin opportunity starts to go down. So if you can get time-to-volume lined up with market demand you are going to extract a lot more margin during the life of the product. If you miss the market by three months, you lose half your profit, sometimes 75 percent."

Manugistics' supplier relationship management product, introduced earlier this year, provides real-time material design, planning and collaboration capabilities and automates all sourcing processes, from supplier selection to delivery of goods.

Supplier Selection
Many companies have a well-established supplier base and look to these software tools to establish online communications and automate existing processes, but others want to find new suppliers.

"The great thing is that companies now can have it both ways," says Ray Letulle, chief technology officer for Moai Technologies, San Francisco. "They are able to initially cast a wider net to many suppliers, which increases the competitiveness, but when it comes down to specific negotiations they can limit their dealings to a smaller number, which gives them the cost efficiencies of a lean network." Moai notes that manufacturers dramatically reduced their supplier base in the '90s to cut costs and forge more strategic relationships, "but the net result of that over time is that you pay more for goods. With automated tools, one of the big efficiencies is that you can send out 50 RFIs [requests for information] and then pick out a small number of responders that look promising with which to negotiate terms and conditions."

Moai's CompleteSource automates all the critical components needed to negotiate strategic purchases online, including complex goods that require multi-stage, multi-parameter bidding.

The desire to cast a wider net was one issue driving strategy at Praxair, one of the world's largest producers of industrial gases and an early adopter of strategic sourcing. Praxair selected software from B2eMarkets to facilitate reverse auctions for many of its direct materials, including items like the thousands of compressed-gas cylinders that it buys each year. "We were using basically North American suppliers but we wanted to expand to global suppliers," says Lou Romano, director of global procurement.

Praxair already was sending out requests for quotes (RFQs) electronically, via zip files on e-mail. "But when we started to hear buzz regarding reverse auctions toward the end of '99, we felt there was an opportunity to use that process as an addition to what we were doing in-house," Romano says. After completing a 12-step strategic sourcing process that it uses for all suppliers, Praxair selected B2eMarkets to provide a hosted solution.

The company held its first live auction in mid-June last year, just weeks after first meeting with B2eMarkets. After identifying and inviting the suppliers it wanted to include, it posted an RFQ on its web site about 10 days before the auction. The actual bidding event took six hours and covered six time zones, with all vendors participating simultaneously. Praxair received 130 bids for several different types of cylinders. "This was a breakthrough for us because we normally would have gotten maybe 30 responses - maybe as many as 45 if we did it twice, perhaps 50 if did it three times," says Romano. "But that would have taken weeks and weeks. This we did in one afternoon."

In addition to expanding its supply options, the auction had other benefits. "We were able to see clearly the market conditions on a global basis and in real time, and we retained all that knowledge so that next time we had a lot of information available to all of our people in procurement," he says.

Praxair has run multiple e-negotiation events every month over the last 13 or 14 months, including in South America and Asia, with a wide variety of commodities and formats: auctions, spot buys, sealed bids and online negotiations. Flexibility of format is important because not every commodity or server lends itself to reverse auctions and not every vendor is willing to participate, says Romano. Praxair has realized an average reduction of 15 percent in direct materials cost, most of that in the form of lower prices.

Aggregating Spend
Aggregating spend for like products across all different parts of an organization is another key way these applications help companies achieve savings.

"Aggregation is one of the key things we find that people haven't figured out," says Atlas Commerce's Tiernan. "When companies implement ERP that often do it by division or business unit. So you can have a global conglomerate with 24 business units, each operating a different ERP. You also see this happening a lot when companies merge or have acquisitions. In 99 percent of the cases, they are not combining spend across units."

Herrmann of SupplyWorks agrees. "This is one of the amazing things - that many of these multinational companies can't usually aggregate data from multiple plants that are actually buying the same parts from the same suppliers. Or-and this is all too common-you will have one plant paying a premium to rush in some parts while another plant has a quantity of those same parts sitting on the shelf in inventory. One of the advantages of a web-based architecture is that we can take data from multiple plants and aggregate it and unify it because we are a central hub."

There is a hitch, however. Very often these different business units have varying names for the same component. "This is particularly challenging when dealing with outsource manufacturing where you may need to aggregate not just data internal to your own business, but you may actually be buying on behalf of some of your partners as well," says Tiernan. "So you have to have the ability to translate part numbers and to map it all together."

One of the projects Atlas enabled at Hewlett-Packard was to aggregate total corporate demand for the HP logo that goes on printers, computers and other products. This not only helped in negotiating contracts for finished logos, but by connecting both plastic molders and resin suppliers in a private network that shared the demand information, HP was able to leverage its buying power all the way down to the raw materials level. At a $20m annual spend, logos are a relatively small item for HP, but the success of this project resulted in the rollout of Metaprise to packaging and power cord suppliers, which represent $500m in direct materials cost. Other products and suppliers gradually will be added to the program.

Another Atlas customer, Joy Global, developed a web portal to enhance communications with suppliers and customers. Joy Global is an international manufacturer, distributor and service provider of underground mining machinery. It sells parts to its customers and works with its suppliers using the eMinePortal that it established last year.

"When we got started what we really wanted to do was find a way to improve the interface between ourselves and our customers, but we recognized that we could also benefit from improving the way we work with suppliers," says purchasing manager Mark Shaver.

Joy currently uses the portal to share information with suppliers, though it soon will implement the Atlas strategic sourcing module for materials procurement. "We elected to do the easiest part first," says Shaver, which is leveraging the ability of Joy customers to place orders through eMine portal. These orders frequently are for items not kept in stock and the portal software automatically routes them to the appropriate supplier.

Complex Data
Giving suppliers visibility to demand and production schedules is another way these procurement and sourcing applications can improve operations, but this also requires the ability to manage complex and non-standard data. "Schedule information can come from a variety of sources and in several different formats," says Paul Lindoerfer, vice president of market strategy and planning at Eventra, Milford, Conn. "So you often have a large amount of complicated data that suppliers have to deal with. You have to transform that data into information that is easy to use."

Eventra's VendorSite puts all the data in a normalized format so it looks the same to suppliers no matter where it came from. It also allows suppliers to drill down in a variety of ways to see underlying documentation like purchase orders. "They can see all activity against any contract requirements, see all the ship notices generated, and so on - it gives them the status of everything at glance. That's an important feature of supplier execution, to get a complete picture of the supply chain in one application that both buyer and supplier can use. It helps them keep in sync with each other."

Being able to see documents online is good. Getting rid of documents altogether is better, according to David Myers, director of eQ applications at QAD, Cupertino, Calif. "I think the notion of a purchase order or a sales order for direct materials is stupid. Most companies we deal with make the same products day in and day out. If they go through a strategic sourcing process and get a contract agreement with qualified suppliers, why send out a purchase order for which the supplier has to create a sales order and then has to send an invoice, all of which have to be matched up?

"Why not break all those steps down and make the supplier responsible for maintaining the inventory? I give you a view of my inventory, you make sure I have products when I need them, and I pay you when I use them. All of a sudden a lot of inventory goes away, the accounts payable function goes away, sales order creation goes away, purchase order creation goes away, and everything responds to electronic signals sent via the internet."

That will be possible with the Commerce Relationship Management system QAD is building, he says. "It is based on XML and will automate the entire process." Parts of this solution already are available, including eQ buy and sell functions and SupplyVisibility.

Another aspect of visibility relates to understanding and keeping track of supplier performance. "What tends to happen is that companies have a very narrow view of back-end performance," says John Proverbs, vice president of global accounts at Webango, Santa Clara, Calif. "They know how a supplier is performing for one particular plant involving one particular product. What they need to know is how a large supplier that may be providing them with a number of different products across several divisions is performing as whole and whether that relationship is moving forward. This is not evident today at all.
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Proverbs says Webango's SRM product, comprised of SourceSelect and ContractControl, helps companies achieve this view, though it requires linkage between an organization's strategic or planning layer, where Webango sits, and its supply-chain and transactional layers. "It's a chicken and egg scenario. In many cases today you have companies saying they have SRM capability but what they mean is they can tell you how many times a specific part was late from one supplier to one division. If you are a CEO or a CFO and you want to know the status of the company's relationship with that supplier, this doesn't give you the answer."

E-sourcing and supplier relationship tools are still in the early adopter phase, says Moai's Letulle. Most companies now are looking to automate the purchasing process and perform online auctions. "What we will see down the road is a lot more integration of these tools with scheduling and supply chain, and a lot more collaboration, not just between buyers and suppliers, but between purchasing managers and engineering to build a strategy around sourcing for new products while the design still is in process. We've got years of work ahead of us to build out all the capabilities."