proc.ppt

Modern Procurement

Yossi SheffiYossi SheffiMIT Engineering Systems Division

2© Yossi Sheffi, MIT

OutlineRole of procurement“Make vs. buy”Strategic considerationsCommitment vs. variable buye-ProcurementCombinatorial procurementExample: transportation RFP – system RFP – lane Spot market


Purchasing as % of Sales

54%

28%

22%

60%

57%

34%

24%

16%

0%

10%

20%

30%

40%

50%

60%

70%

1993 1996

%

MachinaryComputer and telecomFood manufacturingTelecom services


Components of US Corporate Purchases


The LeadersLeading companies have unique business design requiring innovative procurement capabilities

linking suppliers into its build-to-order system creating a responsive, virtually working-capital-free supply chainuses a total systems costs approach, minimizing the sum of the supplier’s and its own costs

relies on value-added suppliers to deliver industry leading products and services, yet a leader in Internet-based procurement

capitalized on supplier relationships to extract >20% cost reduction in external purchases for the 1998 Accord


Revenue

COGS - Material

Labor & OH

Gross Margin

Operating Expenses

Net Income (pretax)

% Improvement

“When the goal is boosting profits by dramatically lowering costs, a business should look first to what it buys.”

Fortune, February 20, 1995

Baseline

$1,000M

390M

275M

$335M

200M

$135M

5%

$1,000M

371M

275M

$354M

200M

$154M

14%

10%

$1,000M

351M

275M

$374M

200M

$174M

29%

15%

$1,000M

332M

275M

$393M

200M

$193M

43%

Percent cost reduction in Direct MaterialsILLUSTRATIVE EXAMPLE

Strategic sourcing efforts can have a significant impact on the financial performance and shareholder value of a company

The Leverage


The Leverage

Industry Purchasing Manufacturing

Computer 1% 5%

Electrical Equipment

3% 11%

Automotive 1% 4%

Electronics 2% 6%

Required cost reduction to achieve 20% increase in profitability:


Procurement Trends

Parts => partners Increased outsourcing across the value chain

Purchased components => subassembliesMore highly engineered technical purchases in the mix of the buyIncreasing reliance on global supply chainUse of the net for RFP/RFQ and public/private exchanges


The Decisions:

?

Make

Buy ?Committed amount/capacity

“As needed” procurement


“Make” vs. “Buy”From River Rouge to Resende


“Make” vs. “Buy”From River Rouge to Resende

Overhead functions

Lochpe-Maxion

Meritor (Rockwell)

Remon

PowerTrain

VDO

Delga

Carese

Internal logistics

Union MantenVolksWagen

Chasis Wheels Engines Pax Cabins Body Paint ShopAxles


Advantages of Outsourcing

Flexibility: convert fixed costs to variable costs Providing flexibility in adjusting capacity (both up

and down)Balance work force requirement

Reduce capital investment requirementsAccelerate new product developmentReduce costs via suppliers’ economies of scale and lower wage structureGain access to invention and innovations from suppliersFocus resources on high value-added activities (core competencies)


Problems with Outsourcing

Labor advantages shrink as countries mature and as direct labor continues to become a smaller part of the total costSupply chain management is more difficult with off-shore suppliersLead time may be a problem with suppliers


The Strategic RiskCreating a competitor

1914 – The Dodge Brothers turn from a Ford engine supplier to a competitor

Japanese consumer electronic industry – started with contracting for US firms for radio receivers (also adopted transistors faster)

Japanese aircraft industries?

Losing control of the channel to a supplier IBM in 1980 designed the PC, the manufacturing process

and the value chain Contracted to Microsoft and Intel “Window Machine” and “Intel Inside”

Losing control of the channel to a customer P&G and Wal-Mart => “Wal-Mart Outside”?


Relationships Evolution

From “lowest price” public-auction-based buying

To long term partnership-based sourcing

To a portfolio approach


ExampleA manufacturer is facing uncertain demandSupplier is offering: Low price for committed capacity (pay

whether it is used or not) Higher price for contracted capacity (use as

much as needed)

Given demand distribution, the question is how much to commit to?


Demand Distribution

Normal Density and Distribution Functions

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

3000 5000 7000 9000 11000 13000

Demand

Pro

ba

bil

ity

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

Cu

mm

ula

tiv

e P

rob

ab

ilit

yNormal Density Function

Normal Distribution Function

Mean = 8,000 units/mo.

Std Deviation = 1,500 units/mo.


Expected Costs as a Function of Committed Capacity

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

$7,000,000

$8,000,000

3000 5000 7000 9000 11000 13000

Committed/Dedicated Capacity

Exp

ecte

d C

ost

s

H = $800

L = $500

H-L

L


Optimal Capacity Reservation

The optimal capacity reserved, Q*, will be at a point where the expected cost from an additional unit of capacity reserved will be approximately zero, -- One unit more or less will both increase the expected costsThe expected cost resulting from reserving the (Q*+1)st unit is H if it is sold and 0 for if it is unsoldThe probability of needing the (Q*+1)st unit is the probability that the demand will be higher than Q*, Pr(X Q*), and the probability of not selling it is Pr(X Q*)The expected cost resulting from reserving the (Q*+1)st unit is: H Pr(X Q*) + 0 Pr(X Q*)Optimality conditions: H Pr(X Q*) = LSolving for optimality:

Pr(X Q*) = (H – L)/H


Levels of Procurement Development

1. Leveraged Buy - Volume consolidation - Supply chain optimization

2. Linked Buy - Buyer-supplier integration - Channel cost minimization

3. Value Buy - Value management - Channel optimization

4. Integrated sell - Commercial synergy

0. User Buy - Independent actions








• User departments establish their own requirement• Procurement organization handles the transactions• High prices, questionable terms• Little strategic value








• Utilize supplier’s fixed costs more effectively• Exploit competitive supply base structure• Leveraged buy• Enhanced negotiation & contracting• Enterprise-wide view of terms and conditions








Leverage points: • Improved coordination, forecast accuracy and predictability• Optimized logistics flow• Value added services• Streamlined transactional information and cash flows• Elimination of non-value-added activities







0. User Buy - Independent actionsLeverage points: • Increased and early supplier involvement in solution design• Reduced complexity and simplified specifications• Increased standardization• Clarified response time objectives• Rationalized requirements• Controlled consumption rates• Performance incentives to achieve total cost productivity








Leverage points: • Integrate multi-company products/services and channel portfolio• Introduce creative risk sharing• Exploit suppliers’ capability and potential• Manage complex channel relationships• Cross-utilize infrastructure and operating resources among multiple parties in the value chain








Consume better

Buy better

Buy for less

Sell better


Segmenting the Buy

HighLow

Low

High

Procurement Complexity

Revenue Impact/Business Risk

How much impact could the purchase have on corporate revenue over time?


Segmenting the Buy

HighLow

Low

High



How complex are the cost driver of the purchase?• Technology/design• Supply chain integration• Life cycle management


Segmenting the Buy

Advertising Telemarketing Branded finished

goods

Critical components High-technology

products and services

Outsourced manufacturing functions

Office supplies Travel

Materials logistics services Benefits programs Professional servicesHighLow

Low

High



HighestCustomerValueimpact


Developrequirements

CreateAnnualplan

DevelopSourcingstrategy

Evaluate& selectsuppliers

Procurematerial

ManageSupplierrelationships

Goals & focus for next year (by category and totals)

Item requirements by category across the user base

Strategy to leverage buying power and minimize total costs by category

Target suppliers, negotiations and contracting

Systems, procedures, & skills to support strategy and execute well

Performance metrics, benchmarks, and improvement programs

Sourcing Process


Procurement: The Killer B2B App.

Main idea: consolidate the buying powerCentralize controlIncrease reachAutomate processesPlayers:

Application providers (Ariba, C1, Netscape…)Consulting services (FreeMarkets, ICGCommerce…)The consortia (Covisint, Transora, e2open…)


e-Procurement extends capabilities to business users to self-service their operating resource requirements via approved suppliers and products.

Many purchasing transactions bypass Many purchasing transactions bypass Procurement entirely, going directly Procurement entirely, going directly

to suppliersto suppliers

InternalInternalCustomersCustomers

DemandDemandManagement EnablersManagement Enablers

SupplierSupplierNetworkNetwork

InternalInternalSystemsSystems

CorporateCorporateIntranetIntranet

ProcurementProfessionals

InternalInternalSystemsSystems

Dep

art

men

t A

Dep

art

men

t A

Dep

art

men

t B

Dep

art

men

t B

INT

ER

NE

T

Payments

Order Status

Orders

Information

Catalogues Suppliers

PCs/Technology

Office Supplies

Copiers

Telecom

Forms

Temp Services

E-Procurement:

Automation


e-Procurement:

Main benefit:Improved Compliance

Benefits are sustainableBenefits are sustainablewith eProcurementwith eProcurement

Time

•Initial excitement

•Early adopters happy

•Management support at its greatest

•Little to no administration required

•System limitations and administrative issues surface

•First user complaints

•Performance tracking systems installed

•Ease of use and reporting become critical

•Significant administration required

•Dismayed users may resort to old methods and sources

Phase ofContract:

Negotiate Deal

ImplementContract

Manage Compliance

BenefitsCaptured

Contract savings decline over time Contract savings decline over time due to due to compliance and measurement compliance and measurement problemsproblems


e-Procurement Applications Landscape


IBM Case


AAAAA+AAAA-A+AA-BBBBB

6/90: $117

90 91 92 93

6/93: $41

IBM Fortunes


The Turnaround


Number of Procurement Organizations –Hundreds!

CountryDivisionBusiness Units

Number of contracts per supplier – Average 5

Procurement Population 5% Sourcing75% Fulfillment20% Contracts/Others

Transactions

Production “Automated” PurchaseOrder/Invoice

General Procurement – “Manual” PurchaseOrder/Invoice

Business Metrics Early 1990’s

Savings/Competitiveness ?

Escapes (By Pass) 45%

Audit Satisfaction 47%Client Satisfaction 40%

P.O. Processing 30 daysCycle Time

ContractCycle Time 6-12 monthsLength 40 (+) pages

Procurement 1990 - 1994


Transaction Automation

Process Optimization

Strategic Procurement

ROI

TECHNOLOGY

The Transformation


PROCUREMENT STRATEGY, PLANNING, PROCESS IMPROVEMENT

Information WarehouseNetwork & Topology

MARKETINTELLIGENCE

SUPPLIERINTELLIGENCE

QUOTING

SOURCE SELECTION

CONTRACT

NEGOTIATIONCATALOGS

FORECASTPLANNING

REQUISITION

APPROVAL

PURCHASE ORDER

INVOICE

ACCOUNTSPAYABLE

PAYMENT

BANKS

–D&BConnect’ns–Market–BasketAnalysis

–SupplierProfiles

–IndustryScoringSys

–InternetLinks

–Auto-BidCycles

–InternetQuoting

–InternetQuotingInteg.W/FrongEnd App

–ContractLead Client

–GlobalAccessibility

–ContractOn LineTool

–WEBAccess

–IdentifyRequiredCatalogs

–3rd PartyHosting

–BuyerlessOptions

–OBI/XMLCapability

–Punchout

–IntegratedWith ERP,TradingNetwork

–ExpandedAutomation

–Buyerless

–SkillsMatching

–WorkflowWEBEnabled

–ElectronicApprovals

–ERPIntegratedThroughoutCompany

–EDI/XMLCapability

–WorkflowEnabled

–TradingNetwork

–Chart ofAccountsLead Client

–ElectronicInvoices

–EDI/XML

–Workflow

WEBEnabled

–Positive & NegativeConfirmation

–ERP, SAP, I2

–ElectronicBankPayments

–Ledger

–Taxes

–Multi-Currency

–EURO

–WEB Enabled

–ERP, SAP, I2

e-Procurement


Regional/NicheCharacteristics

•Single Commodity Specialist•Capable Industry Provider•Price/T’s & C’s Differentiation

Enterprise/Core/StrategicCharacteristics

• Self Sufficient, World Class Service Provider

• Source of Innovation and Leadership in Both Technical and Business Areas

• Long-Term, Value-add Relationship with Shared Goals / Objectives

• Capable Industry Provider• Price/T’s & C’s Differentiation

Non-StrategicCharacteristics

• Low Impact/$ Value• Regional or Local Supplier• Minimal value to mitigate purchased goods/services to other suppliers

• Defined duration

Emerging OpportunityCharacteristics

• New Technology / Product Differentiation

• Undeveloped Relationship• Uncertain Risk• Track Record to be Established

Low HighLow

High

Long Term Strategic Importance

$ Value ofPurchases

Segmenting Suppliers

35% 50%

5%10%


Type of SupplierPercentof Spend Web Value

Core 80% Enabling greater collaboration and integration with key partners

Commodity 15% Building critical mass and extending the reach

Emerging 5% Extending the reach to niche suppliersLeverage existing suppliers

Trade Deep

Trade Broad

Trade New

Exploiting the Leverage of the Web


B

B

B

B

B

SellerSolution

S

S

S

S

S

BuyerSolution

B

B

B

B

B

S

S

S

S

S

e-MarketSolution

Seller Centric – Motivation is to increase revenues and reach a wider market than the seller currently serves. Driven to realize greater returns on investment as web site battles with noise on the web.

Buyer Centric – Motivation is to reduce procurement costs and increase efficiency of procurement processes.

Trading Community – Motivation is to generate revenues by providing value to members of a specific market by introducing new efficiencies and new ways of buying and selling.

Trading Communities


Single Point of Entry to IBM Global Procurement ApplicationsProcurement Value

•Long term cost savings through cycle time reduction, reduction in applications administration cost•Increase the speed to deploy applications to customers/business partners•Maximize shared procurement information•Standards compliance from a single platform (security, data definition)

Supplier Value•Easier to do business with IBM•Register once, be recognized everywhere•Receive relevant content, messages, and offers•Increase our guests’ experience

Portal Strategy: One Customer – One IBM


Results

5%>30%Ledger Miscodes

27,0000Suppliers Connected via Web

$330M0Savings via Web

30 days6 pages

6-12 months40 (+) pages

ContractsCycle TimeLength

95%+80%

??20%

e-Transaction: Invoice Hands Free

1 hourly30 daysP.O. Processing Cycle Time

>80%40%Client Satisfaction

+90%40-50%Acceptable Business Controls

<1%30%Maverick buying

2001Mid 1990’sBusiness Metrics


Any Questions?

? ??

Yossi [email protected]

?

?

?

proc.ppt

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