Optimised E-Sourcing Strategies

Empowering suppliers and enhancing supplier relationships while still achieving best value.

As widely reported in previous ELP publications, European procurement organisations have embraced the reverse auction as the preferred price negotiation tool. However many, including the suppliers on the receiving end of such strategies, are frustrated by its narrow focus. For supply management organisations keen to continue to hit savings targets while not damaging supplier relationships built over years of collaboration, an ideal approach is being sought, one which would retain the instant feedback and transparency of reverse auctions while expanding the dimensions on which suppliers compete, and integrating decision factors and constraints into the feedback. This holistic approach would offer best value outcomes by reducing costs and improving quality, managing risk, and capturing the latent innovation of the supply base, while allowing suppliers to differentiate their offerings in a transparent marketplace by means other than unit price reductions.

With this in mind, the use of E-sourcing platforms is evolving, with approaches allowing both buyer and supplier communities to gain better visibility into costs and risks in the supply chain and work together to come up with innovative cost-saving, value-enhancing solutions that build stronger relationships over time. To illustrate such an approach, and how it impacts both the procurement and sales organizations involved in negotiations, take the following example from a global manufacturing organization.

The sourcing team sat around a conference table at corporate headquarters discussing the $43 million reverse auction that they ran the day before. By any measure, the reverse auction was a success. There were over $7.2 million of hard-dollar savings opportunities in the most aggressive award scenario and price reductions at 20 of 22 plants. The sourcing team also had attractive options beyond these gaudy "best-case" savings figures. All eight of the suppliers that participated in the reverse auction had been qualified for the business during the course of the RFP process. Even if the sourcing team made no multi-plant award commitments, their savings opportunity was over $6.2 million with the low-bid supplier at each plant, $6 million with the second lowest bidders or $5.1 million with the third lowest. The baseline savings scenario -- extending the incumbent supplier relationships at each plant -- guaranteed them savings of $4.1 million. The negotiation had taken under four hours with no travel required by the sourcing team or suppliers.

Two weeks prior, the sales team at one of the key suppliers sat with executives discussing their negotiation strategy. They were capable of supplying 100 percent of the company's requirements, and were the incumbent supplier on $11.5 million of annual volume at six plants. After five weeks developing and refining their proposal, they needed to determine the lowest price they were willing to quote under various award scenarios as well as the relative value of the elements of their proposal that wouldn't be reflected in the reverse auction. At each plant, their capabilities and competitive strengths varied. In three of their six incumbent plants, the sales team knew that the customer had been somewhat disappointed in their quality and their service and would not mind switching the business if given the opportunity. At the other three plants, they believed that their relationship was worth more, and decided to bid at a $25,000 to $75,000 premium over the low price.

They created similar strategies for each of the 22 plants based on their understanding of their competitive position on non-price performance factors. Finally, the sales team worked with company executives on their total volume discount strategy. Assuming that the reverse auction would be competitive, they determined that they were willing to match total volume discounts of up to 2.5 percent at $10 million and 5 percent at $20 million given forecasted economies of scale and the long term value of a prestigious national account.

When the final award decision was made, incumbents retained business at 16 of 22 plants. The average premium paid at these plants to avoid switching costs and business continuity risks was $50,000. Over $14 million of volume was awarded to new suppliers at the other six plants. The low bid supplier was the winner in four of those six cases. Based on the awarded volumes, the team forecasted total savings of over $6 million, including $500,000 of rebates based on multi-plant awards. With the exception of one plant that was forced to switch vendors based on non-competitive incumbent pricing, all plants believed that the net result of the sourcing project would be similar or higher supply quality. In all cases, the plants believed that the best-value decision had been made by the corporation.

Nuanced best-value approaches were utilized by the buyer and suppliers throughout the project to guide their strategic decision making. The sourcing team considered product and service quality, switching costs, qualification costs, supply risk factors and product cost during the RFP, negotiation and analysis processes. The suppliers considered their cost of goods sold, the opportunity cost of their production resources, economies of scale, the reference value of the account, and their points of competitive differentiation and weakness.

Though complex, this type of sourcing project does not depend on unfamiliar or exotic technologies. Rather, it is made possible by the convergence of the electronic RFP, reverse auction and optimization-based scenario analysis software. By combining these technologies with best-in-class sourcing processes and expert resources, the sourcing organization was able to generate a huge number of award scenarios with similar value profiles. This enabled their stakeholders to consider more objectives and enjoy substantial total cost savings without unnecessarily sacrificing quality or supply chain stability. The key technical ingredients to best-value electronic negotiation are transparent feedback, dynamic bidding, expressive bidding and scenario analysis.

Transparent feedback is any technology that provides consistent feedback to suppliers that is directly derived from the bid data. This technology is most typically seen in reverse auctions at the extended or unit price level. But, the technology can just as easily be used in the traditional RFX process, for price and non-price bid components, and for bid refinement purposes.

Dynamic bidding is any technology that enables the bidding process to be conducted in real time, typically within a compressed time frame. While undeniably effective, the application of dynamic bidding is still limited to relatively simple or simplified reverse auction negotiations. The critical growth factors for dynamic bidding are software quality, usability and buyer education. It takes tremendous confidence in oneself and one's technology to execute even a relatively basic reverse auction. As reverse auction technology becomes more seamless and buyers become more seasoned in the execution of intricate dynamic bids, the footprint of this technology will expand.

Expressive bidding is any technology that enables suppliers to fully describe the relationships between their capabilities, pricing and constraints. The first generation of expressive bidding requires buyers to define the ways in which suppliers can express these components of their bids. The next generation of expressive bidding will also enable suppliers to suggest refinements to the buyer's RFX design that the buyer will be able to fold into their analysis and introduce to the entire supply base.

Scenario analysis is any technology that enables buyers, and eventually suppliers, to calculate optimal decisions based on sets of inputs and defined objectives, as well as the sensitivity of these decisions to changes to any of the inputs. Scenario analysis is currently relied on in transportation sourcing and sometimes utilized for packaging sourcing. The technology will see much broader application once it can handle a wider variety of bids and constraints, is capable of assessing the sensitivity of decisions to more types of input changes, and is more efficient for users. Progress in these areas will constantly be hampered by performance challenges which will require significant innovation to overcome.

The most exciting and effective negotiation innovations will be combinations of these four technologies and concepts. Invention will be focused on the application and perfection of these capabilities instead of the discreet capabilities themselves. For the supply management practitioner, things are just starting to get interesting. We are ushering in the next wave of strategic sourcing strategies, and the success stories are compelling.

John Webster, Product Marketing Manager, Emptoris EMEA