Modern Procurement

1
Modern Procurement

• Yossi Sheffi

Yossi Sheffi MIT Engineering Systems Division
2
Outline

• Role of procurement
• Make vs. buy
• Strategic considerations
• Commitment vs. variable buy
• e-Procurement
• Combinatorial procurement
• Example transportation
• RFP system
• RFP lane
• Spot market

3
(No Transcript)
4
Components of US Corporate Purchases
5
The Leaders

• Leading 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 chain

• uses a total systems costs approach, minimizing
  the sum of the suppliers 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
  gt20 cost reduction in external purchases for the
  1998 Accord

6
The Leverage
Strategic sourcing efforts can have a significant
impact on the financial performance and
shareholder value of a company
Fortune, February 20, 1995
7
The Leverage
Required cost reduction to achieve 20 increase
in profitability
8
Procurement Trends

• Parts gt partners
• Increased outsourcing across the value chain
• Purchased components gt subassemblies
• More highly engineered technical purchases in the
  mix of the buy
• Increasing reliance on global supply chain
• Use of the net for RFP/RFQ and public/private
  exchanges

9
The Decisions
10
Make vs. Buy
From River Rouge to Resende
11
Make vs. Buy
From River Rouge to Resende
Union Manten
VolksWagen
Overhead functions
Internal logistics
Lochpe-Maxion
Remon
VDO
Carese
Meritor (Rockwell)
PowerTrain
Delga
12
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 requirements
• Accelerate new product development
• Reduce costs via suppliers economies of scale
  and lower wage structure
• Gain access to invention and innovations from
  suppliers
• Focus resources on high value-added activities
  (core competencies)

13
Problems with Outsourcing

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

14
The Strategic Risk

• Creating 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
• PG and Wal-Mart gt Wal-Mart Outside?

15
Relationships Evolution
From lowest price public-auction-based buying
To long term partnership-based sourcing
To a portfolio approach
16
Example

• A manufacturer is facing uncertain demand
• Supplier 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?

17
Demand Distribution
Mean 8,000 units/mo. Std Deviation 1,500
units/mo.
18
L
H-L
H 800 L 500
19
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 costs
• The expected cost resulting from reserving the
  (Q1)st unit is H if it is sold and 0 for if it
  is unsold
• The probability of needing the (Q1)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
  (Q1)st unit is H ? Pr(X ? Q)
  0 ? Pr(X ? Q)
• Optimality conditions
  
  H ? Pr(X ? Q) L

• Solving for optimality
  
  Pr(X ? Q) (H L)/H
  

20
Levels of Procurement Development
21
Levels of Procurement Development

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

22
Levels of Procurement Development

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

23
Levels of Procurement Development

• 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

24
Levels of Procurement Development

• Leverage 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

25
Levels of Procurement Development

• 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

26
Levels of Procurement Development
27
Segmenting the Buy
How much impact could the purchase have on
corporate revenue over time?
High
Revenue Impact/ Business Risk
Low
High
Low
Procurement Complexity
28
Segmenting the Buy
High

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

Revenue Impact/ Business Risk
Low
High
Low
Procurement Complexity
29
Segmenting the Buy
High
Revenue Impact/ Business Risk
Low
High
Low
Procurement Complexity
30
Sourcing Process
Goals focus for next year (by category and
totals)
Strategy to leverage buying power and minimize
total costs by category
Systems, procedures, skills to support strategy
and execute well
Item requirements by category across the user base
Target suppliers, negotiations and contracting
Performance metrics, benchmarks, and improvement
programs
31
Procurement The Killer B2B App.

• Main idea consolidate the buying power

• Centralize control
• Increase reach
• Automate processes
• Players
• Application providers (Ariba, C1, Netscape)
• Consulting services (FreeMarkets, ICGCommerce)
• The consortia (Covisint, Transora, e2open)

32
e-Procurement extends capabilities to business
users to self-service their operating resource
requirements via approved suppliers and products.
E-Procurement Automation
Many purchasing transactions bypass Procurement
entirely, going directly to suppliers
33
e-ProcurementMain benefitImproved Compliance

• 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

Benefits Captured
Time
34
e-Procurement Applications Landscape
35
IBM Case
36
IBM Fortunes
37
The Turnaround
38
(No Transcript)
39
Procurement 1990 - 1994
40
The Transformation
Strategic Procurement
Process Optimization
ROI
Transaction Automation
TECHNOLOGY
41
e-Procurement
42
Application Portfolio (2001)
43
Application Portfolio (2001)
44
Application Portfolio (2001)
45
Application Portfolio (2001)
46
Segmenting Suppliers
Value of Purchases
Long Term Strategic Importance
47
Exploiting the Leverage of the Web
Trade Deep
Trade Broad
Trade New
48
Trading Communities
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.
49
Portal Strategy One Customer One IBM

• Single Point of Entry to IBM Global Procurement
  Applications
• Procurement 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

50
Results
51
Any Questions?
?
?
?
?
?
?
Yossi Sheffi sheffi_at_mit.edu