Moving Beyond Reverse Auctions for Scalable, Sustainable Value

Moving Beyond Reverse Auctions for Scalable, Sustainable Value A n E m p t o r i s W h i t E pA p E r Emptoris, Inc. www.emptoris.com AN-9/05

table of Contents Executive Summary��3 Why Are Companies Moving Beyond Reverse Auctions? ��5 Sub-Optimal as a Sole Negotiation Strategy ..........................................................................................................5 Not Delivering Sustainable Savings ...........................................................................................................................6 Harming Supplier Relationships ..................................................................................................................................7 How Are Companies Realizing Sustainable Value? ��8 Flexible Requirements .....................................................................................................................................................9 Expressive Supplier Bidding ..........................................................................................................................................9 Supplier Ratings .............................................................................................................................................................. 10 Business Constraints ..................................................................................................................................................... 11 Optimization-Based Bid Analysis .............................................................................................................................. 11 Optimization-Based Supplier Bid Recommendations ...................................................................................... 1 How Are Companies Realizing Value At Scale?��14 Conclusion ��15 About Emptoris ��16 -- © 001 - 008 Emptoris, Inc.

Executive summary The reverse auction can have a significant impact when initially used in enterprise sourcing and has driven hundreds of millions of dollars to companies’ bottom-lines. It increases price transparency in the market and thereby competition. However, by focusing on price, it constrains the supplier to competing solely on that dimension. The buying company misses the opportunity to consider other elements on which a supplier might compete. Moreover, it limits the buyer’s ability to incorporate business constraints and policies into the decision-making process. As a result, companies are finding that the reverse auction cannot deliver sustainable value. Yet, they are faced with significant commitments for cost reduction that must be met to remain competitive and meet market expectations. Need for Sustainability Drives Companies Beyond the Reverse Auction Reverse Auction Beyond Reverse Auction Fixed price-Based Flexible Expressive requirements supplier Bids requirements supplier Bids Negotiate for Negotiate for Lowest Price Best Value Business supplier Constraints ratings Sustainability With a singular focus on price, reverse auctions are not delivering sustainable value. As a result, companies are moving beyond the reverse auction, negotiating for best value, and delivering sustainable value year over year. Companies are stepping back from the one-size fits-all application of the reverse auction to their sourcing negotiations. Leveraging more advanced tools, companies are able to specify more flexible requirements that create more dimensions on which suppliers can compete and express their differentiation. They evaluate these factors in combination with non-price factors such as supplier performance ratings and business constraints using optimization-based decision-support tools. -- © 001 - 008 Emptoris, Inc.

Put in the hands of every buyer in an enterprise, these tools can generate the sustainable value companies need to stay competitive, and companies today are using them to generate sustainable savings of 7% in categories repeatedly sourced year after year. Overall, companies are seeing a number of key benefits: • Sourcing faster—completing negotiations in weeks instead of months and with fewer resources • Gaining price transparency at the item level • Leveraging supplier innovation and not just squeezing supplier margins • Addressing more categories of spend, enterprise-wide • Basing award decisions on best value drivers, not just lowest price • Realizing greater savings—typically $700K on $10,000K in spend -- © 001 - 008 Emptoris, Inc.

Why Are Companies moving Beyond reverse Auctions? Auctions increase price transparency in any market, and with the advent of online auctions, many companies embraced them as a driver of tremendous savings in their sourcing process. In an auction, companies precisely specify their requirements and suppliers bid against one another for the business. It has not been without short-term benefits. Companies have saved hundreds of millions of dollars using online auctions, often in categories where they thought they had already achieved substantial savings and rock-bottom prices through traditional negotiations. Thus, the online auction has been an eye-opener regarding the potential for additional savings. With that awareness, increased expectations have also come. Committed to substantial annual savings targets, procurement teams are trying to repeat their initial success. However, after a few rounds of auctions, the additional savings are not there. This is driving companies to move beyond the reverse auction, as they realize it is: • Sub-optimal as a sole negotiation strategy • Not delivering sustainable savings • Harming supplier relationships Sub-Optimal as a Sole Negotiation Strategy The reverse auction is a price-based negotiation tool, but companies need to factor a number of other criteria into their sourcing decisions. Product quality, payment terms, delivery terms, and historical supplier performance are just a few among many. And, lately with a scarcity in many commodity markets, assurance of supply can become an even more important criterion than price. Moreover, according to A.T. Kearney, leading companies that focus on reducing total procurement costs—and not just price paid—enjoy a cost advantage of more than $60 million for every $1 billion in revenue. In addition to considering other elements of a supplier’s bid and offer, buyers must also consider business constraints under which their company operates. Some of these are driven by corporate strategy and regulations—for example, ensuring that a certain percentage of suppliers are minority or women owned businesses (MWOB) or are local to the country in which the company is operating. There are also constraints designed to manage risk—for example, ensuring the company has multiple sources of supply for critical items or has suppliers who are located relatively close to its plants and offices. Not only is consideration of these types of constraints outside the scope of an auction, it requires considerable number crunching and modeling to try to factor these additional criteria into decision- making. At best, companies will invest weeks to identify a sourcing award allocation without any certainty that it is the best allocation. More likely, they often do not have time to consider these constraints at all. -5- © 001 - 008 Emptoris, Inc.

Despite the importance of these additional factors, the availability of online auction tools has driven many companies’ sourcing strategies in recent years, making price the primary point of competition among suppliers and the primary decision driver for buyers. This has led to sub-optimal strategies and results in many cases. In practice this process should work the other way around, with the sourcing strategy driving the selection of tools. In some cases, for example in a highly competitive market for a wholly-commoditized item, the reverse auction may in fact be the right tool. Or, it may factor in as a component of a multi-stage negotiation. The important point is that the strategy drives the selection of tools to ensure they aptly address all the variables and constraints at hand. Reverse Auction Availability Has Driven Sourcing Strategy Reverse Auction Sourcing Strategy Sourcing Strategy Negotiation Tool Sub-optimal results Best Value Many companies have let the availability of online sourcing tools drive their sourcing strategy, when in fact letting the strategy drive the selection of the negotiation tool leads to the best value. Not Delivering Sustainable Savings In addition to losing tremendous value by relying heavily on price-based negotiations, companies are also finding that after a few rounds of reverse auctions there are no additional savings to be had with that approach. They’ve squeezed all the excess fat out of the market, and they’ve done so at the expense of their suppliers’ margins. With pre-determined lots and a singular focus on price, auctions implicitly follow a “buyer knows best” approach. Whereas suppliers are often better able to determine the best lots and bids (incorporating bundles, volume, and quantity discounts) based on their better understanding of their own internal efficiencies and costs. Without this flexibility, suppliers cannot express any competitive advantage they may bring to the market. Instead, they must compete on the exact terms specified by the buyer and find squeezing margin is their only source of advantage. -6- © 001 - 008 Emptoris, Inc.

Harming Supplier Relationships Over time, this can harm supplier relationships. As noted in a report from The Center for Advanced Purchasing Studies, “acceptance of [reverse auctions] has not been without controversy because…its process is contradictory to the long-term benefits associated with collaborative/cooperative buyer- supplier alliances. This perceived conflict is primarily caused by the tool’s emphasis on awarding business based on aggressive price competition…instead of long-term total cost of ownership (TCO) considerations.”1 “The initial phase of sourcing Moreover, with increases in many commodity prices and automation (e-sourcing) was the equivalent of corporate shortfalls of supply, suppliers recently have greater leverage liposuction creating highly in negotiations and buyers need to collaborate with them efficient and transparent more to find the value. Overall, as companies look for markets that allowed buyers the next wave of savings to meet this year’s corporate to remove the ‘fat’ from supply markets.” objectives, they find that the savings just are not there. “The lion’s share of savings doesn’t come from auctions or Tim Minahan competitive bidding techniques. Supplier collaboration is AberdeenGroup where the long-term money is,” says Pierre Mitchell, head of e-procurement at the analyst firm The Hackett Group. Or, putting it more bluntly, Tim Minahan of the AberdeenGroup notes that “the initial phase of sourcing automation (e-sourcing) was the equivalent of liposuction creating highly efficient and transparent markets that allowed buyers to remove the ‘fat’ from supply markets.” Having run its course, all the excess fat has been taken out of the market, and it’s now time for companies to put on their running shoes and put some real muscle into their sourcing process. 1 CAPS Research. “The Role of Reverse Auctions In Strategic Sourcing.” April 00. Malcolm Wheatley. “Beyond Reverse Auctions.” CPO Agenda. Spring 005. AberdeenGroup. “Intelligent Sourcing: Advanced Sourcing Methods for Value-Based Supply Relationship.” September 00. -7- © 001 - 008 Emptoris, Inc.

how Are Companies realizing sustainable Value? To overcome these challenges and move away from the price-based decision-making put forth via the auction approach, companies are leveraging advanced negotiation approaches that take the data crunching out of the decision-making process and empower buyers to focus on developing the right sourcing strategy and building relationships with their suppliers. To empower buyers to make the best award allocation there are six key elements of a best-in-class approach: • Flexible requirements • Expressive supplier bids • Supplier ratings • Business constraints • Optimization-based bid analysis • Optimization-based supplier bid recommendations -8- © 001 - 008 Emptoris, Inc.

Flexible Requirements To provide real value, advanced negotiation approaches must incorporate a flexible, extensible bidding model that allows buyers to define their requirements in a way that does not constrain suppliers or prevent them from bringing their innovation and preferences to light during the negotiation. For example, a buyer may stay away from fixed quantities, allowing suppliers to bid based on the quantities they are best suited to provide. Or, the buyer may allow different quality grades to be specified and then determine which grades to purchase in which quantities based on the suppliers’ capabilities. Flexible Requirements Expands the Scope of the Negotiation negotiation Approach negotiation Factors reverse Auction Beyond reverse Auction Price Variable Variable Quantity Fixed Variable Quality Fixed Variable Payment Terms Fixed Variable Contract Terms Fixed Variable In a reverse auction, only price is variable. Moving beyond the reverse auction, companies are expressing their requirements more flexibly to expand the dimensions along which suppliers compete. The model must also be extensible to empower the buyer to factor in all the elements that drive best value. By putting this power directly in the hands of the buyer, companies are able to source and model all categories of spend enterprise-wide. Buyers are able to model the unique cost drivers for their category and business gaining the incremental value of advanced negotiation approaches across all enterprise spend. So, be it shipping, hotel accommodations, electronic components, or simply office supplies, any and every category can be sourced using advanced optimization approaches. Expressive Supplier Bidding Given a flexible bidding model as established by the buyer, suppliers must be empowered to express their preferred bids. To reveal their competitive advantage, they should be able to offer discounts and bundled pricing, and flexibly address other non-price factors such as quantity, item specifications, delivery terms, etc. As a result, the buyer will have better insight into the supplier’s capabilities and be able to better leverage their innovation, all without simply squeezing margins. This not only provides better value but also improves the supplier relationship via better collaboration. Reverse auctions, in contrast, limit collaboration by requiring an apples-to-apples comparison across suppliers. This forces buyers to predefine requirements and bundles. In the example below, using the reverse auction, a buyer sourcing a high-quality ingredient at low volume finds that suppliers are -9- © 001 - 008 Emptoris, Inc.

only willing to provide it at a very high price due to the low volume. However, leveraging expressive supplier bidding, the buyer allows suppliers to structure their bids into the bundles that better match their cost structures. And, in this example, given the opportunity to bundle the low-volume high-quality ingredient with a large-volume lesser-quality ingredient, suppliers are willing to provide the high-quality ingredient at a lower price. Using a reverse auction, a company would never have discovered this potential cost savings because it would have locked suppliers into placing bids on a set of pre-defined requirements. Reverse Auctions Miss Opportunities for Savings Reverse Auction Beyond Reverse Auction Reverse Bid Price auction price Bids for high- premium quality ingredient Bids for lesser- quality ingredient Supplier Defined Bundled bid Time With reverse auctions, suppliers are limited to bidding on lots pre-defined by the buyer. Freed from this constraint, they may express alternate bundles that the buyer may not have considered and that they can offer more cost-effectively. Supplier Ratings Supplier ratings are another element that when factored into decision-making can improve a buyer’s ability to negotiate for best value. Supplier ratings may address quality, performance, service, or financial condition. Performance, for example, could include an on-time delivery score, or it may include a composite key performance indicator (KPI) related to service responsiveness as determined by a survey of individuals who work with the supplier. Ratings can also incorporate publicly available metrics about the supplier or ratings specific to the supplier’s relationship with the buying company based on information from production systems. - 10 - © 001 - 008 Emptoris, Inc.

Factoring in performance ratings gives buyers a better view into What Is Optimization? the total cost of ownership (TCO) of various sourcing scenarios. Optimization is the practice of finding the best possible solution to a problem in which there are a number of competing or Business Constraints conflicting considerations. Within the area of sourcing, it is the only approach that Buyers also typically have to consider business constraints, allows buyers to simultaneously evaluate the complete range of variables and constraints purchasing policies, and priorities in their decision. Typically that impact sourcing decisions to identify these are designed to mitigate risk or support business strategy. the best possible sourcing decision. In other words, optimization is the only technology For example, a company may want to control the minimum or that can look at the “whole” problem, maximum suppliers for a given category or item. To reduce supply including all of the interdependent variables concurrently, before recommending the risk, a buyer may want to ensure at least two suppliers for a critical optimal solution. item. Or, to keep the administrative costs of doing business low, It is important to note, however, that they may restrict the maximum number of suppliers with whom some solutions use the term “optimized” or “optimization” but do not incorporate they do business. the comprehensive and sophisticated algorithms used in bona-fide optimization Companies may also limit the volume of an award that goes to a systems. These pseudo-optimized systems new supplier to reduce exposure, or guarantee an allocation of rely on simple ranking methods for bid analysis. The process of ranking bids and/or some portion of the award to a preferred vendor or a minority- or suppliers limits bid analysis to looking at woman-owned business. Geographic considerations may also need isolated factors, whereas true optimization incorporates rankings as part of a global to be factored into decisions to meet, for example, local-content analysis that simultaneously looks at all items, requirements or ensure proximity between supplier and point suppliers, bids, and business constraints. of use. Optimization-Based Bid Analysis With a flexible bidding model, expressive supplier bids, supplier ratings, and business constraints, evaluating different bids becomes increasingly complex. Optimization techniques, however, employ sophisticated algorithms to identify the best award solution. Thus, having defined their total cost model (incorporating price and non- price factors) and having identified any business constraints, the buyer is in virtual real-time provided with the award allocation that provides the best value. Tight integration between the bidding mechanism and the optimization is critical to empowering the buyer with real-time analysis across every dimension of competition and all line items. Optimization is not a single step at the end of the negotiation process. Being able to leverage it in real-time—multiple times during the course of a negotiation—enables buyers to provide feedback to suppliers and make adjustments in the negotiation when warranted based on the incoming bids. - 11 - © 001 - 008 Emptoris, Inc.

In the following example, using optimization to factor in supplier-suggested bundles and business volume discounts, a company realized 7% additional savings. In a category that had already been through multiple rounds of reverse auctions and was thought to be squeezed dry of savings, that’s a substantial breakthrough and a source of incremental value of the buying company. Factoring in supplier performance and business constraints leads to even greater value. Savings Example Using Optimization $,00 $,67 Savings of 7% $,50 Total Cost of Award ($000) $,00 $,50 $,1 $,00 $,150 $,18 $,11 $,100 $,050 $,000 $,950 Reverse Award with Award with Award with auction business volume bundling bundling and award discounts business volume discounts This sourcing example is illustrative of results commonly achieved across a wide range of categories, such as temp labor, electronic parts, or computer equipment. With flexible up-front requirements that allowed suppliers to express their preferred bundles, this company leveraged optimization to review bids including business volume discounts and a variety of different bundling options, as expressed by the suppliers. Given the ease and speed of creating and evaluating scenarios using optimization, buyers can create multiple “what-if” scenarios to conduct cost-benefit comparisons among various business constraints. For example, the cost of reducing the supply base of a critical item from five to two suppliers can now be quantified and factored into the decision-making process. Overall, optimization gives buyers the confidence to know they are making the right sourcing decisions. Optimization-Based Supplier Bid Recommendations This level of confidence can also be extended to suppliers by empowering them with optimization- based feedback that recommends alternate pricing and bundling scenarios based on the overall negotiation dynamics and competitive bids. This benefits suppliers by providing them with additional insight into how they might bid more competitively, in ways they may not have considered. And, it benefits the buyer by introducing additional competition, which is not solely - 1 - © 001 - 008 Emptoris, Inc.

What To Look for in a Solution4 price-based, into the negotiation. Like expressive supplier The following are key components to look for in a bidding, this creates a more collaborative negotiation that is solution that can empower a company to move more likely to capture the value of supplier innovation. Like beyond the reverse auction. the optimization-based bid analysis leveraged by the buyer, Integrated workflow that supports the this also occurs in real-time during the course of a negotiation. buyer and the suppliers and reduces the workload during the multistage negotiation process, beginning with an RFx, moving to an auction, and finishing Optimization Empowers Buyers and Suppliers with award analysis. Multiple online negotiation formats In addition to supporting a buyer’s bid analysis, optimization can (reverse auction, online competitive bidding, multistage negotiation, one-on- be applied to provide real-time feedback recommending alternate one negotiation). pricing and bundling scenarios based on the overall negotiation The ability to manage many line items (for dynamics and competitive bids. Companies today are integrating example, over 10,000 items), hundreds of this into multi-stage negotiation strategies: suppliers, and complex pricing formulas that factor in the costs of doing business with a supplier in a single negotiation. STAGE 1: An RFI is run to get input from suppliers on additional cost elements which are then incorporated into a total Expressive supplier bidding, in which suppliers submit bids consisting of cost model. price and other such attributes as quantity, quality, discounts, and delivery STAGE : An initial RFQ event is conducted without expressive requirements to give the buyer beneficial options. supplier bidding or providing supplier bid recommendations. This stage gathers supplier bid Online feedback to suppliers showing how competitive their offers are (at the information on buyer-defined packages item level and overall) and suggesting bidding strategies to win more business, STAGE : Suppliers are empowered to bid expressively and the integration of optimization with and supported with optimization-based bid this capability to support near real-time automated feedback recommendations in what is often called a “dynamic” Optimization-based bid analysis that is RFQ since its terms and configurations may change tightly integrated into the negotiation based on innovative bidding strategies suppliers bring workflow, making it possible for any buyer to the table. in any negotiation of any category to identify the lowest total cost of ownership (all costs associated with the procuring and using a material or service, including costs for parts, poor quality, logistics, inventory, resources, and ordering). “Dynamic” RFI RFQ Business-constraint modeling that RFQ enables trade-off analysis of different purchasing strategies based on such constraints as supplier count, capacity, Stage 1 Stage 2 Stage 3 delivery requirements, and performance requirements. Support for evaluating suppliers based on criteria using complex formulas for analyzing total cost of ownership and optimization-based bid analysis that factor in cost drivers, supplier capabilities, supplier capacity, supplier performance, and multiple forms of supplier discounts. User-friendliness, especially for suppliers, giving them bidding flexibility, smooth data importing and exporting, and improved reporting. “Reinventing the Supplier Negotiation Process at Motorola.” Interfaces. Vol. 5. No. 1. January- The ability to integrate the software with February 005. existing internal systems to move data quickly into and out of the system. - 1 - © 001 - 008 Emptoris, Inc.

how Are Companies realizing Value At scale? Many companies have applied the five elements above to specific categories or components of their spend. Often, they have done so by leveraging consultants at considerable cost. While they may realize significant value from these engagements, the model doesn’t scale to drive sizable impact— impact that noticeably hits the bottom- and top-lines and drives up earnings-per-share. To realize benefits at that scale, leading companies are putting the power of optimization-based bid-analysis in the hands of every buyer in their organization. This pays off quickly as incremental value is realized across all categories of spend—indirect, MRO, and direct—enterprise-wide. In fact, the AberdeenGroup notes that “companies with at least five advanced sourcing categories, and the prerequisite capabilities, should consider a software-based approach.” They highlight how H.J. Heinz has deployed “self-service advanced negotiation and optimization tools to each buyer’s desktop so advanced techniques are leveraged on 0% of all e-sourcing projects.” This has resulted in “continuous, sustainable savings of 7% on categories repeatedly e-sourced, some as much as six times in as many years.”5 Compared with reverse auctions, advanced negotiations go a long way towards providing better value. Many companies report realizing additional savings, relative to those achieved via the auction approach, of 5% or more using advanced negotiation. And, that does not even represent the auxiliary benefits such as improved supplier relationships, risk mitigation, and better alignment between business and sourcing strategy achieved by factoring in non-price factors and business constraints. Of course, technology is just one part of a solution and most companies take a phased approach to the adoption of advanced negotiation techniques. They often start with Continuous, sustainable key categories and buying groups to incorporate and savings of 7% on categories repeatedly e-sourced, some as develop best practice processes that empower them to much as six times in as many realize the full value of the approach. Armed with initial years successes, they conduct a broader knowledge transfer through which best practices are infused across the buying organization. 5 AberdeenGroup. “Success Strategies in Advanced Sourcing and Negotiation.” June 005. - 1 - © 001 - 008 Emptoris, Inc.

Conclusion The hey-day of reverse auctions is waning as they are not delivering the sustainable savings companies need to stay competitive. While there is a place for reverse auctions within the context of a larger sourcing strategy, companies are moving away from the one-size fits all approach in which reverse auctions were automatically used for many sourcing negotiations. Taking a more nuanced approach, companies are specifying their requirements flexibly and allowing suppliers to bid expressively. In combination with supplier performance factors and business constraints, bids are evaluated using optimization-based decision support that enables companies to negotiate for best value, not just price. Extending this capability broadly throughout an organization and empowering individual buyers with it, companies are able to achieve sustainable savings at significant scale. They can begin to address every category of spend enterprise-wide with these advanced techniques and are realizing consistent savings of 7% year after year. Moving beyond the reverse auction, companies are able address their sourcing more holistically and realize the best value from their supply base. If you have comments on this white paper or would like to discuss any of its points, please contact us at 781-99-91 or at whitepapers@emptoris.com. If you would like to discuss how the Emptoris Sourcing and Optimization solutions can help your company move beyond reverse auctions, please contact us at 781-99-91 or at info@emptoris.com. - 15 - 15 © 001 - 008 Emptoris, Inc.

About Emptoris Emptoris is a world leader in innovative supply and contract management software solutions that empower enterprises to realize best value and accelerate profitable growth. Emptoris solutions are fused by successful Global 000 companies in every industry. Customers include American Express, Boeing, ConocoPhillips, GlaxoSmithKline, Kraft, Motorola, Owens Corning, Syngenta, and Vodafone. - 16 - © 001 - 008 Emptoris, Inc.

For more information about Emptoris, visit: www.emptoris.com, call 1.781.993.9212, or email sales@emptoris.com. Emptoris, Inc� 00 Wheeler Road, Burlington, MA 0180 tel 781-99-91 • fax 781-99-91 • www.emptoris.com © 001 - 008 Emptoris, Inc.

Moving Beyond Reverse Auctions for Scalable, Sustainable Value

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Moving Beyond Reverse Auctions for Scalable, Sustainable Value Document Transcript