If you're not going it already, the first thing you need to do to understand the Digital Age, whether it's for purchasing, production, marketing or anything else, is to spend some time online yourself.
You can't make good strategic decisions if you don't understand the medium. The web is a different medium from most that you're used to. It's functional, as opposed to a display medium like TV or radio or print.
No CEO needs to be an expert in how the web works, but not understanding the basics is deadly. It's a lot like not understanding the differences between a steamship and a sailing vessel. They both ply the ocean, but which you're captain of makes a big difference in what you can do.
How's the best way to do this? Pick a pet project. Then try to do all the research and purchasing online that you can for that project. One of my clients did this with a boat he was refinishing. The actual hands-on use made an already web-savvy CEO even bette.
Next, CEOs need to understand that purchasing is a strategic activity in the Digital Age. That's always been true, but today it's often purchasing that sees and can exploit the tremendous power of the supply/value chain. A CEO needs to look for three specific benefits from online purchasing methods.
First, there should be lower costs. This can be lower costs for materials due to better negotiating or a wider range of bidders. GE Plastics was one of the first to document this. The aircraft industry has found they can reach a wider range of subcontractors electronically than using other methods.
Microsoft provides a good example, too. They developed a system for themselves called MS Market for ordering materials. The number of purchase orders skyrocketed, but because the system was automated it's able to handle $2.6 billion worth of orders with only two folks.
Raytheon looks for similar savings, dropping the cost of issuing the average purchase order from $100 or so down to around $3.
The second benefit should be increased speed. A purchasing function that allows for automating the functions that should be automated can be faster and more responsive. IBM credits improvements in product cycle time, in part, to improvements and changes in purchasing. Those results are pretty spectacular. Major cycle times dropped from 40-70 months down to 24 months. Minor cycle times plummeted from 18-24 months to six.
The third benefit should be increased flexibility. Moving buying to the front lines while still providing central negotiating and oversight does more than just reduce the costs or increase the speed of purchasing. It can be part of an overall culture of decision, where decisions can be made at the lowest level possible and at the level closest to the customer. It can support major changes in corporate culture as well as boost the bottom line.
Now, where to start? Here are some ideas about where to look for maximum payoff.
Companies do two kinds of purchasing. They purchase the materials that go into the products they make. And they purchase other supplies for running the business, often "Maintenance, Repair and Operating" supplies (MRO). This is also called "indirect procurement" as opposed to procurement for the manufacturing process.
For production materials, I think we'll see more automated systems, tying replenishment to manufacturing (or even sales) activity. This is a natural outgrowth of Just-In-Time thinking. At the same, time, expect most of the real purchasing work to be done in the old way, over the phone, and face-to-face.
The reason is simple, what's being purchased is critical to product quality. So is the relationship with the supplier. Purchasing agents will want to pay close human attention to the relationship.
In the computer business, we've seen an increase in Build-To-Order (BTO) systems where the product is not built until the order is placed. Let's use Dell as an example here.
When an order is placed for a Dell computer, orders are also placed, automatically, for the parts needed to make it. This BTO system is very different from a build to inventory system. It enables the manufacturer to maintain far lower parts inventories. Dell holds six days inventory of parts, compared to the industry average of 22 days. You can do quite a bit with the money that frees up.
This kind of purchasing system also means that payment to parts vendors may become an issue. If the purchasing and delivery are fast, the payment system usually needs to speed up as well. In Dell's case payment to vendors is happening in around three days.
Automated systems along the supply chain provide the same benefits that well-negotiated purchasing arrangements always do, but they have the additional benefit of helping improve cash flow and reduce inventories.
MRO supplies costs run 8-17% of revenue for large businesses. That's a lot of money. If you can shave some off product costs, you're ahead of the game. But the real savings on MRO may be in dropping the cost of the purchasing process itself and getting more MRO purchases on-book.
MRO supplies are often the "low hanging fruit" when it comes to using online methods to slash costs. If you've got things you buy where you have lots of purchases of relatively low average dollar value, then online purchasing agreements can have a big impact.
At Merck, for example, 80% of purchase orders fall in this category. If you can decrease the labor intensity of these buys by using online methods, you should drive down costs and increase on-book buys. If you move to automated system you should be able to reduce the cost of routine purchase orders which run between $10 and $150 according to the National Association of Purchasing Management.
How do you accomplish that feat? The trick seems to be to centralize your purchasing but decentralize your ordering.
Use your purchasing pros to negotiate great deals. These deals will be something like the standard Blanket Purchase Order fabled in song and story. It's negotiated at top level, but implemented at line level. There are a few things your purchasing folks should do differently in the Digital Age, though.
First, make sure that there's a good automated report system in place. That way you can have the information you need for re-negotiations and changes.
Second, give preference to vendors to make the process easy for your frontline folks. Systems like Dell Computer's Premier Pages are what you're looking for.
The idea is to make it as easy as possible for your line folks to do the right thing. That will get you more on-book orders and more purchasing leverage.
What if your purchasing people also negotiate with subcontractors? Then you'll want a system of pre-qualifying for potential subcontractors.
Give prospective vendors or subcontractors an easy way to sign up and pre-qualify to receive Requests for Proposal or Requests for Quotation. Having this on your public website works well.
Once they've qualified, add them to an email list that notifies them when there's a Request that they may wish to respond to. You can put bid packages on your extranet or on a private areas of the web.
General Electric and McDonnell Douglas pioneered these systems. They found that their range of vendors increased, and that negotiations went faster than in pre-Digital days and were more likely to get excellent pricing.
If you're the CEO, you got some key strategic decisions to make about your company purchasing. Just remember that everything we're talking about here are business decisions, with new tools to make things work better and more profitably.
Created: 1999
Reviewed: 2/15/03
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