Separate Fact From Fiction About E-Sourcing's ROI

Transcription

1 Strategic Planning, D. Hope-Ross Research Note 18 April 2003 Separate Fact From Fiction About E-Sourcing's ROI Press and vendor reports describing e-sourcing's return on investment may sound impressive, but they're often based on flawed methodology. Despite the questionable methodology, e-sourcing tools can deliver significant value. Core Topic ERP II, Supply Chain & Manufacturing: Supply Chain Management Strategies, Applications and Technologies Key Issues How will successful enterprises select, deploy and manage SCP and SCE solutions to minimize risk and achieve optimum ROI? How will SCP and SCE support current and emerging business models, and key enterprise business initiatives? Strategic Planning Assumption Through 2007, enterprises that focus on e- sourcing exclusively for cost reduction will have technology ROI 10 percent to 40 percent lower than enterprises focused on organizational transformation (0.8 probability). The industry press and vendor marketing literature are replete with stories of enterprises saving hundreds of millions of dollars with e-sourcing tools. Reports of 300 percent to 600 percent return on investment (ROI) in the first year of deployment are increasingly common and would seem to support the case for large-scale investment in these solutions. However, the case for e-sourcing investment is not that simple. Although many believe that e-sourcing technology delivers incredible savings, a closer examination of the methodology used to generate these results reveals that users can often reduce costs significantly without large-scale spending on e-sourcing technology. Enterprises should evaluate less-expensive process improvement steps, in addition to examining the technology investment value proposition. However, e-sourcing can provide benefits that are not typically considered during ROI discussions. That is, e-sourcing tools can provide a catalyst for organizational transformation from transaction-based sourcing to strategic sourcing. An e-sourcing technology purchase can be used to inspire concerted action on improving sourcing and elevating its status in the organization. Enterprises should create and execute against an investment/roi proposition for e-sourcing tools, based on organizational transformation, rather than "knee-jerk" cost reduction. The Conventional Methodology for Computing Savings The savings from e-sourcing tools are typically calculated by identifying an initial item price, which is based on historic price levels or by conducting an initial sealed bid. E-sourcing tools are used to negotiate a new item price. Then, savings are calculated Gartner Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 by subtracting the new item price from the initial item price. The savings reported by this methodology are variable, but impressive. At the high end, users report improvements in unit price of up to 80 percent. On the low end, users report savings of approximately 10 percent. (Savings typically described by industry literature range from 15 percent to 35 percent.) When e-sourcing tools are used for billions of dollars worth of items, tens or hundreds of millions of dollars of savings can be identified by this methodology. However, this methodology is misleading and error-prone. What's Wrong With This Picture? Based on this calculation initial unit cost minus new unit cost equals savings the case for e-sourcing would seem simple. However, such calculations often yield inaccurate savings figures because e-sourcing tools may not be the root cause of the unit cost reductions. The savings may be the result of factors unrelated to the e-sourcing tools: More Attention Savings are caused by improvements in the rigor with which categories that don't require tools are sourced. More Labor Savings-level variations often depend on how well goods and services were sourced historically; improvements often result from adding more personnel, which makes improved sourcing rigor possible. Technology-Independent Best Practices Some savings come from adhering to sourcing best practices that do not require (or are not supported by) e-sourcing tools. Better Negotiation Although e-sourcing tools help facilitate negotiation, such tools are not required for morethorough negotiations; furthermore, deflationary pressures from slower macro environments stimulate price reductions. Purchasing Discipline Most of the savings are not realized until an organization has completed purchasing activity against contracts created through negotiation (depending on the contract, this might be years); thus, savings cannot be attributed solely to e-sourcing tools. At the same time, additional factors can affect savings calculations in one direction or the other: Hidden Technology Costs Millions of dollars may have been spent on complementary information systems, including purchasing, procurement and payment solutions. 18 April

3 Independent Operational Costs Savings may have been affected by switching costs between suppliers, the poor performance of new suppliers or quality problems introduced by lower unit costs. Enforcement Challenges Some savings may never materialize because of an inability to understand and enforce contract terms (for example, an organization may be incapable of identifying instances when suppliers inflate pricing on invoices). Other Sourcing Costs Savings may depend on such activities and processes as value engineering, make-buy analysis, spending analyses and supplier scorecarding, which are unsupported by e-sourcing tools. What's Right With This Picture? Although the huge savings touted in the press may be illusory, e- sourcing applications can yield substantial, albeit smaller, benefits that are difficult to calculate precisely. The incremental savings benefits of using a tool (vs. conducting strategic sourcing manually) are typically in the range of 0.5 percent to 5 percent of unit cost. Even these more-modest unit cost reductions (in combination with other tools and business process reengineering) can result in highly attractive ROI from e-sourcing. In addition, the benefits of sourcing solutions extend well beyond simple unit cost reductions. Cycle-Time Reductions: E-sourcing tools can drive considerable time savings associated with preparing, publishing, receiving and reviewing bid packages. Reductions in cycle time (from bid preparation through contract award) of 30 percent to 50 percent are widely reported by users deploying e-sourcing solutions that replaced manual methods. (In some cases, the elapsed time may actually increase because of the historic absence of competitive-bidding techniques.) Labor Reductions: Users routinely report 30 percent reductions in the number of person-hours needed to prepare bid packages. These labor savings (in combination with the cycle-time reduction) enable strategic sourcing groups to increase throughput. This, in turn, enables strategic sourcing groups to increase the volume of expenditures under their management, as well as the number of money-saving strategic sourcing processes. Because most sourcing organizations are understaffed, increased throughput may be the largest contribution to unit cost savings. 18 April

4 There are also a number of nonmonetary, but meaningful "soft benefits," including: Departmental Collaboration Lowered communication thresholds associated with knowledge sharing, policy revisions and best practices often increase collaboration among sourcing professionals; this can include "virtual teams" that might be physically dispersed, especially in organizations looking to create "centrally led" sourcing functions. Supplier Collaboration E-sourcing tools can create opportunities for the exchange of intellectual capital with suppliers; this often results in "win-win" agreements with sustainable cost savings that may be based on unit cost reduction. Interdepartmental Communication E-sourcing can encourage communication between central sourcing functions and the sourcing functions that may be part of individual business units or specialized disciplines, such as IT. Increased Intellectual Input Communication between sourcing professionals and other constituents with valuable intellectual capital to contribute can include employees from finance, product development and engineering, operations and legal departments; this may also involve third-party service providers that improve the process via delivery of advice and market data. Stronger Supplier Relationships Open selection and negotiation processes can improve supplier relationships (although the downside can be supplier pushback and damaged supplier relationships resulting from coercive negotiation techniques). Process Documentation The reduction of uncertainty and "opacity" creates a superior audit record of solicitation and subsequent contract award. Requirements Definition Increased rigor can be applied to the creation of sourcing requirements and contract award criteria. Workload Planning and Performance Measurement E- sourcing can improve workload planning and oversight by supervisory staff. Although these soft benefits often seem less enticing to savingshungry executives, such benefits may provide major strategic value. This is because the soft benefits of e-sourcing tools set the stage for and promote a more-profound transformation of sourcing practices. Through 2007, enterprises that focus on e- 18 April

5 sourcing exclusively for cost reduction will have technology ROI 10 percent to 40 percent lower than enterprises focused on organizational transformation (0.8 probability). Only through organizational transformation can enterprises expect to reap savings in the sourcing process on a sustainable basis. The savings delivered by e-sourcing applications are generally overstated, hype-driven and based on weak methodologies. Even so, there are tremendous benefits to e-sourcing; however, not necessarily for the reasons most enterprises expect. Acronym Key ERP ROI SCE SCP Enterprise resource planning Return on investment Supply chain execution Supply chain planning Bottom Line: Users should examine the methodology for determining projected return on investment and focus on business process change as the key benefit. Ultimately, users should justify a decision to purchase e-sourcing tools based on their ability to support strategic transformation, as opposed to short-term unit cost reductions. On the basis of organizational transformation to truly strategic sourcing (as opposed to kneejerk cost-reduction goals), enterprises should evaluate the investment/roi proposition of e-sourcing tools. Because of their potential for transformation, Gartner recommends that clients purchase e-sourcing tools. 18 April