Innovative Perspectives: Value Creation and Electronic Procurement John Douglas Thomson RMIT University, 239 Bourke St, Melbourne, Australia, 3000. Business Address: 103/241 Flinders Lane, Melbourne, 3000. Ph: +61 3 9560 1443; 0404 462 325
[email protected] ABSTRACT
management system) contributes to relatively expensive transaction costs and has an intrusive surveillance system acting on behalf of distant shareholders. While this used to be considered efficient (Morgan, 1997) it is now less so because information flows continue to be constrained. The free flow of information to all parts of an organization is being hindered by ‘principal-agent problems and self interest’ (Fukuyama, 1999 pp203), that is proxy agents with their assessment of the interests of the owners and themselves at heart (Schein, 1988). Perhaps the most striking feature of the new technology of electronic procurement is its ability to make information more symmetrically available to all organizational members (Fukayama, 1999), and the resulting potential for the spontaneous development of more efficient arrangements. This could have a significant impact on the behaviour of all individuals, as it influences governance practices, both formal and informal, rational and empirical (Kant, 1781). Tarnas (1996) is of the view that ‘there is a real awareness that things have to change’.
This research addresses the very important question of the impact of web-based electronic procurement systems on corporate governance, as related to organizational purchasing and value creation. Unlike traditional marketplaces where the sale and purchase of products takes place at specific locations, the electronic marketplace is mainly designed to use the Internet infrastructure to exchange information and create virtual communities in space (Hagel and Armstrong 1997), where transactions between buyer and seller take place. But a lack of theoretical investigation and empirical evidence suggests uncertainty as to whether the Internet and electronic technology based transactions represents a ‘new economy’ unbounded by traditional economic principles (Arthur 1994; Porter 2001). For reasons of competitive advantage and intellectual property ownership, there remains a ‘paucity of studies’ investigating value creation mechanisms in the electronic commerce sector (Park, Mezias and Song 2004 p8). This paper suggests a value creation mechanism in the form of an electronic procurement data base model. This generic model was developed for a multinational organization and successfully tested with two other multinational organizations. The capturing of this ephemeral data and creating value from it is the focus of this paper.
1.2 Failures Of Prominent B2B Markets An electronic marketplace is a virtual platform for collaboration between buyers and sellers (Matthewson, 2001). The benefits of electronic marketplaces perceived by many include significant cost reductions through process integration; faster channels of communication, reducing order-to-delivery lead times; costeffective identification of new suppliers, products and services; greater price transparency for both buyers and sellers; increased reach and larger customer bases, lower acquisition costs for new customers; and statistical reports on market activity (Matthewson, 2001). In the electronic marketplace, information and information processing capabilities that increase efficiency or convenience become a source of competitive advantage, the tool to reduce transaction costs and to create virtual communities (Park, Mezias and Song 2004). An electronic market functions as a third party intermediary whose business procedures and technology suggest cost savings to users and streamlined purchasing and sales processes (Swedish Trade Council, 2001). For buyers, electronic markets held the promise of lower purchasing costs while reaching new suppliers - for sellers, electronic markets promised lower sales costs and help in reaching new customers (Chaffey, 2002). But as the failures of prominent B2B markets have shown, creating value from the use of electronic procurement isn’t easy.
Key words Electronic; Procurement; Innovation; trust; transparency; transaction costs; value creation;
1. INTRODUCTION 1.1 Things Have To Change Organisations around the world are implementing the electronic purchase of products, and are looking for guidance as to how this may be best achieved. They have variously adopted the Internet as a pervasive tool for communication, research and medium of business. This adoption has been because competitive global pressures are intense, but these pressures may be perceived to be eased by an improved ability to cope with complexity through use of enabling Internet based technology. Williamson (1975, 1979, 1983, 2000ab, 2002abc) suggests this cohort and its governance system (as a behavioural Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for profit or commercial advantage and that copies bear this notice and the full citation on the first page. To copy otherwise, or republish, to post on servers or to redistribute to lists, requires prior specific permission and/or a fee. ICEC’05, August 15–17, 2005, Xi’an, China. Copyright 2005 ACM 1-59593-112-0/05/08…$5.00.
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2. ADAPTATION AND SEGMENTATION 2.1 Use Of The Market (‘Buy’) To Supply Some Transactions And Vertical Hierarchy (‘Make’) For Others The economist Friedrich Hayek (1945) and organization theorist Chester Barnard (1938) agree that adaptation is the
central problem of economic organization. Hayek (1945 p526-7) focuses on the adaptations of autonomous economic actors who adjust spontaneously to changes in the market, signalled by changes in relative prices - ‘how little the individual participants need to know to be able to take the right action’. Barnard (1938) featured coordinated adaptation among economic actors working through deep knowledge and the use of administration, hierarchy being accomplished in a ‘conscious, deliberate, purposeful’ way (Barnard 1938, p9). Because high performance economic systems display adaptive properties of both kinds, the problem of economic organization is properly posed not as markets or hierarchies but rather as markets and hierarchies - a predictive theory of economic organization recognizes how and why transactions differ in adaptive needs, hence the use of the market (‘buy’) to supply some transactions and vertical hierarchy (‘make’) for others (Williamson 2002a). This suggests it is necessary for an organization to segment its procurement transactions into appropriate groupings; that is whether they will be procured through marketplace or hierarchy arrangements, or both. Once strategic segmentation is identified, deeper secondary segmentation can be undertaken.
tracking the outsourced ‘buy’ procurements was investigated with inter alia, a view to using the data for value creation purposes.
3.
CREATING VALUE THROUGH AN ELECTRONIC PROCUREMENT DATABASE 3.1 Content A Key Value Driver There is much corporate information associated with the procurement function. Its innovative conversion to intellectual capital using electronic technology may be invaluable in the corporate governance of its procurement activities. For an organization to use transaction procurement information to create value, it will need to be able to access with ease and minimum transaction cost, an electronic procurement data base. A lot of the data useful for an electronic procurement database is often spread throughout different organizational functions such as accounting, project management and supply logistics. Wittman & Cullen (2000) predicted that content may become a key value driver. Because of the ability of electronic technology to collect, correlate, track and aggregate all individual electronic transactions quickly and easily, this content becomes potentially very valuable information. Electronic procurement technology enables masses of information, previously been dispersed and fragmented, difficult and expensive to bring together in a timely way, to now be brought together electronically in fractions of a second by any organization with an appropriate procurement data base.
However, these alternative modes of governance differ in their capacities to deliver (Williamson 1991) that is to ‘make’ or produce internally, or to ‘buy’ that is to outsource.
2.2 Competitive Market Testing Program ‘Make’ Or ‘Buy’ Governance A multinational organization undertook a competitive market testing program, specifically designed to test a ‘make’ or ‘buy’ governance structure for the procurement of products identified as ‘non-core’ service business. The aim of the program was to ensure that non core support services were provided in a manner which achieved the best value for money through a market testing process which was transparent, auditable and defendable. Under this program, activities may be outsourced (‘buy’) if it was operationally feasible, practicable and provided better transaction cost and product economy than vertical hierarchy (‘make’). Table 1 provides a summary of the outcomes of 120 ‘make’ or ‘buy’ competitive market testing case studies valued at $5,935m. From Table 1 it can be seen that 67% of the decisions were awarded to the ‘buy’ option, 27% to ‘make’, and 6% to retain existing ‘make’ arrangements.
3.2 Electronic Procurement Generic Model
Data
Base
The generic model is based on the development of a comprehensive electronic procurement data base for a multinational corporation with an annual spend of around $4bn per annum on products (goods and services) from almost every industry sector. The database software used was the familiar MS Access, but most database software would be suitable. Apart from transaction cost considerations, the reasons the MS Access data base software was used was because there were many in the organization who were already familiar with the software. This kept training costs down, assisted acceptance and change management, and maximized the easy use of the data base by the maximum number of employees.
3.3 Model Boundaries
Table 1: ‘Make’ Or ‘Buy’ Outcomes over 120 Procurement Contracts of Value $6b ‘Make’ or ‘Buy’ 120 procurement % by Evaluation Decisions made contracts number In-house Options ‘make’ in 32 26.7% house Commercial Contracts 81 67.5% ‘buy’ ie outsource Status Quo retained 7 5.8% Number of Full Time 15,935 Employee Positions Tested Total Value of Commercial $5935.411m Contracts and In-house Options
The boundaries of the generic model were based initially on existing data of one financial year’s transactions. This data was spread throughout the corporation in various databases such as accounting, project management and logistics. The exploratory research included around 250,000 transactions, 50,000 of which were each over $2,000 in value. The remaining ~ 200,000 transactions were commodity products lower in value than $2,000. The collection and compilation of this data was time consuming and resource intensive, taking three employees around three months. To this database was subsequently added data from another six financial years.
3.4 Model Based On A Unique ‘Field’ Common To Every Transaction
The value creation from this program measured by the reduction in transaction costs from outsourcing ‘buy’ and from improving the delivery efficiency and effectiveness of the ‘make’ option as a result of market testing varied for each contract, but overall was greater than 10%. A means of
Each financial year was established with its own database, and a unique field common to every transaction was identified. This unique field, the buyer’s purchase order number, provided the means by which transaction data within and across each financial year was selected, interrogated, related, dissected,
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3.8 Value Creation by Reducing Problems of Incomplete Information
grouped and extracted in many shapes and forms. A flat file approach made access to specific data easy and quick by people with very limited training, and without overloading or making the database too complicated or difficult to interrogate. Relational database fields were subsequently added such as Zip Codes and pull down menus for seller attributes. Procurement reports were structured to meet a variety of needs at the various organizational levels, for example, strategic, tactical, operational or specific needs.
With such a corporation wide generic electronic procurement database, the corporate governance problems associated with incomplete procurement transaction information and corporate governance issues were reduced. With improved procurement data and knowledge, the corporation was able to better choose markets which enabled it to operate with lower transaction costs. It was also able to better synchronize the organization and agent’s motivation by reducing the differences of interest and information between the two, with ever increasing transparency. The electronic procurement database could immediately provide details of each product purchased, by whom and from which seller/agent in which industry, when. This product and seller data was then used, for example, for strategic procurement purposes. This was achieved by grouping product data into commodity and other useful groups eg pens, pencils and paper into a stationery commodity. Seller/agent data then revealed different or in some cases the same sellers supplying the organization with the same ‘off the shelf’ product at different transaction costs and product prices. This strategic information can be used to arrange competitive bids by fewer sellers at better prices and so lower transaction costs. Alternatively, because this electronic procurement data is so quickly and easily accessible, there may be no need to limit the number of suppliers of a particular product but price setting may be to advantage. Such technological innovation will oblige an organization to review existing buyer-seller relationships and perhaps to establish new buyer-seller relationships.
3.5 Value Creation Based on the Chronology of the Longitudinal Process The electronic procurement database fields were based on the chronology of the longitudinal procurement process flow, systems and structures, ie buyer details, product details and seller details. This included fields for the buyer, buyer’s address and contact details, contract, contract type, account number, purchase order number and date, portfolio, department, division, branch, agency, and postcode, and details of payment arrangements and progress; product description, value and industry sector; seller company number, name and address, and contact details. In this format, the data was easily understood and interrogated by users of the database, who were able to draw upon accurate and timely corporate procurement records. This established the organization’s procurement history in electronic format. Using this generic model, an organization can gain instant access to its own procurement information and procurement intellectual property, valuable for procurement knowledge management and the development of procurement intellectual capital.
3.9 Value Creation Using Electronic Procurement Asset Specificity And The Frequency With Which The Transactions Recur
3.6 Value Creation Through Accessibility to Procurement Data An important issue was the accessibility of the procurement data to general and specialist users, and the ability of these users to easily interrogate the data. Those familiar with MS Access had no difficulty. The data was made available to all users on a flat file basis, that is, all data could be made available to all users all of the time. This meant that up to date procurement information was being used to provide answers to all questions, however these were framed. For the organization of interest, typical questions included Questions With/Without Notice from Government Ministers requesting advice on, say, industry located in a Ministerial electorate, how much was being spent there, with which company, when, for what and so on; what spend did the organization have with a particular company or country; or what was the organization’s financial exposure to certain companies.
The electronic procurement database was used by the corporation to provide an up to date summary of asset specificity, the frequency with which the transactions occurred, with whom, when and how. This is demonstrated across two financial years (Table 3): Table 3. Value and Number of Buyer Transactions Value FY 1 Total FY 2 FY 2 Total FY 1 No of Bracket of Value of No of Value of Transactio Procurement Transactio Transact Transaction ns s ns($m) ions s($m) $150m 4 1404 2 1515 and over $100m to $150m $50m to 3 178 4 306 $100m $20m to 7 195 6 187 $50m $10m to 18 241 12 177 $20m $5m to 28 191 28 197 $10m $1m to 193 395 253 549 $5m $100k to 2221 590 2205 583 $1m $30k to 4746 250 4410 231 $100k $2k to 43769 327 42035 309
3.7 Model Provides Global Summary of Procurements The data base model provided a global summary of all procurements, as shown in Table 2. This data can be dissected down to each individual procurement transaction. Table 2. Electronic Purchasing Statistics – Global Summary Financial Year FY1 FY2 Number of Notifications 50,989 48,995 >$2,000 Value of Notifications 3768.06 4054.03 >$2,000 (in then year $m) Value of Notifications ($m) at 3768.06 4159.94 constant prices
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4.
$30k Less than $2k
~ 200,000
50
~ 200,00 0
Total greater than $2k
50,989
3,768
48,955
50
4,054
VALUE CREATION THROUGH STRATEGIC SOURCING
Figures 1 and 2 demonstrate a summary view of how the purchasing database was tested with two other multinational organizations. These organizations summarized their single procurement transactions to aggregated commodity summaries. These commodity summaries then provided the basis for strategic sourcing activities.
Major procurement contracts, usually high tech projects, were a focus of the organization’s strategic policy because of the potential for local high tech industry development. Table 4, extracted from the electronic procurement data base, provides an indication of whether the policy was working. Detailed investigation of each contract then gave technology and other details.
few
Buyer power transaction governance $110m Rig, Well & Offshore Services $87M
Buyers
Conveyors and Parts $65M
Table 4. Procurement Contracts greater than $5m Total Total Total value Total number value number to local of contracts ($m) of suppliers awarded to contracts ($m) local suppliers 1 2208.7 60 1074.1 52 2 2382.8 52 1528.3 43
FY
many
Fuel s & Lubricants $368M
Contract Mining $355M
Rail Transport $486M Chartering $626M
Civil Works $370 M
Zinc $85M Drilling Supplies and Services $86M
Explosives $125M
Other Steelmaking Raw Materials (inc. Alum, Alloys) $134M
Maintenance Engineering Site Services Underground Services Services Computers/ $499M Mining Equipment $192 M $306 M IT Services $75M Scrap Fixed Plant Spares Contract $320M Road Transport Paint $85M and Machining Labour and Freight $93M $185M $60M Slag Handling $492M Industrial Mobile $64M M Steel Equipment Hire Products Railway $75M $112M Locomotives and Services Consultancy Travel $50M Services $110M $75M Safety Equipment Dredging Property Aviation Port Services $46M $49 M Leasing Services and Charges Packaging $45 M $26 M $42M $26 M Fleet Telecommunications Management Industrial Office Equipment $41 M $35M Consumables and Supplies $58 M $15M Consultancy Electrical Services Consumables $75M $58 M
Strategic transaction governance Energy $610M
Earthmoving Equipment $308M
Draglines $125 M
Iron Ore $420M
Furnace Consumables $160M Chemicals $110m
Rolls and Roll Services $60 M Environmental Services $55M Limestone $45 M Railway Locomotives and Slag Handling $64M M
Grinding Media $44 M
Marketplace transaction governance
Seller power transaction governance
Sellers
many
Coal $310M
few
Figure 1. Positioning Analysis of $8b Procurement Spend – BHP’s Top 49 Commodities
3.10 Value Creation: Procurement Contracts > $100,000 From Non Local Suppliers
Similarly, the Tenix energy sector business unit use of the electronic procurement database for strategic sourcing activities is shown in Figure 2:
Another example is that of a summary of the country of product origin:
Consequential Risk to Company Operations
Table 4. Purchases Greater than $100,000 from non local Suppliers Country of FY1 FY1 FY FY2 Origin 2 No Value Value No Belgium 5 $2,121,098 3 $593,843 Canada 7 $40,493,06 14 $10,200,698 0 Denmark 1 $7,271,003 Fiji 1 $670,000 1 $835,000 France 4 $2,603,403 5 $785,369 Germany 3 $548,256 14 $10,329,825 Greece 1 $288,720 Indonesia 1 $200,000 Ireland 1 $173,040 Israel 2 $416,963 2 $324,628 Italy 2 $333,379 2 $1,070,079 Netherlands 2 $375,028 3 $686,914 Norway 1 $4,370,377 NZ 12 $5,196,147 11 $6,376,322 Singapore 1 $152,480 Spain 1 $127,001 Sweden 2 $1,466,168 2 $1,488,098 Switzerland 6 $1,207,153 5 $1,763,009 UK 33 $14,770,41 49 26,080,506 4 USA 126 $1,1444,80 174 $958,953,255 1,682 Total 210 $1,222,926, 286 $1,024,146,64 275 3
Buyer power Consultancy Computers Services $13.8 and Software M $10.7 M Vehicle Parts Transformers Plant Hire $13.2 M $4.9 M $8.0 M High Cable $5.3 M
Electrical Labour Hire Consumables $14.6 M $7.1 M Travel and Accommodation $9.2 M
Industrial Consumables $5.3 M Lighting Safety and $0.7 M Clothing Cleaning $0.9 M $1.0 M Utilities Low
Office Equipment $0.7 M Marketplace
Fuel / Lubricants $2.0 M
$1.4 M Poles / Cross arms $1.2 M Quarry
Products $1.2 M Low
Pipes / Fittings $2.8 M Vehicle Hire $3.2 M Office Expenses $3.8 Transport / M
Strategic
Marine $5.4 M
Aviation Spares $21.8 M
Electronics $4.6 M Insurance $5.7 M
Industrial Hardware $0.7 M
Marine Engines $19.7 M Surveillance Equipment $2.1 M
Fabricated Hardware $1.5 M Pumps $0.9 M
Steel / Metals $2.8 M
Distribution $3.0 M Cost of commodity (TCO)
Legal $2.3 M
Networks IT Equipment $2.8 M Seller power
High
Source: Raw Invoice analysis (excludes ASP)
Figure 2: Energy Industry Use of Electronic Procurement Database
5.
VALUE CREATION THROUGH ELECTRONIC NETWORKS OF PROCUREMENT RELATIONSHIPS
Veblen (1899) suggested that economics should be concerned with destabilising influences, and that these come about through technological change and through changes of taste. As Veblen himself foresaw, entire industries could be made or broken by a shift in fashion eg nylons replaced silk stockings. Technological change combined with changes of taste are evident today in the emerging industries associated with information and communications technology. Rifkin (2000) expresses the view that markets are giving way to networks on a global basis, comprising supplier networks; producer networks; customer networks; and technology cooperation networks (Castells 1996). These electronic networks of relationships and communication channels essential to anyone doing any job are being created by the people themselves. Seeing a company as a
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living being means that it evolves naturally, that it has its own sense of identity, its own persona, its own goals and its own capacity for autonomous action, and is capable of regenerating itself, of continuity as an identifiable entity beyond its present members, of seeing its members as human work communities (Senge in De Geus 1997). More attention needs to be paid to interoperability between individuals and between organizations by developing value through network centric concepts and capabilities (Ventor 2003). Electronic procurement networks enable such groups of individual agents to share informal norms and values beyond those necessary for ordinary market transactions to develop social capital. Social capital is critical to the management of highly skilled workers manipulating complex, diffuse, tacit, and ephemeral knowledge and processes (Fukuyama 1999, p199). Electronic procurement is potentially a major source of social capital and creates value through a decentralised flat organization - flat organizations create enlarged spans of control and different structural and management arrangements (Nonaka & Takeuchi 1995, p124159). Such transformation is about continuous adaptation of information to leverage new sources of value and the reorientation of organizations to focus attention on emerging and future operations, to change business processes.
6.
procurement accountability based on good governance, independent inspection and careful reporting, there are trends towards central planning using performance indicators, reinforced by obsessions with blame and compensation - hardly designed to create value. The electronic procurement database provides a ubiquitous, secure, robust, protected, routinely used and trusted source of knowledge. Employees need to be connected to a network which facilitates the building of trusted relationships, and provided with access to quality information unconstrained by barriers. Procurement is an all pervading organizational function, and a catalyst and sensor for information into, within, and out of an organization. By using tools and techniques with higher information processing capacity, purchasing can become more informative and efficient. While electronic purchasing provides the promise of instant economic coordination, electronic procurement involves the electronic coordination costs of needs identification, development, expression and use. The electronic procurement data used in the establishment of an electronic procurement data base is already necessary for the maintenance corporate accounts, for corporate financial reporting and for the acquisition of supplies and customer relationship management. What a generic electronic procurement data base will provide is a means to comprehensively integrate these various data. This procurement data can be made available to employees, suppliers and customers as appropriate. Trust and transparency thus become value management tools. Because product markets function on information and trust, all incur reputation risk. The transparency, speed and memory of the Internet is such that the market will quickly judge the quality of individual information, work, and reputation. It is in everyone’s self interest to move towards a higher quality of procurement information, integrity and performance.
VALUE CREATION THROUGH TRANSPARENCY AND TRUST
The literature indicates that interactive electronic procurement models of multi-stakeholder engagement could involve more participants, broader forms of accountability, risk sharing and responsibility, and ‘the inevitability of transparency networks forcing organizations to adopt new systems of governance’ (Williams 2000, p90). Williamson (2002a) suggests transparency drivers include the speed, flexibility and reach of human communications driven by the accelerating power and persuasiveness of information and communication technologies; the growing power of employees, customers and suppliers to find out information about company behaviour, inform others and organize; the creation of new regulatory regimes for transparency and a shift to global structures that enhance accountability in the global economy; the discovery and adoption of new economic measures for social capital that will transform the way growth and value creation is accounted for in the economy and capital markets; and the central role of knowledge, trust and corporate reputation in driving business success in the networked economy. Williamson (2002a)is of the view is that transparency is already well on its way to establishing itself as a powerful norm in global policies and a transformative force within the firm and its stakeholder relationships. Electronic procurement is a demonstrable part of this governance transformation. Electronic procurement by its very nature, provides many powerful surveillance opportunities which may be useful in ensuring transparency and reducing negative behaviours, so encouraging value creation.
7.
There is a need to give users of procurement information the opportunity to use applications that make sense to them while maintaining the ability to exchange information. There is also a need to pay more attention to supporting peer to peer relationships and information exchange that transcends individual systems and organizations. This will empower the edge of organizations and enable change. The generic procurement database provides a model that links networked procurement employees to dramatically increase and organization’s purchasing power. It provides procurement information coupled with changes in corporate governance which can transform organization’s procurement practices. It provides a common language for the articulation of issues and provides a foundation for the development of a detailed conceptual framework and organization procurement history. It will also begin the task of specifying measures useful for organizational transformation.
CONCLUSION
8.
Nash’s (2002) ‘The Prisoner’s Dilemma’ shows that, in certain circumstances, if the members of a group trust each other, they can choose a course of action that will bring them the best possible outcome for the group as a whole. But without trust each individual will aim for his or her best personal outcome which can lead to the worst possible outcome for all. However, O’Neill (2002) suggests that the revolution in accountability has not reduced attitudes of mistrust, but has reinforced a culture of suspicion. Instead of working towards intelligent electronic
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