MRO E-commerce - Where's the Value?

Author : Sandy Dunn
Director, Assetivity Pty Ltd
Webmaster, Plant Maintenance Resource Center

There has been a lot written and spoken regarding Business to Business (B2B) e-commerce over recent months, with some extraordinary claims being made about the potential for savings from this form of business. Many B2B internet hubs have been established, and software vendors are scrambling over one another to claim that their CMMS is "e-commerce enabled". But how do you separate the truth from the hype, and where are the opportunities to use this technology to create value for your business?

Savings, Savings, Savings....

If you believe what you read, General Electric have saved 15% on their total procurement bill through the proactive used of e-commerce. Recently announced global e-procurement initiatives by various industry-based conglomerates, including those in the automotive industry, the mining industry and others are also claimed by the organisations participating in these initiatives to yield similar savings of between 5 and 15% of the total spend. These organisations are claiming to be able to achieve these savings from three sources. First by applying greater global bargaining power, they expect to be able to extract better pricing for the items that they purchase. Second, by streamlining and eliminating paperwork from the procurement process itself, they expect to achieve large reductions in the cost of processing procurement transactions. Third, by allowing selected suppliers access to the buying organisations' internal planning and scheduling processes, they expect to be able to more closely couple suppliers' production planning and scheduling with the requirements of the buying organisations. Let's examine each of these opportunities, with an MRO-bias.

Greater buying power

Many larger organisations, before the hype of B2B, had already embarked on "Strategic Sourcing" or "Supplier Rationalisation" projects to great effect. In essence, these projects were aimed at categorising and analysing MRO expenditure, with a view to rearranging supplier relationships in order to obtain maximum value for the buying organisations.

The first step in these projects is, typically, to collect data about what is being bought, where, and from whom. This is typically more difficult for larger organisations where there are multiple sites, multiple purchasing and accounting systems, and multiple purchasers of goods and services. However, the advent of large enterprise-wide computing systems, such as SAP and others, has made this easier for those organisations using these types of systems. Purchases are then typically grouped into commodity groupings, for further analysis (for example, for a mining organisation, some commodity groupings might be: fuel, tyres, heavy mobile equipment, travel, conveyors, explosives etc.)

Overlaid on this analysis is an assessment of which characteristics of the products and services purchased are important to the purchasers in assisting the organisation to achieve its strategic objectives. For example, characteristics might include:

Quality
Reliability
Delivery
Technical expertise
Customer service
Innovation
Serviceability
Price
Total cost of ownership

From this initial assessment, opportunities are assessed to rationalise the number of items being purchased by, for example, standardising products or services purchased across multiple locations.

The market for each commodity grouping is then assessed - often using Porter's "5 Forces" model to assess market complexity and barriers to entry. In addition, the potential impact that purchase of these commodities has on the organisations ability to achieve its strategic objectives is assessed. A typical framework for these types of analyses (and one that I have personally been involved with) is illustrated below.

Purchase category assessment grid

Commodities are assessed and placed on the grid in the appropriate location. The meanings of the category titles of each of the four quadrants in the grid (Leverage, Strategic, Non-critical, and Bottleneck) will be outlined shortly.

For each commodity, the appropriate sourcing strategy is then developed. There are a number of alternative strategies that may be adopted, as described below:

Strategy Alternatives

Each of these strategies may be applicable in various of the situations identified in the Purchase Category Assessment Grid, as illustrated below.

Strategies vs Procurement Grid

Or another way of assessing purchases is by comparing the number of purchase transactions compared with the total value of those transactions, and assessing the appropriate strategy, as illustrated below:

Volume/Value Assessment Grid

Of course we could combine the two previous charts into a three-dimensional assessment map, but this is a little hard to represent on a two-dimensional web page!

So what has this got to do with MRO E-commerce and the achievement of savings through increased buying power?

First, it is important to realise that not all MRO purchases will enable the achievement of significant savings through increased buying power. Typically, for most organisations, MRO purchases (as distinct from raw material purchases used in the manufacture of a finished product) represents a relatively small proportion of the total procurement spend - normally around 20% of the total, although for companies working in the primary industries (mining, oil & gas production etc.) MRO expenditure is a much higher proportion of the total. However, MRO purchases also typically also represent the majority of the number of purchase transactions within most organisations (usually around 80% of all purchase transactions). For commodity items that have a low relative spend, but a high number of transactions, there may well be more return for effort by focusing on reducing the cost of each transaction (see the next section). For "high impact" commodities that operate in complex markets, where technology is changing rapidly (for example, for organisations in the process industries, the purchase of process control systems and technologies), there may be greater advantage in negotiating some form of strategic alliance with a selected supplier which focuses less on price, and more on jointly developing technologies which will mutually advantage both organisations.

Second, it is important to realise the limitations that various web-based e-commerce business models have on the potential to extract lower prices from suppliers. In an article in the May/June 2000 issue of the Harvard Business Review (yes, that's right, HBR is quoted in an article about Maintenance!), Kaplan and Sawhney outlined a framework for categorising the various B2B marketplaces that have sprung up on the web, and outlined some of their relative strengths and weaknesses. In particular, in relation to MRO hubs, they identified that there are essentially two alternative market-making mechanisms in place within these hubs - Aggregation and Matching.

Aggregation models work by consolidating demand and/or supply under one virtual roof. They add value by reducing transaction costs through providing one-stop shopping. Most catalog-based MRO hubs fall into this category. These hubs can be either neutral (as in the case of Grainger, for example), or can be biased, either in favour of the supplier or in favour of the purchaser. In the case of the former, the hubs aggregate supply from a large number of suppliers, and then operate downstream in the supply chain. In the case of the latter, the hubs aggregate demand from a large number of buyers, and then negotiate upstream with suppliers. The recently announced hubs in the mining and automotive industries are examples of purchaser-biased hubs. The problem with all aggregation models, at least for large organisations, is that they may already hold sufficient bargaining power in the marketplace to be able to match, or even better, the prices on offer through these aggregation hubs. In these cases, the perceived savings to be achieved by negotiating lower prices may prove to be illusory. On the other hand, for smaller organisations, the aggregation model may provide significant benefits.

On the other hand, Matching models work by bringing buyers and sellers together to negotiate prices on a dynamic and real-time basis. This frequently takes the form of an auction. Kaplan and Sawhney argue that this makes matching a more powerful business model, but in the case of MRO supplies, this assertion may prove to be questionable. As outlined below, the reality is that, for MRO supplies, the consistent availability of products far outweighs price in the decision model, for most items.

Finally, it is important to realise that, particularly for MRO supplies, there are more factors in the benefits equation than just price. A 2000 Grainger's survey of MRO procurement, for example, notes that "when selecting an MRO supplier, customers are most likely to place importance on the availability of replacement parts and products; fast and immediate delivery, technical support for products and product-line variety". The survey goes on to say that "Regular availability of the products needed remains the No. 1 criterion for evaluating the performance of MRO suppliers: 50%, or half, of all companies surveyed say that consistent availability of products is their most important criterion.....The second most important criteria are low prices (cited by 16%) and quick delivery (14%)." There is little point in getting a slightly lower price for a particular item, if the item is required in order to avoid production downtime, and the cost of this downtime far outweighs the cost of the part being purchased.

Reduced Transaction Costs

As indicated earlier, MRO expenditure generally represents around 20% of total purchase expenditure, but also represents around 80% of purchase transactions. There are frequently some benefits to be obtained, for low value, high volume purchases, by re-engineering the procurement process to reduce the cost of each transaction. Technology, such as B2B e-commerce, can often assist in achieving these savings, but they are not the only means to streamline the procurement process. Consolidating the number of suppliers, establishing annual supply agreements, the use of corporate credit cards and other methods can frequently achieve significant savings without the need for internet technology. Indeed, it could be argued that these activities should, ideally, be performed before considering an internet procurement strategy.

Nevertheless, the argument for e-commerce enabled purchasing is strong. Recent surveys of the cost of processing purchase orders in several industries provided the following graph. All costs are in $A.

Costs of a purchase order

This would indicate that huge savings are available from using e-commerce enabled purchasing. It should be noted, however, that the graph above tends to overestimate the size of the savings achievable, because it does not take into account the time, effort and cost associated with negotiating and establishing the commercial arrangements necessary to enable e-commerce transactions to take place. For the full benefits to be realised, for example, contracts must be established with the relevant MRO suppliers, with agreed pricing models (and perhaps agreed total expenditure budgets).

In addition, care must be taken if considerable additional hidden costs are to be avoided. For example, in an article in the May 1999 issue of Plant Services Magazine (http://www.plantservices.com), it was stated by a representative of a CMMS vendor that "With an on-line e-commerce system, bulky catalogs are a thing of the past. If a maintenance department needs a certain item, the system allows the user to conduct a search for the part, rather than flip through page after page of a supplier's paper catalog". Call me old-fashioned, but I believe that such "advances" in technology need to be treated with extreme caution. Unless roles and responsibilities are clearly defined, and appropriate formal procurement processes established, there is serious danger of having shop floor personnel spending most of their time browsing the web, looking for a particular brand of widget, when the Purchasing Department has already conducted the appropriate searches, and already established a term contract for the provision of those parts from a specified supplier, in accordance with an agreed Procurement Strategy. More effective in this situation, however, would be "straight-through" processing of purchase orders, where, once a stock item has been requisitioned, the appropriate replenishment order is automatically placed on the agreed supplier, at the preagreed price, and with the preagreed delivery conditions. (Even here, though, care needs to be exercised, because if the item is requisitioned in error, due to a typographical error, for example, then suddenly there is an extra, unwanted item on the storeroom shelf). In this regard, implementing e-commerce-based procurement in an organisation is no different to implementing a new CMMS - care must be taken to clearly establish the goals of the implementation, the appropriate work procedures established, and the appropriate skills given to the right people. In some cases, organisation structure changes may even be required.

Integrated Procurement

In a truly integrated procurement environment, whenever a Maintenance job which requires parts is scheduled, this generates a forecast which flows through to the supplier of that part, who then incorporates that forecast order in his production planning schedule. It also enables the supplier to arrange just-in-time delivery of the part required. This is also seen as being a benefit of e-commerce enabled procurement. But, as you can imagine, for this to work effectively, there must be a far greater degree of certainty and accuracy in maintenance planning and scheduling than currently exists in most organisations. Only organisations that truly have the necessary disciplines established for their maintenance planning and scheduling processes will ever be able to reap significant rewards from an Integrated Procurement environment for MRO purchases.

Conclusion

So where does that leave us? In essence, there are significant benefits to be obtained from MRO e-commerce, but a strategic, and holistic view is required before an organisation embarks on a significant MRO e-commerce project. In particular, care must be taken to target the correct commodities for improvement, and select the most appropriate procurement strategy for those commodities. When it comes to implementation, again, a holistic view is required if MRO e-commerce is not to acquire the tag so often currently used in relation to CMMS systems - "a great idea, but we have never achieved the benefits that we expected to get from the system". It is little wonder then, that a Grainger's survey in 2000 reported that nearly 30% of organisations surveyed either have used, or intend to use, external consultants to improve MRO supply management within their organisations.