Procurement at Beta Corp
Beta Corp (BC) a large pharmaceutical company based in UK is planning to implement an eProcurement (electronic procurement) system that will facilitate among other things, reverse auction for certain product categories. The Chief Procurement Officer (CPO) wanted to be clear on the advantages and disadvantages of using reverse auction. In particular, the CPO was considering two diverse product: hotel rooms and malic acid, a raw material that will be used in one of their end products.
Many pharmaceutical companies looked to procurement management to reduce costs. Worldwide it was estimated that 50% for every dollar earned in revenue was spent on cost of goods. Some pharmaceutical companies concentrated spending with a few preferred vendors in order to improve business relationships and work together to innovate and decrease costs, while others began using online procurement tools with large number of suppliers with each bid. A purchasing society in the US estimated that using e-procurement would reduce the cost of purchase order generation from € 84 to € 17 per order a substantial savings for companies that created a large number of purchase orders each business cycle.
BC aimed to reduce its procurement spending in 2004. In 2003 the total purchase of production and non-production material was approximately €7.5 billion. The CPO wanted to reduce this by about 12.5% in 2004. In 2003 the purchase department at BC had bought goods and services worth € 2.5 billion through electronic reverse auction.
The sourcing group had to determine what characteristics are required for products and services that are amenable for reverse auctions. In auctions, costs were only part of the procurement equation. Exhibit 1 shows the product requirement for hotel rooms and the weight attached to each attributes. In 2003, BC had spent lot of time and effort with the lowest bidder for many items. Consequently, the sourcing group considered the total cost of owning the product which included technical troubleshooting, performance management and process improvements.
Before selecting a preferred supplier the sourcing group quantified the total cost based on prior experiences, by estimating time expected to meet standards and the number of resources required to get the supplier up to speed. In cases where it was costly for BC to change suppliers the sourcing group favoured the incumbent by specifying an internally specified reduction in price in order to source from a different supplier. Typically, this was an internal discussion point, and such information was not shared with the bidding suppliers or the incumbent.
With the e-procurement software system that BC could issue request for information (RFI), conduct electronic reverse auction and requested sealed bids. The system also allowed the suppliers to submit innovative bids. For example, some suppliers bid for the specified amount and also specified quantity discounts or other configurations within the bid. Exhibit 2 is an example of a bid for the same product from two different suppliers.
Within the e-procurement process, BC’s product specifications were transparent to suppliers. The specifications were incorporated in the auction details and disseminated electronically so that all suppliers responded to the same information. For every auction sourcing team had to decide whether the suppliers would given their standing (that is current ranking) and prices offered by competitors or simply the standing of that supplier. The standing reflected only the relative prices; being in first place was no guarantee of a contract. Additionally, the competitive field was generally unknown to the participants; they were unaware of the participants’ name, location or quality standards. The sourcing team decided the amount of information to provide during the auction based on, among other things, the number of suppliers participating and their initial spread between quoted obtained during RFIs.
Prequalification Process: Before sourcing from a supplier, it was subjected to technical and quality audits. The timing of audits depended on type of product being sourced as well as number of participating suppliers competing in that bid. A successful audit was required of all suppliers either before the bidding process or as prerequisite for winning the business.
Sourcing of Hotel Rooms
Because BC was a global company employees tended to travel throughout the year to many locations. BC had reserved approximately 500,000 hotel room nights annually for a total spend on the order of € 70 million during 2003. Traditionally, BC employees would select hotels that were in close proximity to the site they were visiting. Additionally, each employee had its own set of preferences and typically had three or four hotels to choose from. Given personal criteria, employees often booked hotel rooms for themselves or for their visitors on their own rather than through BC’s global travel agent. There was significant price variation within a city and could differ by as much as 75%. However, it was unclear whether this was due to lack of supply or other reasons. In 2004, BC had forecasted around 450,000 room nights with a spend of about €65 million. The sourcing had to figure out how to design a auction model for this service.
Sourcing for Malic Acid
Malic acid was a key ingredient for a new drug called Exelon. BC had a incumbent supplier Tao Pharma Lab who was currently charging €145 per kg. BC believed that Asia was the best option to identify a low cost supplier. Five suppliers were identified as potential candidates for the malic acid business. A few of them had supplied BC other chemical compounds but not in large scale. It was imperative that each of these suppliers have rigorous quality control standards as well as technical capabilities to deliver a consistent product in the necessary amounts; the quality and technical audit was still to be performed.
During the RFI the suppliers were informed of the potential business opportunity and were asked to submit a sealed bid to supply 650 kg of malic acid for validation within BC (Exhibit 3). In the future the selected suppliers would be asked to supply 20,000 kg of malic acid over the next three years