By the time Elvis had left the building at United Technology Cos. headquarters last winter, it was clear that the Hartford-based company's new E-procurement system could procure just about anything. The system didn't actually bring the King back from the grave, but it did manage to engage an Elvis impersonator for a company event, without getting all shook up.
That was something of a personal triumph for Kent Brittan, vice president of supply management at UTC. In 1996, Brittan left his job as CFO of Otis Elevator Co., a UTC business unit, to accept a challenge laid down by the parent company's CEO: shave $750 million off UTC's $14 billion annual purchasing tab by the end of 2000. With 26 years of experience in finance, Brittan knew UTC would need new technology to meet that goal.
"When you have a huge target like $750 million, that isn't incremental stuff," says Brittan. Fortunately, he says, "it was clear that the new Internet procurement tools opened vistas that were very exciting." In late 1996, Brittan began a pilot project with FreeMarkets, a Pittsburgh-based online reverse auction site, to purchase a variety of direct goods (raw materials used by UTC business units to manufacture products). By 1999, UTC was such a devoted user that it bought a 5 percent stake in the online company. To date, says Brittan, UTC has run more than 1,000 reverse auctions (in which suppliers underbid one another), representing more than $1 billion in contracts, on FreeMarkets, with an estimated $180 million in identified savings in the process.
Also in 1996, Brittan started visiting other companies to see how they bought indirect goods ranging from office equipment and phone service to maintenance, repair, and operations (MRO) supplies. He was impressed with a system IBM Corp. had developed for internal use, and pressed the company to sell it to UTC. "IBM had the same issues as UTC — they were worldwide and had large volumes," he says. Most important to the former CFO was the fact that the system could handle — and therefore record and track — any type of purchase, including the occasional celebrity impersonator. In 1998, UTC began using IBM's Global Purchasing Services at its Carrier business unit, and is now rolling the IBM-hosted system out to its other business units.
It's ironic that it was the need for a system to handle indirect purchases that led Brittan to IBM. Before he bought any technology, he had calculated that 60 percent of UTC's purchases — $8.5 billion worth — went directly into product manufacturing, while the remainder were nonproduct or indirect purchases. That's a fairly typical ratio, says Pierre Mitchell of Boston-based AMR Research, with direct material purchases outweighing indirect spending by anywhere from 10 percent to 30 percent, depending on the industry. UTC was unusual because Brittan tackled both kinds of spending simultaneously, and the company made its first online purchases in direct materials. Despite the extraordinary hype surrounding E-procurement today, most companies tackle the smaller expenditure — indirect purchases — first. In fact, the larger prize, direct goods, remains elusive for many.
Why? One reason is that administrative cost reductions show up in the income statement sooner than manufacturing savings. "The real low-hanging fruit is indirect," explains Brittan. "When you do a leveraged deal for photocopiers or cafeteria providers, that starts hitting the P&L right away."
Another reason is the greater opportunity for cost control, which appealed to Brittan's CFO instincts. "If you cut the price of sheet steel, you aren't going to put more sheet steel into the product," notes Brittan. "But in indirects, usage is as important as price. If you cut 30 percent off the price of an airline ticket and people start flying first class, you won't save anything. If you cut the price, cut the budget. The biggest savings is stuff that never gets bought at all."
Strategic purchasing of direct materials offers greater long-term returns, says AMR's Mitchell, but he agrees with Brittan that indirect materials provide an attractive quick fix. "People are getting ROI paybacks in four to eight months," he says. "They've picked their battles wisely, choosing fragmented spending areas with suppliers that are more tech savvy."
Indirect purchasing, Brittan explains, is diffuse. As he puts it, "It is managed by absolutely everybody. The cafeteria is run by HR. Advertising and brochures are run by Communications. The president buys books and flowers. Nobody owns it." Direct purchases are usually handled by one or two specific departments with precise roles. "Direct purchases are covered by standard cost rules and annual inventory valuations, and are helped by MRP [material requirements planning] systems and an annual physical count," he says.
While the fragmented nature of direct purchasing is complex, large suppliers of indirect materials have been quick to help companies gain control of their spending through online catalogs and preferred-supplier agreements. "The Web is a natural for us," claims Jim Ryan, president of MRO provider Grainger.com, who rattles off the names of Ariba, CommerceOne, Intelysis, Oracle, and SAP as examples of E-procurement solutions providers with which the company has alliances.
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