From Soup To E-Nuts

End-to-end E-commerce outsourcing is becoming a reality.
Kris FrieswickFebruary 1, 2000

Like the founders of a lot of Web-based start- ups, Larry Gerhard and Michael Osborn were passionate about their product, but not about the technology required to sell it. In their case, the product was wine. Gerhard and Osborn, who both have plenty of experience in high tech, wanted to open a wine shop for the Internet, dubbed eVineyard. But as the two men knew, selling online in the highly regulated liquor distribution industry is a technically complicated task.

To operate in the 22 states in which it is currently licensed, eVineyard had to have an E-commerce Web site that could serve up entirely different product catalogs, pricing and discount schedules, freight tables, and order screens, depending on where an order would be shipped. The site would also require real-time inventory system integration with the company’s four warehouses (one more is waiting for regulatory approval). In the wine business, explains Osborn, the company’s executive vice president, there are no back orders: “When a particular vintage of wine is gone, it’s gone.”

Osborn and Gerhard, eVineyard’s CEO, evaluated these impending challenges and eventually decided to let someone else conquer them. “There’s plenty of work for us to do without worrying about technology,” says Osborn.

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As a result, the company outsourced its entire E-commerce operation. eVineyard offloaded the creation and operation of its E-business to Pandesic LLC, a Sunnyvale, California-based joint venture of SAP AG and Intel Corp.

In May 1999, eVineyard launched its online store (www.e The company handles nothing but the content. All transactions are processed by Pandesic, which hosts the Web site; serves up the right version of the catalog to visitors; processes credit-card payments through CyberCash, a leading E- payments vendor; and confirms sales using real-time inventory data, which it houses on its servers. The Pandesic system (which is built on SAP’s R/3 enterprise resource planning software) then routes the order to the appropriate warehouse and bills the customer.

Cost? After a start-up fee, eVineyard pays Pandesic a small percentage of its annual online revenue and a nominal monthly hosting fee. Osborn says the company can focus on wine while Pandesic makes sure the site is fully operational, 24/7. Using this operating model, privately held eVineyard anticipates quarter-by-quarter growth of 300 to 400 percent in 2000.

Outsourcing’s bleeding edge

Pandesic is one of a new breed of end-to-end E-commerce outsourcers that has sprung up in the past year or so. These outsourcers integrate traditional E- commerce offerings with back-end systems. In some cases, they also offer traditional logistics, warehousing, and supplier services. It’s a young service, but one clearly needed, as highlighted during the Christmas 1999 buying season, when Web shoppers complained bitterly about chronic online stock outages and late or nonexistent deliveries.

Although no figures are yet available on the size of the full- service E-commerce outsourcing market, traditional E-commerce outsourcing–usually defined as Web-site design, strategy consulting, and software creation and hosting–was a $6.6 billion industry in 1998 and is expected to grow to $39.5 billion by 2002, according to Gartner Group Inc., a technology advisory firm in Stamford, Connecticut. Gartner also predicts that by 2003, fully half of all package-delivery traffic in the United States will be from electronic retailers.

The new breed of outsourcers seeks to take advantage of both trends. Pandesic faces competition from companies like USWeb/CKS, in San Francisco, and Escalate, a Redwood Shores, California-based company. In December 1999, USWeb/CKS launched iAMcommerce, an E-commerce outsourcing package that lets customers “rent” prepackaged E-commerce functionality, with fees based on transaction volume. Although the company does not currently offer back-end logistics integration as part of the standard package, Brian Winter, vice president of service development for USWeb/CKS, says the company will integrate with a customer’s back end on a case-by-case basis, and should have a standardized offering in coming fiscal quarters.

Escalate takes back-end support to its logical conclusion by partnering with warehousing companies and product suppliers, then offering access to those resources as part of an end-to-end E-business package. One such customer, Egreetings Network Inc., an online electronic greeting card and gift service, started selling gift items in November as part of its E-commerce outsourcing contract with Escalate.

Egreetings, which previously had offered only free online greeting cards, hired Escalate this past September. “It was a time-to-market issue,” says Scott Derringer, who until January was director of E-commerce and product management for Egreetings. “We wanted to focus on what we’re good at, which is merchandising for special occasions, and outsource the back-end heavy lifting.”

Egreetings had already established direct links from its Web site to several gift vendors with which it had partnerships, but it wanted to ramp up its offerings. Working with Escalate, Egreetings selected suppliers from a variety offered as part of the Escalate Commerce Network. Together, the two companies approached several others about joining the network. Once a supplier joins the network, its inventory and shipping systems are directly integrated with Escalate’s systems to create a frictionless end-to-end transaction. Once a customer clicks “buy” on Egreetings’s Web site, the cyber- vendor doesn’t have any contact with the buyer until the payment arrives.

“One of the reasons that end-to-end [E-commerce] outsourcing is becoming a hot market,” comments Derringer, “is because it’s a lot of work to integrate with a lot of different drop-shippers, and [outsourcers] do all that.” Egreetings now sells several hundred items through Escalate’s system.

E- risks

End-to-end E-commerce outsourcing may look like a no- brainer for Web-based start-ups, but in these types of outsourcing arrangements, the usual risks of IT outsourcing contracts (such as security, data ownership, scalability, reliability, and performance monitoring) are exponentially more significant. This is because companies that use these services often outsource their entire business model, especially in cases in which they’ve outsourced supplier relationships and logistics.

“We closely examined [Escalate’s] tech team,” says Derringer. “We felt confident taking the step. But if you’re going to outsource this, you need to do a very careful evaluation. You are going into a significant partnership.”

Osborn of eVineyard agrees. “If it weren’t for its unique compensation model, I would be nervous,” he says of Pandesic. “But there’s a tight risk-reward relationship in it for them, too.”

Experts are not convinced that all end-to-end E-commerce outsourcers offer sound partnerships. Stan Lepeak, vice president of Meta Group, a technology advisory firm in Stamford, Connecticut, thinks “one-stop” E-commerce outsourcing is a misnomer, since many of these outsourcing contracts are composed of partnerships with a variety of companies–any one of which could suddenly become a weak link in the chain. For instance, Escalate has teamed with logistics providers Rush Order and e- Nited Business Solutions, credit-verification companies CyberSource and VeriSign, and suppliers representing more than 10 million SKUs.

“There’s no such thing as a one-stop shop,” declares Lepeak. “There are firms that position it that way, but no one firm can meet all user needs.”

Lepeak adds that since this is such a new form of outsourcing, the companies offering it are mostly start-ups without proven reliability or scalability. “Companies need to understand their risk tolerance to partner with these corporations,” says Lepeak. “They need to ask themselves, ‘Am I willing to outsource a piece of my multibillion-dollar corporation to a company without a track record?’”

Will bricks and mortar take a pass?

So far, end-to-end E-commerce outsourcers have targeted Web-based start-ups that lack legacy inventory, warehousing, and logistics systems. But is end-to- end E-commerce outsourcing a good option for larger, bricks-and-mortar companies? Opinions vary.

On the one hand is Debra Brummer, director of E-commerce for The Children’s Place (TCP), a publicly held, $284 million (1998 sales) specialty retailer of children’s apparel and accessories. Based in Secaucus, New Jersey, TCP operates more than 290 stores throughout the United States. In December 1998, TCP decided it wanted to establish a significant E-commerce presence, but it lacked both the technological expertise to build the Web site and the logistics to support what Brummer calls “eaches,” the one- and two-item shipments that typify the E-commerce space.

“The distribution setup we have is to maintain distribution for about 300 stores,” says Brummer. “We ship in bulk, so we didn’t have the bandwidth to service customers one at a time, not even from an MIS perspective.”

She hired Pandesic, and the company’s Web site went live in November 1999. The Children’s Place hired a developer to design the site and then, working in tandem with Pandesic, contracted with warehousing and fulfillment company Fingerhut Business Services Inc., in Minnetonka, Minnesota. Pandesic integrated its E-commerce package with Fingerhut’s systems, and TCP consigned inventory to the Fingerhut warehouse, just as it consigns inventory to its stores. A planning manager was assigned to TCP’s virtual store to monitor inventory and logistics, and to order product as needed.

Although the sale is seamless, there is a significant disconnect in the system, which is currently typical of end-to- end E-commerce outsourcing arrangements. All inventory and sales data for the virtual store is housed separately from the rest of the company’s data. TCP’s finance department currently monitors sales and inventory by tapping into the R/3 systems housed at Pandesic, using an Internet connection, and transferring needed data to the in-house financial system. According to Brummer, the next step in the Web initiative is to integrate the company’s financial systems directly with Pandesic’s system. However, she says she prefers having the inventory and financial data kept separate, because the online revenue is recognized differently than the store revenue. While store revenue is booked at point of sale, catalog and online revenue is only booked when the merchandise ships. “We’ll merge the two pieces of information,” says Brummer, “but you have to keep the two business models separate.”

As positive as TCP’s experience has been, it may be unique to the retail environment. Most companies aren’t comfortable maintaining a completely separate warehousing, inventory, and distribution network when they already have one in place, and that’s not likely to change in the near future, even according to E-commerce outsourcers.

“For today, tomorrow, next month, it’s probably correct that companies don’t want to run parallel systems,” admits Brian Winter at USWeb/CKS. “But there are companies that are doing it right now, and they’re finding out that it’s much more efficient.” Winter predicts companies will increasingly move their inventory, warehousing, and logistics systems into an outsourced model, for both their traditional and E-business lines.

The integration challenge

For now, however, companies that want the ease of E-commerce outsourcing but want to use their existing inventory/warehouse/logistics system have only one option–a back-end systems integration project. Most of the new full-service E- commerce outsourcers claim they can do this, but experts warn it may not be done well. Even the largest IT outsourcers have trouble with back-end systems integration, says Lepeak.

Larger companies would probably be better off using best-of- breed technology coordinated by a single consultant with significant integration experience, but companies that choose this tack may sacrifice time to market in the process, says Lepeak. “One-stop is easy,” he says, “but you get out of it what you put in. Best-of-breed is a lot of work. Most companies are going to be somewhere in between.”

Fortunately for larger bricks- and-mortar companies, some established technology outsourcers know a trend when they see one, and have cobbled together packaged E-commerce offerings of their own. One large outsourcer that is taking the full-service E-commerce plunge is Electronic Data Systems (EDS) Corp., which launched its division last April to offer prepackaged E-commerce outsourcing to large companies. EDS won’t reveal the names of its nine clients, all Fortune 100 companies, because of what it calls the “strategic nature” of the projects. However, these projects involve a standardized E- commerce offering that resembles the fully outsourced model advocated by Winter of USWeb/CKS, in which all supplier, inventory, and shipping data–whether for the E-business or real-time sales–is aggregated on outsourced, remotely hosted applications.

“We architect all the way from the supplier or the channel partners to the customer and back to the manufacturers,” says Martin Hofmann, director for digital supply-chain solutions and business portals at EDS’s division. The cornerstone of EDS’s architecture is the business portal–a Web site through which suppliers, manufacturers, and customers can communicate with a client company and with one another. EDS integrates the client’s back- end systems with suppliers’ systems, so all transactions, whether on- or off-line, can be processed from purchase to shipment, with financial data automatically recorded and inventory adjusted, in real-time, for all parties involved.

The cost of an EDS E.solution can range from $5 million to $200 million, depending on how many suppliers are integrated into the business portal. Most projects involve a flat integration fee and a monthly charge.

This type of outsourced E- commerce model raises another problem, however. As companies adopt Web interfaces with customers and suppliers, suppliers will be forced to maintain a variety of contact technologies, from electronic data interchange to Internet protocol to fax to E-mail. How long before they cry uncle? EDS is already working on a solution for that, says Hofmann: a customized, supplier-based Web site that “collects, sanitizes, and standardizes” the orders from a variety of customers so the supplier has to keep only one type of technology platform.

If your company is considering such a sweeping outsourcing initiative, remember that the rules of traditional outsourcing still apply, warn analysts. Don’t let the rush to E-market obscure the importance of managing the outsourcing initiative–issuing a clearly articulated RFP, evaluating the outsourcing firm, establishing performance metrics, and constantly monitoring the outsourced project.

“Companies tend to outsource the responsibilities,” says Lepeak. “That’s where you run into problems. You outsource the work, and keep the responsibilities.”