E-sourcing: The next wave of B2B?

Michael Mendoza felt duped.

As the purchasing systems manager for Owens Corning, he'd been certain the construction-materials company was getting a good deal from suppliers on the red dye that gives the company's fiberglass insulation its pink hue. Then he went online.

Mendoza set up an online auction that pitted suppliers against each other for the nearly $2 million contract, and within an hour he had shaved a substantial sum off the price of the company's annual supply of the dye. That red-dye auction was one of more than 180 that Owens Corning held last year to find the best deals on everything from pallets to consulting services.

Through the auctions, Owens Corning has saved millions of dollars, knocking an average 15 percent off the price of supplies it negotiated online.

"The reason why this is really a hot spot is that unlike a lot of the other hype of business-to-business e-commerce, this is truly returning measurable savings in a quick way," Mendoza said.

Owens Corning and many other companies are beginning to discover the benefits of so-called e-sourcing--a sort of business-to-business lite.

Many executives have been loath to turn over significant control of their businesses for uncertain benefits, hastening the demise of many business-to-business companies during the past two years. But these same executives appear to be receptive to the relatively simple concept of placing orders online and allowing companies to submit their lowest bids.

To be sure, e-sourcing is no quick fix to the implosion of the B2B sector. The revenues are relatively small compared with what was envisioned by building vast online marketplaces, and the competition is fierce. But e-sourcing is permitting otherwise cautious businesses to at least test the benefits of moving some of their procurement procedures online.

E-sourcing auctions work like an eBay auction in reverse: The company holding the auction goes online not to sell to the highest bidder, but to buy goods from the bidder with the lowest prices and best terms. The buyer typically invites only a handful of suppliers that have been prequalified to participate.

While the benefits may seem obvious, there are many pitfalls. Too many companies are chasing too few dollars, and a legal quagmire involving technology patents has yet to be resolved. In addition, companies testing e-sourcing risk alienating longtime suppliers who may consider their relationships more valuable than offering rock-bottom prices.

Plus, even if e-sourcing is to become widely adopted, it would represent just a glimmer of the grandiose dreams that many B2B companies had of transforming American business.

"This is the desperate attempt by companies marginalized by the dot-com disaster to regain some excitement," said Joshua Greenbaum, an analyst at Enterprise Applications Consulting. "They're really scrambling to find that next niche that will give them some semblance of legitimacy. I'm a little skeptical whether this next big thing will be big enough to make a substantive difference in their future prospects."

Nevertheless, there is evidence that e-sourcing is finally taking off after languishing since being developed by FreeMarkets in 1995. Companies selling e-sourcing software have reported a flurry of business in recent months, and analysts say the gloomy economy has actually helped lift sales, as businesses look for every possible way to save money.

Since the beginning of the year, Best Buy, Bayer and British Airways have announced new e-sourcing projects. E-sourcing software suppliers such as Commerce One, Frictionless Commerce, FreeMarkets and PurchasePro have all introduced or updated their e-sourcing software this year and have declared e-sourcing a central part of their business.

Although business-to-business e-commerce has been derided as yet another Web concept that failed to live up to its potential, a U.S. Census Bureau report released last week says transactions between businesses constituted 94 percent of e-commerce in 2000, with online sales to consumers making up the other 6 percent.

Though a majority of those transactions were sent over private networks using proprietary Electronic Data Interchange formats--not the Internet--companies are increasingly using electronic transactions with trading partners. E-sourcing in particular has been popular.

According to one recent survey, 23 percent of 360 companies bought products or services through an online auction in the last three months of 2001, compared with 17 percent in the third quarter. The survey, by Forrester Research and the Institute for Supply Management, also found an increase in using the Internet to gather bids from suppliers, to 61 percent, up from 54 percent in the preceding quarter.

Mendoza and other information-technology managers say pitching e-sourcing to wary company executives is easier than contemplating other kinds of corporate software that require extensive implementation, training and business process re-engineering. More importantly, e-sourcing software is supposed to deliver a fast and tangible payoff, making the market poised for growth this year, analysts say.

"It's a relatively straightforward return on investment," said Jon Derome, an analyst at The Yankee Group. "Buy product X today and buy it tomorrow with a lower product or process costs. That argument, in today's market, resonates pretty well."

E-sourcing software can be set up in a matter of weeks, or even days, and doesn't require a lot of new equipment or systems-integration work. For Owens Corning, which uses hosted auction software from PurchasePro, it is a matter of logging on to a Web site.

After a few trial auctions, e-sourcing was an easy sell to Owens Corning management, Mendoza said.

It was the same at Eastman Chemical. The chemical manufacturer in Kingsport, Tenn., began using online auction software from Diligent Software Systems, formerly Webango, in 2000, and also participates in auctions through ChemConnect, an online marketplace for chemicals.

Eastman says the Diligent software has not only helped the company find cheaper suppliers, but has also helped it negotiate special terms that make suppliers responsible for tracking and automatically filling inventory or keeping ownership of it until Eastman uses it, known as buying on consignment. The software, which gives each bidder a score, can be configured to give a higher score to suppliers that offer such terms, all of which lower Eastman's costs.

Kendra Harrold, an online-procurement manager and commodity buyer for Eastman, said the company is expanding its use of online auctions and has definitely seen a payoff.

The promise of e-sourcing has not come without hitches, however. For the companies that make e-sourcing software, legal trouble has accompanied their strong sales.

FreeMarkets slapped three software makers with patent-infringement lawsuits this month. The company, one of the few business-to-business e-commerce companies to report revenue growth in the fourth quarter and to raise 2002 earnings estimates, filed lawsuits against rivals PurchasePro, B2eMarkets and Procuri, accusing them of infringing on one or more of its patents.

PurchasePro, whose stock now trades for less than $1, expects e-sourcing application sales to constitute 50 percent of its revenue this year, according to Chris Benyo, a vice president at PurchasePro. The company introduced the product less than a year ago after acquiring its maker, BayBuilder, last April.

E-sourcing software companies make money by either selling software as a service or licensing their technologies. FreeMarkets charges a fee--usually equal to 1 percent to 2 percent of the final sales--for organizing auctions and using its technology. Frictionless Commerce sells a software package, which starts at $1.2 million, that allows buyers to set up their own auctions.

Partly because of increasing competition, a recent report from Forrester Research predicted that many e-sourcing companies will go bust by the end of next year.

The most vulnerable, the report says, are the smaller start-ups whose applications aren't part of a larger collection of products and services for purchasing, order management, accounting and inventory management.

But Kent Godfrey, CEO of Frictionless Commerce, is confident his company will survive, despite the likelihood of a shakeout. As evidence, he touts contracts with British Airways and Philip Morris, as well as the kudos received from analysts on the company's latest product release.

"It's a very complicated business process, and we are the only ones who automate the process completely," Godfrey said.

The Forrester report also said the adoption of e-sourcing has been slower than anticipated and that companies experimenting with it often fall back on old standbys, like spreadsheets, to analyze their suppliers.

One large East Coast company that tested an e-sourcing application last year decided not to purchase the system. The company's head of purchasing, who asked that neither he nor his company be identified, said his company was particularly hesitant after getting burned last year when its online purchasing software supplier went out of business. Besides, the company believes it can still manually negotiate prices with suppliers just as well as it could with an e-sourcing system.

Even Owens Corning has had some difficulties.

For one, e-sourcing doesn't eliminate the extensive legwork required before the auction happens. Although auctions may last only minutes or hours, Owens Corning spent months identifying and prequalifying suppliers to narrow them down to a handful.

In addition, purchasing managers at Owens Corning struggled with breaking the habit of calling up their old suppliers and with learning the discipline of writing detailed requests for quotes to solicit online bids from suppliers.

"The hardest part was changing the behavior of our sourcing folks," Mendoza said. "It's been an exercise in change."