How Are Suppliers Countering the Buyer's New Internet-Enabled Power?
Gary Cokins, CPIM
Gary Cokins, CPIM, Director, Industry Relations, ABC Technologies Inc., Beaverton, OR 97006, 503/617-7100 ext 328, email@example.com
86th Annual International Conference Proceedings - 2001
Abstract. The Internet is shifting power from sellers to buyers — irreversibly. Search engines and great data access is prevalent. Buyers are dictating terms, conditions, and pricing. Suppliers face additional risks from exposing more from their websites. . How can suppliers recover any of the power they are losing?
This presentation describes how suppliers can alter their customers' behavior to minimize the power shift. It describes how trading partners along the supply chain can measure and remove the costs that they create amongst each other. It describes how each trading partner can gain much better insight into the true and relevant costs for their products, SKUs, service lines, freight, channels, and customers for better profit contribution reporting and analysis and margin management. However, to do these things, suppliers will require cost accounting systems, including activity based costing (ABC), that are superior to what they struggle with today.
The Internet is clearly the revolution of the 21st century. Many compare its future impact on society to be greater than the changes that came from the telephone, highway systems, and even electricity. We are all becoming digital citizens as part of a global networked society.
The Internet is Changing Everything. Some e-commerce experts attempt to profoundly distill the impact of the Internet into a single sentence. Some describe it as the opportunity for people to join communities of common interest without boundaries or borders. Others view it as the ultimate network across which data, voice and video communications is carried. Some see the Internet for its expansion of a more mobile information society where the individual has universal access to their personal data, not accessed from a home base, but from wherever they may be sitting, standing, or traveling.
My simplistic reduction is that the Internet is shifting power from the seller to the buyer — irreversibly. The ability for the buyer to access incomprehensible amounts of data using search engines to seek out products and services is now unbounded. Figure 1 depicts how buyers will have access to sellers for purchases 24 hours per day seven days a week (i.e., "24x7") via their website host server. Further, the buyers' increasing desire for unique requirements will likely force suppliers to respond with increasing flexibility. This may add costs to suppliers as pressure is placed on their prices.
Ironically, suppliers are assisting in the shift of power to buyers. Suppliers are providing increasingly more information about their products and services via their websites. Teenagers will perform exhaustive searches to identify the exact make and model of an appliance they want; and then they will locate a much cheaper source from which to purchase the appliance. Adults are learning this too.
Internet portals and exchanges are creating digital market places that introduce increasing flexibility to match suppliers with buyers via virtual auction websites and bidding systems. The buyer has access to a much greater market than ever before. The Internet is a gift to buyers everywhere.
The buyer who benefits from this powershift will not only be the end-consumer shopping at a retail store. Purchasing agents and requisitioners within businesses and governments will also enjoy an upper hand over suppliers. This is the new business-to-business, or B2B, economy. Buyers are already exhibiting new capabilities to determine for themselves broader ranges in terms and conditions with their suppliers. Buyers can compare and contrast features of products and services offered by competing suppliers. To complicate matters for suppliers, consumer expectations are rising faster than some businesses can deliver. Consumer tastes, preferences, and expectations are not static. Many customers base their standards on their last best service experience. The bar rises constantly.
Some argue that e-commerce is not as major an event as the media is presenting it. They see e-commerce as simply streamlining the matching of resources to customers. But it is removing, in a single punctuated change, substantial transaction costs, including some intermediary organizations, like wholesalers and distributors. With this view, e-commerce is not considered as a major transformation since the market exchange behavior will continue to exist as it has for centuries — only much quicker and more dynamic. But the Internet will continue to shift power towards consumers. Despite all of the dot-com hoopla, the historical pattern has been that, competition will award to consumers long-run savings generated from new technologies in the form of lower prices.
Pressure on Prices — How Will Suppliers Counter? Suppliers must now react more quickly than ever before. Call centers and customer support functions have become integral for suppliers — and these services are with new costs not present in old business models.
A major consequence of the powershift to buyers is that tremendous pressure is placed upon supplier prices. Suppliers will no longer be capable of protecting a niche market or of enjoying as large or long lasting profit margins as they had in the past.
How can suppliers counter this power shift? One option is for suppliers to alter their customers' behavior to minimize the power shift. In addition, trading partners along the supply chain can mutually measure and remove the unnecessary costs that they create amongst each other. Each trading partner can gain much better insight into the true and relevant costs for their products, SKUs, service lines, freight, channels, and customers from major advances in profit contribution reporting and analysis and margin management.
This section describes the role that activity based costing (ABC) is now having and will have as the Internet, e-Commerce, and supply chain management mature. As mentioned, the Internet is shifting power from sellers to buyers — irreversibly. Search engines and great data access has become prevalent.
But, before discussing ABC, first let's better understand the current situation of most suppliers. Suppliers are in upheaval. They are the organizations that have to adjust the most to changes caused by the Internet.
The Quandary of Re-engineering. Imagine that an organization has completely and successfully re-engineered itself and become lean and agile, not anemic. Further, imagine that it has streamlined its business processes and workflows, and then it discovers that its board of directors, owners, and shareholders are demanding even better performance and ever higher ROIs, market share, and profits? What are this organization's options? Across-the-board cost cutting and employee layoffs may no longer be an acceptable option without risking rapid deterioration of customer service and eventual sales decline.
One possibility is to raise prices to increase revenues, but in many markets small price increases can lead customers to delay their purchase or to switch to competitors or substitutes. Both outcomes lead to lost sales.
Another possibility for the organization is to abandon unprofitable products, service lines, channels or customers. However, this action first requires the ability to properly and accurately measure costs in order to determine true profit margins. Measuring the revenues is not a problem, but measuring costs is. ABC/M solves that problem. With knowledge of profit contribution margins, the organization can more intelligently rationalize what to change and which business lines or customers to drop.
Another less draconian option is available to suppliers. They can alter the behavior of their trading partners. Through collaboration, persuasion, or creation of incentives for one's suppliers and/or customers, fewer demands on work can be placed on the organization's employees. The newly freed-up time of employees plus their associated operating expenses can then either serve new customers or handle increased business from existing customers. (Alternatively, employees can be transferred to where they might be needed elsewhere in the organization.) Let's explore this option of altering the behavior of suppliers and customers.
Influencing Trading Partner Behavior. Initially some trading partners will exclusively and perhaps selfishly use their ABC data for their own private benefit. They will use it for incremental price and cost trade-off analysis. For example, to entice a customer to reduce its current level of services, they may offer the customers a reduced unbundled price incentive. Presuming the customer accepts the new arrangement, an organization must know in advance how much of the resulting costs will be available and realizable for savings. The critical test equation comes from basic economics:
For service reductions, the incremental change in price and revenues must always be less than the incremental change in cost (and vice-versa for service increases, where changes in revenues must always exceed changes in costs).
If this condition is not satisfied, then the supplier comes out losing profit if the customer elects to select the option.
Figure 1 — Influencing Customer Behavior — shows a case where an unprofitable service is converted into a profitable one by reducing both the service level and price — but the change in cost must decline more than the change in price and revenues for a positive profit impact.
(Figure 1 is not available in text-only version of this document.)
This is a very different and important use for ABC/M data. Note that the data is not used in this application for internal productivity improvement — it is used to influence external demand. The key for the supplier is to somehow alter the behavior of the its customers in harmony with its own cost structure. It is brilliant if it can be done. But the suppliers must have a very good understanding of its own cost structure and how it varies with changes. ABC/M data is essential for this.
The trade-off of price and cost can go in both directions. The service level can be raised, but presumably the price and resulting revenues will rise even more than the incremental costs to yield incremental profit. In the Internet 21st century customer order entry process, progressive companies will provide their customers on-line access to select their own options using web-based pricing. Suppliers may communicate with customers in several ways. Some might proactively "push" their promotions at customers by offering various product and service-level options. Suppliers can also wait for customers to visit and shop at their website. But with Internet auction sites, exchanges, and e-bidding, suppliers will be forced to have cost estimating and profit margin acceptance testing capabilities that are far more advanced than what they have today.
Forget the past methods of pricing and quoting. When a customer inquires the sales or order entry function of a supplier to ask what the price might be for a personalized order with various options and features, the reply from a clerk or tele-sales person can not be, "I will get back to you in a day or two after our operations, cost estimating, and pricing people have given this a look." The information must be calculated at Internet speed. The calculation will require rule-based logic leveraging ABC/M data. Suppliers without this automated and web-based capability risk selling orders at a loss or unwittingly pricing too high and losing customers.
It will not be sufficient for a supplier to have a "static" web-catalog that is periodically updated annually or quarterly. A supplier's web-catalog must be near dynamic and include product features, options, pricing, and availability data. Figure 2 illustrates how Internet exchanges can expose buyers to more suppliers. Supplier auctioning systems will be commonplace to match the buyers' bidding systems. Figure 2 — How Supplier's Counter the Power Shift to Buyers — further illustrates why a supplier's host system will require robust, rule-based predictive cost system relative to what suppliers have today.
(Figure 2 is not available in text-only version of this document.)
In short, price quoting and customer order acceptance testing can not be a back-of-an-envelope exercise. It must leverage rule-based models that reflect a supplier's cost structure.
Big Risks From Flawed Thinking. One of the risks the supplier will encounter will be the assumptions it makes about the inclusion or exclusion of the business sustaining costs that can optimally be absorbed or not in calculating the costs to be used for the profit margin acceptance test of each customer order.
- If too much of the business sustaining or presumably near term fixed costs is excluded, there will be temptation for opportunistically offer low pricing. This creates a risk that repetition of similar orders will gradually replace the company's pricing structure below the level required to fully recover its business sustaining cost structure.
- If too little of the business sustaining costs is excluded, meaning that too much of fixed costs are included in the assumption, then there is a risk that selective reduced pricing may not be ventured to attract a new customer or prevent an existing customer from switching to a competitor.
As the Internet spawns the digital market via web-site auctioning, some believe that companies will start to do things typically reserved for commodity exchanges, like with soybeans, wheat, sugar, and cocoa. There will be opportunities to do things that only commodity traders or brokers have done in the past. With Internet exchanges, every business becomes a broker in a free-floating market with what appears to be a transparent pipeline (transparent to supplier prices, but not to their profit margins that are still undisclosed except in rare seller-buyer relationships). Others believe that buying and selling in most businesses is much more complex than what occurs in commodity market trading.
Technology is no longer an inhibitor for suppliers to economically capture true costs, estimate costs for quotes, and test profit margins. Businesses now face a thinking problem. They must really understand their assumptions about fixed and variable costs --- and the implications of each assumption.
The supplier's option of altering the behavior of its trading partners is not commonly pursued because many organizations haven't adequately considered it yet. Most organizations are habitually inward-focused and concentrate on how they should manage their internal costs. Many companies do not adequately understand their how much of their cost structure is in fact a consequence of the collective suppliers' and customers' demands-on-work. Costs measure effects. The thought of influencing a customer or supplier to behave differently in order to lessen the organization's employee workload is often outside the realm of many organizations' thinking.
Altering trading partner behavior requires trust amongst suppliers and customers. Businesses have historically been wary of releasing information to trading partners even when that information will aid mutual understanding --- and one place where disclosure is needed is regarding an organization's cost structure. Yet many organizations mistrust their own cost data. As previously mentioned, they operate with a resigned acceptance that their cost accounting data is "a bunch of lies --- we all agree to." Understanding true and actual costs is not the whole solution, but it is a part of the solution to increase inter-firm trust and better manage costs and profit margins.
What Role Will ABC/M Play in E-Commerce and Supply Chain Management? Today buyers are increasingly dictating terms, conditions, and pricing. Mega-digital marketplaces continue to be under construction as cyber-exchanges consolidate the place where consumers and producers go to buy information, products and computing capability as well as to process transactions. Suppliers face additional risks from exposing more of themselves from their websites. How can suppliers recover any of the power they are losing to buyers? They do have options, but suppliers will need to be savvy. Information technology is the wild card. ABC will be part of the supplier's solution.
Information technology is enabling the trading partners along the value-creation chain to better coordinate and collaborate for mutual benefit. But trading partners will require cost accounting systems, including activity based costing (ABC), that are superior to the accounting systems they all struggle with today.
E-commerce is causing major changes with two of the major core processes of any commercial or public sector organization:
- The Generate Requests and Orders process
(The "front office" where marketing and sales resides)
- The Fulfill Requests and Orders process
(The "back office" where operations resides)
The "Front Office"
The revolution in the supplier's "front office" is the buyers themselves can now directly participate with specifying, selecting, and acquiring goods and services with little or no assistance from their suppliers. To the experienced shopper, securing a bank loan or specifying options and purchasing a new automobile may be as natural as retrieving cash from an automated teller machine (ATM).
For the front office, I earlier alluded to the ability for sellers to influence and alter (i.e., manipulate) the buyers' behavior by offering various service level options with associated higher or lower prices. This tactic may be the supplier's best defense to minimize the powershift from the seller to the buyer. Supplier auctioning will be commonplace to match buyers' bidding systems. ABC/M will play an important role to assist sellers to understand and test the profitability of their decisions. Those suppliers without an ABC/M calculation engine risk motivating a customer to change their purchase habits and potentially buy goods and services where the seller loses money as a result.
The "Back Office"
The revolution in the back office is located in the execution systems where a supplier's processes are designed to source, make, and deliver to requests and customer orders. Some organizations expect their ERP systems to solve any and all of their execution problems. Regardless of what techniques or solutions that managers select to improve their execution, cost visibility will become increasingly more essential. ABC/M cost data will increasingly help process teams to identify opportunities, assess how they are doing on what is important, and determine if the outcomes of their decisions have been or will be profitable or wise.
Remember that ABC/M is an analytical application. The data from ABC/M can draw on transactional data from the ERP and customer order management systems and then, after translating this information into business intelligence, the ABC/M data may be returned to the these same systems to support rule-based decision support.
The Confusing Pursuit of Value Entitlement. One of the most ambiguous terms in these discussions about business is value. Everybody wants value in return for whatever they exchanged to get value. We can have endless philsophical debates about the definition of value. The ancient Greek philosophers have already put a lot of time into that. The much more interesting question for the 21st century will be "Whose value is more important?" In the supply there are three groups of people who believe they are entitled to value: customers, shareholders, and employees. Are they rivals? Is there a hidden hand of checks-and-balances that maintains an equilibrium so that each gets their fair share? Is this is the essence of managing for the executive management team?
There is interplay between the three. The customer concludes that they received value if the benefits or pleasure they received from a product or service exceeds what they paid for it. At the opposite end of the figure are the owners and shareholders. They also have entitlements to value. As investors, if their investment return is less than the economic return that they could receive from equally or less risky investments, then they are disappointed; they would feel they got less value. There is a trade-off between customers and shareholders. Under certain conditions, increasing customer satisfaction can result in reducing shareholder wealth.
With this reduction of value of entitlement, Figure 3 — How Do All the Systems Fit Together? — illustrates a broad picture of how the front and back office systems plus other systems serve as components in managing the value chain. Here are brief descriptions of three kinds of value. Shareholder value is measured by value-based management (VBM). VBM detects if the profit margins generated from satisfying customers is also sufficient to reward shareholders beyond risk-adjusted investment returns they could achieve elsewhere, including money market instruments. Customer value relies on "front office" CRM systems to assure communications, interactions, and sensitivity to each customers' unique needs. The supplier's employee value relies on the "back office" ERP and APS systems assure effective execution to "fulfill orders." The performance measurement scorecard systems assure that specific groups of people, equipment, and other assets are performing in high alignment with senior management's strategies.
(Figure 1 is not available in text-only version of this document.)
ABC/M data permeates every single element of Figure 3. ABC/M itself is not a program or execution system like those systems in the figure. ABC/M data serves as an enabler for these systems to support better decision making. However, a strong case can be made that ABC/M links CRM to shareholder value which, as earlier mentioned, is heralded as essential for value-based management. The tug-of-war between CRM and VBM is the trade-off between adding more value for customers but at the risk of reducing wealth to shareholders. ABC/M is the only financial calculation engine that can quantitatively translate changes in one value to the impact on the other.
As the 21st century unfolds, organizations will increasingly understand not only the interdependencies of the customers and shareholders, but they will have the analytical tools plus accepted assumptions about how all of these components integrate.
Cokins, Gary, "The ABCs of Cost Management." Purchasing Today®, June 2000, 62.