DALHOUSIE UNIVERSITY

E-Procurement
Virtual Vertical Integration systems for supply chain
management

By
Ahlam Alsulami

Business Issues for Electronic Commerce

December 2013
 E-Procurement and Supply Chain Management 2

Contents

1. Introduction ............................................................................................................................................... 3
2. Growth of E procurement ......................................................................................................................... 4
3. E-Procurement and Vertical Integration ................................................................................................... 7
4. E-procurement and the relationship between buyers and Sellers............................................................ 11
4.1 Improved flow of information........................................................................................................... 11
4.2 Greater Trust and Transparency ........................................................................................................ 14
5.Cost component ....................................................................................................................................... 17
6. Challenges and Limitations..................................................................................................................... 18
7. Conclusion .............................................................................................................................................. 20
8. References ............................................................................................................................................... 21
 E-Procurement and Supply Chain Management 3

1. Introduction

E- Procurement integrates technology into the procurement of goods and services. Procurement

is made up of both direct and indirect procurement. Direct procurement refers to the activities

that directly make up the value chain while indirect procurement is related to activities that

support the value chain such as manufacturing and office supplies respectively (Stephens &

Valverde, 2013). This area of research is important field of study because it is method that an

increasing number of companies are using to cut their costs. Prior to the internet, procurement

across the supply chain was characterized by slow manual procedures and slow processes for

handling the transactions necessary for the company to conduct its operations (Hawking, Stein,

Wyld, & Foster, 2004) Procurement is a critical aspect of the business model and inefficiencies

in this process ultimately affect the entire company. Businesses have been able to use e-

procurement to ensure that inventory is brought to their stores in a way that minimizes their costs

and is responsive to the current demand trends for the time period. Specifically, e procurement is

associated in reduced transaction costs, higher process quality, increased system responsiveness

and greater control over the process (Stephens & Valverde, 2013). These advantages are

accomplished through greater supply chain integration with retail stores, warehouses and

suppliers. E procurement is able to improve the supplier -buyer relationship and to some degree

take on the benefits of vertical integration with less risk and resource expenditure for the

companies involved while still improving supply chain performance. It has been identified that

the relationship that e procurement is able to support through information sharing increases the

levels of trust that in turn lead to costs savings and greater inventory control (Ching & Hsu,

2013). E procurement is therefore changing the nature of the supplier buyer relationship and

moving it towards a more integrated supply chain approach. Companies that have been able to
 E-Procurement and Supply Chain Management 4

align their business strategies procurement have been the most successful in recent years. Apple,

Wal-Mart and Amazon have developed very strong suppler networks with the latter two

demonstrating that core competency can be built based on the ability to management the

complexities of the supplier network (Jawale, 2013). For these reasons e procurement has

become an important tool of supply chain management. The details of the types of integration

and the changes to the traditional relationship are of particular interest to the scope of this paper.

In light of these developments, this paper will cover the ways that modern companies use e-

procurement methods to reduce their costs by focusing on the five aspects of e-procurement i.e.

to source items 1) at the right price 2) delivered at the right time 3) of the right quality 4) of the

right quantity 5) from the right sources specifically with respect to supply chain management.

2. Growth of E procurement

There is no doubt that companies are increasingly relying on electronic solutions to manage

their procurement needs. In 2009, the value of business to business (B2B) activities amounted to

7 trillion dollars internationally, with 24% of these transactions managed using some form an

electronic system. This development is part of the larger trend of technological dependence

within the economy (Ronchi, Brun, Golini, & Fan, 2010).According to Yen (2003)The rapid

growth of procurement has been facilitated on the widespread availability of the five

technologies, electronic mail (e-mail), enhanced fax, electronic data interchange (EDI),

transaction processing, and groupware” (p. 168). The underlying foundation of the benefit of

ecommerce is in the increased availability and access to information across the supply chain.

E procurement encompasses a large part of many companies business as it involves requisition,

purchasing, transportation, storage and receipt of goods. There are three main types of
 E-Procurement and Supply Chain Management 5

procurement systems: buyer-hosted, seller-hosted and intermediated architectures. In buyer

hosted platforms, the customer creates their own system that contains e procurement

functionality. This system them interacts with the supplier's system. When the seller develops e

procurement, the customer will adopt the system that they have developed although the content

management is likely to be customized and managed on their own. There are four types of

intermediated system. These are as follows: 1) Application service providing (ASP) in which the

service provider company provides the application and the using company manages and runs it

on their own 2) Business process outsourcing (BPO) in which the provider of the e procurement

software platform also provides the maintenance and operation of the system and may even

oversee the entire supply chain process. 3) Reseller in which the company buys a software from

a third party reseller and not the manufacturing company and 4) Supplier Network in which the

company uses a supply base that is owned and operated by a third party (Ronchi, Brun, Golini,

& Fan, 2010)

E-procurement can take on multiple forms. They include the following:

1. internet market exchanges through websites that bring buyers and sellers together to

purchase items at a dynamic price as set by the rules of the market

2. Internet B2B auctions where companies can readily and anonymously get rid of excess

inventory

3. Internet purchasing consortiums where many buyers can get together virtually in order to

demand for more compressive discounts than they would on their own through the

aggregation of their buying power (Davila, Gupta, & Palmer, 2003).

4. Procurement software

These methods can be categories according to their level of integration as shown in figure 1.
 E-Procurement and Supply Chain Management 6

Figure 1 Internet based supply chain integration strategies (Frohlich & Westbrook, 2002)

These systems provide a number of benefits related to cost efficiencies. Procuring through the

internet is one way to reduce the transaction costs of low value needs such as maintenance,

repair and support operating items. They are also offer cost savings because the internet is used

as a place where companies can find a possibly wider range of price options that they would

using a traditionally format (Pearcy, Parker, & Giunpero, 2008) E procurement software, the

fourth type of e procurement system, is any internet based software that facilitates the

purchases of goods (Davila, Gupta, & Palmer, 2003) These systems vary in their configuration

and can carry out a number of functions including cataloguing, Repository and Content

Management, abilities to request quotes and information, workflow management, system

integration, order tracking and tracing, electronic invoicing, reporting and order placement

(Ronchi, Brun, Golini, & Fan, 2010).

The figure below from Vaidyanathan et al (2012) demonstrates the e procurement process from a

technological standpoint. Regardless of the software side of the system, this configuration

represents the basic formal of all procurement systems.

 E-Procurement and Supply Chain Management 7

Figure 2 E procurement systems (Vaidyanathan, Devaraj, S, & D'Arcy, 2012).

For the purpose of this paper, e procurement will refer to software and not the other methods. As

will be explained in the following sections procurement that is integrated across the supply chain

as shown in the upper right hand corner of figure 1 creates a demand integration system which is

the most effective means of using procurement systems.

3. E-Procurement and Vertical Integration

Supply chains are composed of all associated activities of the company, from the flow of raw

material into valuable goods. Managing this chain is an important way that companies can cut

down on their costs and improve their efficiency (Ching & Hsu, 2013). Supply chain integration

is seen as in important step in effective supply chain management. This integration should take

place on both and internal and external level. Internal integration takes place when the firm is

able to exercise complete control over the sections of the supply chain under their direct control

throughout the entire organization. When the firm is virtually integrated all of the sublevels and

departments are able to work together to create a seamless process of supply management.
 E-Procurement and Supply Chain Management 8

External integration occurs when the suppliers are integrated into the supply chain process

(Pearcy, Parker, & Giunpero, 2008).

Vertical integration occurs when a firm takes on the manufacture and control of their supply

chain. This method was popular among industries in the past that needed to be able to have very

tight control and high quality. When the design and manufacture of the product occurs in house,

the company has total power of determination over the inputs to the processes and how it is

carried out. They can select and refine their own quality assurance programs. There is

theoretically less concern about the unreliability of the suppliers because they know where the

process is taking place and where the goods are within the system and all times. The company

is also able to transport components in smaller pieces which could potentially be easier to do. In

industries where sensitive information is used and there is a great risk that the designs or other

confident information could be leaked, the company is able to maintain security over this data

rather than having to share it with an outside company (Bugge, 2012).

Vertical integration is not without risks. It can be expensive to acquire the means of production

required to produce the components of the supply chain. For this reason, vertical integration has

been typically reserved for the most important components of the supply chain so that the

benefits of controlling those parts would make up for the risks. In order to overcome the

problems of vertical integration some companies attempt to rely on outsourcing. However,

outsourcing while it can be cost effective has its own problems in terms of procurement. Quality

issues can occur especially if the firm is outside of the home country. Apple for example, has

recently moved some of its operations back to the United States because of problems with their

supplier quality control in their factories in China. Additionally, problems related to cultural

dissonance can reduce morale and drag down performance.

 E-Procurement and Supply Chain Management 9

E-procurement allows companies to “virtually vertically integrate”. This process is described by

Tom Linton, chief procurement and supply chain officer for Flextronics as “managed alignment

of external supply chain capabilities that leverages multiple levels of those capabilities to

improve profitability and cash flow” (Snell, 2013). Essentially through e procurement

independently owned and management companies are able to act with the efficiency of a single

enterprise. Vertical virtual integration through e procurement offers companies the most

appealing procurement structure in terms of costs savings and efficiencies and allows for what is

termed demand chain management rather than supply chain management. Instead of goods

being “pulled” through the supply chain, they are pulled when the end customer triggers the

demand for it. According to Frohlic and Westbrook (2002) this form of management was not

possible before the inception of the internet even though there were clearly defined benefits

for it because maintaining the connections required would no way to access a lot of information

at a low cost. The internet allows for real time data to be shared between the buyer and the

seller. As information flows backward (downwards in figure 1.), inventory flows forward. This

means that goods and services can be delivered when they are needed in the quantities that they

are needed in, in a reliable manner (Frohlich & Westbrook, 2002). The structure of these forms

of companies is shown the figure

 E-Procurement and Supply Chain Management 10

• Brand Level companies: These companies focus primarily

Tier 1 on creating innnovating products and marketing

• Integreation Level: These companies assembled the final

Tier 2 products

• Device Level: Makes the parts for the complated product,

Tier 3 such as semi conductors or computer chips

• Raw Material Level: commodity based, steel, gold, etc.

Tier 4

Figure 3 Virtual Vertical Integration adapted from (Snell, 2013)

The flow of materials is from Tier 4 to Tier 1. This concept is what allowed Dell computers to

develop a competitive edge during the late 1990s, In 13 years this company was able to grow

from nothing to being the industry leader and valued and $13 billion. They were one of the

pioneers of this kind of business model. Rather than attempting to do what others in the industry

were doing at the time, which was complete vertical integration, making things in house, out of

practicality they elected to use virtually integration which CEO Michael Dell described as

“basically stitch[ing] together a business with partners that are treated as if they are inside the

company” (Magretta, 1998).

The benefit of this model is that there is a reduced investment and risk factor. If a company has

two suppliers and one of them becomes inefficient it is easier to relocate the source of that

component rather than attempt to build a new factory or invest in new equipment. Even the

initial capital costs of starting a business using a vertical integration approach would be
 E-Procurement and Supply Chain Management 11

prohibitive because it would mean an enormous expenditure for the means of production to

produce all of the components of the product. For a technological or complex product, these

costs would be a high barrier to market entry and even if the company was able to start, the debt

burden would be prohibitive. The capital investments required would simply prevent the

company from growing. Dell was able to grow 57% a year because they did not have to concern

themselves with creating their own products. The supporting processes of the company would

become immensely time consuming because the company would be several times larger if the

work force was actually employed by the main company (Magretta, 1998).

4. E-procurement and the relationship between buyers and Sellers

4.1 Improved flow of information

Several studies have suggested that the main vehicle that supplies the benefit in e procurement is

the improved communication between the buyers and sellers in the supply chain. Poor

information is associated with a number of inefficiencies within the value chain including more

resources spent procuring and maintaining large inventories; lower customer service possibly

due to stock outs; lost revenue due to opportunity cost on sales; misaligned capacity planning

leading to over or underestimating the amount of production needed; ineffective transportation

through under or over transporting goods and production schedules that are not optimally

designed (Frohlich & Westbrook, 2002). With integrated e procurement system built into the

supply chain the buying company is able to use automated queries to the supplier who in turn is

able to make a customized and rapid response to the buyer. The reduction in time required for a

physical meeting enhances the efficiency of the communication (Yen & Ng, 2003).
 E-Procurement and Supply Chain Management 12

The improved communication between the parties means that suppliers can be more responsive

to the buyer’s needs. There are market phenomena that impact the effect of performance

inefficiencies in the supply chain. In the current economic market, there is a great risk of

volatility. When there is molality further up the chain it is distorted and amplified. This

phenomenon is called the Forrester effect or the bullwhip effect (Wang, Tai, & Wei, 2006). The

Clock speed amplification effect refers to the fact that nearer to the consumer end of the supply

chain, firms see a shortening of product lifecycle and a decline in their price/performance ratios.

The shortening of the lifecycle at the consumer end is if likely because customer changes and

competition compress the time that product remains profitable in the market. This means that in

order to maintain competitive edge, companies have to increase the speed of their own

operations to bring products to market faster (Wang, Tai, & Wei, 2006). In this environment,

speed and flexibility are critical success factors. A company that has more flexibility i.e. the

ability to develop customer benefit packages that contain and appealing mix of goods and be able

to adjust their production output in order to match demand are likely to perform better in the

market place than a company that is not flexible. In the past in order to maximize control over

production companies would vertically integrate however with virtual integration through e

procurement, there is a strong alternative.

Virtual vertical integration allows for firms to communicate with one another about expected

demand. The linkage in the supply chain means that higher up the chain, suppliers can see when

the buying company has sold their products which gives them information about the rate and

times of the year that the products are being sold. Because the production companies can see

when orders are being made they can better anticipate when resupply is needed. They can also

build better statistical forecasting methods that allow them to predict demand. This reduces the
 E-Procurement and Supply Chain Management 13

needs for excess inventory buildup and supports the just in time (JIT) inventory method and

delivery which is associated with lower holding and inventory costs. Just in time inventory

supports the delivered at the right time and at the right quantity aspects of the value chain. The

stability achieved through demand chain management, counters the impact of the bullwhip effect

and lowers lead time, mitigating the clock speed amplification effect (Frohlich & Westbrook,

2002).

At the base of the chain in figure 3, the manufacture is able to forecast what production will be

able in able to adjust their capacity accordingly. In the technology industry in which innovation

is closely linked to c survival, an integrated supply chain allows the suppliers to grow and

change their capacity along with the buying company. As new products are developed suppliers

can even add input about the feasibility and cost of the production of the new product. In order to

respond to demand from the new product, the supplier may need to increase their own

capabilities in order to reach new targets and increase their technological expertise in a given

area. Additionally they may need train new personnel and commit more resources to a single

area of production. The sooner that the supplier is aware of the changes that are needed on their

part; the more effectively they will be able to navigate product transitions (Peterson, Handfield,

& Ragatz, 2003). This model was employed by Dell in the 1990s. According to the CEO

Michael Dell supplier engineers were actually stationed within the company and treated as if

they were within the company. This way new product was developed the supplier company was

involved with the design and was more actively involved in fixing the problems with the product

(Magretta, 1998). While not all companies will house their suppliers in house, virtual vertical

supply chain integration trough e procurement gives them flexibility to call upon their

manufacturers in the say way that an internal supplier would be called upon.
 E-Procurement and Supply Chain Management 14

Using e procurement it is possible to give suppliers much shorter lead times because the

suppliers get information much faster. In the system prior to e procurement the manufacturer

would produce at a steady rate and be warehoused through the channel. At the top of the chain in

figure 2, there would be a realization that there was an overstock. This information would then

have to flow back up the procurement channel over a period of weeks, days or even month

during which time inventory would still be continually produced unnecessarily. Using e

procurement kind of lag is virtually eliminated because suppliers are getting real time data

which allows them to keep only a few days or even a few hours’ worth of inventory on hand

(Magretta, 1998). This is possible because e procurement reduces the operational distance

between the buyer and the seller.

4.2 Greater Trust and Transparency

Trust in business relationships can be defined as the willingness of one party, the trustor, to be

vulnerable to the actions of another party, the trustee, based on the expectation that the trustee

will perform a specific action important to the trustor, irrespective of the trustor’s ability to

monitor or control the trustee” (p.93.) Trust impacts the willingness of the parties involved to

take risks. In the case of business this risk can refer to the willingness to make a transaction.

Lack of trust within the transaction between the buyer and seller increases the overall cost of the

transaction because both will take steps to protect themselves which increases time and

inefficiencies (Bossone, 1999). Trust is something that normally develops over time in the buyer

seller relationship. Companies are less likely to deal with other business that they have no

knowledge or information about and do not trust. They would prefer to do business with

someone that is either established in the market and has proven to be reliable or a company that

they have worked with for some time who has proven to be consistent in their behavior. E
 E-Procurement and Supply Chain Management 15

procurement may assist in bringing about greater trust between buyers and sellers through

increased transparency and greater openness. Trust in supply chain relationships is associated

with a higher in time order fulfillment rate meaning that it makes it more efficient (Lin, Sung, &

Lo, 2005). E procurement systems can be developed that have embedded trust mechanisms

within them allowing buyers and supplier to capitalize on the benefits of increased trust.

When buyers and suppliers integrate their supply chains, it is with the expectation that the two

companies are going to be doing business with each other for some time in the future as there is a

significant investment in terms of time and money into getting the system functioning optimally.

This increases supplier confidence in the strength of the business relationship. Because of the

long term association with this kind of integration suppliers will no longer necessarily be tied to

an open contract. While there is the possibility to add performances clauses into the contract, it

is generally understood that there will be mutual cooperation that will be to the benefit of both

companies. As such, suppliers may feel more comfortable doing things like making investments

to improve their technology and their efficiencies.

When the bargaining power of the buyer is high as is the case with some multinational

corporations like Wal-Mart, the buyer can actually influence changes in the supplier’s business

practices. In fact a number of large buying companies have demanded that in order to be one of

their official suppliers companies need to operate to certain standards. This can mean operating

to a specific ISO level or even an environmental or human rights standard. This influence helps

to ensure that the product that the buyer is getting is manufactured to their exact specified quality

with low to no surprises. They can also ensure their own customers that environmental and other

social concerns are being met. For example, the Disney Company created the International Labor

Standards (ILS) program in 1996. This program aims to control the conditions that their
 E-Procurement and Supply Chain Management 16

suppliers have in place with respect to the work standards of the people that are employed in the

factories that make Disney products. They use the integrated vendor scorecard to rank their

vendor and if a vendor consistent does not meet their standards then they are removed (Disney,

2013). The company that is among the best examples for the success of e procurement is Wal-

Mart. Wal-Mart has an enormous internal distribution system and the first step for the company

was to achieve internal integration. In order to accomplish this Wal-Mart relied on technology to

link all of the store system, merchandising systems and distribution systems. After the

company completed this process it moved to integrate the suppliers in their supply chain (Darling

& William, 1996). The Retail Link system that Wal-Mart uses allows each supplier to access

information about the product that Wal-Mart carries that it is relevant to them create forecasts

based on this system

Figure 4 Wal-Mart System (Darling & William, 1996)

 E-Procurement and Supply Chain Management 17

In the figure, an e procurement management system is shown for Wal-Mart and one of its

suppliers. Systems such as these allow the company to cut down on the time and paperwork

involved in procurement and assists the suppliers to generate more accurate forecasts which in

turn results in more efficient inventory management.

Recently Wal-Mart has implemented their own supplier development program that aims to

improve their working conditions in their factories (The Green Supply Chain Editorial Staff,

2012). Considering that many of Wal-Mart’s factories are in developing countries that have no

other means of improving their production, these kinds of programs are important because they

have tangible benefits on the lives of the people who supply the company while arguably

providing a high quality product. These forms of programs are a part of e procurements ability to

facilitate the acquisition of product from the right suppliers by encouraging existing suppliers to

improve their own performance. These advances demonstrate the versatility of e procurement in

virtual chain integration. Technology has made it possible to integrate supply chains on global

scale at an unprecedented level.

5.Cost component

E procurement can reduce the operating costs of all the companies in the supply chain.

Procurement is complex process that involves several stages that each requires activity on the

part of both the buyer and the supplier. Using an electronic replenishment process can reduce

the costs of the system by reducing the amount of paperwork generated by the processes of both

procurement and fulfillment which can include vendor certification and selection, requisition

preparation and approval, order placement, goods receipt, reconciliation and payment of the

invoice as well as order archiving. Studies have found that there is varying level of cost
 E-Procurement and Supply Chain Management 18

reduction when a business moves from manual to electronic procurement. Woodall (2000) found

that there was a 90% reduction in transaction costs at British Telecom when the company moved

their procurement operations online. Similarly, Ruzicka (2000) found that the traditional

enterprise resource planning transactions could cost approximately $75 per hour compared to

the $3 cost per hour of online procurement. Other studies have found that a company can pay

between 40 and 200 to process a manual purchase order compared to a virtual purchase order

which costs between $1 and $2 (Eisenmann, 2002).

These figures demonstrate that there is a consistent advantage to using an e procurement

solution for companies. Robinson et al, (2005) shows that these benefits can translate into a

wide spread cost benefit when firms chose to use an integrate approach to procurement. When

the companies in the supply chain move from a fully manual to a fully automated procurement

system there is an overall 12.5 percent cost reduction. However, the benefits of this reduction

were not distributed equally nor were they borne equally by all the members (Robinson, Sahin,

& Gao, 2005). Overall, however, e procurement is able to reduce the cost of procurement to the

company, which is major business process thus supporting the at the right price role of

procurement. Despite these benefits integrated e procurement software solutions can be

expensive and may be best suited for companies with large and distributed supply chains who

are able to afford the possibly multimillion dollar cost of these systems (Davila, Gupta, &

Palmer, 2003).

6. Challenges and Limitations

Despite the advantages to e procurement, there are some potential challenges that companies

have to consider. Not least of these issues is security. Competition in the real and virtual world is
 E-Procurement and Supply Chain Management 19

intense in some industries and this leads companies to take steps to gain as much information

about the market as possible. This includes information on their competitors and their behavior.

Some of the methods that are employed to gain this information are potential threats to data

security (Stephens & Valverde, 2013). Because of the integration between companies in the

supply chain of the company, there is the risk that a breach in the system would be able to impact

the entire supply chain. Internet based systems are particularly vulnerable to attacks because they

can act as entry points. Additionally, the current methods of security, which include network

firewalls, intrusion detection systems, encryption, and manual measures such as aggressive

quality assurance and audit procedures are not able to stop attacks at the level of the application

and are unable to stop them at the level of the operating system. Considering that the system

potentially contains sensitive information there is a possibility that security risks lead to sub

optimal integration. Due to the growth of procurement, companies are relying more on third

party systems outside of their control. Trust has been cited as one of the major deterrents to using

e procurement methods

Studies have shown that customers in B2C transactions have demonstrated that they have

increased trust in systems that show that they have encryption and other steps for security.

Vaidyanathan et al,(2012) found evidence that security in ecommerce is associated strongly with

performance. Therefore in developing e procurement solutions it is important that security is

built into the system not only the IT methods but also through procedures that encourage the

human users to take safe actions.

 E-Procurement and Supply Chain Management 20

7. Conclusion

Procurement is a central process in business operations for many companies and therefore an

opportunity for firms to create efficiencies and strengthen their core competences. Supply chain

management has been developed as a means for companies to gain cost controls over their

supply chains. Prior to the inception of the internet supply chain management was the only

means of accomplishing this, because to operate the company and the companies in the value

chain according to a demand chain system was not possible because of the high cost associated

with sharing data. Today however, e procurement allows companies to develop systems that

create closer relationships with suppliers than was previously possible. The closeness of the

relationship between the buyers and the sellers within this virtual vertical integration network

allows companies to take advantage of the benefits of vertical integration without the high costs

associated with this kind of a system. This is accomplished because of the increased quantity

and quality of the information between the suppler and the buyer. In fact, it is even possible to

achieve real time information flowing between the two. This level of communication decreases

the need for storing large quantities of inventory and can even assist in helping companies to

innovate. Increases trust and communication between buyer and supplier increases the quality of

the supplier network because suppliers are willing to take steps to conform with the buyers needs

when a high level of commitment to the suppler is demonstrated. It also allows the supplier to

feel greater confidence in making an investment in their own operations because of the long term

support. This system is not without risks as being internet based; it does have potential security

risks that could decrease the trust that the parties have in these systems. It is necessary that

companies take the necessary protections both on a system wide level and through procedures to

protect the integrity of the system

 E-Procurement and Supply Chain Management 21

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