In the previous posts we discussed conventional outsourcing and the various flavors of Captive Sourcing and their pros and cons. One of the nifty ways to straddle the best of both worlds is to use a private market.
Deep Linking into the Market
If you noticed in the activities before, the eAuction is by run by the software, and owned by the IT Manager linked to a business division, not the sourcing/procurement manager. The pre-work, which I like to call the deep-linking is where the strategic sourcing function comes in. Taking the GE IT sourcing example further, the company has perfected this art with a slew of governing mechanisms and tools. Its prefered IT vendor pool (known as GDC vendors) include Tier 1 Indian companies like TCS, Wipro, Birlasoft, erstwhile Satyam (now Mahindra Satyam) etc. Long term relationship agreements are formalized through multi-year relationship governing contracts known as the Master Services Agreement (MSA). These contracts set up mutually agreed terms and operational metrics that help create the ground rules as a pre-requisite to be able to participate in the auctions. One of these could be that the vendor is certified to be at a certain level of maturity (such as SEI-CMM) as an organization.
Advantages over sole sourcing/captive units:
The advantage to the buyer is the ablity to simulate price competition as in an open market. Besides, being a closed set of players it is a much more predictable environment that begins to approach the reliability and transparency and controllability of an in-house IT without the buyer having to take on a non-core function.
The main, if not only, advantage to the seller is the predictability of assured repeat business year after year (the Master Services Contracts are usually multi-year and a gateway to a few hundred million dollars of assured business). In fact, Jack Welch, the ex-CEO of GE in his autobiography “Jack: Straight from the Gut
” brags about the fact (or arguably the fiction) that a similar large GE sourcing contract with Wipro propelled the company chairman Azim Premji into the list of the richest men in the world.
Needless to say that with a client like GE it would also be a seller’s advantage to have a great logo on the customer list, and the benefits of thought leadership that follows from the association. For example, TCS internalized Six Sigma in a major way within its GE accounts which benefited its employees, its own internal processes and even spawned a revenue stream eventually within its process consulting function now known as lean Six Sigma. There could be similar benefits derived from private market associations with large buyers (for example Toyota and its suppliers). In case of Wipro, it also resulted in an unexpected windfall in the form of Premji finding Wipro's next CEO in Vivek Paul at a GE business, who would go on to take Wipro to new heights.
Caveats:
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| GE CIO Gary Reiner is responsible for GE's massive sourcing efforts: CNN Money Interview |
A private market is essentially a preferred vendor pool where the vendors are invited to bid competitively for the buyer’s business, usually in the form of an online reverse auction. While more commonly used for commodities buying, electroninc reverse auctions in private markets can be used for many types sourcing. In the IT services outsourcing world, it has been used for buying services very effectively by none other than General Electric since the mid-90s right up to this day. Sometime back, CNN Money published this interview with the then GE CIO Gary Reiner on this topic. The interview gives valuable insight into GE's use of IT in the online reverse auction or eAuctions and private markets. Interestingly the CIO was also responsible for GE's overall for buy side strategy for services including IT. Hit the jump to read more.
How does this work?
The online IT reverse auctions starts with a Request for Proposal (RFP) and supporting documents such as a business requirements and functional specification documents are placed on the eAuction web portal. The RFP is owned by an IT Manager working for the business unit which is sponsoring the software project. The auction owner has the choice of sending out electronic invites to participants from a list of preferred vendors and also sets up a date and time when the auction will be held. The auction itself has two flavors - open and sealed bids. Sealed bids are those where the competing vendors know they are not the lowest but cannot see the lowest bid value, while in open bids they can actually see the amount and adjust the next iteration accordingly. The electronic auction itself takes place at a fixed time window. Like regular forward auctions, it starts slow and becomes an edge-of-the-seat experience for the participants as the deadline draws near and the flurry of activity (lower and lower bids being placed) increases until the time draws to a close and they are notified if they are the "lowest bidder" or not. This is followed by submission of an electronic Proposal document (response to an RFP) on the same web portal. This could be either in a next day or sometimes a week from the point when the RFP became available, depending on the project size and complexity.
As the interview with Reiner suggests, all other things being equal, the only differentiator becomes the price. They key though is that in order to ensure a level playing field for themselves (and even differentiate their offer) the vendors try hard to make sure that their proposals are exhasutive and competitive.
Many large buyers, like GE, use proprietary IT software and online intranet portals, but many internet based auction sites are available. There are also specialized ones such is MarketDojo, which target private markets only.
Online auctions – just like eBay, right?
Wrong. An eBay type auction is an example of a “shallow portal” where the buyer and seller can engage in a one-time transaction of a well-known commodity without knowing each other. Creating a private market on the other hand needs a lot of pre-work and due diligence and mutual value discovery and creation on both sides of the transaction to build the deep linkages into the participating organizations that help transform a highly customized service offering like IT ADM to a near commodity product level.
The online IT reverse auctions starts with a Request for Proposal (RFP) and supporting documents such as a business requirements and functional specification documents are placed on the eAuction web portal. The RFP is owned by an IT Manager working for the business unit which is sponsoring the software project. The auction owner has the choice of sending out electronic invites to participants from a list of preferred vendors and also sets up a date and time when the auction will be held. The auction itself has two flavors - open and sealed bids. Sealed bids are those where the competing vendors know they are not the lowest but cannot see the lowest bid value, while in open bids they can actually see the amount and adjust the next iteration accordingly. The electronic auction itself takes place at a fixed time window. Like regular forward auctions, it starts slow and becomes an edge-of-the-seat experience for the participants as the deadline draws near and the flurry of activity (lower and lower bids being placed) increases until the time draws to a close and they are notified if they are the "lowest bidder" or not. This is followed by submission of an electronic Proposal document (response to an RFP) on the same web portal. This could be either in a next day or sometimes a week from the point when the RFP became available, depending on the project size and complexity.
As the interview with Reiner suggests, all other things being equal, the only differentiator becomes the price. They key though is that in order to ensure a level playing field for themselves (and even differentiate their offer) the vendors try hard to make sure that their proposals are exhasutive and competitive.
Many large buyers, like GE, use proprietary IT software and online intranet portals, but many internet based auction sites are available. There are also specialized ones such is MarketDojo, which target private markets only.
Online auctions – just like eBay, right?
Wrong. An eBay type auction is an example of a “shallow portal” where the buyer and seller can engage in a one-time transaction of a well-known commodity without knowing each other. Creating a private market on the other hand needs a lot of pre-work and due diligence and mutual value discovery and creation on both sides of the transaction to build the deep linkages into the participating organizations that help transform a highly customized service offering like IT ADM to a near commodity product level.
Deep Linking into the Market
If you noticed in the activities before, the eAuction is by run by the software, and owned by the IT Manager linked to a business division, not the sourcing/procurement manager. The pre-work, which I like to call the deep-linking is where the strategic sourcing function comes in. Taking the GE IT sourcing example further, the company has perfected this art with a slew of governing mechanisms and tools. Its prefered IT vendor pool (known as GDC vendors) include Tier 1 Indian companies like TCS, Wipro, Birlasoft, erstwhile Satyam (now Mahindra Satyam) etc. Long term relationship agreements are formalized through multi-year relationship governing contracts known as the Master Services Agreement (MSA). These contracts set up mutually agreed terms and operational metrics that help create the ground rules as a pre-requisite to be able to participate in the auctions. One of these could be that the vendor is certified to be at a certain level of maturity (such as SEI-CMM) as an organization.
A key component of the MSA is the SLM (Service Level Management) framework which comprises of SLAs (Service Level Agreement) such as time to respond to and resolve production issues, OLAs (Operational Level agreements) and SPMs or Service Performance Metrics (such as offshore leverage) that all vendors must abide by and be measured against. Many vendors will often use IT Service Management (ITSM) standards such as ITIL (Information Technology Infrastructure Library) as an guideline to develop the process rigor. Furthermore, there are also standards defining everything from the software design and development methodlolgy used such as IBM's RUP or Agile Alliance's Agile, technology stack specifications, coding standards, project management and reporting methodology, to physical and network security/regulatory specs the exclusive-use global delivery centers (GDCs) must be built to. These GDCs are often in India but could also be in onshore North America (usually for clients such as Boeing having special regulatory needs such as an ITAR compliance), China or nearshore locations such as Mexico (for timezone or language specific needs). There are also non-contractual preventive checks and balances mechanisms – for example, a multi-step step Tollgate Review process starting at a buyer owned architecture review board that approves project design stage or a quality control step conducted by a competing vendor prior to production deployment. In short, the best tools and techniques ranging from standardization to conflict of interest are leveraged to remove ambiguity, protect interests and deliver a high quality consistent service experience.
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| IT Service Management practices under ITIL v3 |
Advantages over sole sourcing/captive units:
The advantage to the buyer is the ablity to simulate price competition as in an open market. Besides, being a closed set of players it is a much more predictable environment that begins to approach the reliability and transparency and controllability of an in-house IT without the buyer having to take on a non-core function.
The main, if not only, advantage to the seller is the predictability of assured repeat business year after year (the Master Services Contracts are usually multi-year and a gateway to a few hundred million dollars of assured business). In fact, Jack Welch, the ex-CEO of GE in his autobiography “Jack: Straight from the Gut” brags about the fact (or arguably the fiction) that a similar large GE sourcing contract with Wipro propelled the company chairman Azim Premji into the list of the richest men in the world.Needless to say that with a client like GE it would also be a seller’s advantage to have a great logo on the customer list, and the benefits of thought leadership that follows from the association. For example, TCS internalized Six Sigma in a major way within its GE accounts which benefited its employees, its own internal processes and even spawned a revenue stream eventually within its process consulting function now known as lean Six Sigma. There could be similar benefits derived from private market associations with large buyers (for example Toyota and its suppliers). In case of Wipro, it also resulted in an unexpected windfall in the form of Premji finding Wipro's next CEO in Vivek Paul at a GE business, who would go on to take Wipro to new heights.
Caveats:
As hinted in the interview, reverse auction based private market model is not without its critics. The key drawback is that it engages the suppliers in a fierce price war which eventually erodes their margins to the lowest possible levels to stay in the game, or they risk losing their share of the pie to the rivals. The pricing pressure is acute and often due to scope ambiguity/estimation errors and/or poor change management practices on fixed price contracts, the vendor actually ends up losing money on a project.
In fact Infosys, the second largest player today among the Indian software service providers, famously quit the GE GDC vendor business model in the 90s, even though it comprised of a quarter or more of its business at that time (read the story here). Infosys felt it unfairly commoditized their services and prevented premium positioning that they aspired for.
The caveat on the buyer side is simple – you cannot sustain this unless you have a great post sourcing architecture and relationship management practices in place. You do not have to be a behemoth like GE, with an $4B IT budget that approaches the size of a fortune $500 company revenue. However, you have to have a critical volume of your vendors’ business to have this play out on your terms.
As Reiner mentions in the interview, ideally no one wants to be on the sell side of an eAuction and tries to differentiate their offering so that it cannot be commoditized. But even so, this sourcing model can be a win-win relationship – and as far as GE and its preferred vendors are concerned, is alive and well till today
The caveat on the buyer side is simple – you cannot sustain this unless you have a great post sourcing architecture and relationship management practices in place. You do not have to be a behemoth like GE, with an $4B IT budget that approaches the size of a fortune $500 company revenue. However, you have to have a critical volume of your vendors’ business to have this play out on your terms.
As Reiner mentions in the interview, ideally no one wants to be on the sell side of an eAuction and tries to differentiate their offering so that it cannot be commoditized. But even so, this sourcing model can be a win-win relationship – and as far as GE and its preferred vendors are concerned, is alive and well till today
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