Corrugated comes over the Internet

Building materials supplier Owens Corning is convinced that procurement can be conducted most efficiently and cost effectively via reverse auctions over the Internet.

Watching the bid unfold: John Gellatly (left) and Satish Bhagwat of Owens Corning join Kara Csensich of FreeMarkets on bid day.
Watching the bid unfold: John Gellatly (left) and Satish Bhagwat of Owens Corning join Kara Csensich of FreeMarkets on bid day.

“When we looked into online technology for opportunities where we could compress costs, packaging procurement was quickly identified as a good candidate.” That’s John Gellatly’s summation of how Toledo-based Owens Corning entered the world of packaging procurement over the Internet. Gellatly is global sourcing technology leader at this building-materials supplier, whose insulating materials are hawked by the well-known “Pink Panther” cartoon character. OC is mighty impressed with its early forays into online reverse auctions. In fact, management aims to eliminate traditional competitive bidding practices company-wide by year-end. “The goal is to conduct auctions online for the whole $3.5 billion we spend in competitive bids,” says Gellatly.

Pallets and bulk bags are among the packaging components that OC has put up for bids over the Internet, and stretch film is being considered as well. Corrugated is another example.

Last August, through a Pittsburgh, PA, company called FreeMarkets (www.freemarkets.com), OC conducted a bidding event over the Internet for all corrugated packaging material used company-wide at 21 U.S. plants. When the cyber-dust had settled, OC had inked two-year contracts with 17 corrugated suppliers.

According to Gellatly, the move from traditional to online procurement netted a 10% savings in corrugated costs. Why? Because online bidding, says Gellatly, “lets the market determine what is a fair price for a product.” The fee paid to FreeMarkets by OC is a percentage of the dollar value of the contracts.

Developing the RFQ

So how does a reverse auction unfold? Step one in the process is the development of a bid specification so that a Request For Quote (RFQ) can be sent out. Allen Veeck, senior market maker at FreeMarkets, describes the process.

“We look at a list of companies our client is currently buying materials from and then broaden it considerably to form a large base of suppliers, some national, some regional, some very local. We share this list with our client, who can decide which suppliers should be kept and which ones deleted. We then invite the suppliers on the list to bid on the RFQ. It’s very detailed, including art requirements, payment terms and delivery requirements. If a buyer has proprietary information he doesn’t want out in the public domain, he can have suppliers sign a non-disclosure agreement before they’re even allowed to see the RFQ,” says Veeck.

Finally, it’s bid day, conducted over the Internet by invitation only. BidWare® software developed by FreeMarkets permits the buying team to identify each supplier as bids are posted, but bidders remain anonymous to one another. Essentially it unfolds just like any other auction, except for two things: The bidders are seated at far-flung computer terminals instead of in an auction hall, and the bids move progressively lower rather than higher.

On the bid day for corrugated last August at OC, each plant’s corrugated requirements represented a single lot. Suppliers were free to bid on one lot or all the lots, but each lot was bid separately.

“One advantage of this approach is that it lets suppliers with regional as opposed to national competencies make very competitive bids for lots in the regions where they are strong,” says Gellatly.

The bidding on OC’s first lot began at 11:00 a.m. and was scheduled to end at 11:30. The other lots followed, but these were scheduled to last just 10 minutes each. Veeck says bidding on the first lot is always kept open longer to make sure there are no problems getting everybody connected online.

If the lowest bid is submitted during the final minute of the time allotted, the bid automatically goes into “overtime” for one more minute. This ensures that if a supplier lobs in a low bid at the last second, all other suppliers have a reasonable period of time to match it. If a bid is submitted during an overtime, another overtime is added. So overtimes only cease when a one-minute period passes during which no additional bids are made.

Preliminary award scenario

Unlike traditional auctions, where the highest bid automatically wins, in a reverse auction there’s no guarantee that the lowest bid wins any business. The buyer looks at a variety of factors.

If an appealing bid comes from a supplier the buyer doesn’t know, the buying company can qualify that supplier. Often, quality-control engineers will visit the supplier for a quality audit.

Contracts are not awarded immediately at the close of an auction. In the case of OC’s corrugated bid last August, the RFQ stipulated that contracts would be awarded no later than Jan. 3, 2000.

A contract might typically be for three years, with one year guaranteed and a “meet or release” clause attached to the second or third year. After one year the buyer can choose to look for more competitive quotes. If the incumbent suppliers can’t meet the new quotes the buyer receives, those suppliers are released.

Gellatly says the online reverse auction has a number of advantages on top of the savings it generates. For starters, he likes the expanded supply base that comes with a reverse auction.

“Traditionally a buyer like us might not send out more than five RFQs,” says Gellatly. “But this way, it can be anywhere from 10 to 50 RFQs. These days, with new suppliers emerging from Asia and elsewhere, expanding your base of suppliers is more important than ever.

“The other thing is, you might identify a supplier who isn’t quite at the quality level you require, so you pass them over. But you can explain to them where they fell short, and then you can work with them so that on the next round of bids, you’ve brought another competitive supplier into the market who can meet your specs.”

Gellatly also values the accuracy of information inherent in the online bidding process.

“When you go online, your specifications have to be precise enough so that across the board the suppliers know they’re all bidding on exactly the same thing,” says Gellatly. “Could such a spec be developed by a buyer and faxed to a supply base as large as the one assembled by FreeMarkets? Sure. But it doesn’t happen because buyers don’t have the time to execute at that level. They’re too busy doing their part to keep the plant running from day to day. There’s just no time to reach out to all the potential suppliers that are out there. That’s one of the things FreeMarkets does: supplier outreach and communication. That’s a huge plus for us.”

Gellatly also says it’s one of the things that differentiates FreeMarkets from software being developed by companies like Wanut, CA-based Commerce One (www.commerceone.com) and Germany’s SAP (www.sap.com). “These software offerings also allow a buyer to get the market to bid against itself,” says Gellatly. “But it’s a self-initiated reverse auction, where the buyer develops his own RFQ, identifies his own suppliers, invites them to bid and executes the bid on bid day.” Gellatly is exploring such software applications to see if they might fit the needs of specific OC plants.

In the meantime, with 15 FreeMarket auctions under its belt, OC has enough experience with this new procurement model for management to appreciate its value. Purchasing agents, it should be noted, do not go away. They simply use a different tool.

“On the corrugated bid, eight of our people were involved,” says Gellatly. “Their expertise, their interaction back and forth with our individual plants, is what enabled FreeMarkets to develop an RFQ in the first place.

“Our goal is a trading desk approach, where we don’t have buyers anymore, but traders instead. We want to be as reactive and effective as stock-market traders so that our buyers begin treating their computers as if they were trading desks.”

The future?

Gellatly is convinced that this kind of online supply “channel management” will continue to evolve. An obvious bellwether is the auto industry, where supplier-managed inventory is currently a trend. Gellatly believes today’s information technologies will allow OC to emulate that system.

“Historically we’ve been more likely to estimate the packaging materials we might use and then place an order,” says Gellatly. “Down the road, there won’t be any ordering. Packaging suppliers will have our production schedule and will use it to supply us with what we need. We’ll pay them for boxes we use based on the number of products we ship out the back door.”

The Internet will allow such a system to develop, says Gellatly, because it makes information exchange instantaneous and seamless. But he emphasizes that it isn’t just the Internet that’s critical here. Also important is the Enterprise Resource Planning (ERP) software that ties together manufacturing, purchasing, finance, distribution, marketing, order-fulfillment and just about everything else that makes a company whole.

“For an integrated manufacturer like us, our ERP is still the system we build our world on,” says Gellatly. “The Internet can’t do what an ERP system does as far as running your business is concerned. The Internet is a good tool, and we’re going to try to take advantage of it. But we have no illusions that it will somehow replace ERP.”

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