Finding Net profits

B2B e-commerce is being hailed as the next great opportunity to expand the influence of IT people.

Terms such as value-chain streamlining and disintermediation of workflow processes have crept into the vocabulary of aspiring IT job candidates, as corporate executives push their IT shops to abandon newly installed client/servers or half-completed enterprise systems for another round of huge investments.

As the frenzy escalates to junk old systems or transform software into Internet-based e-commerce applications, who will benefit from an enormous opportunity to cut previously untouchable information costs now embedded within the existing value chain? Costs will be cut when the dynamics of purchasing decisions shift from supplier-to-supplier bargaining to centralised management of the entire procurement process through e-commerce applications that link the production systems of millions of suppliers without intervention by brokers, dealers, wholesalers and promotion agents.

Nevertheless, whenever predictions of huge savings call for a CFO to write a multimillion-dollar cheque, IT executives may boost their standing by offering clues for where the profits may end up after the business-to-business e-commerce revolution settles down in the near future.

It's difficult to find authoritative estimates that quantify the cost savings that e-commerce generates. I was intrigued to read [Fortune, March 20] that Delphi Automotive, Owens Corning and United Technologies saved $US60 million, $US9 million and $US32 million, respectively, by purchasing components, packaging materials and circuit boards on the Internet. Such savings - ranging from 9 per cent to 43 per cent - are difficult to conceive if one considers that suppliers of industrial goods already suffer from very slim profit margins. The huge savings must come from something else!

An examination

Looking for clues, I examined the financial databases of more than 10,000 US industrial suppliers and analysed their cost structures. Since suppliers of finished goods, in turn, depend on other suppliers, I was able to construct a simplified financial model of the median costs of the supply pipeline. It offers an explanation of where the money is spent.

At each step in the chain, each supplier spends money for materials, labour and logistics. Then, each succeeding supplier adds overhead (information costs) then tags on profit. Therefore, for example, "other suppliers" contribute 15 per cent to the value chain and "secondary suppliers" contribute the difference between 33 per cent and 15 per cent, until it all adds up to 100 per cent.

At each stage, a company adds information expenses for sales, marketing, administration, research and development and IT. These costs, averaging 15.9 per cent, are included in the manufacturer's sales price, thus taking a big chunk out of the manufacturer's value added of 44 per cent of revenue (the difference between its 100 per cent and the 56 per cent paid to "prime suppliers").

The suppliers also contribute their shares of information costs to a product's final sales price. All told, the information costs at each of the four stages add up to 34.5 per cent of a product's price, which sticks out as the largest cost-cutting target for boosting profits. What does this mean for IT managers ? It's imperative to analyse the total costs of delivering information within the entire value chain before launching an e-commerce project. Remember that whomever has the power to extract value-chain savings and add to profits will see the greatest benefits.

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