Monthly Archives: June 2006

Decision Optimization Defined

Monday we defined a basic strategic sourcing process, indicated there were five critical process driven phases that can be greatly enhanced by software solutions, and indicated that we would spend one day discussing each of these technologies this week.  Monday we discussed spend management and spend analysis, Tuesday we discussed RFX, and yesterday we discussed auctions.  Today we are going to discuss my personal favorite: Decision Optimization.

There are a lot of definitions out there for decision optimization (often called bid optimization, award optimization, etc.) as it relates to strategic sourcing, but there are very few fully correct ones.  As far as I am concerned, decision optimization is the application of one or more rigorous analytical techniques to a well-defined model to generate the absolute best decision from a multitude of possible alternatives in a rigorous, repeatable, and provable fashion.

There are four key components to this definition.

(1) Rigorous Analytical Technique
Mathematically speaking, the analytical techniques used must be sound and complete.  In everyday English, the algorithms must always produce correct results and be capable of producing the optimal result.  In my book, heuristic, simulation, or evolutionary approaches, favored by some providers, that cannot always guarantee an optimal answer do not count as decision optimization, falling into the category of decision support.  However, hybrid approaches that use (mixed integer) linear programming would count since the heuristics merely guide the search in the most likely direction of the optimal solution, but do not prohibit the identification of the optimal solution even if it turns out to be an unexpected solution.

(2) Well Defined Model
The decision optimization component must not only insist on a well defined model but also allow you to completely and accurately represent your problem in the scenario definition.  Many optimization products on the market force you to over-simplify your problem to the point where the result is truly not the optimal result because you are missing key costs, constraints, or relationships.  For example, many early products (still) assume(d) that you are always shipping to one location or always buying from one location and do not allow true lane support.

(3) Best Decision
The optimizer must be capable of producing the absolute best decision given a sufficient amount of time.  As we mentioned yesterday, decision optimization is very hard and it is conceivable that an optimizer could take a considerable amount of run-time to find the optimal answer.  However, the implementation must support a configuration where the optimizer will not return until it proves the answer is optimal to whatever level of tolerance you specify, not just when it believes it has the right answer with high probability.

(4) Repeatable
The optimizer must produce the same solution or an equivalent solution each time it is run (for approximately the same amount of time). 

Of course, this means that only CombineNet and SCA Technologies appear to be offering true decision optimization solutions now that MindFlow is out of the picture, but even then I find their modeling capabilities lacking in certain areas with respect to strategic sourcing needs. (On the other hand, I do not believe that anyone comes close to CombineNet’s logistical modeling capabilities.)  However, a few other companies are starting to make strong showings, and I fully expect that within a year Iasta in particular might have one of the best offerings based on what I saw in their initial foray into what they call Bid Optimization (released last December) and what I’ve been reading in e-Sourcing Forum (www.esourcingforum.com) over the last few months.

When you consider the recent rampant inflation in energy and raw materials, the constrained capacity of many suppliers, the pressing need for improved top line and bottom results on the balance sheet, and the diminishing returns from traditional auctions at early adopters, decision optimization technology is only going to get more important. As I hinted at yesterday, I think the future leaders in the e-Sourcing space are going to be those that master decision optimization technology and its various applications.

Since this is one of those topics I plan on discussing a lot on this blog, I’ll keep this first entry short and conclude by saying that I firmly believe true decision optimization is the heart of a good strategic sourcing process and one of the best sources of value innovation that money can buy.

(Reverse) Auctions

Monday we defined a basic strategic sourcing process, indicated there were five critical process driven phases that can be greatly enhanced by software solutions, and indicated that we would spend one day discussing each of these technologies this week.  Monday we discussed spend management and spend analysis and yesterday we discussed RFX.  Today we are going to discuss reverse auctions.

Auctions are not new, with historical records indicating that auctions were held as far back as 500 BC in Babylon where women, sought after as brides, were commonly put up for sale.  They were also very common in the Roman empire.  Furthermore, English auctions, where a number of well-to-do ladies and gentlemen gathered in a parlor with their numbered paddles waiting to place bids on pre-determined lots have been occurring regularly for hundreds of years.

Furthermore, internet auctions are not new either – with Free Markets holding online auctions back in 1995.  However, online auctions have come a long way since the first market place offerings which closely mirrored their real world counterparts.

In addition to supporting a host of auction formats, such as sealed-bid, reserve price, fixed-price, Japanese, Brazilian, Vickrey, Dutch, and Yankee, auto-extend features such as last-bid time, and auto-termination features, such as minimum reserve price met, today’s auctions will allow you to analyze bids on more the just price.

Advanced auction platforms will allow you to define adjustments to take into account differences in a multitude of user-defined quality ratings such as waste, reliability, and on-time delivery and rank bids according to these adjusted quotes. This allows you to either award the business to the bidder with the overall best value relative to your defined adjustments and metrics or give suppliers better feedback if a decision optimization and final negotiation round is to follow.

However, even though auction technologies have been around for a decade, as with RFX, there is still room for innovation.  Specifically, I predict that the future leaders in auction technology will incorporate some form of decision optimization directly into the live event.  This will allow you to take best practices and total value management into account during the auction and guarantee that the identified awards not only respect all of your business rules but are optimal in that respect.  You will be able to define constraints, such as no more then 50% of the volume can come from any supplier and at least two suppliers must be selected to mitigate risk, and global value modifiers, such as a non-incumbent supplier comes with a one-time fixed supplier setup charge of $10,000 (amortized over the entire buy from the supplier), and be confident that the award takes these rules and costs into effect.

But don’t expect too many providers to have these capabilities in the near future.  As we will discuss at a later time, optimization is hard – very hard, and even today only a handful of vendors actually have real decision optimization capability in their non-real-time analytics offerings.  With the exception of CombineNet, which is attempting to claim ownership of the sourcing and logistics space (especially now that MindFlow, like many of its other former competitors, is gone), I know of only one other provider of e-Sourcing technologies working toward this capability.  I know of a few that have tried and failed and a few more that decided the potential reward was not worth the perceived risk.  However, if you have the skills to pull it off, when you consider how valuable this will be to a sourcing organization with a large spend and limited resources who could bring even more spend under management while automatically optimizing non-critical direct materials during an automated auction, I think the cost, effort, and overall reward is worth the risk.

RFX Defined

Yesterday we defined a basic strategic sourcing process, indicated there were five critical process-driven phases that may be greatly enhanced by software solutions, and indicated that we would spend one theday discussing each of these phases this week.  Yesterday we discussed Spend Management and Spend Analysis.  Today we are going to discuss the RFX process.

RFX, one of the most generic and overloaded acronyms in the sourcing marketplace today, usually stands for Request For Information (RFI), Request For Proposal (RFP), and / or Request For Quote (RFQ).

RFIs are generally used to identify new potential suppliers or determine if current suppliers are willing or able to supply a new product or service, RFPs are generally issued to interested suppliers who have been pre-qualified as a potential source of a product or service for additional details on the product or service, their processes, and value, and RFQs are generally issued to collect (initial) bids once a pool of qualified suppliers has been determined.

RFX technologies come with many benefits above and beyond simple process automation and sourcing cycle time reductions.  Most solutions will have sophisticated workflow management capabilities, a centralized repository for all project information, best practice templates, survey capabilities, and standardized processes you can base your sourcing process on.

Furthermore, the more innovative technologies will come with supplier portals that will engage your suppliers in the selection process.  Not only will they be able to enter their information directly, but they will be able to offer suggestions and collaborate with you on process improvements and innovative ideas to streamline new product innovation.

When it comes to innovation, RFX is now one of the least innovative technologies on the market, but still one of the most important.  The more time you have to focus on strategic planning versus tactical operations, the more likely you are to spot innovative solutions that will save you bushels of money and increase the overall value of your awards.  RFX was one of the big breakthroughs in strategic sourcing automation – and so was the further introduction of collaborative supplier portals.  The next major innovation will be the integration of business intelligence that will let you discern supplier viability and quality before your first interaction, so you do not waste time screening suppliers already known to be inappropriate to your line of business.

There are a large number of RFX suppliers on the marketplace today, ranging from standalone solutions to tightly integrated solutions like those offered by Ariba, Emptoris, and Iasta.  See the growing company list at SourcingInnovation.com (http://www.sourcinginnovation.com/resources/companies.htm) for some examples and starting points.

Strategic Sourcing and Spend Analysis

Since this blog is about sourcing innovation, we are going to start off by defining a basic strategic sourcing process that could proceed as follows:

( 1) Spend Analysis
( 2) Spend Strategy
( 3) Data Collection
( 4) RFI
( 5) Supplier Qualification
( 6) RFP/RFQ
( 7) Auction and/or Negotiation
( 8) Decision Optimization
( 9) Award and Contract
(10) Contract Management
(11) Compliance Management
(12) Spend Management

A careful analysis of this process will produce five critical process-driven phases that can be greatly enhanced by software solutions:

(12&1) Spend Management and Spend Analysis
(4&6)  RFX
(7)    Auction
(8)    Decision Optimization
(10)   Compliance Management

It’s true that supplier management and compliance management can also be greatly enhanced by software, but good RFX and Auction tools will build in basic supplier management capabilities and good spend management and contract management tools will build in basic compliance management tools and these five solutions together will effectively cover a basic strategic sourcing cycle.

Each day this week we are going to focus on one of these processes, starting with Spend Analysis and Spend Management today. 

Spend Analysis is the process of aggregating, classifying, and leveraging spend data for the purpose of cost reduction, performance improvement, and greater compliance.  It is part of the spend management process, which includes the analysis, award, and tracking of corporate spend, and the first and last step of your strategic sourcing process. 

Successful spend analysis relies on three critical factors: access, resources, and powerful analytics.  First of all, you need access to all of the relevant data – this is where good spend management practices that ensure all of your purchases get classified and entered into your core ERP or financial systems comes into play.  Then you need the resources, which includes financial capital as well as human capital, to do it.  Finally, you need a sophisticated solution that can slice and dice the data by supplier, commodity, period, contract, geographic location, or any other meaningful combination thereof.  It should also have the ability to detect spending patterns and variations. 

This is where technology comes into play.  Good solutions, like the solution provided by Biq, can slice, dice, and drill down on multiple dimensions simultaneously, support custom defined filters, interface with Excel, and process data sets of over 100 million transactions.

Spend analysis is important as it is the first step in the identification of possible savings opportunities.  Likewise, spend management is important because it is the only way to insure you capture the savings you negotiate and one of the best ways to insure compliance with relevant regulations.

Furthermore, innovative spend analysis built on advanced analytics and business intelligence can identify savings opportunities you would most likely miss.  Biq’s offering is one of the most innovative I’ve seen.  Most solutions need to be tightly integrated into your existing systems to work.  Biq’s solution can slurp your data in over the internet, slice it and dice it, and spit back meaningful aggregated summaries in any view you desire.

For more information on spend analysis / spend management solutions and the benefits they can bring to your business, I recommend starting with Aberdeen Group which has been producing great research for a number of years on this subject.  For example, you could start with the executive white paper “Spend Data Management: Unlocking the Value Across the Extended Enterprise” in October 2003, “Best Practices in Spending Analysis: Cure for a Corporate Epidemic” in September 2004, “Spend Compliance Management: Implementing and Sustaining Supply Savings” in December 2004, and Spend Intelligence: the Next Generation of Spend Analysis” in May, 2006.

As always, comments, criticisms, and creative insights can always be emailed directly to thedoctor<at>sourcinginnovation<dot>com.

The Operations Research Process

Operations Research is “the use of mathematical models, statistics and algorithms to aid in decision-making. It is most often used to analyze complex real-world systems, typically with the goal of improving or optimizing performance. It is one form of applied mathematics.” (Wikipedia)

The quest for improvement has been a continual one and operations research has been one of the areas that has been traditionally focused on improving operations across the company, particularly in production, operation, scheduling and physical systems.  As such, there is a wide body of knowledge upon which can draw to improve procurement and sourcing operations when properly applied and modified.  Even Six Sigma’s (Strategic Sourcing) toolbox makes extensive use of techniques and processes that have their foundations in operations research.

But today we are going to talk about the basic process.  There are many good overviews of operations research on the internet, but one of the best sites I have found is the “Operations Research Models and Methods” site(at http://www.me.utexas.edu/~jensen/ORMM/) maintained by Dr. Paul Jensen at the University of Texas.  On the site, he overviews the basic Operations Research Process, which, simply put, is:

(1) Recognize the Problem
(2) Formulate the Problem
(3) Construct a Model
(4) Find a Solution
(5) Define the Process
(6) Implement the Solution
(7) Repeat and Refine

Essentially, the operations research process is your basic problem solving process, like the introductory problem solving process you might encounter if you were studying (cognitive) psychology, the art of mathematics, or (classical) engineering.  Furthermore, it neatly captures the key steps you will have to work through as you attempt to improve and evolutionize your sourcing process.

(1) You first have to define what your primary problem is and what your key goals are.  Are you spending too much money?  If so, where.  Are you spending too much time on the process?  If so, why?  Etc.

(2) Then you have to formulate and frame the key problem.  For example, you believe you’re spending too much on your high volume direct materials or you are spending too much time in your data collection process.

(3) Once you have precisely formulated the problem to solve, you need to model what you believe the solution should look like.  Many individuals and organizations skip this step and go straight to the solution identification step.  However, if you don’t know what the solution should look like, you risk selecting the wrong solution.  For example, if you believe you are spending too much, you might select a (reverse) e-Auction platform.  However, if current raw commodity prices are high, this might not save you any money.  Conversely, if you instead sought out a strategic supplier who would work with you to improve processes and component reusability, you might save a bundle.  Always understand what the solution should look like and what it should accomplish before selecting a solution.

(4) Often this step will be accomplished in practice by selecting a readily available technology, methodology, process, or model from the public domain or commercial marketplace.  Don’t try to reinvent the wheel, chances are your problem is not unique and someone else has already solved it for you.  For example, the inventor and followers of TRIZ (an innovative problem solving methodology that we will discuss at a later time) have collectively reviewed over 2 million patents and discovered that less then 4% contained a new concept and only 1% contained a revolutionary discovery.  The rest were merely improvements on existing solutions and processes.  In other words, there is at least a 95% chance that a solution to your problem already exists, and at least a 99% chance that a solution to a similar problem exists that can be adapted to your problem.

(5) Once you have a selected a solution – be it a technology or a new methodology, you need to define how it is going to be integrated into your current operational processes.  This step is easy to overlook, but if the introduction of a new process or technology disrupts your daily operations, you will not realize the full benefits.

(6) Once you have identified the right solution and determined how to successfully integrate it into your operational processes, you need to implement it and reap the rewards.

(7) Finally, you need to monitor the process, measure the improvements, and look for ways to continually improve it.  Innovation is a continual activity.  There’s always room for improvement, but if you do not look for it, I guarantee you will not find it.

We’ll discuss other problem solving methodologies in the future, including some from psychology, innovation, and the Six Sigma toolbox, but first we are going to review the core executable parts of the sourcing cycle where technology solutions can have the greatest impacts to set the stage for what is to come.

Comments? Criticisms? Creative Insights?  Email me at thedoctor<at>sourcinginnovation<dot>com.