steve keifer herding geese chapter 1

T h e S T o r y o f T h e I n f o r m aT I o n S u p p ly C h a I n

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Chapter 1

The Information Supply Chain

If you were to open up an iPad, iPhone or iPod you might be surprised to learn that many of the components inside of these magical and revolution-ary devices are actually not made by Apple. While Apple enjoys most of the credit for its blockbuster products, a great deal of the innovation occurs in other parts of the supply chain. Consider the iPad2. Within the tablet there is an A5 microprocessor that is designed by Apple, but manufactured on its behalf by Samsung. The 16GB or 32GB of memory available with the device is also supplied by Samsung. Apple’s dependency on Samsung is interesting given that it is one of the key competitors in the tablet market. Another chip, manu-factured by Broadcom, provides the Wi-Fi, Bluetooth and FM tuner functions. The controller for the touchscreen display is also supplied by Broadcom. STMi-croelectronics provides gizmos such as the accelerometer and gyroscopes that enable you to control the machine by tilting it in different directions.1

Apple is not the only company to source components from outside suppliers. If you review a teardown of a Nikon digital camera, a Barnes & No-ble e-book reader, a RIM Blackberry or a Sony HDTV you would find that most of the components are sourced from third parties as well.

Not only do high tech manufacturers source the component parts for devices from third parties, but they are increasingly dependent upon outside companies to design, build, ship, sell and service their products. The term Original Equipment Manufacturer (OEM) is utilized to describe companies, such as Dell, IBM, HP, Apple, Motorola, RIM, Nintendo, Sony, Microsoft, Cis-co and Alcatel Lucent, whose brand names are on high tech products. How-ever, in today’s high tech supply chain some of these OEMs never touch the

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products sold under their brand name. There are specialized service providers that will design, manufacture, transport, distribute and service products on an outsourced basis.

The high tech industry was not always so fragmented. When the first mainframes were introduced back in the 1960s a single company performed all the manufacturing and servicing of the computers. High tech manufactur-ers, such as IBM, GE and Honeywell, not only assembled the mainframe, but designed the memory, storage (DASD) and processors inside. The operating system, database and even some applications were developed by the same ven-dor who manufactured the hardware. Maintenance and repair activities were typically performed by the manufacturer as well. If the mainframe broke or needed an upgrade, the original hardware manufacturer provided the repair and service.

Contrast the mainframe model to the complex, multi-tiered value chain in today’s computer industry. I am writing this book on an “IBM Think-Pad.” However, while the logo on my laptop says IBM, the manufacturer of the machine is actually a Chinese company—Lenovo—which only contributes a small percentage of the parts in my laptop. The components inside the laptop are sourced from third-party suppliers. Kingston supplies the memory. Seagate manufactured the hard drive. Intel designed the microprocessor. Also note-worthy is the fact that Lenovo does not typically sell the machine directly to its customers. My laptop was purchased through our company’s preferred distrib-utor—CDW. The software on the machine is made by another group of spe-cialized companies. Microsoft publishes the Windows operating system and Office application suite. Other software vendors, such as Adobe, Symantec and Apple, provide additional applications for document viewing, desktop security and digital music. And when my laptop breaks, who do I call? Not Lenovo, but a third party, such as a high tech distributor, for warranty support and repair.

My point is that the computer industry has migrated from a vertically integrated model to a highly specialized, heavily outsourced model. Orches-trating today’s highly outsourced, globally distributed high tech supply chains can be extremely complex. The activities of designers (ODMs), contract manu-facturers, 3PLs, distributors and aftermarket service providers must all be syn-chronized to ensure the right products are in the right places at the right times.


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A critical factor for success is the ability to exchange real-time information with a community of business partners in the supply chain.

OEMs, such as Apple, Nikon and Lenovo, need visibility into the avail-able supply of parts, such as processors, memory and storage as well as the raw materials used to make these components, such as silicon, tin and tungsten. Is there a shortage of supply expected in the near future? If so, then the OEM may not be able to manufacture its products in sufficient quantities to meet customer demand.

Specialized “contract manufacturers” will buy the parts, assemble the devices and perform quality testing on behalf of an OEM. Contract manufac-turers act effectively as an outsourced factory. Examples of contract manufac-turers include Foxconn (Hon Hai), Flextronics and Celestica. OEMs also need visibility into the “work in progress” activities of contract manufacturers. How many units of each SKU are being produced? When will these products be as-sembled and shipped? Are there any expected delays arising due to problems with workers or the supply of parts?

Specialized and Outsourced

This type of highly outsourced model, in which OEMs outsource much of the components to suppliers, is growing more common in all discrete manufacturing sectors. Boeing outsourced 65% of the design and manufactur-ing for the recently released 787 Dreamliner. Boeing enlisted the support of 100 different subcontractors and parts suppliers to build the plane. Rolls Royce and GE Aircraft designed the engines. Honeywell and Rockwell Collins pro-vided flight guidance and control. There were suppliers located in Korea and Japan; Russia and India; France, Germany, Italy, UK and Australia.

The manufacturing industry is not the only sector that has become highly specialized with extensive outsourcing. The structure of the health care industry has developed in a similar manner. Doctors, for example, have always been specialized. If you are diagnosed with a chronic condition, such as diabe-tes, cancer or heart disease, you will not only work with a primary care physi-cian, but also with a series of specialists in different facilities. The entire health care system today depends upon referrals.


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Not only are the doctors specialized, but the health care facilities have different capabilities as well. For example, most doctors’ offices lack the sophis-ticated equipment necessary to perform a blood test, MRI or X-ray on-site. Instead, they outsource these functions to specialized lab services and imaging companies.

The financial services industry is extremely specialized as well. Firms that were traditionally banks designed to offer savings and loans, now sell a broader portfolio of insurance, investment and retirement services. Most banks did not build their own insurance and investment practices, but instead resell the services of other financial institutions. Many of the life insurance, retirement and college savings plans offered by banks are actually delivered by third parties.

The mortgage industry has become highly specialized as well. The company from which you purchase your original mortgage likely will pack-age your loan with hundreds of others through a process called securitization. These securitized bundles of mortgages are then sold to investors around the world who then become the recipients of your monthly principal and interest payments. As we learned in the 2008 financial crisis, specialization and out-sourcing is not always a good thing as it can lead to irresponsible behavior on Wall Street.

Companies in every business sector are becoming more and more specialized as they outsource more and more of their business functions. Cus-tomer service is being outsourced to offshore firms, such as Wipro and TCS. IT functions are being outsourced to systems integrators, such as Accenture and IBM. Public relations and marketing are outsourced to large agencies, such as Omnicom and Interpublic. Strategic planning is outsourced to management consultants, such as McKinsey and Boston Consulting Group. Tax and ac-counting functions are being outsourced to Big 4 firms, such as Deloitte and KPMG. It is hard to find an example of an industry today that has not become highly specialized and highly dependent upon business partners for success.

The information Supply Chain

For companies to successfully outsource such a broad range of func-tions so extensively, they must have access to real-time information about the


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activities of their business partners. Unfortunately, however, this “information supply chain” between business partners is not always as streamlined or effi-cient as it should be. Less than 50% of all interactions between business part-ners are performed electronically. The inefficiencies resulting from this lack of automation create a tremendous drag on productivity throughout the world. In fact, many people have referred to the commercial activities that occur be-tween companies—Business-to-Business (B2B)—as the most inefficient part of the global economy. While data flows at the speed of light between comput-ers within the four walls of a corporation, the information flowing between the firewalls of business partners often moves at a snail’s pace.

Inefficiencies exist in the financial services market. Hedge funds de-ploy sophisticated computer algorithms to churn through terabytes of data in order to recommend the best investment strategies for portfolio growth. But when a trade for $500,000 worth of bonds needs to be placed, the hedge fund manager picks up the phone and calls a stock broker that hand keys the order into a computer screen at his desk. After the trade is executed, the broker calls the hedge fund manager back to provide a confirmation. The follow-up call ensures that the hedge fund has an up-to-date view of its position for the three days before the paper trade confirmation arrives in the mail.

The health care system experiences inefficiencies as well. A 45-year old woman might undergo $50,000 of medical procedures and diagnostics in the process of treating a chronic disease. Specialized tests are performed using MRI machines. Expensive consultations are received from industry-leading specialists. Minor outpatient surgeries are undertaken at various hospitals. However, the results of these medical procedures are printed out onto pieces of paper, and then stored in filing cabinets at different physicians’ offices. When a new doctor needs to review the patient’s medical records, he must phone all of the different practices to request that copies of notes, lab results and radiology images be faxed or couriered to his office.

Consumer products companies spend billions of dollars on research and development each year in hopes of inventing the next big energy drink or pain relief medication. When these new potential blockbuster products are ready for sale, the manufacturers blitz television screens with millions of dol-lars of advertisements. But the availability of the products on the shelves of


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stores is typically delayed two to four weeks, waiting for the new product to be properly “set up” in the retailer’s IT systems. Someone in the retailer’s mer-chandising department must hand-key the new product’s size, weight, descrip-tion and price into various systems before it can be sold.

The commercial sector has successfully generated trillions of dollars in productivity gains over the past few decades by deploying information tech-nology within the four walls of their company. However, efficiency levels drop off a cliff when it comes to B2B processes. Much of the information relayed be-tween business partners is exchanged using people and paper-intensive tech-niques such as “snail mail,” fax machines, phone calls and documents attached to emails.

introducing B2B e-Commerce

You may be wondering why these widespread inefficiencies in B2B communication exist? Are there not technologies that could be used to auto-mate the exchange of information between business partners that buy or sell from one another? The answer is “Yes,” there is an entire category of technology called B2B e-commerce that is specifically designed to facilitate regular com-munications of data between business partners.

When most people hear the term “e-commerce” they envision visit-ing the Amazon.com website to buy clothing, books or electronics online for home delivery. We have all become accustomed to paying bills via online bank-ing sites; listing products on Internet auction sites; and buying stocks via elec-tronic trading portals. These are all examples of Business-to-Consumer (B2C) e-commerce technologies. But consumers are not the only ones using the In-ternet for commerce. Many businesses also have the need to buy merchandise, pay bills and trade stocks electronically. These electronic interactions between businesses are what we refer to as B2B e-commerce.

The first B2B e-commerce technology, Electronic Data Interchange (EDI), was introduced back in the 1960s. EDI continues to be used extensively today in the retail, manufacturing, transportation and health care industries. The company I work for—GXS—is one of the leading providers of EDI and B2B e-commerce services with almost $500 million in annual revenues. Tech-nically, EDI refers to a specific standard for exchanging data between compa-


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nies, but the term is also used more broadly to describe the entire category of B2B e-commerce technologies.

I like to define B2B e-commerce as a set of technologies that help to facilitate the real-time transfer of information, money, goods and services. However, I think the best way to understand B2B e-commerce is through real-world examples.

Perhaps, the easiest examples to understand are the B2B “e-procure-ment” applications, which mimic the online shopping experience you are ac-customed to, but for business buyers rather than consumers. Large Global 500 companies and government agencies can use e-procurement sites to purchase everything from raw materials for their manufacturing plants to toner refills for their office printers. B2B e-commerce technologies can be used not only to purchase goods and services, but to manage entire supply chains. American, European and Japanese firms can utilize B2B e-commerce networks to track goods manufactured in China, Malaysia and Vietnam as they travel via con-tainer ships to their destinations around the globe.

The entire health care system depends upon B2B technologies. When you arrive at a doctor’s office, EDI technology can be used to ask your insur-ance company about your eligibility for medical care. If you visit a specialist, “Electronic Health Records” technology can be used to share copies of your medical history, recent lab tests and X-ray images. The electronic records are typically shared across specialized “Health Information Exchanges.” If you are issued a prescription, your doctor’s office may send it electronically to the local pharmacy to fill. Once you have left the doctor’s office, another series of EDI messages can be exchanged with the insurance company to pay for the care you received. These electronic claims and payment transactions can be exchanged over specialized health care “clearinghouses.”

Banks are big users of B2B e-commerce technology also. Most transfers of money that occur between banks around the world are facilitated through specialized B2B e-commerce networks. Another common use case is in the stock market. Professional money managers that buy and sell lots of stocks on behalf of mutual funds, endowments and pension funds can use specialized “FIX networks” to submit electronic orders to their stock brokers. The brokers execute the trades, and then work with the money manager and their bank to


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clear and settle the trades. At every step of the lifecycle of a stock trade, B2B e-commerce technology can be used.

In some cases there are no humans involved at all. Machines commu-nicating with other machines using B2B e-commerce technologies are assum-ing responsibility for entire business processes. For example, hedge funds are utilizing “algorithmic trading programs” to execute stock trades. These com-puter programs automatically monitor the stock market trends, and then de-cide when to buy or sell stocks. The trade instructions are passed electronically via FIX networks to brokers for execution. Next, the details of the trade are collected, matched and forwarded for clearing and settlement. In this “straight through processing model” no humans are involved. The stock trading is or-chestrated completely by computers leveraging B2B e-commerce technologies.

Stock trading is just one example of a business process occurring in what economist W. Brian Arthur describes as the “Second Economy.” He is referring to business processes that once took place among human beings that are now being executed electronically. Arthur predicts that in about two de-cades the digital economy will reach the same size as the physical economy.

investments in B2B e-Commerce

But we still have quite a bit of work to do before we can realize Arthur’s vision of the fully digital Second Economy. One of the key obstacles which must be overcome is the inability of different businesses to exchange informa-tion with one another. As we learned from the examples earlier in the chapter, there are numerous cases in which B2B e-commerce technologies are not be-ing used to effectively streamline communications between business partners.

You may be wondering why not. One of the key challenges relates to small businesses which by numbers represent the majority of companies in the world. In industries such as health care, retail and manufacturing, small busi-nesses outnumber large ones by a factor of 1000-to-1. These small businesses lack the budget, resources and expertise to implement sophisticated B2B e-commerce applications.

Imagine a four-person dentist office that runs its entire business on the PC located at the check-in desk. One day the dentist office gets an email from an insurance company requesting that it submit all claims going forward


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using the “HIPAA EDI 837-D transaction set.” Don’t know what the 837-D is? Neither does the dentist office.

Imagine a three-man hedge fund startup in Connecticut that doesn’t have an administrative assistant to answer the phones or a permanent office space to work out of. One day the hedge fund gets an email from its stock broker requesting that it start sending trades electronically over the Sungard FIX network.

Imagine a 50-person toy manufacturer in China that exports its prod-ucts to “big-box” stores in the US. One day the toy maker gets an email from its largest retail customer in the US requesting that it place RFID tags on all of its shipments and must send “856 Advanced Shipment Notices” when goods leave the factory. The retail customer also stipulates that penalties will begin to be assessed within 60 days if the supplier fails to comply with the new shipping guidelines.

Hundreds of companies have tried to break down the barriers to electronic commerce with innovative and disruptive technologies. During the dot-com era, venture capitalists invested billions in startups to improve B2B interactions in the health care, financial services, manufacturing and retail sec-tors. In the past 20 years, over 60% of the Fortune 50 has made direct invest-ments in companies that provide B2B e-commerce technologies. Big industrial manufacturing companies, such as GM, Ford, HP, Boeing, United Technolo-gies and Dow Chemical, have created joint ventures in the B2B e-commerce sector. Each of the major consumer products companies, including Procter & Gamble, Johnson & Johnson, PepsiCo, Kraft Foods and Coca-Cola, have made equity investments in B2B startups. The big banks, like JPMorgan Chase, Citi-group and Bank of America, each own stakes in multiple B2B e-commerce ventures. Even health care companies, such as McKesson, Cardinal Health, Medco, CVS Caremark and Express Scripts, have invested millions in these technologies. But most of these strategic investments in B2B e-commerce have met with only modest levels of success.

Convincing a few thousand of your small business partners to adopt a new B2B e-commerce technology can be a bit like herding cats—at least that is most people’s view of the situation. But with the right approach, it is possible to achieve high levels of participation in B2B e-commerce initiatives. So perhaps


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the idea of herding geese is a better analogy. Herding geese is much easier than herding cats, that is, if you have a scientific approach.

get the Flock Out of Here

Lack of technology proficiency by small businesses is one of the key in-hibitors to further B2B e-commerce adoption. But there are just as many chal-lenges caused by the hundreds of different technology vendors that develop and sell B2B e-commerce solutions. Many of these vendors generate millions of dol-lars in revenues, but take no accountability for the success of B2B e-commerce ventures. For example, software companies sell big companies the “infrastruc-ture” necessary to build a world-class B2B e-commerce platform and then walk away before the hard work of implementation and onboarding begins.

Another set of challenges is created by the “standards organizations” that operate in various vertical industries. There are hundreds of different B2B standards that companies can use to exchange information electronically with business partners. In fact, many people say that the best thing about B2B e-commerce standards is that there are so many to choose from. The standards industry has become a big business in B2B with hundreds of “industry associa-tions” introducing new e-commerce frameworks every year. Although these associations operate as non-profits the competitive dynamics between them rival even some of the most cut throat activities of for-profit corporations.

There are also some unusual technology dynamics in B2B e-com-merce that would qualify for a chapter in the next Freakonomics book. In most parts of the consumer and business world, new technologies are adopted over a period of a few years, if not months. But new B2B e-commerce technolo-gies often take decades to be adopted. For example, when consumer products companies place labels on multi-million dollar shipments of products destinedfor retail stores, they do not use the RFID technology that recently came out ofthe labs at MIT. Instead, they use barcode labels that were invented back in the 1950s to track railroad cars. When a high tech company, such as Apple, Sam-sung, or RIM, places an order for chips to put in its next batch of smartphones, they could use the “RosettaNet” e-commerce standards developed in the late 1990s. But these cutting-edge, high tech innovators are three times more likely to send their supplier an order using the EDI technology developed for main-


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frame computers back in the 1960s. When I share these stories with colleagues in the IT industry they stare at me in disbelief almost as if to say “Get the flock out of here.”

Herding Geese is the story of the numerous attempts by venture capi-talists, standards organizations, government entities and Fortune 500 compa-nies to create an information supply chain that connects all the business part-ners within an industry electronically. Throughout the book we will examine attempts to implement B2B e-commerce programs in five industry segments —manufacturing, retail, government, health care and financial services. I think you will be surprised to learn not only of the potential for B2B e-commerce in each of these sectors to enable individual corporations to be more successful, but to solve some of society’s greatest challenges. B2B e-commerce is playing a critical role with improving homeland security, reducing sovereign debt, sim-plifying international trade and reforming the US health care system.

I also think you will be surprised to learn how many of these B2B pro-grams have failed to achieve the desired adoption levels and business outcomes despite the level of enthusiasm and investment applied. In fact, at times some of these programs have appeared more like a wild goose chase than an orga-nized industry-wide initiative. There are unique challenges that exist in B2B e-commerce that are not present in any other sector of the Information Technol-ogy industry. Connecting the business applications of two different companies is ten times more challenging than connecting two applications within the four walls of a single organization.

STEVE KEIFER HE

RD

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GE

ESE

Welcome to the world of B2B e-commerce—the little-known sibling of the very cool and popular B2C e-commerce. B2B e-commerce technology is the plumbing that connects networks of business partners together electronically. Hospitals use it to process health care claims. Institutional investors use it to place stock trades. Manufacturers use it to purchase raw materials. Retailers use it to manage inventory.

I know what you are thinking—Ugh! What could be more boring? But, the world of B2B e-commerce is anything but boring. In fact, B2B is home to an unusual set of dynamics that would qualify for the next Freakonomics book. This is a sector where cutthroat competitors from GM and Ford to PepsiCo and Coca-Cola unite in joint ventures to solve common business problems. This is a sector in which 35 of the 50 largest US companies including Chrysler, Boeing, Kraft, Dow and Chase have either funded technology startups or acquired them in hopes of obtaining competitive advantage.This is a sector where technologies developed in 1965 still dominatenewer substitutes introduced in 2005. This is a sector in which the non-profit “standards organizations” compete more ferociously thanthe for-profit technology vendors.

Most importantly, B2B e-commerce is a sector which is playing a critical role in solving some of society's greatest problems. B2B is at the center of health care reform, homeland security and manufacturing competitiveness in the US. And it is a key requirement to enabling growth in emerging markets in Asia and harmonizing the European Union.

steve keifer herding geese chapter 1

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