The Enterprise-wide e-Sourcing Market: Going to the Horse Races

 By Julie Murphree

Like the horse races on a balmy day, the January announcement of the Ariba, FreeMarkets merger excitedly shot e-sourcing consolidation out the gate at breakneck speed. Beyond market consolidation, the pace of activity in the enterprise-wide e-sourcing space is clipping along well due to several interesting issues.

The previous economic crisis, globalization, and advances in Internet-based sourcing make strategic sourcing a critical business initiative for 2004, according to the leading IT research firms. Additionally, a recent Wall Street Journal special section entitled "Adventures in Cost Cutting" highlights how important total cost management currently is to corporate America . In fact, some contend that minus layoffs, only healthy strategic sourcing practices successfully lead organizations toward better management of their costs.

Certainly leading-edge organizations know the formula: Correctly place core strategic sourcing steps, followed by plugging in robust technology. The result means effective strategic e-sourcing will dramatically reduce transaction costs, increase market transparency, and instill discipline and consistency into the sourcing process.

“The past three years have highlighted the importance of supply management to overall business success,” says Tim Minahan, senior research analyst with Boston-based Aberdeen Group. “Unable to grow revenues, companies were forced to develop strategies to rein in costs and to maintain profitability. Increased globalization also required companies to develop strategies to leverage new markets – without impacting service levels or increasing risks. Leading enterprises have found that supply management in general, and strategic sourcing in particular, offers the largest and most direct opportunity to achieve these goals.

Continued Growth in the Market

Last year Boston-based AMR Research estimated the sourcing software and services market to be approximately $1.6 billion for 2002 and would reach $1.9 billion by the end of 2003.

They were pretty close to the mark. The sourcing software and services market for 2003 ended up at $1.86 billion and they project this market to round off at $2 billion by the end of this year, representing a compound annual growth rate (CAGR) of 7 percent. This is consistent with AMR’s prediction that the e-sourcing market will grow an average of 5 percent a year through 2008.

“This is a healthy growth rate for e-sourcing,” says Pierre Mitchell, senior analyst with AMR Research. “And, again, the ERP players will be driving a lot of this growth.”

He highlights the ERP position in the market by pointing out that SAP took the number one spot in e-sourcing license revenue from Ariba last year. SAP’s 2003 license revenue was $250 million compared to Ariba’s $100 million.

Boston-based Aberdeen Group last year revised its growth estimates in the strategic e-souricng market. In it’s report, “Making e-Sourcing Strategic,” the research firm had said e-sourcing would outpace most other enterprise business application providers.

“Specifically, revenues for independent software vendors [ISVs] providing e-sourcing technologies and services will grow from $820 million in 2001 to over $3.1 billion in 2005, representing a CAGR of 39.8 percent,” the study states.

Apparently the market is proving their case. “This should be no surprise to anyone,” says Tim Minahan, senior research analyst with Aberdeen . “Huge opportunity continues to exist in this market. By our estimates, U.S. businesses channeled $270 billion of their spending through e-sourcing solutions in 2002. By 2005 the figure should be $738 billion.”

The lion’s share of e-procurement and e-sourcing revenue still comes from application software licenses (37 percent) and implementation costs (38 percent), according to AMR’s latest research. And application hosting/subscription revenue has gone from just 6 percent in 2001 to 10 percent in 2003.

AMR Research also says e-sourcing and contract management applications’ revenue growth will continue to out-strip the other application areas of buy side content management, indirect procurement and direct procurement. 2003-2008 CAGR for contract management is 20 percent and e-sourcing is 15 percent. None of the 3 other application areas even exceed 2 percent CAGR, with direct procurement actually showing a minus 2 percent.

The Ariba, FreeMarkets Merger

Of course, the big news about e-procurement and e-sourcing players was the Ariba, FreeMarkets merger this last January. Though license revenue was off the first quarter of ’04 (not unusual for a newly merged organization), Ariba’s acquisition of FreeMarkets bolsters its position in the market for online business software services.

“In the spend management space,” says Aberdeen ’s Minahan, “the $493 million merger between Ariba and FreeMarkets is the equivalent of combining the New York Yankees and the Boston Red Sox: the deal looks very good on paper — both for the combined franchise and its customers. And it’s bound to ignite a flurry of merger and acquisition (M&A) activities as rivals move to strengthen their rosters.”

 “Over the past two years, each company struggled to fill gaps in its bullpen and deepen its bench strength,” adds Minahan. “Ariba has been taking steps to build a services organization to bolster its spend category and process expertise, as well as to identify high-margin revenue streams. FreeMarkets has worked to develop an extended sourcing application both to prove itself as a software provider and to retain customers looking to transition to a broader self service sourcing suite. Their union accelerates these strategies.”

The merged company can claim 200 sourcing customers and combined revenue of $360 million based on 2003 year-end results, making it the leader of the spend management software and services business. In addition, the combined company has 400 sourcing experts, including strong coverage in emerging markets in Eastern Europe and China . Together the companies manage $40 billion of spend per quarter and 25,000 sourcing projects per year.

Additionally, Minahan suggests, “Success in the sourcing and spend management markets will require a hybrid delivery model, which incorporates a self-service application platform combined with category-specific market intelligence and process methodologies. The union accelerates Ariba’s category management strategy and enhances the company’s ability to offer procurement services on a full business process outsourcing (BPO) basis or as adjunct services designed to extend enterprise implementations of third-party procurement and sourcing applications.”

“The value of the deal will be determined by how well (and quickly) the combined company can execute,” concludes Minahan.

The analyst community together says Ariba customers benefit from advanced category expertise, global sourcing support, and enhanced negotiation functionality. FreeMarkets customers gain a broader integrated application suite that combines strategic sourcing and procurement execution capabilities. And AMR’s Mitchell points out that most leading-edge companies have tended to use Ariba and FreeMarkets.

What’s In it for You?

If the ideal merger can create hybrid sourcing and spend management delivery models ― ones that incorporate self-service application platforms and category-specific market intelligence and process methodologies ― then are we finally getting the well-bred racehorse?

 AMR Research and Aberdeen Group tell us corporations want three things from enterprise-wide e-sourcing solutions: 1) Total cost compliance, 2) e-sourcing connectivity and visibility into the demand management tools already in place, and 3) true strategic sourcing aggregated from the technology.

 The Ariba, Freemarkets union got us back to the racetracks to bet on solid delivery in the e-procurement and e-sourcing arena. But strategic organizations are not willing to gamble. When they put their money down today, they want the promise of a winner. Strategic sourcing continues to be the one area in corporate America where true total cost management can be managed effectively. More than ever, the providers are required to ante up.

 As they say at the tracks, “And they’re off …