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University of California, Irvine

With the emergence of the real-time economy, the prevailing organizational form for corporations hasevolved from a vertically integrated structure to a networked model.

Introduction and Themes

With the emergence of the real-time economy, the prevailing organizational form for corporations has evolved from a vertically integrated structure to a networked model. Increasingly, traditional corporations are outsourcing components of their organization to specialist firms in areas where they lack competitive advantage, while newer companies adopt this organizational form by focusing on specialized activities and rely on partners to provide complementary products and services. The resulting organization form is a networked structure consisting of a group of businesses that go to market as a set of valued-added partners, often called a value network.1

A significant factor in the emergence of the networked organization as an efficient organizational form is advanced information and communications technology.2 The complex control and coordination requirements inherent in managing activities such as integrated supply chain processes were prohibitively expensive prior to the advent of cost-effective communications technologies, such as the Internet. These coordination requirements include the ability to share information about customer demand, products and production schedules, capacity and inventory, and costs and prices. In many cases, the challenges associated with managing the necessary integration between the manufacturing and operations processes of different firms led firms to own functions and processes where they had no special advantage. These companies were constrained by the costly and functionally limited point-to-point technology solutions at the time, which were based on electronic data interchange (EDI) over value added network (VAN) services.

Today, with the advent of the Internet, specialized business-to-business technology, XML-based process standards such as RosettaNet, and Web services, companies can start to envision the environment where partners share information in a value network. In the ideal value network, each partner possesses significant and differentiated capabilities relevant to executing its component of the business, and the network enables a synergistic combination of the parts to create an integrative enterprise with sustainable competitive advantage. A recent article in the McKinsey Quarterly shows that networked companies outperform conventional ones on key dimensions of performance such as market value per employee and revenue per employee. ³

As companies adopt the networked model, they are confronted with crucial technological issues related to the implementation of the technology platform and the information standards that will facilitate the effective integration of the partners into an integrated community. Let us assume that a set of partners has agreed, in principle, to coordinate their supply chain processes through an integrated community. Recognizing that each company utilizes its own supply chain management solutions, data and information standards, and process definitions, the partners must agree on a technology solution that allows partners to communicate with each other, and implement process maps and translation protocols that allow the disparate systems to communicate with each other. They must also determine whether they want to manage and operate this infrastructure themselves or source this service from a community integration service provider.

In the last two years, as companies have attempted to migrate to the integrated inter- business community model, we have witnessed a variety of approaches. For example, trading exchanges have emerged to provide the connectivity and standards necessary to integrate the operations of multiple partners. Exchanges have been launched by independent companies attempting to create neutral marketplaces for the buying and selling of goods and services within specific verticals, and across verticals. In other cases, large competitors have banded together in consortia to facilitate the purchasing aspects of their operations such as Covisint in the automobile industry, while others are facilitating the selling activities through industry exchanges such as Orbitz in the airline industry. In general, these consortium-based approaches attempt to be inclusive, inviting many industry participants to join the exchange. A different model is that of the private inter-business community - also called a private hub - in which a supply chain leader is linked to its suppliers and customers. Forrester Research defines a private hub as an online venue, controlled by a single firm, that supports integration and collaboration with selected partners.4 Technology companies have also arisen to provide products and services to enable this transition.

From the wide range of community integration solutions, many have failed. These failures occurred for a variety of different reasons. One common factor is that earlier versions of the technology have had limited functionality. In addition, many community builders did not anticipate how the incentives of companies whose participation was necessary for success would affect the outcome. Specifically, the design and functionality of the exchange must be consistent with the competitive structure of the industry, the nature of the product being exchanged and the underlying operational processes. Independent exchanges have been stymied by their inability to achieve liquidity because larger players would not participate without material recognition of the value that they brought to the exchange. Accordingly, independent exchanges are much more likely to succeed in highly fragmented industries. Industry consortia have emerged when there are several large buyers or suppliers in an industry, but these have been challenged by the difficulty of securing consensus among disparate stakeholders with competing and contradictory interests. At first, it appeared that industry exchanges would be a powerful force since they could define and utilize common standards within an entire industry. In reality, the difficulties associated with competitors agreeing on process definitions, information and technology standards have proven to be daunting. Moreover, some dominant industry leaders such as Wal-Mart have refused to participate in industry exchanges because they fear that it would make their superior but proprietary supply chain practices more visible to their competitors.

Private inter-business communities, on the other hand, are usually controlled by a dominant buyer. The lead firm drives the business scenario for the private community, and the objective is to achieve the benefits of supply chain integration. These include lower transaction costs, lower inventories, reduced lead times, and improved coordination via collaborative design and forecasting. Suppliers to the large firm participate for two major reasons – they share in the benefits of supply chain integration and are sometimes required to participate as a precondition for doing business with the large buyer. In some cases, the large firm will provide incentives to suppliers, particularly, small ones, to participate in the integrated community. For these reasons, the private inter -business community has emerged as a viable model in certain environments. In a recent survey, 91 percent of respondents indicated they believe that this will eventually be an important component of a corporation’s e-business initiatives.5

Fundamentals of Private Inter-Business Communities

In order for companies to integrate supply chain processes, it is usually the case that at minimum, they possess internal supply chain management applications, such as those offered by i2 Technologies and Manugistics, running in conjunction usually with an ERP system like SAP R/3. In some cases, an ERP system can suffice. Subsequently, in order to enable process integration between companies they will need to implement B2B middleware, such as the solutions offered by Peregrine, Iona, TIBCO, Microsoft, and webMethods, to name a few. B2B middleware is based on the exchange of data and process information in a standardized, shared and neutral format. In order to achieve this integration, participating companies must utilize standard definitions for inter-business processes and data. It is particularly important that these process definitions be widely accepted among the participants, and prefer ably, within an industry, since a company’s value network is dynamic. The RosettaNet consortium in the information technology industry is perhaps the best example of shared process definitions, including a dictionary of common definitions, a common grammar, and Partner Interface Processes (PIPs) for core supply chain management processes. Clearly, the integrated community will require a reliable, networked infrastructure. In this context, the infrastructure - termed here as a private inter -business community - must enable companies to engage in real-time business and maintain continuous integration of their business processes and applications with their partners. The inter-business community must also provide tools for the management of exceptions and alerts, in addition to detailed reporting on process activity within the community. Correspondingly, as shown in Figure 1, the key components of a private inter-business community include6:

1. Information and communication standards for inter-business processes2
2. B2B middleware
3. Supply chain management software
4. Internal back-end integration services
5. An integrated community infrastructure

Figure 1. Building Blocks of an Integrated Community
(Source: Dr. Omar El Sawy, 2002)

In Figure 2, we show a sample architecture for an integrated community.7

Figure 2. Private Inter-Business Community Infrastructure
(Source: Dr. Omar El Sawy, 2002)

Deploying an Integrated Community

There are three major stages associated with implementing a community integration solution

1. Building the infrastructure
2. Enabling the community
3. Managing the community

Unsurprisingly, implementation of an integrated community is a complex project. Each of the project phases involves considerable challenges. We consider each of these in turn.

As described above, the infrastructure involves the acquisition and implementation of technology solutions within an organization and an intelligent hub. Within an organization, each company will need to acquire the necessary server hardware, and third-party software including B2B middleware, a Web server, translation tools for data transformation, and of course the applications and underlying databases.

It is also worth noting that the software solutions available today are still evolving. In particular, B2B middleware is focused mainly on small numbers of partners and does not scale readily. A recent AMR Research study on supply chain software states that only 12 percent of surveyed companies have more than 5 percent of their suppliers or customers contributing data for supply planning purposes. Since many companies try to utilize B2B middleware to connect trading partners into their supply chain applications, this AMR data seems to indicate that companies have been unsuccessful integrating large percentages of their trading communities using B2B middleware alone. Accordingly, custom software, which typically comes with an expensive price tag, may be required to provide additional functionality to facilitate this integration. In addition to the project implementation that must take place at each partner location, the hub that is the core of the community must be configured and deployed. This includes a set of activities that involves the mapping of processes between systems, configuring the communication routes, building a community operations center with tools for monitoring and managing processes and infrastructure, developing a support function, and providing adequate testing to ensure reliable communications and provision of user training.

Community enablement involves developing communication and information standards, ensuring that each community participant has the required infrastructure, integrating participants into the community platform, readying participants for process integration by developing process maps, data definitions and translation schemes, validating data, implementing security schemes, testing and training users. Given the myriad internal applications that a typical community participant utilizes, heterogeneous hardware platforms and network architectures, this step is highly complex and laborious. In addition to the technical challenges, the difficulty of changing business processes and behaviors in organizations can be a barrier to success. Considering that these communities can involve numerous participants, and that the effectiveness of the integrated community depends on coordinated participation of all of these partners, it becomes apparent that this phase also requires sophisticated program management skills to ensure that each participant can be enabled cost-effectively and in a timely manner.

The ongoing management of an integrated community requires the monitoring of processes and infrastructure, procedures for handling exceptions, periodic reporting, and support services. In addition, process definitions may evolve and the community may be reconfigured requiring process change management and version control. It is important to note that once the private inter -business community is operational, it will not be static. Community management will assume considerable importance. New participants will join the community while others will exit. Process definitions will change and participants will link additional processes. New functionality will be added to the community. Correspondingly, features of community enablement will be present throughout the life of the community. Likewise, new or enhanced technology solutions will become availa ble and will need to be incorporated into the infrastructure.

As is evident from the above discussion, the set of services and functions required to build and operate an integrateed community are highly specialized. Moreover, successful implementation requires knowledge not just of information and communications technologies but also of supply chain processes and industry practices. Successful implementation and operation also requires sophisticated project management to manage the numerous and complex activities required in the rollout.

Sourcing Strategy: Make versus Buy

Once a company has decided to implement a private inter-business community to provide the necessary infrastructure to connect to its suppliers, it has to determine what aspects of the implementation will be conducted in-house and what will be sourced externally. Most companies that source information systems (IS) services externally want better performance from their IS resources – hardware, software, networks, people and processes involved in managing and operating the technology and in supporting users.⁸ They typically want to achieve cost reductions, improvements in service quality, and have access to new technical skills and specific management competencies. In order to understand why external service providers can add value, it is important to understand the economics of information systems management.

There are two fundamental types of economies that can accrue in IS services. The first are economies of scale, wherein the unit costs decrease, as the service grows larger. For example, data center and hosting services often experience a decrease in unit costs as scale increases. This is usually because the fixed costs of service provision, which can be large in many IS environments, are shared over a larger base, or because there are economies of scale in hardware and software prices. The second category is that of economies of specialization. In this case, companies that specialize in specific technology services are better able to keep pace with new technologies and skills, use superior processes and management methods drawing on more experience, leading to greater expertise, and resulting in higher quality or lower cost services for their clients. One particularly important aspect of the economies of specialization is the incentive of a specialized service provider to build software tools to improve performance of the key processes required in an implementation. While a user firm can deploy specialized tools only once, a services firm can deploy the same tool with multiple clients. Recognizing that the marginal cost of software approaches zero, a services provider has the financial incentive to invest in software tools to enable processes crucial to their service offering. For example, a service provider may invest in methodologies and tools to improve the efficiency of software developers, or to enable and provision the participants in a private community. Another critical aspect of economies of specialization is that a service provider may also reduce the riskiness of a project. As is well known, the failure rates associated with many complex technological implementations are quite high, resulting in cost overruns, delays, and in some cases, abandonment of the initiative. While the impact of a cost overrun is clear, it should be noted that the opportunity costs of a delay in implementation can be very high since accrual of the substantial benefits from the project is postponed.

In addition, there are several other strategic and financial reasons why companies prefer to source services externally. Increasingly, companies are focusing on their core competencies and outsourcing non-core activities. Others have articulated this trend as a focus on strategic activities, and the outsourcing of commodity activities. Not only does this achieve the objective of securing the services of a specialist, it also enables management attention, a scarce resource, to be focused on strategic business and technology problems rather than on routine but time-consuming technological detail. Yet another reason why companies prefer sourcing technology services is that it allows expenses to be incurred as a variable cost rather than as capital expenditure, which can be of significant benefit to some firms.

Applying the above arguments to the case of an integrated community, it is apparent that external sourcing has many advantages. In order to evaluate the case systematically, consider its major stages: building the infrastructure, enabling the community and managing the network (Table 1).

Let us first examine whether any economies of scale may accrue to a service provider in the development and operation of a private inter-business community. Recognizing that the lead player in an integrated community is a large firm, there are no likely economies of scale in purchased hardware and software located at the sites of the community participants. Moreover, since the size of the community is independent of the service provider, the costs of communications are also not subject to scale economies. There are likely to be economies of scale in the building and operations of a community operations center and a customer support center. These centers typically operate 24x7 given the global reach of many supply chains, and require multi-lingual support. Since the demand can be aggregated and averaged over the entire client base, a service provider can usually provide this coverage at lower cost.

It is economies of specialization, however, that provide external service providers with a huge competitive advantage over a set of trading partners trying to implement an integrated community using internal staff. Reputable service providers that have built an infrastructure, have previously enabled trading communities, and have experience in operating an integrated community have considerable advantages over in-house teams. First, they typically have a well-defined project management methodology for all three phases with milestones, reliable cost estimation tools, and techniques to manage risk. Second, they have built tools to automate many aspects of building and operating a private inter-business community. These include proprietary tools to provision trading partners, and functionality to facilitate business process integration. In addition, the experience of reputable service providers can be invaluable in understanding where the sources of error are, and in managing risk. Accordingly, the costs of enabling a single community participant can be reduced substantially when using an experienced service provider versus an inexperienced in-house team. Analysis indicates that an outsource provider can enable a community participant for 30-40 percent of the cost of doing it in-house. Moreover, the time required to enable a community participant can also be substantially reduced. Using a service provider with advanced expertise can reduce the time to connect a single supplier by more than 80 percent. When one notes that these integrated communities can connect many internal manufacturing plants, numerous contract manufacturers and hundreds or even thousands of suppliers, the benefits of using an experienced ser vice provider escalate rapidly. Further benefits accrue during the operations phase as a provider experienced in community management — adding and dropping participants, reconfiguring the community, redefining processes, managing version control – and possessing specialized tools can provide services much more cost-effectively.

By far, the largest tangible benefits of using an external service provider occur during the community enablement phase. The reduction in costs associated with this phase, is in itself, substantial. Much more importantly, the implementation schedule can be shortened significantly, allowing for the benefits of supply chain integration to accrue much more quickly than a slower approach. In addition, there are the benefits of a lower level of risk for the project. Not only will prior experience reduce implementation risk, but service providers may also guarantee an implementation schedule and a price. They may also accept incentives, both positive and negative, related to meeting performance targets. As discussed above, a company can pay for use of the system using a flexible, less risky cost model rather than by incurring capital expenditures for an internal project.

There are also intangible benefits. As discussed above, senior IT executives in the business community are freed from managing a large, global, complex technology implementation and can focus on deriving the benefits of supply chain integration rather than on the technology. Other benefits may also accrue. It is likely that over the course of the implementation, disputes may arise over technology and standards. Given the independence of an external service provider, it is more likely that all concerned parties will accept a proposed solution. This solution is even more attractive when one notes that a supplier is likely to participate in many private inter-business communities. To the extent that a specific service provider supports some of the other communities that a supplier would like to participate in, there is a direct benefit to the supplier. However, even when this is not the case, a service provider focused on building additional communities is far more likely to support generalized approaches that transcend the individual community, utilizing industry standards for technology and processes, than a specific supply chain leader’s in-house solution.

The risk associated with a service provider is primarily failure risk. Specifically, there may be large opportunity costs if a service provider does not meet performance objectives, or is unable to implement the inter-business community. Financial penalties may not cover this cost. While there is no denying this potential, these costs can be mitigated by a thorough due diligence process, and active project supervision. Recognize that many of these risks are also present in an internal implementation.

Financial Model

The costs and benefits of an integrated community will, of course, depend on the scope and ambition of the community it is supporting. The two variables that have the greatest impact on network infrastructure costs are the number of participants connected to the community and the volume of documents that flow through the community. In low-volume communities where the number of connected participants is small, the cost to exchange information on a per document basis can be quite high since the cost of the infrastructure is allocated to a relatively small number of documents. On the other hand, as the volume of documents and number of participants grows, the “per document” costs decrease but investments in the infrastructure increase. As discussed above, the primary cost drivers in building an integrated community include infrastructure such as the community intergration platform comprising off-the-shelf software, hardware and routing technology; community enablement including the activities, methodologies and resources required to connect participants to the community; and community management and operations including custom software to manage document exchanges at the process level, process monitoring, data validation, security and support services. It may also require a disaster recovery plan. In a recent study (see Appendix A), Soderberg estimates the cost to build and manage an integrated community for four distinct implementation scenarios. ⁹ The scenarios range from a low-volume community with few participants to a high-volume environment comprising many participants.

The model examines a 3-year lifecycle. The results in Table 2 demonstrate the “per document” cost benefits that a company achieves as it increases the amount of information traffic and the number of trading partners that participate in the community:

Table 2. Cost of Building and Deploying an Integrated Community
*Based on cost model from Soderberg 2002.
**Rounded to nearest decimal place.
***Ranges based on evaluation of current market prices for outsource services.

As is immediately evident from the results, there are clear economies of scale in the deployment and operations of an integrated community. Comparing scenarios 1 and 4, one can see that the volume of documents has increased by a factor of 325, and the number of participants has gone up 5-fold, but the total cost has increased by a factor of 2.5. In this author’s experience, vendor prices for these scenarios can save as much as 75 percent of the per-document cost in the low volume scenarios to approximately 50 percent for the medium volume cases and 0-35 percent in the high volume cases. Of course, the amount of capital required to build an integrated community for high-volume cases is very significant.

Based on this analysis, it is clear that most companies should consider external sourcing of the development and operations of an integrated community. Some large global companies could consider an internal approach. However, it should be noted that while the percentage cost savings for large high-volume communities are lower than for low-volume communities, companies could leverage a vendor’s pre-existing infrastructure and support system, and substantially reduce the time to deployment. This can be invaluable. Moreover, given the intangible benefits of reducing the time managers must spend on technology deployment and lowering the risk of technology implementation, it appears that the external sourcing of the development and operations of an integrated community is an attractive option for all companies.

A Vision for the Future

In an influential article in the <I>Harvard Business Review</I>, John Hagel and John Seely Brownx argue that IT strategy is evolving from a focus on proprietary information systems to shared Web services offered by managed service providers. This approach is Internet based, and relies on an open rather than proprietary architecture. They propose a three-tiered architecture. At its foundation, it includes a software standards layer, a service grid, and an application services layer. The software standards layer includes standards such as XML, information standards such as RosettaNet and communication protocols such as HTTP and TCP/IP. The service grid is the middle layer and provides a set of s hared utilities such as security, authentication and performance assessment, and specialized utilities for service management (e.g. provisioning, monitoring, synchronization, conflict resolution), resource knowledge management (e.g. directories, brokers, data transformation) and transport management (e.g. message queuing, filtering, metering, routing). The third layer includes application services that support everyday business processes such as production scheduling and inventory management. Users interact with the application services layer. Components within this layer can be specific to individual companies residing at their sites, or can be shared. This architecture supports flexible collaboration, not just within a single firm, but also in the extended enterprise because it is based on common standards for information and communication. For this reason, this architecture is particularly suited to the boundary of an enterprise – activities that occur between companies and their suppliers or customers. They suggest that procurement and supply chain management are natural candidates for this architecture. As we have seen in this paper, the vision that these experts articulate for IT services within a company is consistent with the design and implementation of a private inter -business community managed by a managed service provider. Indeed, the vision is already a reality in the supply chain management arena.

APPENDIX A (from Soderberg 2002) Total-Cost-of-Ownership Analysis

This document accompanies an Excel spreadsheet, which assesses the cost of owning and managing a community of trading partners. Together these two documents analyze the total cost of ownership of a proprietary community, which allows a company to securely transport documents and execute transactions with their suppliers and customers. The analysis covers the technology, processes and people associated with the deployment and management of the community over a three-year time horizon. The number of documents transferred on a monthly basis is the primary metric used to measure community size and activity. The analysis is broken down into four different scenarios:

1. 20,000 documents
2. 200,000 documents
3. 2,000,000 documents
4. 6,500,000 documents.

The cost analysis consists of the following three elements:

Community Platform:

This is the cost associated with setting up the community. It includes the following items:

a. Infrastructure: This ranges from Internet access and servers to server storage cabinets and will vary depending on the availability required by the different scenarios. In the model the availability is either 99 percent or 99.99 percent.

b. Console and Router: This is software associated with the translation and routing of documents and is acquired from outside vendors. This constitutes a large portion of the costs associated with the Community Platform. The model incorporates vendor discounts from their list prices. These discounts are assumed to increase as the community expands and the investment in this software increases.

c. Database and system: This is the cost of an Oracle database and the associated hardware on which the database will run.

d. Platform Management: This is the cost of managing and maintaining the platform over a three-year period.

2. Community Deployment and Operation: This is the cost associated with establishing and operating the community. It includes the following items:

a. Activation of community participants: The community participant activation is calculated using a sliding scale that assumes that the time required getting a participant up and running in the community will decrease as more participants are brought online.

b. Community Management: The ongoing management of those relationships is assumed to be a constant number of hours per month per participant, in which the ongoing issues of community participation are addressed.

c. Process Management: This consists of the handling of exceptions in the document transfer process and is calculated using an increasing number of full-time employees as the document volume increases.

3. Custom Software: This is the cost associated with developing customized software to assist in establishing participants in the community and in operating the community.

a. Provisioning Tool: In order to integrate participants into the community quickly and inexpensively, custom software is developed. It is considered to be a nominal cost in the low volume scenario (20,000 participants) and increasing to a higher amount for the remaining three scenarios.

b. b. Community Operation: This assists in managing the flow of documents and to reduce the amount of manual intervention necessary to handle exceptions. The sophistication of this software, and associated cost, are assumed to increase as community activity grows.

Author’s Note: The analysis purposely does not consider company specific economic variables such as cost of capital, opportunity cost, time to market cost, etc. It assumes that a company embarking on an internal development has the expertise to properly architect and design their integrated community. It also ignores the internal risk involved with successfully building, deploying and managing an integrated community. Each of the aforementioned caveats will tend to increase total costs of ownership and should be carefully considered.