In part one of this series, I introduced Elementum (who by the way is not a client of ours, nor is Flextronics, not that it would matter to us anyway), its background, its products, and some initial perceptions based on the firm briefing me. I have yet to talk to its customers and will report back once there is more progress on that front. Still, there are many interesting implications stemming from this venture that are worth exploring – and there is a lot to explore here. Here we go…
In Part 1, I started asking some questions regarding the wisdom of such a foray by Flextronics. Too often, brick-and-mortar firms have delusions of grandeur regarding their ability to develop and commercially externalize various supply-side services. This could be forming a group purchasing entity, forming an industry marketplace (which have recently turned private and become de rigeur again in the era of private/hybrid clouds), setting up an international trading group, commercializing an advanced capability such as price risk management (this is an HP example), developing an online marketplace for trade payments (banking example), creating an industrial BPO offering, or any other of myriad services that can often be combined – as we wrote about here. It’s not to say that these aren't valuable, but it turns out that they often aren't really core to the business, and eventually get brought back in-house or shut down completely.
Big Supply Management and Why This Makes Sense
Still, there is an advantage to be had. And for some major supply chain participants, it is in fact core… if they can execute. It’s sort of like a “magic quadrant” for supply management organizations (see here for more) in that you can have a great vision, but it means nothing without the ability to execute. Note that when I say “Supply Management,” I mean “Big Supply Management” (i.e., continually optimizing the supply side of supply networks through re-configuration and better management) rather than re-badging the purchasing department. I wrote about this topic and the 11 key capabilities for creating synergy between direct procurement and the rest of the supply chain here (it’s a report I did with ISM that E2open helped sponsor – and I think it’s pretty good… humbly submitted of course).
Anyway, let’s first place ourselves in the shoes of Flextronics and see why this venture makes sense (before tackling the implementation challenges).
First off, Flextronics is in a cutthroat, low-margin business, and its revenues are declining. It currently trades at about 20% of its trailing revenues. So, revenue uplift and brand multiplier uplift are both needed. It is a non-investment grade rated company in comparison to Hon Hai and Jabil (which can borrow more cheaply).
Second, in order to boost revenues to compete against the likes of Hon Hai (Foxconn) and boost valuation multiples to something more like Plexus, it has to focus on innovation on multiple fronts. So, consider Flextronics’ Lab IX incubator firm that funds “early stage disruptive technology companies incorporating hardware and software innovation.” Elementum clearly falls into the latter category. Of course, you might say that it’s a business application rather than embedded software in a product, but I would argue that the line between product, embedded software, supply chain telemetry beyond the product, and SCM/business software will increasingly blur (“Internet of Things,” “Smarter Supply Chains,” “Big Data,” etc.) – so you better design the last one to incorporate the former, right?
More practically, Flextronics doesn’t just want to just be a tactical contract manufacturer, but a strategic end-to-end supply chain services and software provider. That’s right, software provider. See the tagline on their Global Services and Software business. As an aside, sourcing was not listed as a core competency, but there are a few possible reasons for that: don’t raise the ire of OEMs; don’t list a “secret sauce”; don’t sell something that’s not yet ready for externalization.
Creating Flexible Supply Chains
Anyway, to be strategic and innovative, they need to bring in external innovation like P&G did with its Connect & Develop program and spin those competencies right back out as a competitively differentiating capability (software or services) with the classic IBM playbook of “we do it so well in our own supply chain that we’ll do it for you too.” Therefore, such venture investments are obviously not just Treasury playing the role of VC, but also a way to build and embed a broad gene pool of supply chain DNA into the firm to then monetize – way beyond manufacturing. For example, consider Flextronics ownership of supply network design software (and services) at its SimFlex subsidiary.
Also relevant to the previous point, consider the Flextronics Milpitas campus that just won an Industry Week award. It serves not just as a high-tech prototyping and manufacturing center, but also as one of Flextronics’ innovation centers – as well as a center of excellence to improve internal processes such as customer ramp-up and other processes. The same applies to supply-side innovations. For example, Flextronics Milpitas was an early adopter of Resilinc and used it during the spring 2011 Thailand flooding to quickly identify and mitigate flood-related risks at key suppliers. This is well documented in the following MIT case study write-up. Flextronics was so impressed and found the capability so strategic (to its customers and therefore to it) that it essentially decided to “replicate” the functionality in a more captive solution via the Elementum Exposure product. To quote Tom Linton, Flextronics’ head of supply chain (and one of the founders of E2open) from an interview last year, “I won’t be completely satisfied until I have the entire map of every part number for every product at every supplier at every customer we serve mapped.”
This means more than 600,000 active part numbers and 30,000 suppliers at over 120 factories around the world. This capability is core and Flextronics is being smart by not relegating it to a third party service providers or public cloud based supplier network that can use such network derived supply chain intelligence to monetize for itself (i.e. it is applying strategic sourcing principles properly to its own SCM/Procurement software spending). This is why we’re not overly keen on something like SAP’s Ariba Network in the supply chain where it jointly owns the commercial data between a buyer and supplier. This is just one of our Procurement Cloud Technology Bill of Rights, which we actually did a whole webcast on (you can view a free version of it here). There are similar data confidentiality concerns that could be made with regards to the multi-tier supply network intelligence gathering inherent in SAP’s Supplier InfoNet or Product Stewardship Network, but this is too long to get into here.
Of course, this also begs the question of whether a buyer like an OEM should look to one of its major suppliers like Flextronics to provide supplier-facing software that serves Flextronics’ competitors? Do you think Jabil or Celestica are going to happily load up all their multi-tier data to a Flextronics-incubated solution – and take comfort that there will hopefully be a “business firewall” in place?
Building Amazon or Force.com for B2B Won't be Easy
Elementum is going to find that it takes a lot more than some strong architecture and a few mobile applications to become a $10B supply chain SaaS provider. Besides, we believe that the real opportunity in Supply Chain and Procurement services is at the BPaaS and PaaS layers (which we look at more broadly than just simple rentable application development and deployment environments) to allow service platforms that support standards-based “OpenStack-like” set of mix-and-match heterogeneous services delivered in private/hybrid service deployment models. There is no real Force.com equivalent in the procurement and supply chain world, although Amazon is a dark horse player obviously, and we’ll see where a player like Elemica might fit as a true supply chain platform player (or Ivalua in Source-to-Pay or Nipendo or Tradeshift in Purchase-to-Pay). We did a whole webcast on Cloud for Procurement trends recently if you want to learn more about this topic.
Still, don't get us wrong, there is definitely value in building internal capabilities and “business services” in a multi-tenant cloud-enabled way that can be externalized and commercialized. This is because such services help improve internal operations to better manage the internal supply chain (and in the case of Flextronics, it’s a landscape of systems such as SAP SNC, hundred of instances of Baan ERP, custom systems, etc.) across the hundreds of interleaved customer-specific supply chains. Such enterprise level systems like this type of simple supply chain control tower are also important for providing customers with their own custom views into their subset of the broader Flex supply network – like the Elementum Perspective application is designed to do. As an analogy, think about why a supply chain player like Maersk would use a solution provider like CombineNet— can you say massive logistics network optimization?
This is the second major benefit in such an internal-turned-external capability. It improves customer service, win rates, design-for-supply modeling, and account profitability via higher valued-added services.
Finally, it hopes to bestow a higher valuation multiple. It’s not about being a big profit center in its own right. Just to provide some perspective, even if Lab IX and investments like those in Elementum only improve a revenue multiple improvement from 0.2X to 0.3X of revenues (keep in mind that E2open is trading at about 8X of revenues), that is $3 billion of value created on, say, $100 milion of investment. The numbers are not exact here, but you get the point.
So, how to wrap up here? Well, obviously there is more to this story than just a new player offering mobile SCM visibility applications. To get the deeper meanings and deeper value, you have scratch under the surface. You also have to work with better partners who’ll push your thinking and make you better. For supply chain and procurement organizations, this means pushing yourself to be a better service provider (and trusted advisor and provider of predictive market intelligence), especially in this emerging age of business services industrialization. It also means extending that philosophy out to the third parties that you work with to help you assemble your service portfolio based on budget, timeline, and stakeholder needs.
It’s a wild and wooly mega market just for procurement services (which includes application services), and there’s a great deal of convergence and volatility right now. So you need to start placing your bets (and inaction might not be the best one).
If you want to get into the right game and improve your odds, and if you like what you read here and want to go a little deeper, we’d very much appreciate your support by becoming a subscriber in our Spend Matters PLUS service or a member of our Spend Matters PRO community. For our PRO members, we will be covering not only competitive implications of new entrants like Elementum in the supply chain market, but also how practitioners can similarly be strategic in crafting their internal service portfolios, doing the make vs. buy (especially relative to other internal groups like IT and shared services/ ‘global business services’), making smart choices, considering externalization, broadening into newer finance-centric areas like tax efficient supply chains and supply chain finance programs, and then engaging the providers properly and finally implementing well. Obviously it’ll be a multi-part series! As always, stay tuned, and don’t hesitate to contact me with any questions or comments.