Vendors will never make money off optimization unless they originate the opportunity!

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Editor’s note: This post about the market opportunity offered by sourcing optimization technology is from Michael Lamoureux, aka the sourcing doctor, in answer to Jason Busch’s counterpoint to Michael’s original post (Optimization is not optics — it’s obligatory!) that both published last Friday.

Vendors have every right to make money from buying organizations just as buying organizations have every right to make money off their customers. And vendors should make top dollar from top offerings with top ROI, but they won't unless there is a demand for those top offerings. And right now, despite the widespread need, and unequivocal value, the market is bottomed-out because there is just no demand.

And the reason there is no demand, is the vendors have not created it!

What almost all of the sourcing optimization vendors have continually failed to understand is that selling advanced tech first requires creating a need for it.

1) No one wants what they don't understand.

And trust me when I say that most people don't understand optimization. Some still don't know what it is or what it can do. Others believe they need to know advanced math to use it. While math helps to create advanced/custom models, it is not necessary to know because good solutions hide all the math from those who don't need to see it. (Especially in America, people don't know math. The U.S. Ranks No. 32 in math in education, with less than a third of eighth-graders testing proficient. And the statistics get worse. By the time they reach adulthood, only a third of those, or 11% to 13%, will be deemed to be "proficient" at math as an adult.) Still others don't understand the value that can be achieved with optimization beyond multi-round RFX, e-auctions, deep should-cost modeling or advanced analytics (such as predictive or prescriptive offerings). And, of those who understand optimization from early experiments, they still believe it's difficult to use, kludgy, wonky and requires a PhD in hyper-dimensional mathematics.

2) No one sees the value in a new offering if the old offering still works just fine.

This is something the video game platform providers understand quite well. If G-Box 1 works just fine, and the average user still has a stack of games to play on it, why does the user need G-Box 2? Until a game comes out for the G-Box 2 that has gameplay mechanics and graphics above and beyond anything available on the G-Box 1, no one can be expected to want the G-Box 2. So the G-Box maker focuses on creating great, but affordable, games, or negotiation partnerships with game studios that will create games that people will want that will show off the power of the G-Box 2. Once people want the games, they then start to see the value of the G-Box 2.

3) Even if value is seen, the appetite for investment is limited until the value is experienced or realized.

Again, something the video game platform providers understand. It's no use creating demand for a new system if the price point is too high for the average buyer. That's why most of the platform providers will sell their game systems at cost, and sometimes even take a loss (that they will more than make up later on game sales).

But that's only enough if the market is already hungry for the vice that the platform will fulfill and you are offering a clearly better version. But what if there is no market? This is where you have to take a cue from the "pharma" providers. You want to get someone addicted, the first few hits have to be free!

If sourcing optimization providers want to make money off the technology, they have invested a lot of time and money in with high hopes of high-dollar rewards, they are going to have to take a cue from the "pharma" providers and stop trying to make money off the base tech and start giving it away for free.

Now I'm sure all the vendors are asking, "has the sourcing doctor gone crazy? Optimization costs us money and didn't he just say we deserved to make money?" Well, the answer is yes, yes, and yes. But just because you shouldn't charge for base optimization technology, doesn't mean you couldn't charge for enhanced optimization technology and value-added services.

One thing everyone needs to remember is that the value of optimization increases as the size of the model increases and the accuracy of the data increases. The bigger and badder the model is, up to whatever maximum size the tech can handle, the more opportunities the "math" can uncover. But big models require big data, and where does the user get this big data? Probably not from the sourcing RFI!

All a sourcing RFI is going to contain is product (breakdown) costs. But that's not the total cost. The total cost also includes transportation costs. Tariff costs. Storage costs (possibly multi-echelon). And so on. Since most buying organizations don't have this data, they typically estimate these costs based on current or prior costs, or marketplace quotes, for transportation and tariffs. But actual rates will vary depending on loads, promised demand, contract opportunities and so on. Tariffs depend on classification codes, actual lanes and FTZs. Storage costs vary depending on private/shared warehouses, inventory levels, etc. And all of these costs can be reduced significantly under the right situation. And if transportation costs are 20% of product cost, inventory costs can be up to 25% of product costs, and tariffs can vary by 100% (depending on route ) — how much is a buyer leaving on the table? Possibly twice as much as optimization on the base model and base data is going to find!

But buying organizations probably don't have this data, and don't have the time or channels to get it. But a vendor who serves a community does! These data streams are a huge value add and something a buying organization will pay for after they get comfortable with, and see the value from, base optimization alone.

Plus, the sourcing doctor said only core capability (and baseline optimizations should be free). He realizes that you can only allocate so much solve time in a basic license, and if an organization wants to run more than the baseline models or run advanced models, who says they can't pay for solve time beyond a free baseline?

Furthermore, in addition to selling subscriptions to these data streams for accurate cost estimating, there are other data streams of value. The best models balance cost and risk — but where does an organization get supplier and supply chain risk data? Typically not internally. This means they need that data from third parties. Optimization makes an organization even hungrier for these data feeds and for pre-defined mappings of the appropriate data to values and constraints usable in enhanced optimization models.

And then, there's the fact that while it's very easy for an average buyer to define goals and constraints, it's not so easy to define the right cost models or comparative scenarios for advanced optimization scenarios when you don't have the experience. This means that, as buyers become more comfortable with optimization and addicted to the savings and cost avoidance it generates, they are going to need, and want, advanced cost modeling and out-of-the-box starting models for their industry's categories. That's more up-sell opportunity.

In other words, not only can sourcing optimization vendors create an industrywide demand by giving away the first hit for free, but they can create a whole new set of recurring revenue opportunities that might not exist otherwise.

So, vendors, smarten up and make this Christmas a white one!

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