Embed Size (px)
Citation preview
TO BE OR NOT TO B2B: EVALUATING MANAGERIAL CHOICES FOR E-PROCUREMENT CHANNEL ADOPTION
Qizhi Dai
Assistant Professor Lebow College of Business, Drexel University, Philadelphia, PA 19104
Email: [email protected]
Robert J. Kauffman Professor and Director, MIS Research Center
Carlson School of Management, University of Minnesota, Minneapolis, MN 55455 Email: [email protected]
Last revised: October 9, 2003
______________________________________________________________________________
ABSTRACT
With the increasing popularity of commercial uses of the Internet, business-to-business (B2B) e-commerce and e-procurement are moving corporate purchasing to the World Wide Web. E-procurement systems are computer systems and communication networks through which firms buy and sell products. We identify two types of e-procurement systems: extranets and electronic markets. Extranets connect the buyer and its suppliers with a closed network. In contrast, electronic markets create open networks for buyer and supplier interactions. The differences between these two types of e-procurement channels lie in system implementation costs, marketplace benefits, and the extent of supplier competitive advantage that develops due to information sharing. In this article, we develop a new theoretical model to analyze the adoption of e-procurement systems from the buyer’s perspective, to explore the set of conditions under which the buyer will prefer to procure via an electronic market instead of using proprietary extranet connections. The primary finding is that a buyer will adopt an e-market approach when the supplier’s competitive advantage derived from access to strategic information is modest compared with the variable net benefit that the e-procurement channel generate. We also find that the buyer is likely to have a bigger trading network with an e-market than with an extranet in order to capture the greatest available benefits. Overall, this study offers guidelines for managers to design and select e-procurement channels to fit different procurement needs.
KEYWORDS: B2B e-commerce, economic analysis, EDI, electronic markets, e-procurement, extranets, information asymmetry, IOS, networks, supply chain management
______________________________________________________________________________
ACKNOWLEDGEMENTS. We thank the anonymous reviewers and participants in the 2001 INFORMS CIST meeting and the Information Technology Management review process for useful input on earlier versions of this paper. We also acknowledge the helpful suggestions of Gordon Davis, Paul Glewwe, Kunsoo Han, Joakim Kalvenes, Hamid Mohtadi, Barrie Nault, Fred Riggins, Eric Walden, and participants in the Friday IS Research Workshop at the Carlson School of Management. Rob Kauffman acknowledges the support of the MIS Research Center of the University of Minnesota.
INTRODUCTION
Managing the procurement of supplies is an important activity in support of the firm’s overall
efforts to both control purchasing process expenses and lay a foundation for the competitive
product prices. To enhance the efficiency of purchasing and supply management, firms have
been gradually adopting information systems (IS) and communication networks to automate the
major procurement processes. For example, proprietary systems have been implemented to
transmit documents electronically to business partners to reduce order processing costs. And
with more recent commercial uses of the Internet, firms have been computerizing their
procurement processes using emerging technologies and moving their corporate purchasing to
the World Wide Web. These systems mainly serve corporate procurement needs, and we will
refer to them as electronic procurement or e-procurement systems in this article, and study the
adoption decisions of these systems from the buyer’s perspective. According to Gartner Inc., the
global sales of e-procurement software totaled nearly US$1 billion in 2000, rising from US$62
million in 1997 (Rosall, 2002). IDC, a leading provider of technology intelligence and industry
data analysis, has predicted that e-procurement, through a combination of EDI and Internet-based
systems, will grow from US$225 billion in 2002 to about US$1.5 trillion by 2006, a seven-fold
increase (Hamblen, 2002).
Along with the increasing adoption of e-procurement systems, a variety of functions have
been developed to support purchasing activities. For example, e-catalogs aggregate product
information, and reverse auctions and forward auctions match demand and supply. Meanwhile,
e-procurement systems are implemented and operated with different structures in mind to suit
their organizational investors. In some systems, electronic procurement is channeled through
public exchanges; in others, inter-firm transactions are carried out through private networks. For
1
firms that are considering adopting e-procurement systems, the variety of system structures and
the new functionality prompt senior managers to ask a key question: How should firms
differentiate and assess e-procurement channels, and then choose the one that will best meet their
needs?
To address the above question, we examine the features and benefits of e-procurement
systems in supply chain management from the buyer’s perspective, and develop a theoretical
model that is based on prior research in the Economics, IS and Supply Chain Management
literatures, to analyze technology adoption decisions that are faced by senior managers. The next
section characterizes e-procurement systems in terms of two different types: extranets and e-
markets. The latter choice prompts us to state the managerial question in the Shakespearian
terms used in the title of this paper as “To be or not to B2B?” With these words in mind, we
want to emphasize the extent to which a commitment to an e-market approach for procurement is
associated with the Internet and the B2B e-commerce phenomenon. We also want to show the
importance for management to think through the alternatives of e-procurement and to make
appropriate adoption decisions. We also will review related research in Economics, IS and
interorganizational systems (IOS) and supply chain procurement-related e-markets, which lays
the foundation for the model we will build. Our emphasis is on the difference between extranets
and e-markets, and how senior managers should understand them and the related issues in the
larger context of procurement IOS. The third section develops the theoretical constructs and
relationships associated with the basic modeling framework.
The fourth section analyzes firm adoption decisions in the context of the model, and reveals
the conditions under which an e-market is preferred over an extranet. The primary finding from
this research is that a buyer will adopt an e-market approach when the competitive advantage
2
that a supplier gains over its rivals by joining the e-procurement network is modest. A second
important finding is that the buyer will need to have a bigger trading network with an e-market
than with an extranet in order to achieve the highest benefits. Thereafter, we discuss the
managerial implications of our theoretical model and apply our analysis to understand some of
the current industry practices in e-procurement adoption. We conclude with an assessment of the
contributions and implications of this research for both research and practice.
THEORETICAL BACKGROUND
In this section, we briefly review the development of e-procurement systems and discuss the
two forms of e-procurement channels, extranets and e-markets. We also draw on prior research
on IOS to develop the framework for modeling firm decisions in adopting e-procurement
systems.
Extranets and Electronic Markets in E-Procurement
Although the term “e-procurement” was introduced in recent years with the advent of e-
commerce, IS solutions—actually interorganizational information systems (IOSs)—have been
used for corporate procurement since long before the commercial use of the Internet. One
important type of IOS is electronic data interchange (EDI), the business-to-business exchange
of electronic documents in a standard machine-readable format. EDI systems are exemplars of
the early practice of B2B e-commerce and e-procurement, albeit outside the scope of the
technological innovations that are typically associated with the Internet today. The functions of
such EDI systems ranged from simple order entry and invoicing, to product promotion,
document and data sharing, joint product development and even process knowledge transfer
(Johnston and Vitale, 1988; Riggins and Rhee, 1999; Chatfield and Yetton, 2000).
3
More recently, the commercialization of the Internet has brought about Internet-based or
Web-based EDI. Using this mechanism, firms transmit data via the public network infrastructure
for the Internet, instead of value-added networks or VANs (Riggins and Mukhopadhyay, 1999;
Kauffman and Mohtadi, 2003). Another form of Internet-based B2B e-commerce utilizes
another technology-based approach: an extranet, a secure and private, Web-based network,
which provides pre-selected suppliers, customers and other business partners access to the
initiator’s corporate databases, or facilitate collaborative tasks among a group of organizations
(Riggins and Rhee, 1998). Via extranets, firms not only can order and purchase from suppliers,
but they also can share product and sales information with each other.
Moreover, innovative Internet-based exchanges have opened up new intermediated channels
for corporate purchasing. Along with electronic catalogs, electronic auctions and other
capabilities, these exchanges aggregate product and price information, match supply and
demand, and facilitate transactions between buyers and their suppliers (Dai and Kauffman,
2002). Through these online markets, buyers can do one-stop, comparison shopping for
thousands of suppliers and select the best source among them in real-time. They also can
bargain and negotiate with suppliers, place orders, make payments and receive invoices.
These e-procurement systems vary in many aspects, including the underlying technologies
and specific functions. One fundamental feature that differentiates these systems is the openness
of the trading networks they create. For example, Web-based B2B exchanges provide open
networks with potentially larger pools of business partners for their member firms—both more
buyers to reach for orders for each supplier, and more choices among different suppliers for each
buyer. EDI systems are proprietary closed networks: they are only open to pre-selected business
partners, who are able to meet special business process, quality and financial capabilities
4
requirements. In this study, we refer to the Web-based B2B electronic marketplaces as e-markets. In
contrast to e-markets, extranets are closed proprietary electronic trading networks as extranets, and one
instance of extranets are EDI systems. But extranets also include other interorganizational information
systems that provide closed inter-firm trading networks. Table 1 provides some basic comparisons in
terms of the features of the network, the means by which market-making occurs, the extent of
information sharing and the associated implementation costs.
Table 1. A Comparison of Extranets and E-Markets in E-Procurement
DIMENSIONS FOR COMPARISON
EXTRANETS E-MARKETS
Network features Private networks – only open to pre-selected business partners
Open networks – accessible to a large set of potential business partners
Market-making Limited market-making functions and restricted set of trading partners
More market-making functions and easier access to a larger pool of potential partners
Information sharing Both transactional and strategic information can be shared
Mostly transactional information is shared; strategic information is not
Implementation costs High costs to have additional participants in the network
Low costs to add additional participants to the network
Extranets and e-markets differ in the market-making capabilities they offer to participants.
First, many Internet-based market-making capabilities such as online auctions and RFQ’s are
available in e-markets. They tend to lower the buyer’s costs in searching for the right products.
Second, an e-market provides an open online marketplace which makes it easier for the buyer to
identify and develop new suppliers among firms that are not in the buyer’s current supplier set
but are potentially valuable exchange partners. These e-market functions help users with
information processing. This eases the job of finding the right products, although firms may find
these e-market functions beneficial to different degrees under different market situations. For
example, in a market where vendors are selling differentiated products, buyers may have to
spend time and effort to find the desired products and to do comparison shopping. In this case,
5
they will be able to benefit greatly from the rich set of market-making functions and expanded
pool of potential suppliers that e-markets offer. In contrast, in a market where there are a limited
number of suppliers providing commodities, buyers may not need to do extensive search on the
product and price information, and thus the marketplace benefit may not be viewed as important
as in a differentiated market. But, buyers will still enjoy the reduction in time and effort spent on
searching for product and price information via the various market making functions.
The openness of e-markets offers enhanced marketplace benefits, but tends to reduce
information sharing between the buyer and its suppliers. In e-markets, the level of information
sharing between buyers and suppliers will be lower than in extranets due to privacy and security
concerns, or the limitations of the underlying technologies. Transactional information such as
ordering and invoicing data can still be exchanged through online markets just as occurs via
extranets. But suppliers may be unable to obtain very much strategic information about the
buyer, such as the buyer’s inventory level, and may lose access to detailed sales and product data
that are sources of competitive value.
E-markets and extranets do not only differ in the above benefits they offer to participants.
They also differ in the costs required for players to implement and operate the e-procurement
systems. To join in an extranet, for example, a supplier has to invest in proprietary technologies.
Typically, the high system implementation costs will tend to act as a barrier that keeps the
adoption rate of EDI low among small and medium sized firms (Iacovou and Benbasat, 1995).
In contrast, e-markets are built around open standards and the communication infrastructures of
the Internet. As a result, the technology requirements for a supplier to participate can be
obtained at much less expense than the proprietary technologies needed for joining an extranet.
For the same reason, it becomes easier for the buyer to add suppliers to its e-procurement
6
network with an e-market than with an extranet. The cost advantage of e-markets is also
recognized in industry practices. For example, management at Schlumberger Inc., a Texas-based
company that focuses on the oil and gas, energy and utilities, information services and
telecommunications industries, has pointed out that EDI systems required a series of expensive,
one-to-one connections with individual suppliers while a Web-based marketplace connected with
hundreds of suppliers through a single system at a lower cost (Ovans, 2000). In the electronics
industry, firms have noted that the use of the Internet as the infrastructure reduces costs because
there is no need for proprietary hardware and software, such as specialty terminals and software,
along with the higher associated maintenance costs (Giudici, 2000). In addition, another study
found that EDI transactions cost about $8 while Web-based transactions cost only about $1 per
transaction (Kiesel, 2003). This shows that the variable cost of e-markets is lower than extranets.
Regardless of the differences, extranets and B2B e-markets both are designed and
implemented to empower buyers to locate and procure products with the support of computers
and communication networks. They are among the most effective kinds of IOS investments that
we have seen to date, in terms of their capacity to generate value and transform firms and the
marketplaces within which they operate. Hereafter, we will draw on research in IOS to examine
the important aspects of e-procurement systems in general, and then study the differences
between extranets and e-markets along these lines.
Interorganizational Information Systems
Prior research on IOS has studied several issues related to IOS adoption. We briefly review
these studies to lay the foundation for the modeling in the following section. See Table 2.
7
Table 2. A Summary of Procurement-Related IOS Research
ISSUES MAIN FINDINGS REFERENCES
Network externalities and subsidy policy
When more suppliers join an IOS, the buyer’s benefits increase while each supplier’s benefits decrease.
A buyer may offer subsidies to encourage supplier participation.
Riggins, Kriebel and Mukhopadyay (1994); Wang and Seidmann (1995); Barua and Lee (1997)
Determinants of IOS adoption
Perceived benefits, external pressures and organizational readiness positively affect firm intentions to adopt EDI systems
Iacovou and Benbasat (1995); Chwelos, Benbasat and Dexter (2001)
Operational efficiency
IOS generate efficiency by reduced documents processing and transmission time, improved data quality and fewer errors.
Johnston and Vitale (1988); Mukhopadhyay, Kekre and Kalathur (1995)
Marketplace benefits
IOS create electronic marketplaces that lower search costs; B2B electronic markets enable firms to find better deals.
Bakos (1991); Garicano and Kaplan (2001)
Information sharing
In addition to transactional information, inventory levels, sales data and demand forecasts may be shared that enable suppliers to better schedule production.
Product design information can be shared and suppliers can accumulate expertise about market and product.
Suppliers offer incentives to buyers in exchange for the strategic information.
Seidmann and Sundararajan (1997); Riggins and Rhee (1999); Lee and Whang (2000); Chatfield and Yetton (2000); Lee, So and Tang (2000); Mohtadi and Kauffman (2003)
The IOS adoption literature offers theoretical models to analyze the impact of technology-
based procurement solutions on the system initiators and participants, as well as managerial
guidance related to how they should be implemented and managed. Riggins, Kriebel and
Mukhopadhyay (1994) developed a two-stage economic model that characterizes how a buyer’s
subsidy strategy can be leveraged to expand its IOS network. They argued that in an IOS
network, the benefit of participating suppliers decreases as more suppliers join in. This effect is
referred to as negative externalities, and tends to stall adoption by suppliers. To overcome this
8
stalling problem, the buyer must be willing to subsidize suppliers as long as it can gain additional
benefits by having an additional supplier in the network. Besides the negative externalities,
Wang and Seidmann (1995) took into account the positive externalities that the buyer, the IOS
network initiator, enjoys from supplier adoption. They modeled the benefit of EDI as reducing
transaction costs for the buyer, and pointed out that partial adoption by the suppliers may be
optimal for the buyer when the supplier adoption cost is sufficiently high. Their study also
shows that non-adopting suppliers lose market share to adopting suppliers as the buyer shifts its
orders from non-adopters to adopters. Other aspects of the IOS adoption problem have been
studied by Barua and Lee (1997), who built a Stackelberg model to analyze firm strategy for the
introduction of an EDI system in a vertical market involving one manufacturer and two
suppliers. They focused on the timing of adoption by the two suppliers when the buyer employs
penalty and subsidy policies.
Although the theoretical models investigate adoption strategies, the IOS adoption literature
also offers many empirical studies that examine the determinants of adoption decisions. One
such study is by Iacovou and Benbasat (1995), who developed a conceptual framework to
examine the major factors that influence EDI adoption practices. The authors identified three
relevant factors: perceived benefits, external pressure, and organizational readiness. Chwelos,
Benbasat and Dexter (2001) extended this model with sub-constructs for the three factors and
empirically tested the model. In their extension, a construct for “external pressure” is
conceptualized as a combination of pressures from competitors and their trading partners. On
the basis of a survey of 268 responses, they found that all these three factors had significant
positive effects on firm intentions to adopt EDI systems. In a similar vein, we next will discuss
9
the various benefits that senior managers believe they will be able to obtain by adopting IOSs in
supply chain management.
In this business context, IOSs generate efficiency benefits for both buyers and suppliers
through reduced flow time and costs of document generation and transmission, improved data
integrity and fewer errors (Johnston and Vitale, 1988). Mukhopadhyay, Kekre and Kalathur
(1995) reported on an empirical analysis of the effects of Chrysler Corporation’s adoption of EDI
systems. Their results show that the firm obtains approximately $100 in savings per vehicle,
attributable solely to electronic document preparation and better information exchange. These
savings come from reducing inventory holding costs, obsolete inventory costs and transportation
costs. By receiving order information that is directly entered by buyers, suppliers can reduce the
costs of order entry and at the same time capture data more quickly. The response time for
feedback on product availability and price will also be reduced.
In addition to the efficiency gains from reduced order processing costs, firms can also benefit
from the market-making capabilities of IOS. Bakos (1991) has argued that IOS networks create
electronic marketplaces that function as intermediaries between buyers and sellers. An important
feature of these electronic marketplaces is that they reduce search costs that buyers must pay to
obtain the product and price information, which, in turn, enables buyers to search more to locate
desired products and lowers the average seller prices. While Bakos (1991) analyzed the market
making benefits of IOS conceptually, Garicano and Kaplan (2001) conducted an empirical study
on the costs of inter-firm transactions on an Internet-based electronic marketplace. They
measured the costs of purchasing used cars on an Internet-based marketplace and reported that
buyers are able to get products that better meet their needs on the Internet than from a physical
10
market. This benefit is referred to as a marketplace benefit since it comes from the capabilities
of an electronic marketplace in matching demand and supplier at lower costs.
Although IOSs were first designed to facilitate inter-firm purchasing transactions
electronically, they also have been deployed to share other types of information in a more timely
and efficient manner so that better decisions can be made (Lee and Whang, 2000). More
specifically, a buyer can share its data about inventory level, sales or POS, and sales forecast
with a supplier. Such information typically is not meant to support transactions between buyers
and suppliers as the transactional information, but instead enables a supplier to obtain a more
timely and accurate forecast about market demand and buyer performance. As a result, the
supplier is able to better respond to market opportunities and earn a competitive advantage over
its rivals who do not have such information (Seidmann and Sundararajan, 1997). Moreover, with
the electronic communication functions of IOS, complex and detailed product design information
also can be transferred between buyers and suppliers, enabling joint product design and
development (Chatfield and Yetton, 2000). Suppliers participating in extranets will be able to
accumulate expertise about market demand and product features, which usually leads to product
innovation and market expansion (Riggins and Rhee, 1999). Such information benefits the
supplier strategically instead of operationally, and thus is referred to as strategic information.
However, the buyer does not gain much by just sharing such information, and thus the
supplier will need to provide incentives to entice the buyer to share its demand information. One
common practice is to enter into programs that aim to reduce the buyer’s overhead and
processing costs, or the replenishment lead time (Lee, So and Tang, 2000). For example, “quick
response programs” require the supplier to react quickly to the buyer’s orders with a small
amount of inventory and reduce the lead time for replenishing the buyer’s inventory. However,
11
reducing lead time will tend to increase the supplier’s logistics, inventory holding and storage
costs (Lee, So and Tang, 2000). Viewed this way, the supplier is actually making an investment
that mostly will benefit the buyer, with the result that the supplier internalizes as part of its own
costs.
In summary, IOSs generate several benefits for firms. By conducting transactions with them,
firms achieve efficiency benefits and marketplace benefits. By sharing strategic and proprietary
information, suppliers obtain competitive advantage over rivals while buyers get relationship-
specific investment from suppliers. However, in prior research, these benefits and their effects
on adoption practices have been studied in the context of just one type of IOS: EDI systems. But
e-procurement systems vary in their technical designs and organizational structures, and senior
managers need guidelines to distinguish and choose among the various types of e-procurement
channels. For this purpose, we develop a formal model to analyze decisions about how to adopt
the appropriate e-procurement channel in the next section.
A BUYER-FOCUSED MODEL FOR E-PROCUREMENT CHANNEL ADOPTION
The adoption of e-procurement systems requires the participation of multiple firms. Among
them, certain firms will act as initiators by selecting the procurement channel and strongly
encouraging their business partners to adopt the related technology. We examine the adoption of
e-procurement systems from a single buyer’s perspective. In this context, the buyer plays the
role of an initiator, while suppliers act as followers. For example, Chrysler launched its EDI
program in 1984 and, according to Mukhopadhyay, Kekre and Kalathur (1995), almost all its
suppliers adopted this network by 1990. Wal-Mart is another good example here; it runs a proprietary
network and asks its suppliers to link with this network (Karpinski, 2002). More recently, when big
corporate buyers started to move to online markets, they also requested specific suppliers to
12
participate and make their systems compliant to make the solution viable. Schlumberger Inc.,
which we referred to earlier in this article, for example, asked its suppliers to participate in
CommerceOne’s MarketSite when MarketSite was chosen as the purchasing channel for
Schlumberger’s office supplies (Ovans, 2000).
In the following analysis, we model the case of a single buyer with its multiple suppliers.
Assume that the buyer has N suppliers and initiates the implementation of an e-procurement
system. That is, the buyer will define the technical and business characteristics of the system,
and must make a choice between two different alternatives: a proprietary extranet and an e-
market mechanism. In addition, the suppliers will decide whether to join the buyer’s network, so
a sequential decision will be involved. To participate, a supplier must make an aggregate
investment, c, in the software, hardware and telecommunication network so that it can exchange
documents and information electronically with the buyer. For example, in the case of traditional
EDI systems, the supplier has to subscribe to a VAN to be linked with the buyer’s system. The
aggregate investment reflects both fixed and variable costs that a supplier has to incur in order to
set up the electronic linkage with the buyer’s e-procurement network. At the same time, the
supplier will enjoy efficiency benefits, e, that include reduced data entry and order processing
costs due to electronic communications with the buyer. (For reference, the reader should see
Table 3, which includes definitions for all of the notation used here and later in this article.)
13
Table 3. Modeling Notation Summary
NOTATION DEFINITION a Supplier’s competitive advantage when the first supplier joins the
e-procurement system r Buyer’s operational efficiency c Supplier’s system implementation costs g Buyer’s variable marketplace benefits e Supplier’s operational efficiency i Supplier relationship-specific investment costs UBuyer Buyer’s net benefits with an e-procurement system
JoinSupplierU Supplier’s net benefits when it joins the e-procurement network NoJoinSupplierU Supplier’s net benefits when it does not join the e-procurement
network },...,1{ Nn∈ Number of suppliers participating in the e-procurement network,
out of the total N suppliers with the buyer f(n,N) Negative externality ratio, which reduces the supplier’s competitive
advantage as the number of participants increases h(.), h0, h1 The buyer’s total, fixed, and variable system implementation costs s Subsidy level for adoption XNT, EMKT Superscripts to denote selection of extranet, XNT, or e-market,
EMKT, respectively, applied to various parameters in the model.
As discussed in the previous section, the supplier also enjoys a competitive advantage that is
derived from the more timely access to strategic information via the electronic communication
with the buyer. Such benefits decrease as the number of participating suppliers increases since
more suppliers have better access to the information. So every participant’s advantage over
other non-participants will be reduced. Let a represent the supplier’s competitive advantage
when the first suppler joins the e-procurement system. As the number of suppliers increases,
each supplier’s competitive advantage decreases by the negative externality ratio, f(n, N), which
is a function of the number of participants, n, and the total number of suppliers in the e-
procurement network, N. We view N as a given parameter and so do not discuss its effect. Thus
altogether, a supplier will expect to get benefits equal to aNnfe ⋅+ ),( by joining the e-
procurement network.
14
Along with increased information sharing via an IOS, buyers and suppliers may enter into
programs that involve other efforts and gains that are made at the interorganizational level. One
instance is vendor-managed inventory (VMI), a program by which the supplier manages the
buyer’s inventory and schedules replenishment and delivery, essentially bearing the inventory
management costs for the buyer. Such programs shift the costs and benefits between the buyer
and its suppliers. In the context of e-procurement where the buyer defines the system
characteristics, we represent these as an investment cost i on the supplier side which benefits the
buyer. More specifically, the supplier takes time and effort in monitoring and managing the
buyer’s inventory, and even holds safety stock to secure supply. Such investment is spent
specifically for the buyer and can not be recovered or redeployed easily for other customers,
although the experiences and knowledge obtained can be applied to other situations. As a result,
we will refer to it as a supplier relationship-specific investment. A supplier may incur such a
cost over time, but in our discussion here, we aggregate the ongoing cost for the relationship-
specific program and represent it as one cost variable for the supplier. Therefore, when a
supplier considers whether to join, the net benefits it perceives are given by:
(1) ciaNnfenU JoinSupplier −−⋅+= ),()(
The superscript Join on the net benefits of the subscripted Supplier represents the case in which
the supplier joins the e-procurement network.
In contrast, if the supplier does not join the e-procurement network, it will not incur the costs
for setting up the systems, nor does it gain the efficiency benefits. However, it will be at a
disadvantage to other participating suppliers. For example, it will not have access to as timely
and as accurate information as other suppliers do via the electronic communication networks of
the e-procurement system. To contrast this situation with the competitive advantage of
15
participating suppliers, we represent such competitive disadvantage as aNnf ⋅− ),( . This is the
perceived loss of not joining, represented as
aNnfnU NoJoinSupplier ⋅−= ),()( , (2)
where the superscript NoJoin represents the case that the subscripted Supplier does not join the
e-procurement network.
As the initiator, the buyer makes significant investments in designing and implementing the
e-procurement system. In addition to the up-front costs, the buyer will incur marginal costs as
suppliers join the network, including additional communication linkages and data processing
expenses. We represent such costs as an increasing function of the number of suppliers, n,
participating in the network, nhhnh ⋅+= 10)( where h0 > 0 and h1 > 0.
The buyer will obtain operational efficiency by implementing the e-procurement system in
the form of reduced inventory costs and ordering costs, and this efficiency gain increases with
the number of suppliers who join in the network. Representing the buyer’s gains from
operational efficiency, r, when an additional supplier joins the network, we get the total
efficiency benefits for the buyer, rn ⋅ . Moreover, the buyer benefits from the effort that a
participating supplier makes in such bilateral programs as VMI. Such effort is represented as the
supplier relationship-specific investment, i, and is directly transferred from the supplier to the
buyer, indicating that the buyer obtains a benefit i from the supplier. In the case of VMI, to the
buyer, this benefit factor i represents the reduced variable cost in inventory control. As the buyer
is able to get such a benefit from each supplier participating in the network, it will gain in ⋅ in
total this way. If all suppliers enter into the VMI program with the buyer, the buyer may be able
to eliminate all inventory control costs including the fixed cost of running a warehouse.
Another possible source for the buyer’s benefit is the e-procurement’s function as an
16
electronic marketplace that enables the buyer to meet its demands with less effort and time,
through, for example, electronic RFQs or electronic tendering. When there are many suppliers using the
e-procurement network, the buyer is able to gain big cost savings by using these electronic mechanisms to
find desired products. The more participants in the e-procurement system, the more opportunities
the buyer has to find desired products at lower costs. As a result, the marketplace benefit is
represented as an increasing function of the number of participating suppliers, , where g >
0. As a whole, the net benefit that the buyer expects to achieve by implementing an e-
procurement system is then given by:
ng ⋅
)()( nhnginrnnU Buyer −⋅+⋅+⋅= (3)
In summary, our model is set up to examine the e-procurement channel adoption of a single
buyer that purchases its supplies from a set of N suppliers. The buyer initiates and operates the
e-procurement channel, by incurring a system implementation cost which is a linear function of
the number of participating suppliers. A supplier also incurs an aggregated system
implementation cost if it chooses to join the e-procurement network. With the electronic linkage,
the buyer and the supplier may enter a program such as VMI by which the supplier makes an
effort specifically for the buyer. This is a relationship-specific investment that the supplier
makes, and such effort is represented as a direct benefit transfer from the supplier to the buyer.
If a supplier chooses to stay out of the buyer’s e-procurement network, it still will have the
business from the buyer although it is at a disadvantage to the suppliers who join in the e-
procurement network.
We illustrate the various benefits and costs in Figure 1 for buyers and suppliers. The reader
should note that we have chosen to represent the factors related to e-procurement systems
without incorporating market demand for products and their related sales volume and effects
17
explicitly in our model. We recognize that the effect of sales volume could be reflected in the
buyer and supplier efficiencies; for example, the higher the volume, the larger the efficiency
benefits. This would permit us to derive implications about the effect of sales volume based on
the obtained efficiencies related to e-procurement adoption decisionmaking. However, through
the modeling approach that we have chosen, we are able to examine some other major aspects of
the complex e-procurement adoption decision processes that we feel are critical to include in a
representative model, while achieving insights about some of the other value tradeoffs for
decisionmaking that appeared important to us.
Figure 1. The Benefits and Costs of E-Procurement Systems
Supplier: • Efficiency: e • Competitive
advantage: f(n,N)⋅a • Implementation
cost: c
Buyer: • Efficiency: r • Marketplace
benefit: g⋅n • Implementation cost:
h(n)=h0+h1⋅n
Supplier decisions: • Join vs. No Join • Whether to make a
relationship–specific investment i
Buyer decisions: • Network size • Extranet vs. e-market
• Supplier makes the buyer relationship-specific investment i;
• The buyer benefits from the supplier’s investment i
ANALYSIS OF THE BUYER’S ADOPTION DECISION
In this section, we analyze the basic model to reveal the factors in the e-procurement
adoption decision making process. In the following analyses, we define the negative externality
ratio f(n, N) in the following format based on its aforementioned characteristics:
1),(
−−
=N
nNNnf . This way the ratio decreases when more suppliers join in the e-procurement
network, reducing the competitive advantage each participant enjoys. And when the first
18
supplier joins, the negative externality ratio is f(1, N) = 1, and so the participating supplier
obtains the competitive advantage a. We first derive the maximum net benefits for e-
procurement systems in general, and then examine the differences between extranets and e-
markets. Finally, we analyze the buyer’s subsidy policy in promoting supplier adoption.
Adopting an E-Procurement System
Here, we will examine the benefits of e-procurement systems in a general and
undifferentiated format. The results and insights will be applicable to any e-procurement
channel, including both extranets and e-markets. The scenario we study occurs when the buyer
initiates an e-procurement system by announcing to its suppliers the opportunity to participate in
the network. The suppliers decide whether to join based on their own perceived net benefits.
The buyer recognizes that suppliers will estimate their own net benefits, and accordingly, it
estimates its own net benefits and determines the optimal size of its e-procurement network.
For one supplier to join when there are already n –1 suppliers in the e-procurement system,
its perceived net benefit should be greater than when it does not join: .
Substituting Equations 1 and 2 for and yields:
)1()( −≥ nUnU NoJoinSupplier
JoinSupplier
)(nU JoinSupplier )1( −nU NoJoin
Supplier
aNnfciaNnfe ⋅−−≥−−⋅+ ),1(),( (4)
Further substituting 1
),(−−
=N
nNNnf in Equation 4 we get cN
nNaei −−
+−⋅+≤
1122 . Thus, the
maximum possible relationship-specific investment that a participating supplier will make for the
buyer is:
cN
nNaei −−
+−⋅+=
1122 (5)
Recognizing this condition, the buyer can estimate its own net benefit with n suppliers in the
e-procurement channel:
19
cnnhhN
nNanenngrnngnhinrnnU Buyer ⋅−⋅+−−
+−⋅⋅+⋅+⋅+⋅=⋅+−⋅+⋅≤ )(
1122)()( 1 (6)
So, the buyer obtains maximum benefit when it has n* adopting suppliers:
412)(
41)(
41)}({maxarg 1
0
* +++
−−++
−=≡
≤≤
Ncha
Ngera
NnUn BuyerNn
(7)
The second order derivative of Equation 6 with respect to the number of adopters, n, is
14
2
2
−−=
∂
∂
Na
nU Buyer . Considering that and N > 1, the second derivative0>a 02
2
<∂
∂
nU Buyer . This
is a sufficient condition for the optimal supplier network size n* to hold.
Note that the result in Equation 7 is obtained based on the condition for supplier
participation, . Later by Proposition 5, we will explain the case
when this supplier participation condition is not satisfied at the optimal network size n
)1()( ** −≥ nUnU NoJoinSupplier
JoinSupplier
*.
Substituting n* in the buyer net benefit function depicted in Equation 6, we represent the
maximum net benefit for the buyer as:
cnnhhN
nNaegrnnU Buyer ⋅−⋅+−⎥⎦
⎤⎢⎣
⎡−
+−⋅+++⋅= **
10
*** )(
1)122()( (8)
Equation 7 shows that the size of the e-procurement network increases with the variable
efficiency gains and marketplace benefit for the participants, while decreasing with the variable
costs and supplier competitive advantage. When the competitive advantage for joining the e-
procurement system is great, suppliers will find it more beneficial and thus will be willing to
make more relationship-specific investments for the buyer. The result is that the buyer is able to
achieve greater net benefits with fewer participating suppliers. On the other hand, the buyer’s
costs in operating the system as the initiator will increase with the number of participants. Hence
the optimal size of the e-procurement network will be smaller.
20
Choosing Between an Extranet and an Electronic Market
We remind the reader that the basic model that we outlined above is intended to represent e-
procurement systems in general. Next, however, we will apply it to discuss the differences
between extranets and e-markets. We will use the superscript XNT to represent extranets, and
EMKT to represent e-markets.
As discussed earlier, extranets and e-markets differ in the market-making capabilities they
offer to participants. E-markets offer electronic tendering, e-RFQs and auctions to reduce the
time and effort that the buyer takes to locate desired suppliers and products. Although some
extranets also take advantage of the Internet to offer these functions, extranet solutions tend to
emphasize information sharing. Their functions for matching the buyer’s demand with available
supplies tend to be limited compared with e-markets. In our model, such differences are
captured by the higher variable marketplace benefit in an e-market than in an extranet, .i.e.,
. Extranets and e-markets also provide different levels of support for sharing
information between the buyer and its suppliers. As a result, the supplier’s competitive
advantage relative to its rivals will be less with an e-market compared to what it can achieve with
an extranet, i.e., .
XNTEMKT gg >
XNTEMKT aa <
In addition to the above benefits, extranets and e-markets also differ in terms of the costs
required for the participating firms to implement and operate an e-procurement system. In the
second section, we showed that a supplier typically will bear a lower system implementation cost
to join an e-market than an extranet, i.e., . Similarly, the variable cost for the buyer
will also be lower with an e-market approach than with an extranet, i.e., .
XNTEMKT cc <
XNTEMKT hh 11 <
We notice that when an additional supplier joins the e-procurement system, the buyer incurs
the variable cost h1 and the supplier incurs cost c. So, we refer to the sum of h1 and c as the
21
variable cost of the e-procurement channel, or the variable e-channel cost, and represent it by β.
Similarly, we will refer to the sum of the efficiency gains, r + e, when a supplier joins, as the
variable e-channel efficiency. Following the same logic, we refer to the sum of the variable e-
channel efficiency, er + , and the variable marketplace benefit g as variable e-channel benefit,
representing it by α. Moreover, we define the variable e-channel net benefit as the difference
between the variable e-channel benefit α and the variable e-channel cost β, and represent it by ν
as in the following equation:
)( 1 chger +−++=−= βαν (9)
Considering the above differences, and assuming that the buyer and suppliers achieve the
same efficiency gains with the two approaches, we can examine the optimal e-procurement
channel adoption choices from the buyer’s perspective.
PROPOSITION 1 (THE BUYER’S NON-E-PROCUREMENT ADOPTION PREFERENCE PROPOSITION). When the variable e-channel net benefit is negative and can not be offset by twice of the supplier competitive advantage, i.e., 02 ≤+ aν , the optimal choice for the buyer is to not to adopt e-procurement networks.
Proof. Considering that )( 1 chger +−++=ν , we transform the optimal network size n*
into the following format:
⎟⎠⎞
⎜⎝⎛ ⋅
−+
+⋅−
=+
+⋅−
= aNN
aNN
aNn
112
41
412
41* νν (10)
We notice that 2112≈
−+
NN , so we will use this approximate value in this proof.1
1 There are two reasons that we can use this approximation in the following analysis. First, since we consider the supplier base N as a fixed number, the formula
112
−+
NN is a constant and will not affect our
derivative analysis. Second, we can see that 2112lim =
−+
∞→ NN
N, and also that large buyers tend to transact with
tens or hundreds of suppliers. Considering these two factors, we believe that there will not be any inappropriate biases introduced into our analytical results by approximating
112
−+
NN with the number 2.
22
Then, equation 10 can be represented as follows:
( aa
Nn 24
1* +−
= ν ) (11)
When 02 ≤+ aν , Equation 11 tells us that , indicating that the optimal network size is
less than or equal to zero. That is, for the buyer, the best choice is to have no e-procurement
network. ٱ
0* ≤n
Proposition 1 shows that if the variable e-channel net benefit is negative and its value cannot
be offset by twice the value of the supplier’s competitive advantage, then it is to the buyer’s
benefit not to adopt an e-procurement network. However, when e-procurement systems bring
about sufficient efficiency gains, marketplace benefits or supplier competitive advantage, the
buyer will find it beneficial to adopt. Next, we will analyze how the buyer chooses between e-
markets and extranets. The first issue we examine is the difference between an e-market and an
extranet in terms of the optimal network size.
PROPOSITION 2 (THE BUYER’S OPTIMAL E-PROCUREMENT NETWORK SIZE PROPOSITION). When the variable e-channel net benefit is positive, i.e., ν > 0, the optimal e-procurement network size for the buyer will be larger with an e-market than with an extranet.
Proof. Using Equation 7, we obtain the following derivatives:
,0)(4
112
*
<−−++⋅−
−=∂∂ hcger
aN
an since ν > 0 ⇒ 0)( 1 >+−++ hcger ;
04
1*
>−
=∂∂
aN
gn ; 0
41
1
*
<−
−=∂∂
aN
hn ; and 0
41*
<−
−=∂∂
aN
cn .
This indicates that the optimal size of the e-procurement network in terms of the number of
supplier participants n* increases with g, while decreasing with a, h1, and c. Meanwhile,
, , , and . As a result, , XNTEMKT aa < XNTEMKT gg > XNTEMKT hh 11 < XNTEMKT cc < ∗∗ > XNTEMKT nn
23
indicating that an e-market will have more participants than an extranet for the buyer to be able
to achieve maximum benefit. ٱ
Proposition 2 shows that, as long as the variable e-channel benefit is great than the variable
e-channel cost, at the optimum there are more suppliers in the e-procurement network with an e-
market than with an extranet. Figure 2 illustrates how the buyer’s net benefit changes with the
number of participating suppliers. With an e-market, when one more supplier joins the network,
the additional system implementation costs are lower, and the competitive advantage that
participating suppliers enjoy over their rivals erodes less. As a result, the buyer is both willing
and able to have more suppliers in its e-market than in an extranet. Moreover, 0*
<∂∂
an
indicates that with an extranet a single supplier obtains a higher competitive advantage a by
joining in the trading network. Thus, the supplier is willing to make a larger relationship-
specific investment i for the buyer. As a result, the buyer is able to gain more benefits from one
single supplier and can maximize its net benefit with fewer suppliers considering that system
implementation costs increase with the number of participating suppliers.
24
Figure 2. Analysis of the Buyer’s Net Benefit in Terms of Network Size, UBuyer(n)
n nEMKT*nXNT*
UBuyer(n))(nU EMKT
Buyer)(nU XNTBuyer
But whether the buyer adopts an extranet or an e-market depends on its net benefits. In other
words, the buyer will prefer an e-procurement channel that gives it the greatest opportunity for
gain. As we discussed earlier, extranets and e-markets differ in terms of the buyer’s variable cost
and marketplace benefits, and the supplier competitive advantage and implementation costs.
Hence, it makes sense to examine how the buyer’s net benefit, UBuyer(n*), will change with these
factors. This will permit us to find out when a buyer ought to prefer an e-market to an extranet,
and vice versa. Our analysis leads to the following proposition.
PROPOSITION 3 (THE BUYER’S E-MARKET ADOPTION GENERAL PREFERENCE PROPOSITION). The buyer will prefer an e-market to an extranet when ν≤≤ a0 , i.e., the supplier’s competitive advantage is positive but not greater than the variable e-channel net benefit.
(See Appendix for proof.)
We next illustrate the buyer adoption preferences visually in Figure 3.
25
Figure 3. Analyzing the Buyer’s Adoption Preferences
ν
0 ≤ ν < a
0
4
32
0 < a ≤ ν
1
General E-Market Adoption Preference
Non E-Procurement Adoption Preference
0 ≤ -ν/2 < a
0 ≤ a ≤ -ν/2
Contingent Extranet Adoption Preference
a
In the figure, the vertical axis is the supplier’s competitive advantage, a, and the horizontal
axis represents the variable e-channel net benefit ν. In the scenario that proposition 3 depicts,
ν≤≤ a0 indicates that the firms are performing in the scope of Area in Figure 3. The
buyer’s net benefit increases with the variable marketplace benefit g, and decreases with the
supplier’s competitive advantage a and the variable e-channel cost, h1 + c. Meanwhile,
, , , and , and hence the buyer will obtain
a higher net benefit with an e-market than with an extranet. In Figure 3, the region labeled as
Area shows the scenario
XNTEMKT aa < XNTEMKT gg > XNTEMKT hh 11 < XNTEMKT cc <
2/0 ν−≤≤ a , which is a subset of what the Buyer’s Non-E-
Procurement Adoption Proposition (P1) describes. Hence, if firms operate under this condition,
then they will tend to stay with the traditional non-electronic procurement channels.
Although the buyer will certainly prefer an e-market to an extranet as an e-procurement
channel when the supplier competitive advantage is less than the variable e-channel net benefit,
its preference will not be so clear in other cases. When 0≥>νa , labeled as Area in Figure
3, if the buyer adopts the e-market instead of an extranet, its net benefit is reduced by the lower
26
supplier competitive advantage while being increased by a higher variable marketplace benefit
and lower channel cost. The same is true when 02≥−>
νa , which falls in Figure 3’s Area .
Therefore, in these cases, the buyer will choose between an e-market and an extranet depending
on the impact of supplier competitive advantage relative to the combined effect of variable
marketplace benefit and channel cost. This result is summarized as follows:
PROPOSITION 4 (THE BUYER’S CONTINGENT EXTRANET ADOPTION PREFERENCE
PROPOSITION). When 0≥>νa or 02≥−>
νa , the buyer will prefer an extranet to an
e-market, if the impact of supplier competitive advantage is bigger than the combined effect of the variable marketplace benefit and the variable e-channel cost.
(See Appendix for this proof.)
Proposition 4 states that when the supplier enjoys a high competitive advantage and this
factor has a big impact on the e-procurement channel benefits, the buyer will tend to prefer an
extranet. Specifically, the first condition, 0≥>νa , says that the supplier competitive
advantage is greater than the variable e-channel net benefit when the latter is positive. The
second condition, 02≥−>
νa , states that the supplier competitive advantage is greater than half
of the variable e-channel net benefit if the latter is negative. When either of these two conditions
is satisfied, the buyer tends to favor an extranet over an e-market if the change in the supplier’s
competitive advantage also has a greater impact on the buyer net benefit than the changes in
marketplace benefit and e-channel cost.
The above analyses show that the buyer’s adoption preference for e-procurement systems is
contingent on relative value and impact of the various benefit and cost factors that the systems
bring about. In short, an e-market is more appealing to a buyer when the supplier’s competitive
advantage is modest compared to the variable e-channel net benefit. But, when the supplier’s
27
competitive advantage is significant and also has a big impact on the buyer’s net benefit, an
extranet will turn out to be more beneficial to the buyer. The supplier’s competitive advantage
comes from sharing strategic information and the e-channel benefits are based on the improved
efficiency in searching for desired vendors and supplies. Hence, the Buyer’s E-Market
Adoption General Preference Proposition (P3) and the Buyer’s Contingent Extranet Adoption
Preference Proposition (P4) imply that the buyer will find an e-market more beneficial when the
e-procurement channel offers big cost savings for the transaction processes while the supplier
obtains a relatively small gain from access to the strategic information via the e-procurement
channel. However, if the supplier has a big stake in the strategic information while efficiency
gains is relatively small by using the e-procurement channel, then an extranet turns out to be the
choice.
Buyer’s Subsidy Policy
To understand the buyer’s strategy for promoting e-procurement adoption among suppliers,
we now return to the basic model for the undifferentiated e-procurement system. A supplier
joins an e-procurement system only when it is better off by joining than not joining, as shown by
Equation 4. However, when the supplier has to bear a high cost or its efficiency gain and
competitive benefits are so low that it finds itself worse off by joining the network than not
joining even when it does not make any relationship-specific investment for the buyer, it will
choose to stay out of the buyer’s e-procurement system. As a result, the size of the e-
procurement network will be affected in the manner described in the following proposition:
PROPOSITION 5 (THE SMALLER UNSUBSIDIZED NETWORK PROPOSITION). In the absence of a subsidy, the e-procurement network size will be smaller when
ceaNNhgr −+−+
>−+112
1 than the optimal size from the buyer’s point of view.
(See Appendix for proof.)
28
The sum (r + g – h1) is the increase in the buyer’s net benefit and the sum ceaNN
−+⋅−+112
is the increase in a supplier’s net benefit, when the supplier joins the e-procurement network
without making any relationship-specific investment for the buyer. In other words, r + g – h1 is
the marginal net benefit for the buyer, and ceaNN
−+⋅−+112 is the marginal net benefit for the
supplier. The intuition for Proposition 5 is that when the buyer’s marginal net benefit is greater
than the supplier’s marginal net benefit in joining the e-procurement network, then the network
will shrink if the buyer does not subsidize participating suppliers. In this situation, since the
buyer’s net benefit reaches its maximum with a network size of n*, the buyer will get a smaller
net benefit from implementing the e-procurement system with any participation that is less than
this maximum.
In this case, to expand its e-procurement network, the buyer may force the suppliers to join
by stopping doing business with those who refuse to participate in the network. This is referred
to as a mandatory policy, and it indicates that the buyer transacts only with suppliers that are in
its e-procurement network. Some companies may employ such a strategy to promote e-
procurement adoption among suppliers. However, we observe that not all of a firm’s suppliers
typically are participating in its e-procurement network. According to an InformationWeek
(2001) survey, among 500 US companies that are large and innovative users of information
technologies, a company had only 39% of its suppliers joining its electronic supply chain in
average. This means that even powerful buyers may be unable to get all of their suppliers into
their e-procurement networks, and still must do business with those that do not join their e-
procurement networks. This survey tells us that companies are using other strategies than a
mandatory policy to encourage the adoption of e-procurement channels. In this case, companies
29
either do nothing or employ a subsidy policy (Neef, 2001). We have shown the case without
subsidy, and next, we will examine the case when the buyer subsidizes the suppliers. In this
study, we have assumed that suppliers are homogeneous and do not act strategically in joining
the buyer’s e-procurement network. In this situation, the buyer’s subsidy policy is described in
the following proposition.
PROPOSITION 6 (THE BUYER-SUBSIDIZED NETWORK SIZE PROPOSITION). Provided
that ceaNNhgr −+−+
>−+112
1 , the buyer will be able to achieve the optimal network
size with a subsidy )1(2
12)(21
1 −+
⋅−−−++≥NNahecgrs per participating supplier.
(See Appendix for proof.)
Proposition 6 states that the buyer can make the e-procurement network reach its optimal size
by subsidizing its suppliers. In order to reach the optimal network size, the buyer has to offer a
subsidy at least as high as )1(2
12)(21
1 −+
⋅−−−++=NNahecgrsL . The minimum subsidy is ,
which is half of the difference between the buyer’s marginal net benefit and the supplier’s
marginal net benefit. If the subsidy is below this threshold, the buyer will not be able to get as
many suppliers to participate in its e-procurement network as in the optimal scenario. With the
minimum subsidy, suppliers will not make any relationship-specific investments. In addition,
the buyer’s maximum possible net benefit, U
Ls
Buyer(ns*), remains the same as the case where no
subsidy is provided because the subsidy offered to the suppliers is paid back to the buyer via
suppliers’ relationship-specific investments i when optimal participation occurs. So, the subsidy
strategy enables the buyer to achieve the optimal network size and net benefit. Proposition 6
also suggests that the buyer can determine the level of subsidy according to how much
relationship-specific investment it expects to obtain from the supplier.
30
DISCUSSION
We now consider some of the managerial implications from the analyses of our model, and
discuss the effects that the various factors have on e-procurement adoption practices. These
include the e-procurement network size, the effects of information sharing, how product
characteristics influence channel choices, and the management of e-procurement channel
portfolios. As a whole, our analysis provides guidelines for assessing, selecting and even
designing the e-procurement channels.
Network Size
One important issue related to e-procurement adoption is the size of the trading network and
how that directly affects the net benefits of the initiator and the participants. Our model shows
that the optimal network size for the buyer increases when the variable channel efficiency and
marketplace benefit increase, or the channel cost and supplier competitive advantage decrease.
As a result of these effects, the buyer will want to have more suppliers joining an e-market than
an extranet. Moreover, our model also shows that with either an extranet or an electronic
market, an individual supplier’s relationship-specific investment and competitive advantage are
unambiguously higher when only a few suppliers participate in the electronic connection.
Therefore, a buyer who desires a bigger relationship-specific investment from particular
suppliers will prefer a smaller network.
Information Sharing Effects
In examining the characteristics of e-procurement channels, we find that e-procurement
systems can be deployed to share strategic information and support collaboration between buyers
and suppliers. Better access to such information enhances the supplier’s competitive advantage
(i.e., a high level of a) over its rivals, and in turn, increases the relationship-specific investment
31
that the supplier is willing to make for the buyer (i.e., a high level of i). In this case, the buyer
and the supplier maintain a collaborative relationship which is characterized by a high level of
information sharing and coordination. In addition, the supplier competitive advantage derived
from a high level of information sharing tends to have a big impact on the benefits that the buyer
and the supplier can obtain from adopting e-procurement channels. Thus, according to
Proposition 4, the buyer will find an extranet more beneficial than an e-market. In contrast, if the
buyer keeps a transactional relationship with the supplier in a manner that only transactional
information is exchanged, the competitive advantage that the supplier can obtain is low. As a
result, the buyer is more likely to prefer an e-market as described by Proposition 3. Therefore,
management ought to carefully consider the nature of buyer-supplier relationship when choosing
e-procurement channels.
One related industrial practice involves manufacturing processes2. With a make-to-stock
(MTS) process, a buyer manufactures and stocks its products before serving its customers from
end-product inventory, and thus it purchases its supplies in large batches based on sales
forecasts. In contrast, with a make-to-order (MTO) arrangement, a buyer manufactures its
products after a customer order has been received and accepted and, as a result, the purchasing
needs are more uncertain. In this case, the buyer tends to have more coordination with suppliers,
and requires suppliers to be more responsive and flexible so that orders can be delivered with
right quantity at right time. Such requirements are reflected in our model as a high level of
supplier relationship-specific investment i and competitive advantage a attributable to close
coordination, which characterize a collaborative supply chain management relationship.
2 We are grateful to an anonymous reviewer for suggestions on the differences between MTO and MTS, and the different product types.
32
Therefore, a buyer is more likely to adopt an extranet approach than an e-market for an MTO
production process than for an MTS production process.
Why Product Characteristics Matter
In addition to buyer-supplier relationships, our analyses also provide insights on how the
characteristics of the product purchased will affect the choice of e-procurement channels.
Generally, there are two types of goods that firms purchase: direct goods bought for primary
activities and indirect goods for support activities (Neef, 2001). In industrial companies, primary
activities are directed at the physical transformation of product inputs and the handling of the
final products that are delivered to customers. The support activities enable the primary
activities (Porter, 1985). This indicates that direct goods are more important strategically than
indirect goods to buyers, and hence the process of procuring direct goods emphasizes factors
such as quality and innovation, more so than prices. Furthermore, buying indirect goods
involves dealing with a large set of vendors with frequent orders typically of small size. Instead,
direct goods are purchased on a more regular basis from a limited group of suppliers with orders
of larger size (van Weele, 2000).
In our model, these differences are reflected by the different levels of marketplace benefits
(g) and the network size (in terms of number of participants n). Specifically, a buyer will prefer
to have a trading network with more participants and obtain greater marketplace benefits for
buying indirect goods than direct goods. Thus, the buyer will be more likely to purchase indirect
goods through an e-market. This helps to explain the large amount of online purchasing for
maintenance, repair and operational (MRO) and office supplies that has been occurring in the
marketplace. These products are used in support activities in the value chain, and so are of low
33
strategic importance to the buyer. But via e-markets, a buyer is able to purchase MRO and office
supplies at lower prices and thus obtain cost savings.
Private Exchanges and Industry Consortium-Supported Exchanges
In this article, we differentiate e-procurement systems as extranets and e-markets, and reveal
their respective strengths and weaknesses. But can e-procurement channels be built that combine
the strengths but alleviate the weaknesses of these two types of systems? In fact, private
exchanges can be viewed as one outcome of such efforts. In a private exchange, the buyer
creates a closed electronic marketplace with its selected suppliers. Compared with open e-
markets, a private exchange creates an exclusive community of the buyer and its suppliers, and
enables the buyer to share strategic information with suppliers. Meanwhile, a private exchange
offers more market-making functionality that can enhance the level of marketplace benefits to
the participants. For example, in the healthcare industry, Neoforma (www.neoforma.com), an e-
commerce technology and service provider, and the industry’s supply management organization,
Novation (www.novationco.com), have developed and launched a technological platform that
enable hospitals to set up individual private marketplaces online. Through their online
marketplaces, hospitals will be able to find supply information and identify cost saving
opportunities through the market making functions. In addition, they will also be able to take
advantage of the supply chain management services that streamline the inventory, requisitioning,
ordering and receiving processes.
Another form of e-procurement channel in between extranets and e-markets is buyer-side
industry consortium-supported exchanges. These exchanges offer the similar set of market-
making capabilities as e-markets, and also enable buyers to both transact with its current
suppliers and develop new suppliers. But one important feature that differentiates consortium-
34
supported exchanges from pure e-markets is that the former offers a secure platform and
standards for inter-firm information sharing and collaboration which the latter lacks. This way,
industry consortium-supported exchanges have a higher level of competitive advantage for
suppliers than open e-markets, while maintaining the same level of marketplace benefits.
In short, private exchanges and industry consortium-supported exchanges appear to have
been developed to either enhance the market-making capabilities that have been a constraint in
the performance of procurement extranets, or to expand information sharing and coordination
capabilities that have made e-markets less attractive. These practices have shown that e-
procurement channels can be tuned in terms of the variety of business functions they offer and
the organizational structures they use to meet different corporate purchasing needs under
different operating and manufacturing situations.
E-Procurement Channel Portfolio Management
A buyer may favor one particular type of e-procurement channel over another when its
purchasing requirements are different. For a firm that has to fulfill a variety of procurement
needs, the proliferation of e-procurement channels with different technical and structural features
offers a great opportunity for portfolio management of e-procurement channels. For example,
Dow Chemical Company (2003) has set up four e-channels to link its suppliers via the Internet.
Dow purchases non-strategic supplies for daily operation through eMart, its own online
marketplace powered by Ariba, and buys MRO equipment through Trade-Ranger, a third-party
marketplace. Meanwhile, it uses the anonymous e-market of ChemConnect
(www.chemconnect.com) for online auctions and spot transactions, while it is in the midst of
setting up direct ERP system connectivity through industry-consortium supported Elemica
(www.elemica.com) for streamlining supply chain and exchanging information and data.
35
With the idea of developing and then managing an e-procurement channel portfolio,
management faces the task of choosing the appropriate channel to satisfy a given procurement
need. Our analysis, as shown in above discussion, has offered a set of guidelines for
management to compare and select e-procurement channels for different product types and/or
purchasing requirements. One important implication that we have derived is about how to think
through what ought to be the appropriate e-procurement channel choice (or mix) to meet varying
purchasing requirements.
CONCLUSION
Our work offers a number of theoretical contributions for academic research on technology
adoption in the e-procurement context, as well as practical implications for senior managers who
wish to make choices between extranets and electronic markets for their purchasing activities.
Theoretical Contributions to Research on E-Procurement
In this paper, we have drawn on prior research in IOS adoption and electronic markets in
several different disciplines to analyze channel selection issues in electronic procurement. We
developed an approach to characterize the variety of interorganizational information systems for
corporate purchasing, and identified two relevant types of e-procurement channels, extranets and
e-markets. They differ in the extent to which the trading network is open to participation and in
the level of information sharing. Accordingly, the benefits and costs that they bring to
participants in their trading networks are different. We analyzed these features and emphasized
the effects of competitive advantage, marketplace benefits and variable costs on e-procurement
channel adoption decisions.
36
We then developed a theoretical model that takes into account the above factors to examine
firm decisions in selecting e-procurement approaches. Our analysis points out that a buyer tends
to choose an electronic market when the supplier’s competitive advantage is modest compared
with the efficiency benefits that the e-procurement channel creates. But a buyer will find an
extranet to deliver greater benefits if a supplier derives great competitive value from favorable
access to strategic information via the e-procurement channel and such value has a big impact on
the buyer’s net benefit. In addition, we find that an e-procurement trading network will tend to
be larger with an e-market approach than an extranet since the reduced variable cost and
increased marketplace benefit enable the buyer to set up electronic communications with more
suppliers. These implications do not only reveal conditions under which one e-procurement
channel ought to be adopted versus the other, but also enable us to better understand industry
practices in e-procurement channel adoption.
Although this study focuses on adoption of e-procurement channels, the characteristics that
we have examined are common for IS that support inter-firm transactions and information
exchange. Hence, our analysis also provides insights in understanding other IOS-supported
business processes, such as order management systems initiated by suppliers. One common
feature among these systems is information sharing between business partners via electronic
communication networks, and the value of different types of information to participants in these
trading networks. In the context of e-procurement, we considered the competitive advantage that
suppliers obtain through timely access to such strategic information as inventory level and sales
forecast. In a similar vein, buyers may derive value from shared information about supplier
performance in an IOS network initiated by suppliers, and our analysis would be extended to
understand such effect.
37
Limitations and Future Research
Our investigation of e-procurement channel adoption in this article has several limitations.
Our model assumes the suppliers are homogenous in adoption costs and benefits. This way, we
are able to focus on capturing the richness of the relationship dynamics and interdependence
between the buyer and suppliers, controlling for differences among suppliers. In fact, we
recognize that suppliers will differ in their capabilities to build electronic connections with the
buyer and to integrate the external link with internal business processes. Suppliers that have
more resources and can reengineer their internal and interorganizational business processes to
take advantage of the electronic connections with buyers can obtain higher benefits (Lee, Clark
and Tam, 1999). And they may be more willing and ready to join the buyer’s e-procurement
system, and thus become early adopters while others will join only when a subsidy is offered. To
account for these differences among firms, future research should be to relax the assumption of
homogeneous suppliers in our model to permit the analysis of supplier heterogeneity. With
supplier heterogeneity, our analysis can be extended to examine the case of a hybrid solution for
e-procurement adoption and more sophisticated subsidy policies. Another assumption about
suppliers is that they do not act strategically in making adoption decisions. If suppliers are
profit-maximizing and acting strategically, the buyer may not be able to achieve the best
outcome by adopting a subsidy policy. We will need to extend the structure of the model to
relax this assumption if we want to fully address this issue, and this should be a direction for
future research.
Our model is a static model: the adoption costs and benefits are assumed to be time-invariant.
This implies that a decision about e-procurement channel adoption is likely to be the same at
various points of time. Thus, our model is not built to identify the optimal time to adopt a given
38
e-procurement channel, even though this is often a critical element for senior management
decisionmaking in technology adoption contexts, where market changes affect the flow of
potential benefits to adopters (Au and Kauffman, 2001; Benaroch and Kauffman, 1999). Future
research should take into account the effect of changing system development costs as
technologies advance over time and some of these other considerations. A two-stage model or a
dynamic model incorporating time-varying parameters may be able to shed light on the question
of optimal adoption timing.
In this study, our analysis focuses on the organizational choice between e-markets and
extranets. We can extend this research to the case when firms switch from one type of e-
procurement system or technology to another type, especially when one is based on open system
solutions while the other is a closed system. In addition, our model is based on linear functions
of the costs and benefits. Another extension for future research is to investigate the results for
non-linear functions to see if our propositions will hold. One possible form, for example, is to
represent the cost as a quadratic function of the number of participating suppliers.
As an exploratory effort, our model has assumed that the benefits and losses are additive,
leaving out the possibility of simple and complex interactions among these individual elements.
We know that, in reality, these factors may influence each other. Moreover, our analysis takes a
buyer’s perspective and so focuses on the buyer’s decision to adopt e-procurement channels, and
does not address the case where a supplier initiates an order management system or a customer
relationship management system. To study how suppliers choose interorganizational
information systems, we need to adjust the model and the analysis to more accurately portray the
viewpoint of a supplier.
39
Another possible direction for extending our work is to study the dynamics of e-procurement
technology platform adoption in many-to-many scenarios—multiple buyers and suppliers. This
extension will bring about several changes. If a supplier is connected with more than one buyer,
its total cost for entering the e-procurement network will vary with the number of connected
buyers. In addition, the total relationship-specific investment that the supplier makes for its
buyers will also be a function of the number of connected buyers.
In conclusion, IT has greatly increased the options that firms have for engineering their
business processes to more productively transact with their business partners. Traditional IOSs
facilitate information sharing among firms, and foster closer partnerships between buyers and
suppliers. However, the emerging e-procurement applications and electronic markets of the
Internet provide a new alternative channel for buyers to purchase goods and services from their
suppliers in a new world of technology that few would have thought was possible only ten years
ago. Faced with these options in procurement, senior managers need guidelines to make the
appropriate but hard choices. Our intent is that this article has been to provide insights and
managerial guidance to make some initial steps in that direction. Our exploratory analytical
model provides a necessary basis for managers understanding and comparing different adoption
strategies, and will be a useful starting point for further research. We expect that e-procurement
systems and electronic markets will become an increasingly important corporate purchasing
channel. So it is important for researchers and practitioners to develop a deeper understanding
and a prescriptive framework for evaluating the various e-procurement channel choices.
REFERENCES
Au, Y., and Kauffman, R. “Should We Wait? Network Externalities, Compatibility, and Electronic Billing Adoption,” Journal of Management Information Systems, 18, 2, Fall 2001, pp. 18-46.
40
Bakos, J. Y. "A Strategic Analysis of Electronic Marketplaces," MIS Quarterly (15:3), September 1991, pp. 295-310.
Barua, A., Lee, B. “An Economic Analysis of the Introduction of an Electronic Data Interchange System,” Information System Research (8:4), December 1997, pp. 398-422.
Benaroch, M.; and Kauffman, R.J. “A Case for Using Real Options Pricing Analysis to Evaluate Information Technology Project Investments,” Information Systems Research (10:1), March 1999, pp. 70-86.
Chatfield, A. K., and Yetton, P. “Strategic Payoff from EDI As a Function of EDI Embeddedness,” Journal of Management Information Systems (16:4), Spring 2000, pp. 195-224.
Chwelos, P.; Benbasat, I.; and Dexter A.S. “Empirical Test of an EDI Adoption Model,” Information Systems Research (12:3), Septermber 2001, pp. 304-321.
Clark, T. H., and Lee, H. G. “Performance, Interdependence and Coordination in Business-to-Business Electronic Commerce and Supply Chain Management,” Information Technology and Management (1:1), November 1999, pp. 85-105.
Dai, Q. and Kauffman, R.J. “Business Models for Internet Based Procurement Systems and B2B Electronic Markets,” International Journal of Electronic Commerce (6:4), Summer 2002, pp. 41-72.
Dow Chemical Company. “e-Business @ Dow: Connecting with Dow -- Suppliers,” June 2003. Available on the Internet at www.dow.com/ebusiness/what/s.htm.
Garicano, L. and Kaplan, S. N. “The Effects of Business-to-Business E-Commerce on Transaction Costs,” The Journal of Industrial Economics (49:4), December 2001, pp. 463-485.
Gilbert, A. “E-Procurement: Problems Behind the Promise,” InformationWeek (813), November 20, 2000, pp. 49-57.
Giudici, M. “EDI Giving Way Slowly to Net e-Biz.” Electronic Buyers’ News (1237), November 13, 2000, pp. 88-90.
Hamblen, M. “After the Hype,” Computerworld (36:52), December 23, 2002, pp. 33-34.
InformationWeek, “At a Glance: Suppliers in the Electronic Supply Chain,” September 17, 2001. Available on the Internet at www.informationweek.com/story/showArticle.jhtml? articleID=6506684.
Johnston, H.R., and Vitale, M. R. "Creating Competitive Advantage with Interorganizational Information Systems," MIS Quarterly (12:2), June 1988, pp. 153-165.
Karpinski, R. “Wal-Mart Pushes Web EDI,” B to B (87:10), October 14, 2002, pp. 15-16.
Kauffman, R. J. and Mohtadi, H. “Open Versus Proprietary Systems in B2B E-Procurement: A Risk-Adjusted Transactions Cost Perspective,” Working paper, MIS Research Center, Carlson School of Management, University of Minnesota, Minneapolis, MN, 2003.
Kisiel, R. “Suppliers, Big 3 Want to Streamline Data Exchange.” Automotive News (77: 6037), May 12, 2003, p. 8.
Lee, H. G., Clark, T., and Tam, K. Y. “Can EDI Benefit Adopters?” Information Systems Research (10:2), June 1999, pp. 186-195.
41
Lee. H. L., So, K. C., and Tang, C. S. “The Value of Information Sharing in a Two-Level Supply Chain,” Management Science (46:5), May 2000, pp. 626-643.
Lee. H. L., and Whang, S. “Information Sharing In a Supply Chain,” International Journal of Technology Management (20:3/4), March/April 2000, pp. 373-387.
Mukhopadhyay, T., Kekre, S., and Kalathur, S. “Business Value of Information Technology: A Study of Electronic Data Interchange,” MIS Quarterly (19:2), June 1995, pp. 137-156.
Neef, D. e-Procurement. Prentice Hall, Inc., Englewood Cliffs, NJ, 2001.
Ovans, A. “E-Procurement at Schlumberger,” Harvard Business Review (78:3), May/June 2000, pp. 21-22.
Porter, M. E. Competitive Advantage. Free Press, New York, NY, 1985.
Riggins, F. J., Kriebel, C. H., and Mukhopadhyay, T. “The Growth of Interorganizational Systems in the Presence of Network Externalities,” Management Science (40:8), August 1994, pp. 984-998.
Riggins, F. J., and Mukhopadhyay, T. "Overcoming Adoption and Implementation Risks of EDI," International Journal of Electronic Commerce (4:1), Summer 1999, 103-115.
Riggins, F. J., and Mukhopadhyay, T. “Interdependent Benefits from Interorganizational Systems: Opportunities for Business Partner Reengineering,” Journal of Management Information Systems (11:2), Fall 1994, pp. 37-57.
Riggins, F. J., and Rhee, H-S. “Toward a Unified View of Electronic Commerce,” Communications of the ACM (41:10), October 1998, pp. 88-95.
Riggins, F. J., and Rhee, H-S. “Developing the Learning Network Using Extranets,” International Journal of Electronic Commerce (4:1), Fall 1999, pp. 65-84.
Rosall, J. “Internet Commerce Buy- and Sell-Side Software Market Share and Forecast: 2000-2005,” Gartner Inc., Stamford, CT, January 2002.
Seidmann, A. and Sundararajan, A. "Building and Sustaining Interorganizational Information Sharing Relationships: The Competitive Impact of Interfacing Supply Chain Operations with Marketing Strategy," J. DeGross and K. Kumar (editors), Proceedings of the 18th International Conference on Information Systems (ICIS-97), Atlanta, GA, December 1997, pp. 205-222.
van Weele, A. J. Purchasing and Supply Chain Management. Thomson Learning, London, UK, 2000.
Wang, E.G. and Seidmann, A. “Electronic Data Interchange: Competitive Externalities and Strategic Implementation Policies,” Management Science (41:3), March 1995, pp. 401-418.
TECHNICAL APPENDIX
Proofs for Propositions 3 and 4. These propositions together describe the buyer’s
preferences in adopting e-procurement channels under various conditions. To identify and verify
42
these conditions and the buyer’s adoption preferences, we examine differences between the
buyer’s maximum net benefits with an e-market and an extranet through the Taylor series linear
approximation of the buyer’s maximum net benefit, , represented in Equation 8. )( *nU Buyer
Using Equations 7 and 8, we transform the buyer’s net benefit as follows:
0
2
1
011
01
101
1
1121
81
1212
21
412
41
1212
21
1212
21
1212
21
hNN)chger(
aaN
h)N(
)N(a)gchre(N)chger(a
N
h)N(
)N(a)chgre(n
ng)nhh()N(
)N(a)gchre(n
ng)n(h)N(
)N(a)gchre(n)n(U Buyer
−⎥⎦⎤
⎢⎣⎡
−+
+−−++⋅⋅⋅−
=
−⎥⎦
⎤⎢⎣
⎡−+⋅
+−−++⋅⎥⎦⎤
⎢⎣⎡ +
+−−++−
=
−⎥⎦
⎤⎢⎣
⎡−+⋅
+−−++⋅=
⋅+⋅+−⎥⎦
⎤⎢⎣
⎡−+⋅
+−−++⋅=
⋅+−⎥⎦
⎤⎢⎣
⎡−+⋅
+−−++⋅=
∗
∗∗∗
∗∗∗∗
(A1)
As we made clear previously, extranets and e-markets differ in terms of the supplier’s
competitive advantage and costs, and the buyer’s variable costs and marketplace benefits.
Extending our earlier notation, we use the following to represent these differences:
□ Supplier’s competitive advantage change: XNTEMKT aaa −=∆
□ Supplier’s cost change: XNTEMKT ccc −=∆
□ Buyer’s variable marketplace benefits change: XNTEMKT ggg −=∆
□ Buyer’s variable costs change: XNTEMKT hhh 111 −=∆
□ Buyer’s net benefits change: , where is the
optimal network size with an e-market and is the optimal network size with an
extranet. These two are different due to the differences in the costs and benefits that the
two e-procurement channels bring about for the buyer and its suppliers.
)()( ** XNTXNTBuyer
EMKTEMKTBuyer nUnUU −=∆ *EMKTn
*XNTn
43
According to the comparison between extranets and e-markets that we offered in the second
and fifth sections of this paper, we know that ∆a < 0, ∆c < 0, ∆g > 0, and ∆h1 < 0. So ∆U can
be represented by:
cc
)n(Uh
h)n(U
gg
)n(Ua
a)n(U
U*
Buyer*
Buyer*
Buyer*
Buyer ∆⋅∂
∂+∆⋅
∂
∂+∆⋅
∂
∂+∆⋅
∂
∂=∆ 1
1
(A2)
Now, to simplify the presentation, we let 8
1−=
Nb ; ger ++=α ; ch += 1β ;
)( 1 chger +−++=−= βαν . We intend that b is a parameter related to size of the supplier
base, and b > 0. We note that α is the variable e-channel benefit, β is the variable e-channel
cost, and ν is the variable e-channel net benefit. And, In addition, we notice that 2112≈
−+
NN ,
and so we will use this approximate value discussed in Footnote 1 earlier in the paper in the
following analyses. Hence, Equation A1 can be represented as follows:
0
2* 21)( h
aabnU Buyer −⎥⎦
⎤⎢⎣⎡ +⋅⋅⋅= ν (A3)
Next, we examine how the buyer net benefit changes with the cost factors c and h1, variable
marketplace benefit g, and supplier competitive advantage a in terms of the partial derivatives of
Equation A3.
⎥⎦⎤
⎢⎣⎡ −⋅⎥⎦
⎤⎢⎣⎡ +⋅=
−⋅⎥⎦
⎤⎢⎣⎡ +⋅⋅+⎥⎦
⎤⎢⎣⎡ +⋅⋅=
∂
∂
aab
aab
ab
anU Buyer
νν
ννν
222
)(21221)( 2*
(A4)
bab
gnU Buyer 42)( *
+⋅=∂
∂ν (A5)
⎥⎦⎤
⎢⎣⎡ +⋅−=
∂
∂b
ab
hnU Buyer 42)(
1
*
ν (A6)
44
⎥⎦⎤
⎢⎣⎡ +⋅−=
∂
∂b
ab
cnU Buyer 42)( *
ν (A7)
Substituting Equations A4-A7 in Equation A2 yields:
)(42222 1 chgbaba
aabU ∆−∆−∆⋅⎥⎦
⎤⎢⎣⎡ +⋅+∆⋅⎥⎦
⎤⎢⎣⎡ −⋅⎥⎦
⎤⎢⎣⎡ +⋅=∆ ννν (A8)
Next, we examine the signs of ∆U in the following two cases.
Case 1. ν≤≤ a0 for Proposition 3 (The Buyer’s E-Market Adoption General Preference
Proposition). This is the scenario that we depicted as Area in Figure 3. With this condition,
ν = r + e + g – (h1 + c) ≥ 0, and 1≥aν . Considering that 0
81>
−=
Nb , we can easily determine
the signs of the partial derivatives shown in Equations A4 through A8: 0≤∂
∂
a)n(U *
Buyer ,
0>∂
∂
g)n(U *
Buyer , 01
<∂
∂
h)n(U *
Buyer , 0<∂
∂
c)n(U *
Buyer .
With ∆a < 0, ∆c < 0, ∆g > 0, and ∆h1 < 0, we can further determine the sign of ∆U
according to Equation A8. In particular, ∆U > 0 implies that .
Therefore, we conclude that, in this case, the buyer will prefer an e-market to an extranet. This
completes the proof for Proposition 3. ٱ
)()( ** XNTXNTBuyer
EMKTEMKTBuyer nUnU >
Case 2. 0≥>νa , or 02≥−>
νa , for Proposition 4 (The Buyer’s Contingent Extranet
Adoption Preference Proposition). This is the scenario that we depicted as Areas and in
Figure 3. In this case, 12 <<−aν , and the signs of the partial derivatives are determined based
on 0>∂
∂
a)n(U *
Buyer , 0>∂
∂
g)n(U *
Buyer , 01
<∂
∂
h)n(U *
Buyer , 0<∂
∂
c)n(U *
Buyer . Since ∆a < 0, ∆c < 0,
45
∆g > 0, and ∆h1 < 0, the two items constituting ∆U as shown in Equation A8 have opposite
signs. The first item is negative, with 0<∆⋅∂
∂a
a)n(U *
Buyer ; but the second item is positive, with
0)(421 >∆−∆−∆⋅⎥⎦
⎤⎢⎣⎡ +⋅ chgb
ab ν .
Therefore, if the supplier competitive advantage has a bigger impact on the buyer’s net
benefit than the combined effects of the variable marketplace benefit and channel costs, then
and as a result, the buyer will prefer an extranet to an e-market.
This completes the proof for Proposition 4. ٱ
)()( ** XNTXNTBuyer
EMKTEMKTBuyer nUnU <
Proof for Proposition 5. We next examine the supplier benefits when the e-procurement
network reaches its optimal size for the buyer, based on Equations 1 and 2.
1),()(
***
−−
⋅+−−=−−⋅+=N
nNacieciaNnfenU JoinSupplier
11),1()1(
***
−+−
⋅−=⋅−−=−N
nNaaNnfnU NoJoinSupplier
The difference in the supplier’s benefit between joining and not joining is:
1212
11
1
1
−−+
⋅+−−=−+−
−−−−
+−−=
−−
NnNaice)
NnNa(
NnNacie
)n(U)n(U***
*NoJoinSupplier
*JoinSupplier
(A9)
Substituting Equation 7 in Equation A9 gives the following equation:
ihgrceaNNnUnU NoJoin
SupplierJoinSupplier −−+−⎥⎦
⎤⎢⎣⎡ −+⋅
−+
=−− )(21
112
21)1()( 1
** (A10)
When ecaNNhgr +−⋅−+
>−+112
1 , Equation A10 tells us that
inUnU NoJoinSupplier
JoinSupplier −<−− )1()( ** (A11)
46
Since i is the investment cost that the supplier makes for the buyer and i ≥ 0, Equation A11
means that , i.e., the supplier is worse off by joining than not
joining. Therefore, we can conclude that n
)n(U)n(U *NoJoinSupplier
*JoinSupplier 1−<
* suppliers will join the e-procurement network.
In the absence of a subsidy, the maximum possible network size that an e-procurement
system will reach should occur when i = 0, or the supplier does not make any relationship-
specific investment for the buyer. Setting i = 0, with network size n(i=0) under this condition, the
suppliers’ net benefits become: 1
000 −
−⋅+−=−⋅+= =
== NnN
aceca)N,n(fe)n(U )i()i()i(
JoinSupplier ,
and 1
111 0
00 −
+−⋅−=⋅−−=− =
== NnN
aa)N,n(f)n(U )i()i()i(
NoJoinSupplier . The condition for ni suppliers
to join the network is , leading to )n(U)n(U )i(NoJoinSupplier)i(
JoinSupplier 100 −≥ == 2
12)(2
1 ++−
−≤
Ncea
Nni .
This means that the maximum network size is:
212
21
0+
+−−
==N)ce(
aNn*
)i( (A12)
Since ecaNNhgr +−⋅−+
>−+112
1 , we get , which means that, without subsidy,
the maximum network size will be smaller than the optimal size from the buyer’s viewpoint. ٱ
**)i( nn <=0
Proof for Proposition 6. Next, suppose that the buyer’s subsidy to suppliers is given by s.
In this case, the supplier will joins the procurement network if .
Then we find the maximum possible relationship-specific investment from a supplier will be:
)1()( −≥+ nUsnU NoJoinSupplier
JoinSupplier
sN
nNaceis +−
+−⋅+−=
1122 (A13)
47
The buyer’s net benefit becomes snnhnginrnnU sBuyer ⋅−−⋅+⋅+⋅= )()( , and the profit
maximizing network size is 4
12)(4
1)}({maxarg 10
* +++−−+
−=≡
≤≤
Nghcera
NnUn BuyerNn
s ,
which is the same as the network size without subsidy, n*.
As discussed earlier, the maximum supplier relationship-specific investment is is represented
in Equation A13. Rearranging Equation A14 and plugging in n* yields another new finding
about the subsidy: )1(2
12)(21
1 −+
⋅−−−+++=NNahecgris s , where is is the supplier’s
relationship-specific investments expected by the buyer. Since is ≥ 0, the buyer’s subsidy will
satisfy the condition )1(2
12)(21
1 −+
⋅−−−++≥NNahecgrs ٱ .
48
