The Economics of EDI

lectronic Data Interchange has long been viewed as one of the enabling technologies that will help companies tame the "paper tiger" and reach new heights among the growing number of users of the technology - now in its third decade - runs high. But when it comes time to ask for the often significant amounts of cash needed to launch a system or upgrade an existing one, EDI can present problems.

The basic idea behind EDI, which allows business partners to exchange documents such as invoices, purchase orders and shipping notices via an electronic network, is to speed up everyday transaction and eliminate some of the reams of paper most companies most currently deal with. But some of EDI's most significant benefits - productivity, efficiency, accuracy - are difficult to quantify or forecast. For one thing, unlike other, internal technology improvements, the success of EDI depends on outside forces - namely, the trading partners with which a company wants to do business electronically. Not only that, but many companies already using the technology were pushed into it by larger trading partners and so skipped a thorough cost analysis; as a result, it's often difficult to use their experiences as a benchmark. In short, it can be tough to predict with any certainty when - or if - an EDI system will return its investment.

Cost-justifying EDI can be a "vague process," admits Doug Hanson, program manager for Scientific Engineering Workstation Procurement (SEWP) at NASA's Goddard Space Flight Center in Greenbelt, Md. "The savings are there, but it's difficult to determine what those savings are."

The Goddard Center recently began exploring EDI in accord with a presidential edict requiring federeral agencies to be EDI-compliant by 1997. That edict, and the increasing pressure brought to bear by large EDI adopters on their smaller trading partners, is spurring a second wave of companies to begin looking seriously at electronic data interchange. Many of them, particularly smaller players, are worried about the costs of EDI startup and communications (often handled by a commercial value-added-network, or VAN) and the ongoing difficulty and expense of setting up with additional trading partners.

To those potential new users, EDI managers and IT professionals overwhelmingly send the message that EDI does generate savings, oftentimes dramatic savings, even if they're not the type that can be easily anticipated at the start of a project. NASA's Goddard Center, for example, which manages the contracts for many of NASA's Unix workstations, has invested what Hanson says is a manageable amount and expects to realize rapid payback from its ongoing EDI pilot. "Between one year and two, we'll start getting our money back out of the system," he says.

Similarly, Hastings Books, Music, and Video Inc. expects its new EDI system, which is based on FourGen Software Inc.'s financial and supply-chain management programs, to pay for itself within 13 months of going online - if not before. "The rollout was Nov. 14, 1994," says Mike Woods, vice president of information systems for the Amarillo, Texas-based retail chain," and the system will pay for itself by the end of the year. We're happy with that."

With a little perseverance, EDI practitioners say, managers can "drill down" on these kinds of numbers to determine which areas are likely to generate savings for their own companies.

Sources of Savings

The number-one reason is reduced processing time. For example, by exchanging purchase orders electronically with Government Technology Services Inc. (GTSI), a major government reseller, the Goddard Space Flight Center shaved several days off its GTSI procurement cycle. Hastings' new EDI system is expected to reduce the time it takes suppliers to deliver goods to Hastings stores from three weeks to one week. And Ted Wilkinson, staff systems manager at Health Net of Woodland Hills, Calif., the state's second-largest health- maintenance organization, says his firm has eliminated several person-days per month from its invoicing process, which is in a pilot EDI project using Digital Equipment Corp.'s Alpha computers.

Where exactly do such savings come from? Personnel costs are one big factor, as data-entry employees, if still required at all, can be used in dramatically reduced numbers. Hastings Books, Music, and Video, which had plans to implement EDI when it was incorporated in 1991 and is now in the process of upgrading and expanding the system, figured out how many people it would need if it didn't use EDI at the outset. "The number of people [required] in accounting, purchasing, product sites and clerical would have far outweighed development and implementation costs within IS," says Woods. In fact, "any one of those departments would have outweighed the costs [of] EDI."

Getting rid of the paper process - the printing, stuffing envelopes and mailing - was a significant cost-saver for Avex Electronics Inc., says Mike Gordon, manager of the Electronic Commerce Group for the multinational contract manufacturer. Gordon estimates the Huntsville, Ala., company saved half a million dollars in 1994 and more than a quarter of a million in 1993 thanks to EDI.

Error reductrion can also significantly contribute to the bottom line, says Sigrid Marmann, president of Datatech EDI Systems, a San Rafael, Calif., developer of financial EDI applications. Depending on the thoroughness of a company's quality-assurance program before EDI is introduced - and on the firm's volume , since larger numbers of transactions tend to yield higher error rates - corporations can expect to see between a 10 and 40 percent improvement in accuracy, which, in turn, ups the intangible but often crucial customer- service factor.

Beyond such quantifiable changes are a raft of second-tier improvements that managers may overlook when trying to forecast the effect of EDI. High on managers' lists are reduced inventory, faster collection of receivables and improved productivity. Personnel once stuck with error-correction or data-entry tasks can be reassigned to more value-adding positions, and job-enhancing equipment, such as new computers, can be received and deployed more quickly thanks to shortened procurement cycles.

Marmann reports that her chients have successfully renegotiated payment terms with some of their business partners for more favorable terms. And Health Net's Wilkinson is one of many managers who plans to exploit electronic data for market analysis and other kinds of corporate research. "We get better accuracy but also better detail in the invoice," he says. "It increases the amount of available information."

Business consolidation is another longerterm benefit of EDI, as companies winnow their vendors and suppliers down to the key, EDI-enabled players. Digital has reduced from 1,300 to 250 the number of transportation partners it deals with while automating 75 percent of the freight invoices it handles, according to Wayne Toye, worldwide EDI marketing manager for the company in Stow, Mass.

Strategies for Success

Buy for growth.Following the age-old adage that you have to spend money to make money, vendors and users alike advise that companies invest upfront in a system that's able to automate a substantial chunk of their business and that will be up to future expansion, both from a standards and a volume point of view.

Faced with an edict from a larger trading partner, small firms may be tempted to purchase only the EDI translation software that allows them to receive purchase orders electronically or to set up the system to conform only to that one company's proprietary transmission requirements. But if that order is simply printed out and roouted inside the company as it always was, the cost benefits, if any, will be minimal, says Marmann. And as trading partners move away from customized systems and over to the X.12 transmission standard, businesses should ensure that they'll be able to keep pace by buying a standards-based system themselves.

Target the top. Most managers agree that the best way for companies to reap the highest benefit from EDI is to identify those partners with which they do the highest volume of business, and begin trading electronically with as many of them as possible. The more trading partners you can bring online, the quicker it will be to make money back on a system, says Lew Jenkins, chairman of Premenos Corp. in Concord, Calif., which recently began marketing Templar, software that lets companies exchange secure documents over the Internet. "The easiest way to save money is to amortize cost over a huge base," he explains.

In implementing its second phase of EDI Hastings Books is "focusing on the top 15 percent of our vendors," says Woods, which will represent 85 percent of the company's product procurements. As a primary goal, Woods says, the firm hopes to have its top five vendors using five standard EDI document types by year's end.

Exploit EDI Internally.Once a system is in place, observers say, it's in a company's best interest to use it to it's full potential. To fully realize the benefits of automated business transactions, many companies find themselves scrapping either part or all of their existing shipping, purchasing and accounts-receivable systems. If this sounds like business-process reengineering, it is. "EDI is an enabler," Toye says. "Many times when [customers] look at broadening the system, [reengineering] and EDI go hand in hand."

Reduce transmission costs.Once a system is up and running, communications costs can take a big chunk out of whatefver savings EDI is generated. Many firms exchange EDI documents either over a dedicated telephone line or through a third party VAN. According to the EDI Group Ltd., an Oak Park, Ill., consultancy that surveyed 1,560 EDI sites last year, the cost of maintaining a third-party network was second only to initial startup costs in overall EDI-related expenditures, taking up an average of 10.7 percent of a company's EDI budget.

But a third option has recently emerged. Premenos markets an EDI system that runs over the Internet. The problem with the Internet has been its lack of security when handling important documents, such as purchase orders. Premenos' Templar software features a built-in encryption system developed by RSA Data Security Inc. to ensure that transmission integrity is not violated across the Internet or other TCP/IP networks.

The savings can be substantial, Templar testers say. "We already had an Internet connection, and it's a flat fee for everything we send," says Avex's Gordon, explaining why the firm is trying out Templar. "The VAN is $3,000 a month, and they charge by the character. Our goal is to get rid of the VAN."

As more companies explore cheaper, direct connect options, value-added network service providers will likely respond to the challenge with lower rates, improved services or both, observers say. For customers, the overall result should be more-manageable transmission costs coming sometime soon.

Don't rule out a PC-based system. The PC is still an area of considerable debate in EDI circles. While several vendors - not suprisingly, vendors of midrange systems - attack the PC as underpowered and undesirable for true EDI, the jury is still out on the question.

One aspect is clear, however: PC-based EDI systems are significantly less costly to implement than their higher-horsepowered cousins. Datatech EDI develops EDI bridge software that sells for $2,300 and works exclusively with Computer Associates International Inc.'s PC-based AccPac Plus Accounting system. Marmann estimates that an AccPac Plus user can implement EDI purchase orders and acknowledgments using Datatech software for less than $5,000 - "and that includes personnel."

Digital's Toye and Premenos' Jenkins are among the executives who dispute that view - Jenkins characterizes most PC-based EDI as of the "rip and read" variety, in which electronic transmissions are printed out for use within the company, while Toye says PCs can't handle some standards or more than a couple of partners. But Marmann is firm in her conviction. "Everybody's talking about bringing EDI down to a PC network. You can get a Novell network in gigabytes, and look at the 486 or [Pentium] chips you're talking about power," she argues. "For medium sized companies. $20 [million] to $80 million, PCs are appropriate."

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