By Anna Khanzhina

Co-author: Ike Zhou

Intro

With the amount of hype around Bitcoin, you would think that crypto-currencies are the only form of blockchain technology worthy of note. Even though cryptocurrency may be a game-changer, that only scrapes the surface of blockchain technology which goes far beyond means of financial transaction.

It has been called the industrial revolution after the internet and the potential impact on the way of life as we know is huge.

Basic terminology

Blockchain is defined as decentralized, distributed and public digital ledger that is used to record transactions across many computers so that the record cannot be altered retroactively without the alteration of all subsequent blocks and the collusion of the network.

To simplify, you can imagine an infinitely ongoing Tetris game where the blocks do not clear. Every record is a block taking up a space in the whole chain; one that cannot be deleted, replaced or overridden. Most importantly, however, blockchain is decentralised and immutable. That means no single user can interfere with the data or cause unauthorised changes.

Application to procurement and supply chain management:

1. Due Diligence

Trust is the key to any long-term business relationship. A lack thereof, will imply increased costs for the business transaction. For instance, well-established companies may refrain from working with new suppliers or push for unfavourable financial terms until there is a track record of positive performance. While due diligence is time-consuming, menial and costly, it is a necessary form of risk mitigation and must be performed by the procurement team.

Blockchain promises to be a game-changer for organisations that require more nimble supply chains to deal with changing demands from their clients. It also looks promising for organisations moving towards becoming a platform provider instead of simply being a market player.

It can digitalise this clunky process by being a generator of credit. A blockchain with the confirmed history of all transactions can verify the following information which is crucial to the buyer-seller relationship:

· Authenticate parties involved in a deal

· Verify the quality and specifications of the product or a service

· Verify the location of the product

· Verify the existence of previous transactions

· Verify that the buyer has the funds to pay for the product/service

The vital component however, is decentralised vendor performance management network. Blockchain implies access to the transaction logs for all parties present on the network. Buyers can easily rate the quality of vendor’s performance as well as their goods and services provided.

The platform approach will allow organisations to onboard new counterparties much more efficiently with an accelerated due diligence process. A blockchain’s decentralized network of computers will be able to capture and time-stamp individual transactions made by any member of the supply chain. This information is then recorded on a shared ledger that is unceasingly and collectively updated in real time. The validity of each transaction is checked by an algorithm to prevent fraud.

2. Smart contracts

Blockchain can also enable procurement professionals to improve on the contracting process by having electronic smart contracts which are executed automatically given a set of pre-determined conditions. Smart contracts can be visualised simply as programmable if-then statements. If condition A happens, then action B is taken.

The smart contracts will be able to verify the performance or non-performance of the contract and execute the terms of the contracts automatically. Hence, pre-determined rules, penalties, obligations and other conditions can be executed as a fully traceable part of the chain.

A wide variety of supply chain transactions can apply this technology, including delivery of raw materials or finished goods, payment for value-added services, transfers of copyright or IP value, and insurance payouts.

In an example of orange juice sold to the drink producers, we can see a case for the utilisation of blockchain technology.

A farmer in Brazil harvests the oranges on his farm and sends it to the processor, CitrusBR. During this stage, a smart contract could include condition such as delivery time, delivery quantity and price per ton. There would also be penalties for the failure to achieve part of the contract. At CitrusBR’s factory, these factors can be verified, and the agreed upon payment mode would be automatically triggered (whether it’s payment on delivery or credit terms). After processing, CitrusBR will need to transport the orange juice concentrate from its factory to the packers or soft drink producers globally.

A simplified process without the use of blockchain is as follows:

Figure 1. Traditiona supply chain organisation http://orangebook.tetrapak.com

No matter which process is chosen, smart contracts can still be utilised to monitor the conditions of the product throughout the whole transportation process to automate the checking of contract terms and the payment process after each transfer of title (from transporter to storage, vice versa, or to the end user).

This will minimize the involvement of expensive intermediaries such as banks, insurance companies and other counterparties.

3. Visibility into Supply Chain

As every transaction and operation on blockchain is traceable, it potentially empowers procurement function to verify authenticity and perform quality control at all the stages. A block records the status of the ledger at a specific point in time, and each block is connected to its chronological predecessor, which guarantees authenticity. That means that both goods and services can be traced throughout the purchasing cycle.

This visibility serves as a base for ethical sourcing and mitigating supply chain risks. Every product purchased can be broken down into components and traced up to the point of origin; every service can also be traced in order to track the use of ethical labour resources, facilitating sustainability of the supply chain. This would possibly solve such problems as use of illegal labour and sourcing of materials from conflict regions.

On a more ground level for daily operations supply chain traceability and visibility means higher control from buyer’s side over the risks connected to timely order fulfilments, quality control, materials shortage, etc. For example, a product transported along the supply chain blockchain will have its location verified at all the stages.

For procurement it means that such issues as delays or theft will be identified more accurately with ability to react faster. In 2012, a US government investigation discovered $1 million in counterfeit parts intended for military helicopters. Fortunately, government protocol requires a paper trail for all parts and photographic proof of process authorization, so the source of the counterfeits was ultimately identified. With blockchain implementation, such issues will become a thing of the past.

4. Automation of ordering and payments

When we are talking about the P2P process and documentation, we imagine a multi-step process that involves documentation for both buyer and seller. To visualise the process, let’s see the exact stages:

· Purchasing: ordering - buyer prepares purchase order, records it in the system and sends it over to the seller. Seller accepts it, sends order confirmation and records in his own database

· Logistics: receiving – Seller delivers product to the buyer, after which buyer keep a record in a form of GRN (goods received note), which is also sent to the seller

· Finance: payment – Seller sends an invoice, buyer does 3-way match which includes PO, GRN and invoice, after which approves and releases the payment. After that seller checks the payment against his records to make sure everything is in order.

As we can see, the same transaction, whether it’s paper based or electronic, is kept in 2 different ledgers on buyer’s and supplier’s side, and both sides need to make additional checks for documents and conditions to tally.

So why is business done that way? The answer is quite simple: because businesses don’t trust each other, as there could be multiple versions of the truth. But it also creates a duplication of effort to generate all those documents and process them.

So what if blockchain would be used for the same process? In this case the process will be more or less the same, but instead of sending over PO and GRN, those would be kept in a blockchain, just as a single record. After this the invoice becomes redundant, as there is no need to confirm the 2 previous events and do the 3-way match, as the prices cannot be modified and it’s impossible to issue an incorrect invoice. That would mean that the payment could be released instantly, and with the use of cryptocurrency any intermediaries like bank would also become redundant.

Thus, blockchain, as a single ledger, stores all the transactions with indisputable records of historic transactions that is trusted by both parties.





Once again, what are the benefits of blockchain for Supply Chain?

1. Greater trust and transparency

All the parties are registered, their public IDs are verified, history of transactions and payments facilitate trust between the market players.

2. Cost saving by eliminating intermediaries like brokers, lawyers, etc.

Blockchain effectively removes the middlemen, which means faster transactions for all the parties, faster access to funds for vendors resulting in cost reduction for both sides.

3. Higher productivity due to automation

Blockchain will streamline the process and eliminate all the labour cost connected to processing various transactions, unnecessary process control and related paperwork

4. Higher security of transactions

Automatic processing, matching and payments mean reduction of human factor and higher accuracy that would help avoid the errors from manual execution

5. Fair and compliant procurement

Blockchain facilitates end-to end visibility into purchasing process and prevents fraud, money laundering and another unfair business practices. On the sourcing stage it can provide fair tenders by sealing bids and keeping them confidential.

6. Risks mitigation due to control over the supply chain

7. High speed of execution

Possible Challenges

Blockchain technology is still in its infant stages and companies are mostly using it for pilot projects. Full scale implementation throughout entire supply chains might still be a few years away. As such, there is still improvements to be made and mistakes to be committed. Smaller companies with lower R&D budgets should stay on pilot project levels until there is a model for full scale implantation to be copied from.

Scalability could be an issue that will come up during full scale implementations. The nature of blockchains is that it will be slower than central databases. The reason is that on top of all the functions a central database has to do, blockchains still carry the burdens of verification, transaction consensus mechanisms that come about as transactions are queued

Regulatory authorities usually trail behind upcoming technology and the situation is no different with blockchain. Regulators are struggling to hammer together a due process for cryptocurrencies and it will be some time before they get to other blockchain applications. Hence, an air of uncertainty will hang over this topic for some time to come.

Conclusion

Blockchain as a technology represents a leap forward for that procurement professionals should not ignore. Integrating blockchain into existing processes could provide improvements in efficiency, transparency, security and trust. Before leaping onto the bandwagon, organisations should take a calculated decision on the processes they want to improve and the implications of implementation.

To ensure the scalability of blockchain through entire processes, advocates of blockchain and executives should keep in mind the possible interoperability from the start of the blockchain implementation projects.

The exceptional potential of blockchain applications is undeniable. In sectors with mission-critical applications—such as health care and the military—knowing the source of all parts, having information on product quality, and being able to pinpoint the supplier of a faulty component can save lives.

The decision, however, to join a blockchain consortium or set up one’s own often comes down to strategic intent and relative market power. For established MNCs, owning a blockchain platform can be a way to consolidate operations, create a marketplace, and change an industry’s competitive dynamics.

It is also the best way to unlock the full potential of blockchain. Since governance is not consolidated in a single organisation, the more equal distribution will go a long way in breaching the trust barrier and enhancing the sharing of information.

Smaller companies and those with a lower budget for R&D should keep tabs on the improvements in blockchain, learn from their larger peers through business cases as they await the best solution for their own implementation.

With the rise of the internet, many barriers have been removed on the physical constraints of data transfer. However, trust is one of the last major barriers preventing us from enjoying a fully optimized flow of information that market economies will thrive on.

The ability to breach this final frontier is within reach with the oncoming implementation of blockchain technology in our hyperconnected age.

For supply chain and procurement, this could be revolutionary!