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EDI 101

How EDI Works: A Guide to Electronic Data Interchange

There’s a reason hospitals, insurance companies, and e-commerce giants like Amazon and Walmart require their trading partners to be EDI capable. But what does EDI stand for, and why is it so important? 

EDI (Electronic Data Interchange) standardizes the exchange of important business documents, reducing errors and ensuring real-time updates that improve operational efficiency. In fact, many industries with complex supply chains rely on it to avoid costly miscommunications and delays.

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What is Electronic Data Interchange (EDI)?

EDI (Electronic Data Interchange) is a system that allows manufacturers, retailers, suppliers, and logistics companies to standardize the direct exchange of documents between computers. While many organizations use different document formats, EDI ensures consistency and uniformity, making it more reliable than email or fax for maintaining clear communication.

Imagine reading a restaurant menu in Paris without knowing any French. If a waiter who speaks English translates it, you would understand the options clearly (or standardized, as the information is now in a format both you and the waiter understand), making it easier to order something you’ll enjoy. The result? A smoother, more pleasant experience all around — especially for you and the waiter.Similarly, EDI translates different formats into a uniform structure, enabling the real-time exchange of critical documents like payment information and shipping details. This allows all parties to process data quickly and easily, streamlininglogistics, supply chain, and procurement operations while keeping everyone in sync.

Five benefits of EDI

Companies that adopt EDI benefit from streamlined operations and improved performance across several key areas, such as: 

  • Improved efficiency: EDI enables faster communication than manual methods, allowing trading partners to complete tasks more quickly.

  • Reduced costs: Paper-based transactions demand more labor and resources, making them more expensive. EDI eliminates these inefficiencies.

  • Enhanced accuracy: EDI automation minimizes errors associated with manual data entry, such as incorrect entries, and helps detect discrepancies early.

  • Better supply chain visibility: EDI provides real-time updates, unlike manual communication, which takes significantly longer.

  • Competitive advantage: Greater efficiency and customer satisfaction give EDI-capable businesses an edge over those yet to adopt the technology.

How EDI Works

Simply put, the EDI process involves electronic communication between different systems. EDI files flow from your logistics systems directly to a partner’s order management system and vice versa. This system-to-system exchange relies on several integrated components, including:

  • EDI standards: These standardized formats dictate the structure and content of EDI messages. Different EDI standards, such as EDIFACT and ANSI X12, serve various industries and regions. For instance, HIPAA applies to the healthcare sector and is widely used in North America.

  • Translation: Translation software converts your internal documents, like invoices, into the appropriate EDI format. This ensures that the data is accurately interpreted and transmitted between systems.

  • Mapping: Mapping tools align data between EDI systems and internal business systems, ensuring consistency and integrity during the exchange.

  • Protocols: Protocols manage the secure transmission of data once it’s converted into the EDI format. Common protocols include AS2 (Applicability Statement 2), a highly secure method for EDI communication that’s ideal for transfers requiring proof of receipt, and FTP/SFTP (File Transfer Protocol/Secure File Transfer Protocol), with SFTP adding a layer of protection, making it a more scalable and secure option for data exchange.

  • Data elements: These are the specific pieces of information within an EDI document, such as item quantities and unit prices in a purchase order.

  • EDI envelopes: The electronic equivalent of physical envelopes, these package files for transmission. There are three types: Transaction Set Envelopes, which contain individual transactions like invoices or purchase orders; Functional Group Envelopes, which group related transaction sets together; and Interchange Envelopes, which include all data exchanged with a trading partner during communication.

Each element — standards, translation, mapping, protocols, data elements, and envelopes — works together to facilitate a complete EDI interaction. Let’s take a closer look: 

The EDI Implementation Process

The EDI process usually involves three main steps. For example, let's say you’re purchasing equipment from a partner and sharing purchase orders and invoices via EDI. Here’s how the exchange would happen:

1. Document Collection and Preparation

In a paper-based transaction, you’d typically send a printed invoice to your partner. With EDI, the software creates a digital file containing the necessary details for the purchase order. Before that can happen, the documents need to be prepared using different systems. EDI offers several ways to prepare documents efficiently:

  • Manually entering data

  • Reformatting electronic reports into the correct format

  • Exporting spreadsheets and databases from your system

  • Using apps that automatically generate files for EDI translation

2. Document Translation to EDI Format

Next, the collected information must be fed into an EDI translator to convert it into the standardized Electronic Data Interchange format. You can handle this in-house or use an EDI provider. If managing it internally, mapping skills are essential. Once the process is complete, you’ll have an EDI 850 document (a standardized purchase order) ready to go.

3. Partner Connection and Document Transmission

Now, it’s time to transmit the formatted document to your partner. There are three ways to do this:

  1. Point-to-Point/Direct EDIs
    A point-to-point EDI relationship through a protocol such as OFTP2 enables you to exchange documents directly with trading partners using the same EDI solution. This method is ideal for partners you frequently work with because integration is typically faster than value-added network setups (more on those below). You also maintain complete control, ensuring more secure interactions without third-party intermediaries.
  2. VANs
    In contrast, VANs simplify the process because the provider handles the exchange for you, making it easier to get started without needing in-depth knowledge of each partner’s EDI solution. Although less cost-effective than direct EDI, VANs operate on a per-transaction basis, which can increase costs over time.
    VANs are a good fit for partners you don’t interact with often, as their lower upfront costs may result in savings for businesses with occasional transactions.
  3. API-Based Connections
    API-based connections, such as those provided by Orderful, enable real-time data exchange and simplify integration, even with trading partners who use different EDI solutions or handle varying transaction volumes.
    APIs eliminate many of the traditional complexities associated with EDI setups, making it easier to onboard new partners and adapt to changing business needs. API-based systems also provide greater flexibility, allowing for seamless updates and integration with cloud-based applications, which can be crucial for businesses looking to scale efficiently.

Three Examples of how EDI Works

1. Business Partners Exchanging EDI Documents

As mentioned, EDI facilitates a wide range of inter-business document exchanges, allowing companies to seamlessly transmit critical information across systems without manual intervention. Common examples of EDI documents include:

  • EDI 856 (Advance Shipping Notice)

  • EDI 810 (Invoice)

  • EDI 850 (Purchase Order)

  • EDI 855 (Purchase Order Acknowledgment)

  • EDI 820 (Remittance Advice/Payment Order)

  • EDI 977 (Functional Acknowledgement)

2. EDI Automation in Warehouses

In warehouse operations, depositors use EDI 940 (Warehouse Shipping Order) to instruct the warehouse to initiate a shipment. Once the shipment is completed, the warehouse sends an EDI 943 (Warehouse Stock Transfer Shipment Advice) to confirm. When the receiving location accepts the shipment, they issue an EDI 944 (Warehouse Receipt Advice) to acknowledge receipt, ensuring seamless communication and effective inventory management.

3. The EDI Order-to-Cash and Procure-to-Pay Processes

When a business receives a purchase order specifying the goods and quantities requested by the buyer, there’s no need for manual data entry. In the Order-to-Cash and Procure-to-Pay processes, EDI software automatically extracts and compares this information to the corresponding invoice to ensure accuracy. The system flags any discrepancies for further review, reducing errors and speeding up resolution times. After the comparison, the system sends an acknowledgment of the purchase order, indicating whether it is "accepted," "rejected," or "accepted with errors.”

Take Advantage of EDI Today

If you're looking to simplify your operations, meet industry EDI regulations, and cut costs, Orderful can help. Our fast and easy EDI integration brings more transparency to your processes and enables you to connect with more trading partners.

Talk to an Orderful EDI expert today and discover how EDI can make your business run smoothly and grow faster.