What is Electronic Data Interchange (EDI)? & How It Works

Creating a purchase order, mailing it to the supplier, waiting for an invoice — not too long ago, exchanging business documents with trading partners was a tedious process with numerous stops and starts. For many business owners, this manual documentation method for sending and receiving goods posed many challenges, including wasted resources and human error.

Fortunately, traditional business exchange is no longer the only option. Today, numerous organizations use electronic data interchange (EDI) solutions to streamline and automate communications with suppliers, customers, carriers, and more.  

If you’re looking to improve trading and shipping speeds, promote supply chain visibility, or scale a rapidly growing business, an EDI system is exactly what your company needs. So, what is EDI, and how does it work?

What is EDI?

Trade relationships typically require employees to manage communications with third-party logistics providers (3PLs), customers, carriers, suppliers, and more. Staff manage emails, faxes, and snail mail and enter order information by hand. Not only does this method require dedicated employees, but it also slows operations and leaves your company susceptible to human-caused mistakes. 

EDI is a system for electronically exchanging business documents between partnering companies and supply chain connections. Rather than manually sending physical documents or emails back and forth, EDI software uses standardized transaction codes to share data between computers. 

With an integrated EDI solution, incoming and outgoing documents are sent back and forth seamlessly, even between businesses with completely different internal business management systems. Data for invoices, shipping notices, purchase orders, and more are quickly shared in a format compatible with every partner’s operations and expectations. This leads to faster communication between all stakeholders and improved operational efficiency — in other words, it’s easier for trading partners to do business with you. 

EDI applications extend to logistics, supply chains, procurement, and manufacturing production across business segments. Here are some examples of EDI at work: 

• EDI in operations management facilitates the movement of all documents, from invoicing and purchase orders to warehouse management. Operations managers can track all processes, from the procurement of raw materials to product delivery.
• EDI for logistics helps companies of all sizes meet compliance standards while providing real-time data on shipping, such as vehicle location and movement of loads. Logistics managers can use EDI to calculate rates, build auditing records, and optimize supply chain efficiency.
• EDI for retail allows retailers to manage inventory much faster than a human could. It automates vendors' shipment details and invoices to increase delivery speed and accuracy.
• EDI in healthcare automates document transfer between service providers, patients, and insurers. EDI also enables providers to ensure HIPAA compliance through secure transactions. 

How Does EDI Work?

EDI transactions move from computer to computer (or system to system) using specific transaction codes. You can think of these standards as universal languages used to simplify communication — without them, different computers in the process wouldn’t be able to read and understand the information contained in each document. Several document standards are commonly used in business-to-business (B2B) transactions, including X12, Tradacoms, ODETTE, and EDIFACT. 

EDI transmissions also use protocols to enhance security. These protocols uniquely define encryption levels, ease of transmission, and the required software and hardware. Business owners must choose both an EDI document standard and an EDI protocol for their operations. All trading partners must use the same protocol for communication between computers to be possible (or implement a value-added network).

Common protocol formats include Secure File Transfer Protocol (SFTP), Applicability Statement 2 (AS2), and Simple Object Access Protocol (SOAP). Critical information, such as sender and receiver IDs, is encoded within the EDI data segments. And like standard mail, digital envelope structures carry data between sender and recipient. 

Because companies choose their EDI standards and protocols, trading partners frequently need to translate or standardize transactions through a process called “mapping.” Mapping takes data from one EDI format and translates it to another so that the recipient’s computer system understands it. In other words, an EDI solution maps the data received from partners into a format readable by your internal business system. 

5 EDI Transaction Types

EDI transactions are classified into several categories based on methods of transmission, such as the Internet, mobile devices, and managed services. Common EDI communication standards include the following:

1. Direct EDI, sometimes called “point-to-point EDI,” is direct communication between two business partners. Direct EDI requires agreed-upon standards and protocols or a mapping solution and EDI infrastructure.
2. EDI with a value-added network (VAN) — a secure, private network that manages data transmissions and delivers the information to a virtual “mailbox,” not unlike a post office — facilitates mapping and outsources the need for direct contact between your business and trading partners. Typically, the receiving organization must manually manage incoming EDI messages. 
3. EDI via AS2 uses the internet to send data between parties securely. AS2 creates an “envelope” for the EDI data and uses encryption and digital certificates to protect the information between your computer and the recipient’s. 
4. Web EDI uses a standard internet browser to communicate with business partners who lack EDI infrastructure and allows for simple document exchange. 
5. EDI outsourcing means a third-party provider manages all EDI transmissions across a supply chain, including mapping and managing mailboxes.  

Benefits of EDI

Yes, EDI simplifies the process of managing relationships with trading partners. But what else does it offer? Here are five more upsides to EDI integration:

• Cost savings: EDI can lead to significant long-term savings for your bottom line because it optimizes workflows, increases efficiency, and mitigates costly errors. EDI adoption also reduces paper, printing, mailing, and storage expenses. 
• Increased efficiency: EDI allows for immediate, simultaneous transmission of documents to partners throughout the supply chain. Estimates suggest businesses that adopt EDI improve efficiency and reduce order shipping time by 50%.
• Greater accuracy: By reducing opportunities for human error, EDI saves businesses time and money in lost, delayed, and inaccurate orders and warehousing mistakes.
• Improved security: The right EDI solution can actually improve data transmission security while enhancing tracking and auditing capacity. Thanks to security protocols, EDI allows companies to transmit information safely and efficiently.
• Enhanced data insights: A powerful resource for businesses of all sizes is meaningful data with actionable insights. EDI helps provide businesses with data at every supply chain step while automating tasks to allow for more strategic decision-making to drive growth. 

Getting Started with EDI: 4 Steps

Implementing an EDI solution for your business may feel like a daunting task, but the process is worth it. Follow these four steps to set up a successful EDI system:

1. Choose a Standard Language

If you're not using a VAN or outsourcing EDI, your company must agree upon a standard EDI language with each trading partner. As mentioned, there are several types of EDI to choose from, each suited to different use cases.  

2. Select an EDI Software

EDI software solutions must have functionality for sending and receiving messages as well as translation integrations, if necessary. As a result, adequate software also reduces chargebacks from incorrect data. 

3. Set up a Communications Network

EDI requires a communication system adapted for each transaction. Your business can use a VAN, outsource communications, or decide on a peer-to-peer direct network connection with business partners. 

4. Prepare Documents

When you're ready to shift over to EDI, your company needs to import all data systems into the EDI software. Once the EDI system is implemented and up-to-date, you can automatically prepare documents for export, translation, and transmission. 

4 Key Considerations for Implementing EDI Effectively

EDI is inherently complex because it needs to adapt to each B2B partner's standards. However, with the right tools and support, EDI offers substantial benefits for your business’ improvement and growth. To get the most out of EDI, you should consider:

1. Mapping Software

Also called translation software, this essential tool takes data — including names, addresses, currency amounts, part numbers, and quantities — and effortlessly map them from various business application formats to standardized EDI document types and back again. 

2. Trading Partner Agreements (TPA)

TPAs allow trading partners to consolidate the standards for business documents and define communications terms and conditions. This may include simplifying 3PL integrations and transmissions.  

3. Batch Enveloping 

Batch enveloping, or “de-enveloping,” allows your business to receive and sort large batches of EDI messages. Batching automatically groups or splits transactions into distinct areas — this is essential for companies receiving hundreds or thousands of EDI messages daily.

4. Message Routing 

Message routing mechanisms allow businesses to quickly read and sort EDI messages and deliver them to the appropriate department or partner, including correct formatting for the final recipient. 

Get Started with EDI today 

EDI has the power to transform and automate businesses of all sizes, improving efficiency and delivering valuable data insights for supply chain optimization. Orderful overcomes common limitations of traditional EDI solutions by providing consolidated EDI infrastructure, faster onboarding, and reduced EDI costs. Our application programming interface (API) is designed to fix and validate EDI transactions faster, making trading simpler, cheaper, and more effective for your company.  

Still have questions? Speak with an expert to better understand how EDI functions can work for your business. Our team can clarify company-specific EDI applications and provide insight into how EDI saves costs and drives growth.