What's Working in B-to-B Online Exchanges
(1to1 Magazine, September 2002)

Online exchanges, also known as e-marketplaces, burst on the scene during the dot-boom, glowing with anticipation that the Internet could smooth the business-to-business supply chain, reduce costs, provide global access to customers, and create more efficient business processes for industries of all stripes.

Exchanges would bring together purchasers and vendors in one or more industry verticals, and allow them to offer products or services, conduct auctions, develop proposals and quotes, research market conditions, and do just about anything else involved in making it easier and cheaper for buyers to buy and sellers to sell.

By early 2000, the boom was in full swing. GartnerG2 was tracking as many as 2,000 online exchanges, and they estimated that transactions through e-marketplaces ran at $140.8 billion, with the leading industries being consumer packaged goods, retail, chemicals, industrial equipment, automotive, metals, high tech, petroleum, utilities, communications services and aerospace. In that same report, Gartner analysts predicted "ample opportunity for growth."

And then the fall. Like their dot-com brethren, the exchanges were sadly over-hyped, over-funded, and–in many cases–run by entrepreneurs lacking sufficient experience in the industries they were trying to revolutionize. So the exchanges dwindled, with the dot-crash of summer 2000. The streets were littered with the likes of Chemdex, Promedix, Petrocosm, Metalspectrum, Metalsite, Aluminum, Freightwise, PaperX, AshphaltExchange, BuildNet, Heavyware, and Aerospan.

While most exchanges simply closed their doors, others managed to morph their business models and survive. Ventro, e-Steel, eBreviate, and VeticalNet, the venerable pioneer of multi-industry exchanges–all converted to vendors of supply-chain software and services.

The year 2000 became the last time Gartner would estimate industry size for the exchanges. The Gartner analysts have moved on to other businesses, and the company now has no plans to update the numbers.

Gale Daikoku, the lead GartnerG2 analyst on online exchanges says, " All these e-businesses followed a curve, which we call the ‘e-business hype cycle.’ They moved from their initial launch due to a technology trigger, driven by inflated expectations, followed by disillusionment, and finally an upswing–one hopes–when they figure out how to deliver value and become profitable."

Daikoku believes that, to be successful, the exchanges must focus on providing real value to the participating members, whether by offering strong products and services, or lowering costs, or creating a technology or business-process standard that makes the industry more efficient. "The challenge plaguing the early players," recalls Daikoku, "Was the value proposition. They didn’t understand the needs of the market. It became a chicken and egg thing. If they didn’t offer anything of value, they then couldn’t attract the volume required to sustain an ongoing marketplace, ‘e’ or otherwise."

But there was still a glimmer of hope for the exchange model. As the third-party exchanges were imploding, there emerged a number of "consortia," or e-marketplaces founded by large-volume buyers in certain industries, who would band together and force their suppliers to sell to them through a new channel, with common standards and lots of visibility into pricing and inventories. Some of the early players were Covisint, formed by General Motors, Ford and DaimlerChrysler; Exostar, created by Boeing, Lockheed Martin, Raytheon and BAE SYSTEMS; Cordiem, built by 12 airlines, including American, Delta and United; and E2Open, led by IBM, Lucent, Panasonic and other hi-tech giants.

Forrester senior analyst Dan Garretson has been investigating the exchange category recently, and he concludes that there is still plenty of life. "The surprising thing is, exchanges are not dead," says Garretson. "All the consortia users we are speaking with are generally positive in their outlook. There’s more satisfaction out there than dissatisfaction. It’s been a long process, but there are clear benefits to be had."

So what’s proving to be beneficial in the online exchange arena? What’s working?

Certainly, Daikoku’s emphasis on the importance of providing value has been proven. One leading private exchange, ChemConnect, survived by developing a wide range of solutions for its members. According to Michele Hincks, vice president of marketing for ChemConnect, one of the surviving private exchanges, "We listened to our customers, and rapidly developed services that meet their needs. We help them keep abreast of developments in the industry, find new suppliers, automate their negotiation processes, seamlessly trade commodities, manage their financial risk, and reduce the inevitable paperwork associated with pre- and post-sales activity. ChemConnect’s members can buy and sell faster, better, and maybe even cheaper."

Garretson notes that the consortia had the advantage of beginning from a position of strength. They already had the critical mass, and their suppliers were forced to play ball. "Once the early private marketplaces were up and running, the big boys woke up and decided to build their own e-marketplaces," says Garretson. "The only wrinkle was regulatory concern about possible monopolistic practices, but those were put to rest fairly early on, after a thorough investigation by the FTC."

Garretson’s current hypothesis is that the ultimate benefit these consortia will provide is technological. "The barrier to efficiency for these industries has been the different systems and protocols each company built up over the years–the EDI systems, the ERP systems, few of which could talk to each other. The Internet is in a position to provide a hub, similar to the public switching network that underlies the telephone system. The e-marketplaces translate the various protocols and solve the technical problems that were in the way of integration. So it’s the connectivity that is the big benefit."

On the other side of the equation, what’s working for the suppliers? The most obvious benefit for them is access to new markets and new customers. Dow Chemical has been using ChemConnect for 19 consecutive months. Dow found it possible to auction off otherwise unsellable "off-grade" materials, and earn a million dollars per auction. Notes Jens Garby, global director of customer interface for Dow’s Engineering Plastics division, "Before ChemConnect, we couldn’t even afford to dispose of this material. It was costing us quite a bit to destroy it in an environmentally sound manner. Now we have found companies who are willing to pay us to take it off our hands!"

While there are clear advantages on the supplier side, online exchanges tend to favor the buyers. As they squeeze inefficiencies out of the process, e-marketplaces force sellers to bid against each other, pushing prices close to break-even and reducing their margins. To avoid the perils of a commodity marketplace, suppliers are seeking ways to differentiate themselves. Notes Garretson, "suppliers are now scrambling to add value, like services."

Is the online exchange impacting the customer relationship?
With all this power shifting to the buyer side, what is the impact of the e-marketplace on the seller’s ability to manage relationships with customers? Surprisingly, very little. The e-marketplaces have deliberately set themselves up as neutral parties. They are neither a hindrance, nor a middleman, nor even an influencer. They do not choose who will participate. Their role is to facilitate the existing relationship between seller and buyer. They do not replace it.

So a seller must still develop his own selling strategies. He must continue to build and nurture his customer relationships–communicate with his customers, send them product information, handle their inquiries, solve their problems, give them gifts at the holidays, and take them out for golf.

What’s different now is perhaps the seller’s ability to allocate resources. Since much of the communication is automated by the exchange’s system, sales teams and customer service personnel have more time to devote to proactive account management. "Our sales people are still out there working the relationship," says Dow’s Garby. "But they now benefit from the reduced paperwork, and they can spend more time developing new products together with their customers, instead of putting out fires."

But as much as time is saved on managing the relationship with customers who participate in the exchange, Garby admits that Dow is still forced to maintain old-fashioned processes to serve the customers who cannot or will not migrate to ChemConnect. "As surprising as this may be, we still have some customers who are not on the Internet yet. Or they haven’t provided Internet access to all the employees who need it. We have other customers who don’t trust the new way of doing business, or who simply find it cumbersome. So for them, we have to keep a duplicate process in place."

Dan Jankowski is senior vice president of global communications at Covisint, the automotive purchasing consortium created by GM, Ford and DaimlerChrysler. Jankowski often finds himself asked at industry events whether Covisint will mean suppliers can get rid of their salespeople. "This question amazes me," he says. "Of course suppliers still need to manage the ongoing relationship. They still have to demonstrate their ability to perform, to be competitive, and to be responsive to customers. One portion of their daily work, thanks to Covisint, will get condensed, from a matter of weeks to a matter of hours. That’s good. But all it means is that now the customer-facing people can be freed up to do more strategic things."

Covisint’s belief is that the supplier who embraces the online exchange and takes full advantage of its capabilities is going to have a competitive advantage. "Our members are going to be nimbler, and more decisive in the marketplace," says Jankowski. "The industry is moving in this direction, and the best suppliers are moving with it."

As online exchanges continue to shift the price advantage to the buyer, sellers will have to adjust their strategies in the equation. Steve Diorio, author of Beyond e: 12 Ways Technology is Transforming Sales and Marketing Strategy (McGraw Hill, 2002), describes the power shift this way. "The traditional levers of the relationship are gone," says Diorio. "The exchanges take away the personal points of differentiation. It’s like school uniforms. Everyone looks the same. So suppliers must create the value through pure performance, whether in pricing, speed, quality or services."

Diorio recommends that suppliers seek additional sources of value from the e-marketplaces. First, he suggests identifying value-added services that buyers will perceive as worth paying for, such as dispute settlement, customs clearance or logistics support. Second, Diorio identifies information as a source of competitive advantage. "The transparency of information in the e-marketplace levels the playing field, but it can also be used cleverly for advantage in other channels. There are opportunities to capture, process and resell data–if you look at information as a valuable by-product of participation."

Despite the shake-out, it’s clear that online exchanges are surviving, even thriving. Early fears that these marketplaces would somehow destroy the relationships between buyer and seller have been put to rest. In the world of the e-marketplace, both buyers and sellers can profit.

Case study
A private exchange survivor: ChemConnect
Founded in 1995 as a bulletin board site, ChemConnect supports the chemicals and plastics industry with modular online tools and services. ChemConnect is based in Houston, and now boasts 8,000 member companies in 135 countries. In 2001, ChemConnect ran $4 billion in transactions through its various systems. (www.chemconnect.com)

ChemConnect’s service offerings comprise four broad areas:

  1. Market information, allowing member companies to review market conditions before developing their strategies.
  2. Negotiation tools that simplify the back-and-forth between buyer and seller, reducing errors and lowering transaction costs. The specific tools include a commodity exchange where millions of metric tons of commodity chemicals are traded, and an auction and reverse-auction capability where members can trade with each other privately.
  3. Risk management systems for hedging against price volatility, in cooperation with the Chicago Mercantile Exchange.
  4. Fulfillment services, which is a centralized hub that automates many of the post-sales data-exchange processes typical of industrial transactions.

Members pay a flat fee, ranging from one to hundreds of thousands of dollars per year, plus fees based on use of the commodity exchange system. Privately held, and funded by over $180 million in industry and venture money, ChemConnect is on target to reach profitability by the end of 2002.

Michele Hincks, ChemConnect’s vice president of marketing, credits her management’s deep experience with the chemical and plastics industry as one key to their success. "We began by offering an interactive negotiation trading tool, but it was not widely accepted," she says. "So we brought in senior people who really understood what our customers needed. Both Dow and GE said they were looking to automate the auction process, where they could extend private invitations to certain buyers, and efficiently run auctions and reverse auctions. So we added the auction capability."

But when ChemConnect was ready to move into the commodity chemical marketplace, they realized it worked differently. "Standardized products like methanol and benzene don’t require a lot of negotiating," says Hincks. "What they do require is an easy means of fulfillment, without a lot of repetitive key-entry of data. So we acquired Envera, which had the state-of-the-art fulfillment system, CheMatch, which increased the liquidity we could offer to both buyer and seller, and Chalkboard, which allows us to offer real-time trading of natural gas liquids, like propane."

Another reason for ChemConnect’s success, Hincks admits, is more closely tied to luck than skill. "We are simply in the right market. Chemicals is a $1.7 trillion industry. It’s huge, and global, and fragmented. So there’s plenty of opportunity for an e-marketplace to make a difference." In contrast, she points out the experience of Chemdex, a now-defunct experiment that focused on research chemicals only–a market segment too small to sustain an exchange.

How has ChemConnect weathered the dot-crash? By sticking with their business strategy of listening to customers and providing valuable service offerings. The one alteration they’ve made, Hincks says, is in tone. "Our original plan was to revolutionize the chemicals business. We now realize that we are instead helping the industry’s evolution."

Case study
The automotive behemoth: Covisint
The launch of Covisint was announced in February of 2000 by General Motors, Ford and DaimlerChrysler, and they were quickly joined in April by Nissan and Renault and the next year by Peugeot. The Covisint team moved quickly, and by the end of 2001, materials worth $51 billion had been purchased through the system. There were 5,000 companies registered with the service, and 200 different catalogs offering their products. During last year, Covisint managed 1,400 online bidding events and 95,000 catalog transactions. (www.covisint.com)

And the company’s growth curve has accelerated. In the first quarter of 2002 alone, another 54,000 transactions were logged, and 2,600 additional companies registered.

When the business was first announced, however, it kicked off a storm of controversy. The automotive industry is one of the most competitive–and least cooperative–in the world. Suppliers feared margin erosion. The government worried that the oligarchs were creating a cartel. But after a thorough FTC review, and some judicious toe-dipping by pioneering vendors, the service found its niche.

Covisint was founded when purchasing officials at Ford and GM, who had originally been developing independent systems of their own, decided to collaborate. Suppliers were begging them to create a single protocol. So it’s no surprised that the core function at Covisint focused on procurement, especially auctions. But the original vision for the service included other offerings as well, and many of these have already seen the light: collaborative project management, tools for managing product development and design, and quote management.

Today, the services are divided into two categories:

  1. Strategic sourcing, which includes the auctions and the catalogs, plus electronic RFQ services and project management tools for collaboration.
  2. Portal connectivity, which allows message movement among members, essentially replacing EDI. Also included in this category are a worldwide industry directory, with both free and paid listings, and a quality planning tool that allows suppliers to improve their ability to meet the quality requirements set by the large buyers.

The company’s value proposition focuses on reducing costs, improving business-process efficiencies, and speeding time to market. According to Dan Jankowski, senior vice president of global communications, the automation dramatically reduces the time normally devoted to purchasing processes of all sorts. In an auction, for example, participants not only have improved visibility into the actions of the other players, but the whole process is done in record time. "When you lose the bid in an online auction, you lose it really fast. So you can cut your losses and get on to other things."

Covisint’s revenue model is unusual: they take a set-up fee and, thereafter, a percentage of the money saved by buyers, with a cap.

Even though more than 7,000 companies are already participating in Covisint, Jankowski recognizes that the long-term key to success will be its ability to convert the slow-adopters. "We still need to educate the market on how our tools work," says Jankowski. "There’s a long history of difficult relations in our industry, and plenty of reluctance still out there. Consider this: last year DaimlerChrysler announced that they would demand a 5% cost reduction from al their suppliers, across the board. No wonder there’s fear out there. This is an intensely competitive industry."

Covisint also must continue to evolve with the industry. Jankowski is confident that he is now ahead of the marketplace, technologically, and in terms of introducing efficiencies into industry processes. But the industry will eventually catch up, and change its internal processes. So Covisint plans to stay one step ahead.

Its strategy for attracting new users by making itself an indispensable hub of information to the automotive industry. "Everyone needs to keep technology costs in line. We want to become the de facto standard for the flow of information and communication in the automotive world."