B2B exchanges

Time to rebuild
May 17th 2001
From The Economist print edition

The once-promising field of business-to-business exchanges is in turmoil. But a genuine transformation is going on nevertheless

“IF YOU build it, they will come.” That seems to have been the mantra of the hundreds of public business-to-business (B2B) exchanges that popped up during the Internet boom. The idea was that such marketplaces would act as matchmakers between buyers and sellers in particular industries, and take a small fee in return. As business-to-consumer websites struggled to make money, B2B exchanges became all the rage. Many were built. Share prices soared. But almost nobody came.

Ventro, a B2B pioneer based in Mountain View, California, is a case in point. The firm, formerly known as Chemdex, set up public B2B exchanges for the life-sciences and medical-equipment industries and was the first such marketplace to receive venture capital. After a flotation in July 1999, its shares rose from $15 to a high of $240. Its revenues in 1999 were $30.8m. Mary Meeker, Morgan Stanley Dean Witter’s bullish Internet analyst, predicted that revenues in 2000 would reach $129m.

Such optimism proved unfounded. This year, Ventro’s revenues are likely to be rather lower: zero, to be precise. On April 30th, it reported its second consecutive quarter of no revenue, and admitted that it did not expect any revenue in the next two quarters either. Ventro’s marketplaces have been shut down, three-quarters of its staff have been sacked and its shares are now trading below $1 (see chart). The company is running through its remaining cash as it struggles to reinvent itself as a provider of B2B-exchange software, rather than an exchange operator.

The outlook is equally bleak for other public exchanges. According to International Data Corporation, a market-research firm, of the thousand or so B2B exchanges launched in the past 18 months, only about 100 are handling any genuine transactions. Instead, the action in B2B turns out to be elsewhere: in industry-specific consortia and in private exchanges operated by large companies. Here, too, things have not turned out quite as expected. There is definitely money to be made in B2B exchanges, but the field will be slower-moving and less lucrative than was once thought.

With hindsight, it is not hard to see why public exchanges have done so badly. Signing up suppliers and putting software in place was not enough; the missing element was liquidity. In contrast, when several large companies form a B2B consortium and commit themselves to using it, some liquidity is guaranteed. Covisint, a car-industry B2B consortium whose members include General Motors, Ford, DaimlerChrysler, Renault and Nissan, is expected to handle $750 billion in annual purchasing when it is up and running (several months later than first planned).

Consortia have other advantages. Unlike independent public exchanges, they have the clout and the backing to define and impose standards. And their members, which tend to be large companies, can force their suppliers to sign up or risk losing business.

But consortia have drawbacks, too. For a start, they raise the prospect of collusion between members, to the disadvantage of their suppliers—even if B2B is still so embryonic that there is little to worry about just yet. They are also unlikely to make all that much money. And to the extent they do, a chunk of their profits may come at the expense of their owners.

In some industries, firms used independent public exchanges briefly and then opted to set up consortia instead, with a view to lucrative flotations. At one time, some industry exchanges were expected to be worth more than their parent companies. Instead, says Henry Elkington, an analyst at Boston Consulting Group, consortia are now seen as boring but important utilities, akin to the bodies set up by banks to handle cheque clearing.

Perhaps the biggest drawback of consortia, however, is that, if several competing firms in a particular industry agree to team up, all will benefit from being able to deal with their suppliers more efficiently—but none will gain any advantage over its competitors. Firms are also wary of revealing proprietary information to their rivals through such exchanges. This is where the third approach to B2B—private exchanges—comes in.

Unlike public exchanges and consortia, which bring together many buyers and sellers, private exchanges allow a single firm to deal with its customers or suppliers directly, and to control who sees what. There is still plenty of scope for improving efficiency. IBM, for example, estimates that it saved $377m last year by using its private exchange, through which it can reveal sensitive price and inventory information to chosen customers and suppliers. Private marketplaces also have the advantage that they allow firms to sell products based on features other than price, by providing additional information to potential buyers. Such subtleties tend to be lost on public exchanges.

The likely outcome is that firms will use a mixture of public and private exchanges. A company may, for example, establish a relationship with a supplier through a consortium, and then invite that supplier to use its private exchange. The key, writes Mr Elkington in a report published this week, will be to exploit public exchanges to create private sources of advantage.

Getting beyond simple

So far, however, few companies have done this. Instead, most are concentrating on the simplest aspect of B2B: online procurement of office supplies. According to Keith Krach of Ariba, a leading B2B-software vendor, online procurement reduces transaction costs and paperwork, provides economies of scale through consolidated purchasing and reduces the level of unapproved “maverick” purchasing. This is all true, but it suggests that B2B boils down to a cheap way to order envelopes.

The challenge is to get from online procurement, which is easy, to a vibrant private exchange that can be integrated with existing supply-chain management systems. The good news for B2B vendors is that large companies are serious about taking their purchasing online; unlike other supposedly revolutionary software strategies, such as data-mining or customer-relationship management, B2B is not regarded as a fad. According to Boston Consulting Group’s forecasts, by 2004 one in three transactions between companies will be conducted online in America, and one in five in Europe.

The bad news is that the adoption of B2B will take several years, since companies will first have to put the Internet at the heart of their day-to-day operations. And at that point, the distinction between B2B software and other e-business software starts to blur, which puts sellers of B2B software, such as Ariba and Commerce One, in a difficult position.

Firms that specialise in B2B software might be pushed aside by larger software companies, such as Oracle, IBM and SAP, which are adding online procurement and other fancy B2B functions to their existing e-business software—and offering the lot at a knock-down price. As a result, the outlook for B2B specialists is uncertain. Worries about a forthcoming report on the subject by David Hope-Ross, an analyst at Gartner Group, caused Ariba’s share price to fall by 15% last week; Mr Hope-Ross is expected to predict that specialist B2B software firms will be extinct by 2004.

Ironically, it now looks as though the greatest beneficiaries of B2B will be large old-economy firms such as GE (see article), which will use online purchasing to squeeze their suppliers; and established software firms, which will sell them the software to do it. Most independent public exchanges are dead already, and things are not looking good for fledgling B2B software firms either. So much for the dream of friction-free capitalism levelling the playing field between large and small firms. Contrary to expectations, the lesson of B2B seems to be that big is beautiful.