Exchange First Movers

SAN MATEO (05/15/2000) - For those on the verge of breaking with the past and either starting or joining a business-to-business trading exchange, there's a lot more to consider than Web connections to buyers and sellers.

To begin with, the first movers, or founders of these exchanges, need domain and industry expertise to set up a viable system. Likewise, exchange participants will need a full understanding of how these exchanges work, a solid negotiating stance, liquidity, and -- particularly for suppliers -- value-added services.

Like other exchange pioneers, ChemConnect, the company that oversees the World Chemical Exchange, is preparing for its future as a commodities exchange. The company is working to entice participants with transaction-related services, such as product testing, transportation, logistics, and, eventually, financial services, says Jay Hall, vice president of product management and co-founder of San Francisco-based ChemConnect, a first mover in the high-volume industrial chemicals industry.

"All of these exchanges need these different support services -- their analogues in the real world," Hall says.

The conventional wisdom is that the winners among the first movers will be the buy-side companies because exchanges are expected to give them more leverage in their dealings with supply-side companies. But power doesn't necessarily shift completely in favor of the buy-side, says Mark Hogan, president of General Motors Corp.'s Detroit-based eGM division.

"I don't think it's going to shift or give us any more leverage, or [suppliers] any more leverage," Hogan says. In fact, smaller suppliers stand to benefit "quite a bit" from the exchange phenomenon, he adds.

"The tier-2 and tier-3 suppliers ... can aggregate their purchases of commodities and small parts with the big guys, and thereby get the economies of scale that go with volume purchasing," Hogan says. "It's huge for them."

GM, Ford Motor Co., and DaimlerChrysler AG recently agreed to create a single Internet exchange to rationalize their supply chains, and in so doing, create a model for other industries.

But aside from the investments made by exchange leaders, participants are also likely to invest in an exchange, says Geoffrey Bock, an analyst at the Patricia Seybold Group, in Boston.

"It's not necessarily free to all comers," Bock says.

It's also not necessarily easy. The competition will be intense, with an upstart exchange potentially taking control of an industry and undermining the initial investments, Bock explains.

"[But] don't forget the halo effect on your market capitalization," says David Yockelson, an analyst at Meta Group Inc., in Stamford, Connecticut.

"[Participation in an exchange] almost guarantees that your stock will go up."

Sell-side companies may need that market bump to offset a potential squeeze in profits. There may be "an erosion in margins" among suppliers who either don't know their break-even points or fail to adhere to them, says Kevin Prouty, an analyst at AMR Research, in Boston.

"If you don't know your break-even point, you'll be in real trouble. You can put yourself out of business by bidding low," Prouty says.

For some exchange participants, the concerns may be more mundane.

John Schultz, an executive vice president and managing director for California Casualty home and auto insurance, in San Mateo, California, says his company has been leasing secondhand networking hardware for the past 15 years. This year, the company is leaning toward using the new Cymerc exchange for the leasing. Cymerc will serve as a test case for whether California Casualty can get better prices and conditions for essential equipment -- and whether it will use exchanges for other business needs.

"We think prices should be coming down as more product becomes available to us," Schultz says.

And what's the reward for "being more efficient in the back room?" The savings will be passed on to the next crop of policyholders, Schultz says.

First movers may find the longer-lasting rewards to be the experience they gain as pioneers and the impact they will have on the directions of the exchanges they join, analysts say. There are also financial rewards beyond the savings incurred from streamlined supply chains: The promise of getting in on the ground floor of what may turn out to be a very lucrative business model shift.

Exchange lingo

Auction: The process of bidding on a contract or RFP (request for proposal) via an Internet exchangeBuy-side participants: Businesses that need products and services as well as the cashMRO: Goods for maintenance, repair, and operations sourced indirectlyNet market-maker: Vendor responsible for overseeing an Internet exchangeProcurement: The act of attaining direct and indirect -- MRO and commodity -- suppliesSell-side suppliers: Businesses that offer products and/or services via an exchangeTrading network: A business-to-business, many-to-many Internet-based commerce environment

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