Online Exchanges Examine Options

WASHINGTON (07/17/2000) - When leading steel companies set out in 1996 to create an industrywide online exchange, one of their first moves was to engage antitrust counsel to advise on the plan.

That was only prudent. After all, the Progressive Era corporations built by steel-industry titan Andrew Carnegie and financier J.P. Morgan were early targets of modern U.S. antitrust laws. More recently, the industry has faced repeated antitrust scrutiny since the early 1960s.

So when - an online exchange that brings together some of the biggest producers of steel, aluminum and other metals with thousands of customers - opened for business in the fall of 1998, strong safeguards were already in place: The company relies on specific antitrust policies and rules for information exchange.

Every employee is briefed on antitrust and must sign a two-page list of dos and don'ts. And Arthur Andersen visits twice a year to audit antitrust compliance.

"Antitrust in the metals industry is nothing new," explains MetalSite President and CEO Patrick Stewart. "Antitrust concerns and policies are a way of life for these companies." Indeed, Stewart was invited to speak on the importance of antitrust at a recent Federal Trade Commission workshop on business-to-business exchanges in Washington, backing up federal regulators who have made it clear that the rest of the b-to-b industry had best follow his lead.

The conference came as the growth of b-to-b exchanges highlights new competition issues, challenging an emboldened Justice Department fresh from its historic victory over Microsoft and its successful opposition to the WorldCom-Sprint merger.

Online exchanges offer opportunities for buyers and sellers to operate and exchange information more efficiently, resulting in lower transaction costs and easier comparison shopping. Some sites run auctions. Others simply organize products in catalog fashion. The basic issues raised by the new exchanges are as old as the antitrust laws that prohibit agreement by suppliers to raise prices and buyers to lower prices. In the online world, regulators have several concerns.

The most obvious is collusion: If a group of competitors representing a significant portion of a market decides to jointly sell their goods, it's a small step for them to conspire to fix prices. The same holds true if the leading purchasers in a market join forces for joint buying. "The whole promise of the exchange is compromised if competitors can collude on price," says John Nannes, deputy assistant attorney general. So far, few exchange sites have drawn significant antitrust inquiries.

The FTC is reviewing Covisint, the Big Three automakers' exchange. Last month the Justice Department announced it was scrutinizing an as-yet-unnamed exchange set up in April by six meat and poultry processors, including Cargill and Tyson Foods. The Justice Department is also looking into Orbitz, the online ticket-selling venture of leading airlines (which, strictly speaking, is not a b-to-b site). Antitrust experts and regulators agree, however, that those inquiries should be the exception, rather than the rule. "I do not see a lot of enforcement activity," says Edward Correia, an antitrust attorney for Latham & Watkins.

The FTC's former scholar in residence predicts that "most sites will pass muster." While throwing down the antitrust gauntlet, federal regulators have also made it clear that they know what is at stake. "These electronic exchanges can generate substantial cost-savings, efficiency gains and great benefits," says Nannes.

The key, he says, is to look for potential problems at the outset and establish rules or limits before regulators have to get involved. "Care has to be taken to design [b-to-b exchanges] in such a way that they don't have anticompetitive effects," Nannes says. Adds FTC Commissioner Mozelle Thompson: "It's not the Wild West out there. If you couldn't do it offline, you can't do it online either." In theory, designing competitive exchanges shouldn't be too difficult if companies pay close attention to the details and seek sound legal advice.

Addressing antitrust concerns should be easier than dealing with other legal issues that have plagued Web developers and regulators alike. In the area of privacy protection, for example, few laws directly apply to online privacy, and many businesses going online have had no prior experience with the issue. And taxation of Internet sales has been caught up in the same controversy that catalog vendors contend with. Antitrust law is considerably more settled and developed. And certainly no one in the Clinton administration is calling for voluntary, industry-supervised antitrust enforcement.

On the contrary, the administration's lead antitrust official, Assistant Attorney General Joel Klein, has been eager to take on high-tech assignments, including suing Microsoft and blocking the WorldCom-Sprint merger. Awareness is growing, though the fast pace at which some smaller startups move may cause them to overlook potential problems.

"There are still some people living in dreamland that have got to deal with this, but it's slowly gaining mindshare," says Gretchen Teagarden, a Salomon Smith Barney analyst who has spoken to hundreds of exchange executives.

Companies that build and manage exchanges are also well aware of the issues.

"It's just a cost of doing business," says Robert Tarkoff, general counsel at Commerce One. "People who take these very extreme views tend to be people who haven't been really involved. The solutions are pretty clear. It's just a matter of implementation."

If the FTC's two-day conference is any measure, regulators have already grabbed the industry's attention. Hundreds attended the event, which had to be moved to an auditorium at the Department of Agriculture to accommodate the crowd. When FTC Commissioner Orson Swindle asked for a show of hands, he discovered less than half of the people attending were lawyers or bureaucrats, the typical attendees for such events. Instead, most said they were from the business sector. A key factor in determining the fate of the new exchanges, according to antitrust experts, will be the way sales are conducted when participating buyers or sellers represent a substantial chunk of the market. If all sellers offer the same price for their goods, antitrust regulators will be wary.

Of less concern would be an exchange creating a common platform for offering goods at competing prices. Apart from blatant collusion, regulators also worry that buyers or sellers could use online exchanges to signal each other about upcoming price moves. That concern was one factor that led the Justice Department to sue major airlines in 1992 over a computerized ticketing database. The resulting settlement restricted the information flow among carriers over the system.

Regulators today urge exchanges to review and perhaps limit the amount of information flowing among competitors - especially data about prospective prices - to stay out of trouble. Improper signaling can occur even when all the information is in public view. Take the case of the Federal Communications Commission's 1996 wireless-telephone license auction. Three carriers were nabbed for cutting deals by adding a few digits to the ends of their bids. The companies were involved in heated bidding to buy regional licenses. When other bidders entered the fray for those regions, the companies quickly jumped into the bidding for other areas where the new bidders appeared to be active. The idea was to reduce competition for individual regions, leaving them to the companies most serious about winning those licenses.

To make clear the quid pro quo they were seeking, the firms tacked the three-digit codes designating the regions they wanted onto the ends of their bids in the other regions. Instead of bidding $3.99 million, one carrier bid $3,990,204 - 204 designating the Indianapolis wireless license that the carrier wanted. Ironically, new technology could provide some answers to the antitrust issues raised by the online exchanges. FreeMarkets cofounder Sam Kinney wowed the crowd at the FTC's conference when he narrated, auctioneer-style, replays of sales conducted on his site. In one example, suppliers bidding for a contract were told only where they ranked in the bidding - not the amount of other bids or the winning bid.

When the auction ended, only the winning bidder and the purchaser knew the final price. Competition among the exchanges is another concern, although the current nascent stage of exchange development ensures that the problem may not fully develop for some time. A site that gains a substantial share of a market's sales might look to raise fees for users or discriminate against would-be participants.

Exclusionary conduct in that situation would draw immediate scrutiny. Yet some say that shouldn't be a problem, as most exchanges are upstarts or face steep completion. "If it's possible to join another exchange, you're not going to get a lot of sympathy for complaints about exclusion," says Correia. Washington has issued clear warnings. It's up to the b-to-b exchanges to take heed.

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