Money for Nothing

Why should you give online marketplaces a cut of your revenues just for attaching a few wires to your supply chain?

The Internet is creating a new group of online upstarts that hope to capture a small percentage of your spending. Forming electronic marketplaces for everything from logs to office supplies, hundreds of new venture-backed startups are dreaming of redirecting the spending flows of worldwide supply chains, eventually creating mighty rivers of revenue for themselves - all without ever touching a product.

Marketplaces that bring together buyers and sellers online are the vanguard of the new economy, right? With all their benefits of increased choice and competition, cost savings on purchased goods and reduced transaction costs, it seems almost ungrateful to quibble about the fact that these marketplaces take a small percentage of each transaction (usually between 2 per cent and 5 per cent) for themselves. Isn't this transaction cost the inevitable price of doing business in the new economy - like the taxes charged for entering a new foreign market? In a word, no - not unless it comes with more valuable services than just putting buyers and sellers together.

Well before the Internet became a B2B boomtown, FreeMarkets of Pittsburgh was proving that online auctions of everything from circuit boards to street-sweeping services could reduce costs. FreeMarkets helps its clients write comprehensive request for quotations (RFQs) that place all sellers on a level playing field. FreeMarkets reduces the risk that sellers will pad their bids to shield themselves from any misunderstandings in the product requirements on the part of buyers. Then FreeMarkets beats the bushes for potential suppliers, screening each one to ensure its qualifications. With a solid group of qualified and informed suppliers, prices usually drop.

Buoyed by the early success of such exchanges, new entries have flooded the market with a build-it-and-they-will-come mentality. Pick up a trade magazine from your favourite industry and you will find dozens of upstart exchanges, all vying for a fraction of your spend. In every case, taxing the spend may hold promise for a time, but in the long run successful B2B exchanges will be forced to provide compelling supply-chain value or be relegated to the role of a technology service provider by those who hold the spending power.

Already, US companies with extraordinary spending or selling power, like manufacturers (General Motors, Ford Motor and DaimlerChrysler), retailers (Sears/Roebuck Co and Carrefour) and suppliers (DuPont and General Electric), have announced their own exchanges - effectively limiting the startup partner's role to technology provider. For the very big spenders like Wal-Mart, the power is in the spend. Why would Wal-Mart want to share its spending power and resultant prices with competitors like Kmart? More important, why would suppliers routinely sell their goods at Wal-Mart prices to smaller, less reliable partners? And the transaction fees are an annoying drain on already thin margins.

Adding Value

To attract big buyers and sellers, successful exchanges must find new ways to add value and improve the flow of material through the supply chain - such as offering financial or logistics services to complete the sale. New exchanges created in partnerships with supply-chain software makers like i2 Technologies and Manugistics, aim to facilitate the entire fulfilment process from sale to delivery. While getting a good price on a few hundred tons of specialty steel is nice, the steel you just purchased may be 1000 kilometres away from your factory in the back of some warehouse and could take weeks to move to where you need it. Getting a good price along with a fulfilment plan means having the steel delivered on the day you need it and at an exciting price. Linking business exchanges with logistics services that aid in supply-chain planning clearly adds value that customers will support.

Even in fragmented industries where there are fewer large buyers and sellers, online exchanges will struggle to tax sales without providing clear value. Certainly in many fragmented industries, simply matching in buyers and sellers creates value by reducing search and transaction costs. For example, DoveBid, based in Foster City, California, has produced extraordinary value for buyers and sellers in the used factory equipment market, where information is poor and geographically dispersed. Other online info-intermediaries, such as life sciences marketplace Chemdex, based in Mountain View, California, provide value by consolidating information from widely dispersed suppliers, making one-stop shopping for specialty goods like laboratory equipment possible. But simple consolidation of buyers and sellers has limited value and leaves the exchange's business model wide open to potential competitors. Successful exchanges will create other compelling value propositions or find their business models threatened.

Reworking the Supply Chain

Consider the story of Redwood City, California-based company Instill. Seven years ago, Instill entered the food services industry, offering to link restaurant operators with food distributors such as Houston-based Sysco. By automating the buying process, Instill hoped to charge the distributors a small fee for each order. The problem with this model was that the distributors saw little value from the service and quickly decided to start their own exchanges. Struggling for survival, Instill shifted its focus. It found that it could deliver real value to restaurant chains that lacked the information resources to keep track of their spending with major food suppliers such as Kraft Foods. The result for Instill was a new model in which the restaurants - rather than the distributors - paid for the ordering systems and enjoyed the value Instill provided.

In the alcoholic beverage market, insider has also tailored an offering that provides the supply chain with real value. Threatened by the possibility of outsiders invading the industry, Indianapolis-based distributor National Wine and Spirits worked with its counterparts in other states to form an exchange that would benefit everyone. Navigating the mind-numbingly complex patchwork of state and federal regulation, eSkye links retail stores, distributors and suppliers, providing visibility into a supply chain where little data existed. eSkye adds value by automating the ordering process for the retailer while providing product flow information to distributors and suppliers. The key to its success is a detailed understanding of the complex regulatory environment in a relationship-driven industry, making copycat services less likely.

Already, examples like these show that merely hooking up wires to a supply chain will not provide enough value over the long haul. With the novelty of B2B exchanges draining away, online marketplaces will find it taxing not to provide truly valuable services that are hard to duplicate.

M Eric Johnson is a member of the faculty at the Tuck School of Business at Dartmouth College. His research focuses on how information technology is changing supply chains.

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