Sobering view

By Bill Burnham As far as B2B exchanges are concerned, meta networks provide a sobering view of the future. Meta networks connectthe individual B2B exchanges together thus undermining the ability of any one exchange to generate substantialnetwork effects.

By Bill Burnham

As far as B2B exchanges are concerned, meta networks provide a sobering view of the future. Meta networks connect the individual B2B exchanges together thus undermining the ability of any one exchange to generate substantial network effects. Exchanges will compete on efficiency, service, and price, but never generate incredible returns.

Why is this vision of the future important? Because it highlights the fact that owning a successful exchange is unlikely to produce incredible investment return, even if a given exchange dominates a market.

Just look at what are arguably the two largest and most established exchanges in existence, the New York Stock Exchange and Nasdaq. While together these exchanges dominate the trading of U.S. stocks, as a group they generate less than $1.5 billion a year in revenue. The two exchanges have margins that make them look more like commodity producers than monopolists.

In contrast to the exchanges, brokerages and processing firms make the real money -- $100s of billions in revenue and $10s of billions in profits.

Look for the three C's
These firms make money by providing investors with the three C's: credit, clearing, and custody. All exchanges need the three C's in order to operate efficiently. And all customers need the three C's to complete a transaction.

The lesson for B2B companies is that the real money will be made by providing the ancillary services and technologies used by all exchanges. Exchanges won't matter. At Softbank Venture Capital, this realization has led us to invest in private B2B companies focused on technology and services, such as Perfect.com, Syntra, and Hubstorm, rather than the high-flying industry exchanges.

Investors should approach the various exchange models with skepticism and a focus on those companies providing core software technologies or services.

Sticking to these principles should enable investors to live through the "Great Exchange Mania" and be all the richer for it.

Bill Burnham is a General Partner at Softbank Venture Capital and was a former Wall Street E-Commerce analyst. Softbank is an investor in ZDNet. For more information on Softbank Venture Capital, go to www.sbvc.com

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