The best kept secret of B2B

Public B2B trade exchanges are victims of the fastest rise and fall from grace in Internet history. Investors quickly realized that small, independent exchanges were having serious trouble attracting buyers and sellers—and trouble making money.

By the end of 2000, several of these independent exchanges, including Industrial Vortex, an industrial parts marketplace; Chemdex and Promedix, life-sciences and medical products exchanges run by Ventro; and RedLadder.com, a construction marketplace, had announced cutbacks or gone belly up.

The shakedown left room only for gargantuan consortium-run exchanges such as Covisint (an auto industry exchange backed by GM, DaimlerChrysler, and Ford) and smaller public exchanges that have found a niche market or a creative way of generating revenue that does not tax the supplier or the buyer.

Still, online marketplaces are a smart bet. But the real opportunity lies in private—not public—exchanges. Medium to large companies are building their own private marketplaces, not to capitalize on yet another Internet gold rush but to cut costs and streamline business processes by moving their entire supply chain online.

Whereas public exchanges are essentially open marketplaces that must first attract buyers and sellers—then generate revenue from advertising, transaction fees, or some unique offering such as a vast database or a parts-finding service—private exchanges take a company's existing group of suppliers and distributors and put them online. For example, when Amtrak created its private exchange, it moved key railway parts suppliers online to facilitate transactions including passenger and express business cars.

The numbers attest to the growing presence—and influence—of private marketplaces: Approximately 30,000 private exchanges are currently in development, compared with some 600 public exchanges now in operation, according to the GartnerGroup. And in 2000, 93 percent of B2B e-commerce was transacted through such private exchanges, according to a study by eMarketer. Companies such as Dell Computer and Wal-Mart have also moved their supply chains online, and many more are following suit. In fact 54 percent of companies surveyed were already purchasing online by mid-2000, and 87 percent of those who didn't were planning to purchase online within one year, according to Goldman Sachs.

Most likely, your company's first foray into rolling out an e-business plan consisted of setting up an e-procurement or customer relationship management system (see "Buying Power", and "Satisfaction Guaranteed"). The next step may be to join one or more established public trade exchanges like VerticalNet or Covisint as a means of buying and selling goods and services at reduced prices, with better exposure and greater convenience.

But if you're satisfied with your key suppliers and distributors, and the volume of business you do warrants making a significant investment in process improvements, then it may be time to set up a private trade exchange.

The benefits speak for themselves. "Private exchanges take a naturally occurring community of buyers and sellers and put them on the Web. This lowers transaction costs, provides better information up and down the supply chain (which makes for better inventory management), and allows for collaboration around new product design or market intelligence," says Randy Covill, senior analyst for retail practice at AMR Research.

When a company has many small suppliers, streamlining the transaction and communications processes saves money for the company, its suppliers, and ultimately the customer. Brian Hodgson, director of product management for SupplyWorks, a company that builds exchanges for industrial manufacturing concerns, estimates that customers will save from 5 percent to 10 percent depending on the number of suppliers.

The electronic exchange system is not a new idea. Companies have been doing business with each other via proprietary electronic data interchange (EDI) systems for years. But these private networks for data transfers between companies tend to be costly and complicated, and the supplier (often a small company making a low profit margin) has usually had to bear the brunt of transaction costs. Web exchanges, however, provide a relatively inexpensive platform and a familiar interface.

When the National Railroad Passenger Corporation, more commonly known as Amtrak, decided to create a private online trade exchange, the main goal was to save time. Raj Srinath, director of corporate finance, says the company had very specific plans when it launched its exchange. The company uses it only to finance what it considers smaller transactions ranging from $10 million to $25 million, including train equipment such as passenger cars and express business cars. Bigger transactions are still done the traditional way, using phone, fax, and U.S. mail. Moving these smaller deals online has saved Amtrak a great deal of time, says Srinath: "Instead of mailing and faxing information, the entire transaction is done in one online module, from sending out information and responding to quotes to finalizing the financial transaction. What used to take three to four days now takes from 30 minutes to an hour at most."

Unicco Service Company, a large outsourcing facilities company, had customer service in mind when it started setting up its private exchange. As an extension of its e-procurement system, Unicco is building myUnicco.com, a private portal for customers. "myUnicco.com puts all the information on our products and services in front of the customer, but it also includes a very detailed navigation tool, status reports on members' accounts, customer survey information, and tools to facilitate communication between Unicco and our customers," says Jeff Peterson, vice president of IT and shared services. Peterson believes that a service like myUnicco.com is what will differentiate Unicco from its competitors. "It shows that we're ahead of the tech curve in how we provide services, even if it's just by providing account management online," he says.

Before your company begins building a private exchange, there are some important things to consider. Depending on your business and how big and complex you want the exchange to be, the cost of software and setup can run anywhere from a few million dollars to tens of millions of dollars. The return on investment may also not be as immediate and tangible as with an e-procurement or customer relationship management (CRM) system.

But because most private exchanges are still in the early stages, there are some unique opportunities to get started without making a major up-front investment. For instance, Amtrak experienced timesaving benefits from the start with its exchange, without bearing the cost of setting it up. Instead technology provider Capital Stream set up the exchange for Amtrak and is recouping its investment by charging user fees to members as well as varying fees to buyers and suppliers on a per-transaction basis.

CapitalStream specializes in exchanges for the commercial finance industry and approached Amtrak because it needed a company to pilot its new Bid Management Service. Under the arrangement, Amtrak retains full control of the business side of the exchange (that is, relationships with suppliers and distributors), and for now there's no initial cost to join the exchange.

Other exchange solution providers are taking a similar approach. SupplyWorks currently offers a pilot program to entice customers to come on board. The interested company chooses a few key suppliers and buyers, and SupplyWorks sets up the exchange for 30 days to demonstrate the value of moving the supply chain online. Unlike CapitalStream, SupplyWorks generates revenue by charging participating buyers an upfront licensing fee and ongoing operations fees for use of the software, hardware, and support services.

Financial investment is only one angle to consider, and the cost and benefits of an exchange depend on your company's goals. Because Unicco's aim was to provide better customer service, its return on investment is harder to measure in numbers. But, says Peterson, "We just won a large account where I know our e-business strategy was a key factor in the selection process."

It's also important to keep in mind that a private exchange may yield new sources of revenue down the line. Having every transaction between manufacturers, suppliers, and distributors viewable online makes it easy to collect data on transaction history and inventory. This information can then be used—even sold—up and down the supply chain.

"Most manufacturers have bad information about what the final demand will be in the market because they're isolated from the consumer by layers of distributors," says AMR's Covill. "There's real opportunity for the trade exchange to derive revenue from selling business intelligence analysis to all members of the exchange. This information will help everyone in the supply chain react in real time to demand."

Once you've decided to take the plunge and set up a private exchange for your company, there are some things you'll need to consider to get off to a good start. Lou Unkeless, vice president of product strategy and product marketing for RightWorks, a company that provides e-procurement and exchange solutions, suggests that you "create or find a vision of the future state of your business. Determine exactly what e-business means to you and understand what your company will look like one or two years from now. Then establish a plan that makes sense and lets you go as fast as you want. Choose a plan that lets you make money at each step. Whether it takes you six months or five years to get there, don't wait. Start taking steps today."

Once you've established a plan, let your key players in on it. Covill suggests bringing your primary suppliers and buyers into the decision-making process. Unicco is taking a similar tack with myUnicco.com by rolling out the service for two of its biggest customers to test before making it generally available.

But for the most part, your partners will be happy to make the transition. Where public exchanges often make suppliers bear the cost of transaction and open them up to competition, private exchanges enhance the existing supply chain relationships and dynamics by bettering communication, improving visibility into product demand and availability, and ultimately cutting costs for the supplier—sometimes by as much as 35 percent, according to SupplyWorks' Hodgson. Most private exchange solution providers have learned that no supplier wants to pay to sell its goods, so they leverage transaction, subscription, and setup fees against the buyers. For the buyer, these fees work out to be far less than the 5 percent to 10 percent saved by using an exchange.

Finding the right exchange provider is key, and the process should begin when your company first develops its e-business plan. If you suspect that you may eventually want to expand beyond e-procurement to a CRM system or private exchange, look for software that will grow with your business. And though a software provider may have all the offerings you will ever need for your e-business strategy, you need to know early on how well the products are integrated with each other and with software you may already have in place.

While it's important to have compatible software, it's just as important to have compatible ideas. Hodgson suggests that a company make sure it shares the same business objectives as its exchange provider. "Our philosophy is that [the exchange] is a technical tool to strengthen the business process or relationship between buyers and suppliers, as opposed to an auction, which creates more of an antagonistic relationship between them," he says. "A lot of suppliers worry that they'll have to invest in the integration, and that it will just drive their margins down. But an exchange is really a means to provide better communication so the parties can jointly cut costs and make a better relationship."

It's also important to choose a provider that knows your market and business models as well as you do. SupplyWorks only deals with companies that are involved in manufacturing goods, and CapitalStream specializes in commercial finance. A provider who knows your vertical market can make better use of participating suppliers and buyers, as well as market data. This makes for a more powerful product and better integration. But at the same time, you'll want to make sure the provider and solution you choose allow you to control every aspect of supply chain management, from transaction automation, to sharing information up and down the chain, to data analysis and industry benchmarking. After all, if you're going to the trouble of putting all this data online, you need to be able to use it to refine your supply chain and key business relationships.