beyond the exchange future of b2b

Beyond the ExchangeThe Future of B2B

(^speculators \

86 HARVARD BUSINESS REVIEW November-December 2000

by Richard Wiseand David Morrison

To see how business-to-business commerce

will evolve on the Internet, you need only

look at the revolutionary changes that have

transformed financial markets in recent years: an influx of specialists,

a proliferation of creative business models, and a new set of challenges

for buyers and sellers. Here's a road map for what's ahead.

— '^ *̂*4 ' ^ T^ f o ^3 *" ^^^^*^W

HARVARD BUSINESS REVIEW November-December 2000 87

Beyond the Exchange: The Future of B2B

THE USE OF THE INTERNET to facilitate commerceamong companies promises vast benefits: dramati-

cally reduced costs, greater access to buyers and sellers,improved marketplace liquidity, and a whole new arrayof efficient and flexible transaction methods. But if thebenefits are clear, the path to achieving them is anythingbut. The B2B market is still in its infancy, and its struc-ture and players remain in rapid flux. Despite breathlesspress coverage, very little is known about how business-to-business commerce will evolve on the Internet.

The high level of uncertainty is causing widespreadanxiety among executives - and for good reason. Whetheras buyers, sellers, or both, all companies have substantialstakes in the business-to-business marketplace. Theirsupply chains, their product and marketing strategies,their processes and operations-even their business mod-els-will be shaped by the way B2B relationships areformed and transactions are carried out. Yet at thismoment even the most basic questions remain difficultfor companies to answer: Which exchanges should weparticipate in? Should we form a trading consortiumwith our competitors? Should we demand that our sup-pliers go on-line? What software should we invest in?Executives understand that the wrong choices couldhave dire consequences, but they also know that in thefast-paced world of the Internet they need to act soon orthey'll be left behind.

Fortunately, there is a model for the future shapeof B2B: the financial services industry. Characterizedby information-based transactions, large and liquid ex-changes, and intense competition, financial marketsclosely resemble the new B2B markets. But unlike theirB2B counterparts, the financial markets have beenaround for centuries. Their evolution provides importantclues to the likely evolution of B2B. In particular, therecent restructuring of the financial industry suggeststhat, counter to the common wisdom about B2B today,exchanges are not the primary source of value in mar-kets that are information intensive. Rather, value tendsto accumulate among a diverse group of specialists thatfocus on such tasks as packaging, standard setting, arbi-trage, and information management.

We will use the financial services industry as a win-dow into the future of B2B. We will show why thecurrent exchange-based model is structurally fiawed,examine the major trends that will influence the strate-gies of both entrepreneurs and established companies,and describe the key market players that are likely to

Richard Wise is a vice president and David Morrison isa vice chairman of Mercer Management Consulting inBoston. Wise cowrote "Go Downstream: The New ProfitImperative in Manufacturing" (HBR September-October^999), ond Morrison is the coauthor of How Digital Is YourBusiness? (Crown Business, 2000).

emerge and the roles they'll play. The future we envisionis already coming into being. New B2B players are nowemerging with business models that mirror those thathave come to define and dominate the financial industry.

The Flaws in the Exchange ModelMost B2B activity to date has centered on on-line ex-changes and auctions, and most observers have assumedthat these electronic marketplaces would come to dom-inate the B2B landscape. Once you look beyond thehype, however, you quickly see that most Internet ex-changes are floundering. They suffer from meager trans-action volume and equally meager revenues, and theyface a raft of competitors. One of the leading chemicalexchanges, for example, has seen its postings grow con-siderably since its launch in early 1998, but it's still pro-cessing less than one trade per day. The hard truth isthat few of these exchanges will ever create the liquidityneeded to survive.

The current B2B model has three fatal fiaws. First, thevalue proposition offered by most exchanges-competi-tive bidding among suppliers allows buyers to get thelowest possible prices-runs counter to the best recentthinking on buyer-supplier relations. Most companieshave come to realize that getting supplies at the lowestprice may not be in their best economic interest. Otherfactors, such as quality, timing of deliveries, andcustomization, are often more important than price indetermining the overall value provided by a supplier.(That's particularly true for the many manufacturersthat have adopted lean, low-inventory production sys-tems that depend on reliable, precisely scheduled ship-ments of supplies and components.) Many companieshave spent the last two decades methodically forgingtighter, more strategic relationships with suppliers-many such afflliations have involved joint product-designefforts, integration of complex processes, and long-termservice contracts. The on-line exchanges' focus on arm's-length, price-driven transactions flies in the face of allthis hard work.

Second, the exchanges deliver little benefit to sellers.Yes, suppliers have access to more buyers with onlya modest increase in marketing cost, but that benefit isoverwhelmed by pricing pressures. Few suppliers want tobe anonymous contestants in ruthless bidding wars, andfor the highest-quality, most innovative suppliers, pricebaftles are anathema. As a result, the buyer-biasedexchanges that characterize B2B today will not be ableto achieve a critical mass of participants and transac-tions-they will be forever starved of liquidity. To be suc-cessful in the long run, B2B markets need to offer strongincentives to both buyers and sellers.

Finally, the business models of most B2B exchangesare, at best, half-baked. In their rush to get on-line, the


Beyond the Exchange: The Future of B2S

companies that run the exchanges haven't taken thetime to study their customers' priorities in-depth, createdistinctive offerings, or even map out paths to prof-itability. They've simply used off-the-shelf software to setup simple auctions as quickly as possible. Because thesoftware is readily available and relatively cheap, the bar-riers to entry are low, and the resulting proliferation ofnew exchanges is undermining the margins of all play-ers. Indeed, the influx of new entrants is leading to thesame type of market fragmentation that exchanges weredesigned to overcome in the first place.

The current B2B model, propped up by cheap invest-ment capital, is not sustainable. As the markets mature,they will have to evolve in ways that fix the problems ofthe existing system. New structures will enable buyersand suppliers to form tight relationships while stillenjoying the reach and efficiency of Internet commerce.Rewards will begin to fiow to sellers as well as buyers.And new business models will provide profits in a worldof dirt-cheap transactions. The B2B business will, inother words, reshape itself to resemble the financialservices industry.

Four Formative TrendsUntil recently, business-to-business markets had little incommon with financial markets. But with the spread ofdigitization and, in particular, the Internet, B2B com-merce has taken on many of the characteristics of finan-cial trading. Greater market liquidity and transparencyhave enabled more efficient pricing and more effectivematching of buyers and sellers, and, most important,value has shifted from the product itself to informationabout the product. While the transfer of physical goodsmay remain the end result of a business transaction, theinformation that shapes the transaction -

that could offer tailored loans. Even though the processof customizing a financing package was time consum-ing, expensive, and restricting, there was often no alter-native. In recent years, however, highly complex financialtransactions bave been successfully packaged as securi-ties that can be freely bought and sold. Securitizationhas vastly increased the financing choices available tocompanies-and vastly reduced the fees earned by tradi-tional banks.

Standards made securitization possible. By adoptinguniversal standards for loan terms and lending parame-ters, the financial industry enabled more customiza-tion within open marketplaces. Consider the mortgagemarket. Traditionally, mortgages were customized loanshandled by local banks. Rates, terms, and lending require-ments varied greatly. But spurred by the advent of lend-ing agencies such as Fannie Mae and Ginnie Mae, themortgage business has evolved into an efficient nationalmarketplace of securities, with arm's-length transactionsbetween dispersed buyers and setiers. The traditionalbank's role of general ist, in which it handled every aspectof a mortgage, has been split into three specialist roles;origination, a customer relationship task still handled bylocal banks or mortgage brokers; securitization, a finan-cial task handled by Fannie Mae and Ginnie Mae workingwith investment banks; and loan servicing, a processingtask handled by large-scale service companies.

We expect to see a similar fragmentation of roles inthe B2B world as markets are restructured to accommo-date the complex goods and services that accotmt for thebulk of most companies' spending. Already, some ex-changes are repositioning themselves to play narrowerbut more lucrative roles. FreeMarkets, best known forrunning Internet auctions, is rapidly turning itself intowhat might be called a specialist originator-a company

^ew business models will provide profits intranSÜCtlonS. The B2Belectronically. And that information is often Q WOrld Of dirt"'

more valuable to companies than the un-derlying goods, business will, in other words, reshape itself

Over the last two decades, as deregula- , t i ^t n • i • • i

and digitization have swept through to res€mble thefnonciol services industry.

that helps buyers gather and analyze the informationnecessary to purchase complex products and serviceselectronically. FreeMarkets knows that its greatest valuelies not in conducting auctions, which is rapidly becom-ing a commodity service, but in identifying and qual-ifying bidders and in creating detailed, standardizedrequests for proposals that enable the bidders to providecomparable quotes even on highly specialized products.Auctions are becoming adjuncts to FreeMarkets' primaryrole of providing structure, standards, and liquidity forcomplex transactions.

financial services, the industry has gonethrough a radical restructuring. Traditional brokerageand banking channels have been dismantled, and trans-action fees have fallen precipitously. As a result, powerand profit have migrated away from centuries-old busi-ness models toward a wide variety of innovative andoften highly specialized new models. Four major trends-good predictors of how B2B commerce will evolve-havecombined to reshape the industry.

From Simple to Complex Transactions. To fulfillcomplicated financing needs, a company once had toforge a close working relationship with a major bank



As FreeMarkets handles more transactions, its productdescriptions will become more refined and standardized,reducing the investment it has to make in subsequentauctions and expanding the range of auctionable items.It is unlikely, however, that FreeMarkets will be able toretain proprietary control over the standards it is helpingcreate. The experience ofthe financial industry providesanother clear lesson here: while many securitized prod-ucts, from auto leases to credit card receivables, startedout as proprietary inventions, they eventually becameroutine, widely traded offerings. In much the same way,the standards for describing products for on-line sale willbecome universal as other exchanges copy FreeMarkets'templates or as industry-specific standards emerge fordescribing product and transaction attributes.

As this happens, FreeMarkets'focus will likely shift totwo areas: providing on-line expertise in sorting outwhich product features best meet a particular buyer'sneeds and leveraging its knowledge of qualified suppliersto serve buyers as a demand aggregator. Like a mortgageoriginator, FreeMarkets will concentrate on the initialqualification, specification, and packaging role, handingoff the transaction itself to larger, more liquid exchangepartners. (For a business-to-consumer version of thismodel, see the sidebar "Learning from B2C: MySimon")

From Middlemen to Speculators. As financial mar-kets became more competitive, transaction fees steadilyeroded. Stock trades that used to generate fat commis-sions, for example, are now executed for a few dollars-oreven for free. The disappearance of transaction incomehas set off an intense search for new sources of revenue,which has in turn given rise to a new set of businessmodels. Instead of extracting fees from trans-actions, a number of financial services playersnow make their money by actively trading in theunderlying market. Several ofthe leading invest-ment banks, for instance, have increasingly dedi-cated their capital and people to investing fortheir own accounts, and these investments gen-erate a large and growing share of their overallprofits. The companies still need to be closelyinvolved in client transactions, but mainly for theinformation about market trends they provide.

As the profit margins of B2B exchanges getpushed down by competition, some exchangeswill start to take their own speculative positions,buying and selling large quantities ofthe goodstraded in tbeir markets. In this "e-speculator" model, run-ning the biggest exchange still provides a source of com-petitive advantage, but, just as in the financial markets,the advantage comes not from fees but from a superiorwindow into the dynamics of the market. Ultimately, ex-changes might even reduce their commissions to a pricebelow zero; that is, they might pay for a flow of deals inorder to gain valuable information about the market.

Learning from B2CMySimon

Most business-to-business exchanges focus on relativelysimple transactions involving commodities, commonmaintenance items, or basic services like cargo transport.Yet the vast majority of business spending lies in themore complex categories of components, services, andcapital goods. Here, purchase decisions hinge on manyvariables beyond price, and, as a result, companies usu-ally rely on salespeople and other traditional channels,such as distributors and value-added resellers.

Can the Internet provide a mechanism for enablingcomplex transactions? MySimon, a consumer shoppingservice, suggests how specialized shopping intermedi-aries may emerge in B2B markets to fill this need.

Using decision-support software from Active Research,MySimon offers tailored purchasing advice in a variety ofproduct categories while allowing buyers to compare theofferings of many vendors. It helps consumers sort

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through an arrayof purchase dimensions, decide whichareas are important to them, and then see how well theavailable offerings match up with their requirements.

Here's how you buya DVD player through MySimon.First, the Web site provides an overview of DVD players,highlighting key specifications and the most importantways that each model varies from the others. Then, throughActive Research's proprietary recommendation engine,MySimon walks you through a real-time trade-off surveyassessing the value you place on various features andbrands and testing different bundled attributes - all toassess what you care about in a DVD player (Exhibit i).

The Active Buyer's Guide then recommends severalDVD players that best fit your needs (Exhibit 2), listssites on the Web where those models are available, andshows the prices (Exhibit 3). You can click through toplace an order.

Exhibit 2produces a list of recommendations...

MySimon renders obsolete the value-added role of thetrained salesperson and goes beyond the role of the typicale-retailer. Rather than selling the product, MySimon acts asa personal adviser to guide the customer to a source forpurchase. The company generates revenues from vendorslotting fees and advertising.

With similar decision-support tools, more complexB2B sales will become feasible on-line. This trend willlikely be accelerated by the advent of extensible markuplanguage (XML), a set of software standards for displayingand sharing detailed information such as pricing and prod-uct specifications over the Web. Purchase support couldbecome a unique source of value and customer loyalty, withthe actual transactions handed off to sites that competesolely on price and availability. Companies such as GeneralElectric and Milacron are already moving to provide moreof this decision-making information on their Web sites.

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One pioneer in e-speculation can be found in thefinancial industry itself. Knight Trading Group, a whole-sale market maker for stocks, executes trades behind thescenes for the largest on-line trading firms, includingE*Trade and Ameritrade. Knight has invested in a highlyautomated system that can execute a large volume oftrades efficiently, and roughly 40% of all on-line trading

The restructuring of the financial services industrytook two decades. The changes will happen muchmore quickly in B2B e-commerce, where regulationis thin and competition is already intense.

now flows through the company. Rather than earningprofits through commissions on trades, however, Knightpays the on-line brokers for their order flows. The com-pany uses the order information to analyze marketmovements and adjust its own positions accordingly.While most exchanges struggle to break even, Knightenjoyed a 35% operating margin and a 68% return onequity for the 12 months that ended with April 2000.

Enron is also using the e-speculator model. Originallya gas pipeline operator, the company steadily expandedto become a major provider of many other energy prod-ucts. It has recently exploited its privileged position toestablish a thriving on-line exchange in which it makesmoney not from commissions but from buying and sell-ing a variety of energy products, including natural gas,electric power, pulp, and pollution credits, for its ownaccount.

Following the lead of investment banks, Enron is nowpursuing the logical extension of the e-speculator model:creating and selling derivatives such as options, futures,and swaps, which allow other market participants tomitigate their price risks. Enron currently transacts$1.5 billion in derivatives per day on-line, and it has beendoubling its transaction volume each quarter. Theseinstruments allow the company to profit in two ways.They are lucrative to sell, and they allow Enron to hedgeits market positions, decreasing its exposure to tradinglosses.

From Transactions to Solutions. Decreases in trans-action income have also led financial firms to emphasizecomprehensive money-management services to enhanceprofit margins, cement customer relationships, and lockin predictable revenue streams. An early sign of this shiftwas the rise of mutual funds and asset managementservices in the late 1980s. More recently, we have seena proliferation of sophisticated services such as invest-ment planning, tax and estate planning, and tailoredinvestment accounts. In addition to generating substan-tial returns for the providers, such integrated services

have considerable appeal to well-heeled clients, whowant to manage the overall costs and returns of theirportfolios rather than maximize the value of any onetransaction.

The B2B landscape is also well suited to solutionproviders. By using the Internet to bundle productswith related information and services, creative com-

panies can improve the effec-tiveness and efficiency of theirclients' businesses. By doing so,they will be able to forge strong,long-lasting client relationshipsthat will de-emphasize productprice and exchange-based trans-actions. Early examples of solu-tion sites are now appearing on

the Internet. Some are operated by suppliers looking tocounter the role of the exchanges; others are portalsoperated by third-party intermediaries.

An example of the first type is Milpro.com, a site oper-ated by machine-tool manufacturer Milacron. Milprosells high-margin Milacron coolants, cutting wheels, anddrill bits directly to small machine shops. But the sitealso helps these customers handle a broad array ofrelated business challenges, such as buying and sellingused equipment, identifying new business opportuni-ties, and troubleshooting problems. For example, thesite includes a software "wizard" that guides customersthrough a set of questions about a process (such as grind-ing) and related problems (such as chatter marks) andthen recommends particular products, much as an expe-rienced sales representative would. Through such ser-vices, Milacron has been able to attract the attention andthe business of small machine shops, a group that's diffi-cult and expensive to reach through traditional channels.Those shops, in turn, gain access to expertise that theycould not otherwise afford-and that would not be avail-able through a transaction-focused exchange.

An example of a third-party solution site is Biztro.com,a portal for small-business transactions. Biztro aims tosolve small-business managers' back-office headachesthrough an integrated suite of applications for such func-tions as payroll, benefits management, human resourcesmanagement, and procurement. Biztro has signed dealswith a group of product and service providers, includ-ing Dell and OfficeMax. The providers are able to sellthrough the portal, and Biztro earns a commission onthe transactions. By providing a high level of conve-nience, Biztro shifts customers away from purely price-based purchases.

From Buyer-Seiier Exchange Transactions to Sell-Side Asset Swaps. With the rise of large, sophisticatedmarket makers and the emergence of digital networks,more and more securities trades are being executedwithout hitting the floor of a traditional exchange. Many



financial companies, for example, are joining electroniccommunications networks, or ECNs, in which they canmatch trades with other participating members, savingthem the cost of going through an exchange and allow-ing them to trade day or night. Charles Schwab has goneeven further. It runs its own internal trading operation,enabling it to carry out many mutual fund transactionsby simply swapping shares among its customers withoutinvolving or even notifying the mutual fund companies.Besides eliminating transaction costs, such internal trad-ing preserves Schwab's control over client transactionsand the resulting information.

Similar sell-side swap models are emerging in B2Be-commerce. In stark contrast to most existing exchanges,which tend to penalize sellers, asset swaps benefit sup-pliers by allowing them to better utilize their key assets-whether factories, trucks, warehouses, or containers forshipping. At the same time, they enable buyers to tapa broader, more efflcient supply base.

The swapping model is particularly attractive in highlyfragmented industries, where small-scale suppliers oftenlack a broad geographic reach and are highly vulner-able to fluctuations in demand. The trucking businessis a perfect example. Many segments of the truckingmarket are populated by independents or small flrmsthat cannot individually achieve scale economies, partlybecause of the unpredictability of their routes. Unableto coordinate pickups and deliveries among their ownsmall sets of customers, truckers routinely return fromdeliveries without cargo. That means higher costs for thetruckers and higher shipping fees and slower deliverytimes for their customers.

Most B2B Web sites in the trucking business don'thelp truckers address these problems. Instead, they useauctions to pit carriers against one another in cutthroatbidding wars, which only exacerbate an already badsituation. Transportal Network, in contrast, uses theInternet to allow carriers to trade capacity with other

The Emerging B2B Landscape

Specialistoriginators

3 ) E-speculators

Mega-exchanges

4 ) Solution providers

Mega-exchanges act ascentral hubs for the executionof most transactions and forbuyer-supplier communication.

E-speculators participate in orrun exchanges,gaining real-timeinformation in order to take director derivative market positions.

Sell-side asset exchangesgain efficiency by swapping andreselling orders among a closedsetof suppliers. . ,. , ..,,,,,

Specialist originatorsstandardize and automate thebuyer decision-making processfor more complex products andthen send the transactions tothe exchanges for execution.

Solution providers operateseparately from open exchangesby embedding the product sale ina suite of unique, valuable services.



carriers, filling those empty trucks and creating a bettersystem for all involved. In conjunction with its asset-swapping service. Transportal also offers truckers theability to pool their purchases of employee benefits andinsurance, parts and equipment, financing, and otherproducts, enabling them to gain scale advantages with-out losing their independence. Customers, meanwhile,benefit from a stronger, more efficient base of carriers.

New Business ModelsThe restructuring of the financial services industry tooktwo decades. The changes will happen much morequickly in B2B e-commerce, where regulation is thin andcompetition is already intense. As the trends we'vedescribed play out, B2B commerce will be structuredvery differently from the way it is today. (See the exhibit"The Emerging B2B Landscape.") Rather than beingdominated by monolithic exchanges, it will encompassseveral distinct, interdependent business models.

Because scale and liquidity are vitally important toefficient trading, today's fragmented and illiquidexchanges will consolidate into a relatively small setof mega-exchanges that will occupy the center of theB2B universe. Although most transactions will flowthrough them, they will not generate much profit orshareholder value. As transaction fees fall or disap-pear entirely, the exchanges may turn into nonprofitcollectives. (See the sidebar "For the Traditional Ex-change, a Collective Approach.") Many B2B playerswill maintain stakes in the exchanges for the benefitof more lucrative e-commerce endeavors such as orig-ination or speculation.

Surrounding the mega-exchanges and pluggedinto them in various symbiotic ways will be the spe-cialist companies. Originators such as FreeMarketswill structure and take orders for complex transac-tions, aggregate them-bundle them into large orderrequests-and send them to mega-exchanges for eife-cution. The originator role will be most valuable inmarkets with relatively expensive products that areneither commodities nor completely customized, suchas automotive and aircraft: components, industrialequipment subassemblies, and complex services suchas insurance.

To be successful, an originator will need to con-centrate initially on creating standards for tradingcomplicated products and providing real-time supportfor customers on-line. An originator will be able toachieve an advantage by understanding a complexproduct category and customer decision-making para-meters better than its competitors; it will also benefitby adeptly using configuration and decision-supportsoftware. Profits will come primarily from commis-sions and from slotting fees paid by vendors and

exchanges in return for preferential positions with theoriginator, much as food manufacturers pay slotting feesto grocery chains for prime shelf space. Many of theniche portals already in operation will likely use theirknowledge of narrow business communities to movetoward an originator model.

Savvy e-speculators, seeking to capitalize on an abun-dance of market information, will tend to concentratewhere relatively standardized products can be trans-ferred easily among a large group of buyers. They'llalso look for price volatility, which will provide tradingspreads. Expect to see e-speculators in markets for spe-cialty chemicals, paper, and certain basic auto parts.

To thrive, an e-speculator will need to develop strongfinancial and risk-management skills. A speculator'sadvantage will come from having better, more timelymarket information than other participants. To get thatinformation; it will have to partner closely with at leastone mega-exchange or operate as the profit-making arm

An Overview ofthe New B2B Models

Key enablingcharacteristics

Mega-exchange • Maximum liquidity

• Common transactionstandards

Specialist originator Complex productsRelatively expensive products

E-speculator High degree of productstandardization or fungibility

• Moderate to high pricevolatility

Solution provider • Product cost a small portionof overall costs

' Product-related issues impactother costs

Sell-sideasset exchange

High fixed costs

• Relatively fragmentedsupplier and customer base



of an exchange. Speculators will likely earn profits notonly by trading but also by creating and selling varioushedging instruments.

In many markets, a handful of independent solutionproviders with well-known brand names and solidreputations will thrive alongside mega-exchanges. LikeMilacron, a good number of them will leverage distinc-tive technical expertise to become indispensable to cus-tomers-and thus reduce the importance of price inbuying decisions. Many will derive a substantial propor-tion of their profits from high-margin add-ons and con-sumables. The solution model will be most common inmarkets where the product itself represents a small por-tion of a customer's overall costs but heavily influencesthose costs, as in specialty chemicals, engineered plastics,and cutting tools. For example, specialty chemical admix-tiu-es represent a small percentage ofthe cost of con-crete, but the wrong admixture can cause an extremelycostly problem: the cement won't cure properly.

Many B2B transactions will consist of seil-side assetexchanges, in which suppliers will trade orders amongthemselves, sometimes after initial transactions with cus-

tomers are made on the mega-exchanges. Sell-side swap-ping will be most valuable where markets are highlyfragmented, both on the buyer and seller sides-where,for geographic or information reasons, demand and sup-ply are often mismatched and where suppliers can ben-efit greatly from keeping expensive fixed assets fullyutilized. Industries with these characteristics includetransportation, metalworking, plastic molding, fanning,and construction.

A company seeking to pursue the asset-exchangemodel win need to have strong relationships with thesupplier community, since success will hinge on its gain-ing a critical mass of supplier transactions. It will alsoneed to be adept at understanding supplier problems;sales of products and services that solve them will likelybe an important source of profits.

Investing in New Skillswhether a company is hoping to play a role as a B2Bservice provider or simply needs to transact businesswith other companies, it will have to develop a deep

Relevant industriesor markets

Requiredcapabilities

Sou rces of Sou rces ofcompetitive advantage profit

' Most vertical industries

Major horizontal purchasecategories

Large-scale transactionprocessing

Perceived neutrality

Scope and liquidity

Standard settingProfits are slim or exchangeis nonprofit

' Electronic and mechanicalcomponents

• Automotive and aircraftcomponents

• Insurance

• Strong consultative salesskills

' Deep product understanding'Strong customer relation-ships

' Deep knowledge ofproduct category

• Effective use of decision-support softwareAccess to qualified suppliers

'Ability to bundle transactionvolume

Transaction commissions• Slotting fees from vendors,exchanges

Electrical powerChemicalsReplacement auto parts

Financial engineeringand hedging skills

• In-depth knowledge ofmarket and market dynamics

'Timely market information'Transaction scale'Alignment with a major 'buyer or seller

' Playing the spread

•Selling hedging instrumentsto participants

• Specialty chemicalsEngineered plasticsCutting tools

Strong technical skillsProblem-solving mindset

' Brand strength• Rich set of offeringsCustomer lock-in

' Higher product margins'Valuable add-ons and refills

TransportationMetal machiningConstruction

' Strong supplier relationsTiips

'Ability to offer additionalrelevant services

' Perceived neutrality

LiquidityFirst mover with keysuppliers

• Selling ancillary products/services to members

HARVARD BUSINESS REVIEW November-December 2ooo 9S


knowledge of the emerging landscape and the variousbusiness models it will contain. (See the exhibit "AnOverview of the New B2B Models.") As we've seen, theplayers' value and power will vary considerably depend-ing on the industry and the products involved. Eachcompany will have to create its own path to success-andnot all products are suited to Internet transactions; verycomplex, very expensive items such as aircraft or merger-and-acquisition advisory services will continue to be soldprimarily through personal relationships and multisteppurchasing processes.

For the Traditional Exchange,a Collective

First-generation B2B exchanges,faced with boycotts by suppliers andantitrust scrutiny from regulators,are likely to evolve in two importantways. First, since the best method ofachieving sufficient market liquidityis to enlist every participant's sup-port, the exchanges will move awayfrom being for-profit entities andmove toward being collective indus-try efforts run for the benefit of all.

Second, they will move beyondexecuting transactions to create theinfrastructure and standards neces-sary to streamline communicationbetween buyers and sellers. This willaddress pressing issues of efficiency,such as speeding up the flow ofproduct information, automatingbilling and payment, and linkingbuyer and seller production pro-cesses more closely. And it will allowthem to handle not only simpleproducts but complex custom com-ponents and services, which accountfor most business purchases.

Covislnt,the automotive mega-exchange hatched by GeneralMotors, Ford, and DaimlerChrysler,is already moving down this path.Conceived as a for-profit enterprisethat would earn commissions on thetransaction volume generated by its

founders, Covisint has changed thatproposition in the face of resistancefrom suppliers. To ensure broad par-ticipation, Covisint has opened upits exchange to many other automanufacturers as equity owners,and 40 suppliers have been givenprofit-sharing stakes. In their publiccomments, Covisint's owners arenow talking less about sponsoringauctions and are instead trying toreduce the roughly $140 currentlyspent to process an average pur-chase order.

If the automotive industry-where buyers are concentrated andsuppliers are fragmented - is mov-ing toward a collaborative exchangemodel,other industries are boundto follow. Once again, this mirrorsa similar evolution in financial mar-kets. Over the past several decades,numerous subscale regional stockexchanges were replaced by twolarge exchanges, the NY5E and theNASDAQ. Both exchanges operateprimarily for the benefit of membersrather than to maximize the profitsofthe exchange, and both haveplayed a key role in developing theinformation standards and infra-structure for electronic trading andfunds exchange.

Many of the financial services companies that ulti-mately profited from the restructuring of the marketswere not traditional banks or brokerage houses. Theywere companies that were ahle to spot disruptive trendsand were willing to reconfigure their businesses, oftenat high cost and risk, to seize the new opportunities.Charles Schwab is perhaps the best example. Schwabreinvented itself not once but three times: it started asa discount broker, became a provider of asset manage-ment and back-office services to financial planners, devel-oped a mutual fund "supermarket," and then became

a hybrid clicks-and-mortar solu-tion provider combining Web-based transactions with personaladvice. Each reinvention requiredsignificant investments-such asthe recent purchase of U.S. Trust tofulfill the goal of providing assetmanagement solutions-but ulti-mately increased Schwab's cus-tomer base, profits, and marketvaluation.

Managers contemplating theirnext B2B move should take theexample of Schwab to heart. Rad-ical changes in markets requireradical responses. For many com-panies, traditional skills in suchareas as product development,manufacturing, and marketing maybecome less important, while theability to understand and capitalizeon market dynamics may becomeconsiderably more important. En-ron's experience illustrates thepoint. In building its e-commercemarket-making capabilities, Enronhas aggressively brought in newpeople with new skills. Engineershave been replaced by traders,economists, and risk managers.That kind of change is tough tomake, but as Schwab and Enronunderstand, it's essential to suc-cess. Indeed, in the digital age,timidity is just another word forirrelevance. v

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