A B2B Exchange is Born: Will e2open.com Succeed?

Business-to-business relationships on the Internet have lately gravitated toward the formation of giant exchanges. Competitors in industries such as automobiles, aerospace and chemicals have come together to establish massive electronic marketplaces aimed at reducing inefficiencies and slashing costs of dealing with suppliers. On June 7, IBM and several telecommunications and electronic giants made the most recent splash in this field when they announced the creation of e2open.com, a giant exchange for the computer, electronics and telecommunications industries. Will this exchange achieve its founders’ vision? The answer, according to experts including Wharton professors, is: That depends.

To be launched in mid-July, e2open.com clearly has huge potential. In addition to IBM, its founders include Hitachi, Matsushita, LG Electronics, Nortel Networks, Seagate Technology, Solectron and Toshiba. Technology powering the exchange will come from Ariba and i2 Technologies, two leading B2B e-commerce technology providers, in addition to IBM. e2open.com’s financial and advisory partners include Crosspoint Venture Partners, a Silicon Valley venture firm; Morgan Stanley Dean Witter, an investment firm; and McKinsey, a consulting firm.

The founders say the goal of the electronic marketplace is to bring together thousands of computer, electronics and telecom companies around the world to do transactions over the Internet. e2open.com’s participants today account for some "$700 billion in goods and services bought and sold in the worldwide electronics industry’s supply chain."

While IBM spokesperson Carol Makovich declines to guesstimate the volume of goods and services that will be traded through e2open.com, analysts see enormous potential. They expect the electronics sector to account for online business-to-business purchases of almost $600 billion by 2004 of which almost $450 billion will be sourced from online exchanges like e2open.com. In comparison, the auto online exchange of Detroit’s Big Three–called Covisint–is expected to handle the bulk of their $200 billion in annual purchasing.

John Mumford, a founding partner of Crosspoint Ventures and acting CEO of e2open.com, claims that three factors make this exchange different from other electronic marketplaces. "First, we’re already in business and working together as partners. Second, we have a clear strategy to move forward, as evidenced by our decisions to build this e-marketplace on the technologies of Ariba, IBM and i2. And third, we are well financed, with more than $200 million of financing commitments from the founding partners and our financial partners, Crosspoint Venture Partners and Morgan Stanley Dean Witter."

Wharton faculty members point out, however, that the success of the e2open.com exchange will depend on several factors. "A B2B exchange needs high penetration in the market. It is useless if only the small players or just few players are involved in the exchange," says Morris Cohen, co-director of the Fishman-Davidson Center for Service and Operations Management. Having roped in the major players like Hitachi, Matsushita and Nortel, there might appear to be little fear that e2open.com will end up as a marginal player among online telecom and electronic exchanges.

Interestingly, though, while e2open.com includes several top names from the world of computers and electronics, there are also some significant omissions. Some press reports had suggested that Nokia, Motorola, Ericsson and Philips might join the exchange, the official announcement does not mention their participation. Says Makovich: "We have talked to many companies and continue to talk to many others. There may be other companies who may join as founders.We have to wait and see.

Another factor that affects the success of online exchanges is the degree to which goods can be sold as commodities. "It is difficult to sell sophisticated goods through exchanges," argues G Anandalingam, who teaches Operations and Information Management at Wharton. He argues that only for goods that are commodities or are fast becoming commodities will such online exchanges work. "Cellular handsets, for example, are fast becoming commodities," Anandalingam says. "For such equipment, the use of online purchasing exchange can be useful to lower costs and order standard equipment. In such cases, the company-vendor relationships will become very fluid, with vendors competing mainly on price and quality. But I cannot visualize sophisticated optical networking equipment, which needs to be customized for the user, will be sold through such an exchange".

Cohen, however, maintains that high-value, low-volume transactions can be funnelled through online exchanges, while for high-volume transactions, companies are likely to stick to fixed suppliers. He argues that all company and vendor relationships are unlikely to become fluid. "Companies do need special relationships with vendors. Inputs need to be customized, and standards have to be adhered to, so I do not think that companies will give up long-term vendor relationships," says Cohen.

Companies like Dell Computers practice just-in-time inventory management, which involves sourcing equipment from vendors when orders are received to maximize customization. Cohen says that companies using online exchanges will also have to figure out how to do this. While exchanges lower transaction costs greatly, companies have to be careful about in-bound and out-bound logistics costs. In other words, many companies have vendors near their factories to ensure low transport costs of raw materials as well as finished goods. These benefits may be lost when trading on an online exchange.

Initially, at least, companies are likely to use online exchanges to try and fix unexpected shortages or gluts. Moreover, for spot purchases arising from a sudden increase in demand, companies may increasingly look at online exchanges instead of going through intermediaries like distributors who buy up excess supplies. This is precisely what has been happening in commodified exchanges like metalsite.com and e-steel.com, two exchanges aimed at the steel market. Steel companies use these exchanges to unload excess product, while small buyers have the chance to do business with the big boys in the steel business–without having to depend on sales executives or rounds of golf with Big Steel executives.

The success of a business-to-business exchange also depends on how well its standard software platform can be integrated with a firm’s supply-chain management. Hubert Vaz-Nayak, director of KPMG’s telecommunications cell, notes that online exchanges will dramatically change the way business is organized across industries if supply-chain management can be integrated into the online exchanges. Already initiatives like RosettaNet, an independent, self-funded, non-profit consortium, are trying to develop and deploy standard electronic business interfaces. These standards form a common e-business language, aligning processes between supply chain partners on a global basis. "If you have an open standard like Rosettanet, it is easy to link to outsourcers because everybody is operating on the same standard. As a result, it becomes much easier to exchange information," says Vaz-Nayak. Adds Makovich: "We believe there is ample room for multiple exchanges; In fact in the future, they may interact quite a bit. There will be the ability for members of one exchange to be inter-operable with members on other exchanges."

The establishment of common standards within B2B exchanges will let companies juggle their suppliers, depending on who has what supplies available. Such online exchanges can then be used to pinpoint excess capacities and utilize them. Nayak uses the example of electronic chips to illustrate his point. While the lead time for increasing the production of chips could be as high as 12-14 months because the semi-conductor industry works on a three-to-five year capacity expansion plan, a buyer could potentially cope with a huge increase in its demand by using an online exchange to ascertain which chip maker, if any, has the capacity to fill a new order.

It is still too early to say whether e2open.com or any of the other 500 B2B exchanges will succeed. Most industries like steel or aircraft manufacturing tend to have at least three or more different exchanges, which are slugging it out to emerge as the primary exchange for that industry. Even in the electronic and telecommunications industry, apart from e2open.com, which is not yet operational, i2 Technology has promoted Hightech Exchange. Compaq and Hewlett Packard have also planned an exchange.

Still, online exchanges are undoubtedly changing the way industries and firms operate. Intermediaries like wholesalers and distributors are slowly being eased out, or starting to realize that their roles will have to change if they want to survive in the supply chain. Vendors in tough competition with one another, and without the advantage of cozy relationships with their buyers, could also suffer from lower margins as prices are squeezed through bids and auctions. "Vendors will be concerned (about a profit sqeeze) especially if the industry goes through bad times," says Vaz-Nayak. "Well, it’s all part of this new drive towards electronic induced efficiency." e2open.com has as good a shot as any of profiting from it.

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