Dodging Icebergs

Net markets looking for ways to survive

The dismal news at the Ground Zero conference last month was that Chemdex, a pioneering digital exchange, would be scuttled. It was shocking news at an event that had become a lovefest for the business-to-business industry.

Yet it was also a fitting culmination to a year that had seen the entire Net marketplace industry shattered. Well-known exchanges such as CapacityWeb, Efdex and Hsupply failed, as did vendors like BizBuyer. Stocks in top-tier players like Ariba, Commerce One, and VerticalNet lost a total of $49.7 billion in market value between March of last year and early January.

Nearly all marketplaces continue to handle an insignificant number of trades and few, if any, are profitable. They still seem far from reaching the all-important "market liquidity," where the markets pool deepens enough to let trade flourish. Instead of the optimism that swept them into 2000, marketplaces and their vendors now contend with a chilling lack of funding, confidence and sense of direction.

"Were just swinging the pendulum from extremes of how wonderful to how depressing it will be," says Ann Perlman, executive chairman and chairman of the board at Moai Technologies.

Even so, analysts and executives have faith that e-commerce will succeed. Forrester Research predicts that B2B commerce on the Internet will hit $1.3 trillion in 2003. The problem is businesses havent figured out how to automate enough of the right business processes to convince buyers and sellers that exchanges are worth using.

"We have to build richer, more high-value marketplaces. They need to automate as many troublesome business practices that will justify customers coming online," says Philip Lay, managing director at consulting company Chasm Group.

There are myriad problems with this, both technological and human — yet business models are threading their way through this treacherous sea. So what routes are they taking, now that the once-tropical climate has sprouted killer icebergs?

Ventro Venture

Chief Executive Dave Perry says Ventro is charting a new course by helping others set up exchanges, after its experience with Chemdex and Promedix. It will shut down the two independent exchanges in the first quarter, laying off 235 people and writing off about $400 million.

Ventro and other independent exchanges took it on faith that they could win customers with the promise of Internet efficiency. This assumption has been proven wrong.

"One of the themes we took to be holy was you had to be independent," Perry says, referring to his initial belief that Ventro should not partner with industry players but remain neutral. "It was just wrong. Competitors hate to work together, but it was necessary," he says.

Without an industry partner, Ventro had no direct ties to the customers it most wanted. The company changed tactics with the last four exchanges it started — Amphir, Broadlane, Industria and MarketMile. In an attempt to secure liquidity, all four have equity partners in target industries. Chemdex went on to form an alliance with chemical distributor VWR Scientific, but it was too little, too late.

Several other electronic marketplaces have pursued partners, believing they would yield liquidity. Six-year-old ChemConnect knocked on the doors of major industry players when it went fundraising last year. About 33 companies, including BP, Dow, General Electric and Mitsui Mitsubishi, became equity partners, according to Linda Stegeman, senior vice president at ChemConnect.

Other players retreated from the equity game, seeking a stable business providing services to marketplaces. Weeks after Ventro hung out its shingle in the service business, VerticalNet sold off its only liquid marketplace, NECX, to electronics consortium Converge and signed a three-year deal to provide the software and services to run the exchange.

One of the chief reasons for the change in tactics was the rise of industry-sponsored consortia, such as chemicals exchange Elemica and automaker consortium Covisint.

The technical challenges in running an exchange are still daunting, Perry says. Its difficult to integrate so many different buyers and sellers e-procurement systems into one exchange, let alone do it quickly. Then there are the operational challenges of managing and updating a catalog of millions of products, as well as managing high volumes of transactions.

Also, companies havent found the right business model to make the work pay. "Transaction fees are going away or being eroded, so theyre looking for new revenue streams," says Jeff Fedor, president of software vendor Ardesic.

The view is even more pessimistic in the investment community. The problem comes down to human behavior, says Gary Dennis, senior vice president in investment banking at Robert W. Baird & Co.

"People dont want to change," he says. They wont use a new Web site when theyve worked the phones and personal relationships so well for so long, he says.

With human inertia, the difficulties of technological integration, the absence of clearly successful business models and the need for revenue-producing liquidity, he believes only a handful can manage such exchanges. Only the very largest and well-funded companies can afford to set up exchanges, and theyll simplify the integration work by using exchanges to manage their own supply chain needs.

Fighting Chance

That view puts marketplaces out of the hands of the independents almost entirely. But some players, like Altra Energy Technologies Chairman Rusty Braziel, say the openings are wider than many pundits think. With more than $2 billion worth of transactions monthly, Altra expects to reach "cash-flow break-even" within weeks, Braziel says.

Altra began, not as a marketplace, but as a software vendor to help clients manage energy transactions in natural gas and electricity. When it began offering trades, it also provided services for delivery and settlement of energy trades. This ability to integrate the transaction chain is one crucial part of Altras success, but there are two others, Braziel says. Because people dont change, Altra uses a big sales force. It also partnered with two big energy brokers — just the kind of distributors and middlemen that e-commerce was supposed to cut out.

"The needs of buyers and sellers dont always match. I want to sell 200, you want to buy 300. Many B2Bs simply ignored that intermediation step that goes on in all spot markets, and those that did failed," Braziel says.

Its a failing that he believes will also hamstring industry-sponsored marketplaces.

However, a growing number of industry officials believe the industry-sponsored business model has advantages. Independent markets are suited to trading in "indirect materials," such as fuel or paper, which arent used in final products, they say. These are low-margin goods compared to "direct materials" — the materials and engineered parts used in everything from cars to computers.

That encourages many vendors, such as Moai, that are trying to introduce new services to exchanges. After starting out with a basic auction format, "we found that when we introduced multiple variables and multiple stages in negotiations, that was very popular," Perlman says.

The question comes down to whats the mix of services that creates a truly compelling marketplace.

"Theres a natural evolution. It will just take time," says Dennis at Robert W. Baird.