Beyond the Exchange: The Future of B2B
by Richard Wise and 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.
The use of the Internet to facilitate commerce among companies promises vast benefits: dramatically reduced costs, greater access to buyers and sellers, improved marketplace liquidity, and a whole new array of efficient and flexible transaction methods. But if the benefits are clear, the path to achieving them is anything but. The B2B market is still in its infancy, and its structure and players remain in rapid flux. Despite breathless press coverage, very little is known about how business-to-business commerce will evolve on the Internet.
The high level of uncertainty is causing widespread anxiety among executives—and for good reason. Whether as buyers, sellers, or both, all companies have substantial stakes in the business-to-business marketplace. Their supply chains, their product and marketing strategies, their processes and operations—even their business models—will be shaped by the way B2B relationships are formed and transactions are carried out. Yet at this moment even the most basic questions remain difficult for companies to answer: Which exchanges should we participate in? Should we form a trading consortium with our competitors? Should we demand that our suppliers go on-line? What software should we invest in? Executives understand that the wrong choices could have dire consequences, but they also know that in the fast-paced world of the Internet they need to act soon or they’ll be left behind.
Fortunately, there is a model for the future shape of B2B: the financial services industry. Characterized by information-based transactions, large and liquid exchanges, and intense competition, financial markets closely resemble the new B2B markets. But unlike their B2B counterparts, the financial markets have been around for centuries. Their evolution provides important clues to the likely evolution of B2B. In particular, the recent restructuring of the financial industry suggests that, counter to the common wisdom about B2B today, exchanges are not the primary source of value in markets that are information intensive. Rather, value tends to accumulate among a diverse group of specialists that focus on such tasks as packaging, standard setting, arbitrage, and information management.
We will use the financial services industry as a window into the future of B2B. We will show why the current exchange-based model is structurally flawed, examine the major trends that will influence the strategies of both entrepreneurs and established companies, and describe the key market players that are likely to emerge and the roles they’ll play. The future we envision is already coming into being. New B2B players are now emerging with business models that mirror those that have come to define and dominate the financial industry.
The Flaws in the Exchange Model
Most B2B activity to date has centered on on-line exchanges and auctions, and most observers have assumed that these electronic marketplaces would come to dominate the B2B landscape. Once you look beyond the hype, however, you quickly see that most Internet exchanges are floundering. They suffer from meager transaction volume and equally meager revenues, and they face a raft of competitors. One of the leading chemical exchanges, for example, has seen its postings grow considerably since its launch in early 1998, but it’s still processing less than one trade per day. The hard truth is that few of these exchanges will ever create the liquidity needed to survive.
The current B2B model has three fatal flaws. First, the value proposition offered by most exchanges—competitive bidding among suppliers allows buyers to get the lowest possible prices—runs counter to the best recent thinking on buyer-supplier relations. Most companies have come to realize that getting supplies at the lowest price may not be in their best economic interest. Other factors, such as quality, timing of deliveries, and customization, are often more important than price in determining the overall value provided by a supplier. (That’s particularly true for the many manufacturers that have adopted lean, low-inventory production systems that depend on reliable, precisely scheduled shipments of supplies and components.) Many companies have spent the last two decades methodically forging tighter, more strategic relationships with suppliers—many such affiliations have involved joint product-design efforts, integration of complex processes, and long-term service contracts. The on-line exchanges’ focus on arm’s-length, price-driven transactions flies in the face of all this hard work.
Second, the exchanges deliver little benefit to sellers. Yes, suppliers have access to more buyers with only a modest increase in marketing cost, but that benefit is overwhelmed by pricing pressures. Few suppliers want to be anonymous contestants in ruthless bidding wars, and for the highest-quality, most innovative suppliers, price battles are anathema. As a result, the buyer-biased exchanges that characterize B2B today will not be able to achieve a critical mass of participants and transactions—they will be forever starved of liquidity. To be successful in the long run, B2B markets need to offer strong incentives to both buyers and sellers.
Finally, the business models of most B2B exchanges are, at best, half-baked. In their rush to get on-line, the companies that run the exchanges haven’t taken the time to study their customers’ priorities in-depth, create distinctive offerings, or even map out paths to profitability. They’ve simply used off-the-shelf software to set up simple auctions as quickly as possible. Because the software is readily available and relatively cheap, the barriers to entry are low, and the resulting proliferation of new exchanges is undermining the margins of all players. Indeed, the influx of new entrants is leading to the same type of market fragmentation that exchanges were designed to overcome in the first place.
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