The state of electronic exchanges

Over the last two years, journalists, scholars and self-proclaimed experts have written volumes about business-to-business e-commerce. Thousands of newspaper articles, dozens of popular business books and countless online newsletters examine the phenomenon from every angle--save one. None of these sources has conducted a rigorous examination of the new business model we call e-marketplaces.

We define an e-marketplace as a forum that leverages the Internet to facilitate commerce among businesses. Such a definition encompasses a wide range of entities: independent dot-coms financed by venture capital, industry consortia backed by pooled funds and private networks created by individual companies.

Such e-marketplaces burgeoned during the last five years, but a shakeout has begun. The fate of individual firms, however, will depend on the strategic decisions they make over the next year.

This year, Booz-Allen & Hamilton teams identified 2,233 publicized e-marketplaces and profiled 1,802 of them in detail. Our examination offers insight into the drivers of success and provides a baseline for monitoring the inevitable fallout over the coming year.

Our research documented three ownership models and six basic service offerings across 24 traditional industry segments. By examining the key data on service offerings in combination with the market size, we have concluded that independent e-marketplaces risk extinction. Founded in the heady days of Internet mania, most face huge ongoing technology investments, price erosion and limited liquidity resulting from their failure to create a clear value proposition that appeals to either buyers or sellers.

The e-marketplaces formed by consortia appear to have the strongest base, but they risk being hobbled by conflicting agendas among their founding companies. If they can survive the machinations of their founders and integrate the services required in a particular industry, consortium-based e-marketplaces are most likely to blossom into defensible full-service operators.

Finally, private networks sprouting from the in-house systems of many major companies represent a threat to both independents and consortium-based e-marketplaces. Operated for the exclusive use of the single owner, private networks may consume resources that could otherwise support the independents.

A model of evolution
There are three basic ownership models for e-marketplaces: independents, consortia and private networks.

The majority of e-marketplaces were developed by independent entities. The vast majority remain private, dependent on venture-capital funding to finance their. With so many competitors, and with venture funding increasingly scarce, most privately held independents will quickly disappear.

The consortium model, in which various industry players combine forces to create a common forum for the exchange of goods and services, has received broad press coverage. Yet these e-marketplaces account for fewer than 5 percent of the total. This small group receives a wealth of attention because of its typically deep-pocketed founders and the often unique conditions that allowed competitors to band together to develop their own e-marketplaces.

Private networks represent an even smaller proportion of e-marketplaces. The most common function of private networks is online cataloging to facilitate sales from the sponsoring company, but some networks also support such supplier-focused services as supply-chain planning and design collaboration.

Our profiling efforts show that some industries have far too many e-marketplaces. For example, 106 center on the transportation-and-logistics industry. With such a large number of exchanges in a relatively small industry, most of these competitors will disappear. In larger industries with relatively few exchanges, the competitive pressures will be less intense. Although effective execution of differentiating strategies ultimately drives success or failure, e-marketplaces in industries with relatively few exchanges have the best chance for survival.

The highest failure rate, however, likely will be among the 170 generalist e-marketplaces, which lack the base provided by a well-defined vertical market. These generalists focus on a specific, narrow functionality like auctions and forego a particular industry focus. An industry-focused player that tailors generic software to the nuances of a specific industry will have better odds of generating enough value to cover its cost. In examining the service offerings of the e-marketplaces, we discovered six core services--information exchange, digital catalogs, online auctions, logistics services, supply-chain planning and design collaboration--plus numerous niche and specialty services. One might expect the penetration rate for a core service to be high, as individual e-marketplaces adopt a mix of services in order to attract the greatest membership. Yet penetration rates vary widely, from a high of 65 percent to a low of 4 percent.

Nearly two-thirds of the e-marketplaces offer information-exchange services. Such a high penetration comes as no surprise: Information exchange costs relatively little and helps build a sense of community among the membership.

Digital catalogs have the second-highest level of penetration. Though more costly than simple information-exchange services, digital catalogs offer a much clearer value proposition to customers and suppliers.

Online auctions, offered by 55 percent of the profiled e-marketplaces, represent the third service offering. With consistent reports of double-digit savings for buyers, online auctions provide an easily measurable value proposition in e-marketplaces.

Beyond online auctions, the penetration rates for service offerings drop dramatically. Logistics--facilitating the physical flow of goods within a firm or between a firm and its suppliers and customers--ranks fourth. Managing the wide variety of transportation modes and linking the fragmented carrier market offer a rich value proposition to many customers. At the same time, smoothing the physical movement of goods rather than just the data flow offers a more difficult challenge than the top three services, a difficulty that helps explain the relative paucity of players.

Supply-chain planning tools help companies share sales and production forecasts over the Internet. Such collaboration reduces uncertainty in planning, which in turn decreases the need for inventory safety stock.

Design collaboration ranks the lowest among our core services. Of greatest interest to e-marketplaces serving original equipment manufacturers (OEMs), design collaboration allows these manufacturers to work with their first-tier suppliers to share the workload in product development.

Though the specifics vary dramatically, 45 percent of the e-marketplaces offer some other form of service. These value-added services appear to be an area where players can differentiate themselves.

Looking at services
Rather than simply examine the penetration rate of individual service offerings, we also decided to look at the service mix proffered by the exchanges. The segmentation provides a richer portrait of the evolution of the e-marketplace phenomenon and hints at which firms are most likely to survive the shakeout.

Total Procurement: The largest cluster encompasses companies that concentrate on digital catalogs and online auctions, the two core Internet procurement services. The majority of this segment also offer information exchange services.

Catalog Buying: A quarter of the companies in the sample classify as Catalog Buying operations. Two-thirds of this segment provides information-exchange services in addition to digital catalogs. Private networks represent a disproportionate percentage of this segment: Although private networks constitute only 3 percent of the e-marketplaces in operation, they account for 6 percent of the Catalog Buying segment.

Auction Houses: E-marketplaces focused primarily on online matching of buyers and sellers constitute one-fifth of the profiled population. These companies focus on auctions and do not offer digital catalogs, though a small percentage offer other services. Because online auction functionality, pioneered by FreeMarkets, dates to the earliest days of business-to-business e-commerce, several Auction House e-marketplaces have six years or more of experience--an eon in Internet time.

Collaboration Facilitators: Although Collaboration Facilitators occupy a much smaller slice of the surveyed population, they represent an emerging trend. Most early e-marketplaces focused on online auctions, and many of them found that service too one-sided to attract a sustainable community of buyers and sellers. Accordingly, they added other services likely to attract suppliers. The Collaboration Facilitators segment goes a step further, abandoning the tensions inherent in the procurement and price-negotiation processes and focusing on aiding collaboration between buyers and sellers. Both supply-chain planning and collaborative design tools encourage cooperation between buyers and sellers. As a result, they attract participation from both sides of the commercial transaction. Concentrating on win?win options, these e-marketplaces do not offer auction services.

Full Service: Full Service exchanges represent only 5 percent of the e-marketplace population. A company needs deep pockets to develop information exchange, digital catalogs, online auctions, logistics services, supply-chain planning and design collaboration. Although all the core services achieve a high penetration in this segment, only six entities offer all six services. The Full Service cluster has the highest percentage of consortium sponsorship. Although consortia represent less than 5 percent of the total e-marketplace population, they account for 19 percent of this segment.