The state of electronic exchanges

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Specialty Services: The entities in the Specialty Services segment offer only two core services: information exchange and logistics services. In fact, some players in this segment may not qualify as e-marketplaces by others? definitions. But because they leverage the Internet to facilitate commerce among businesses, these Specialty Services providers meet our definition. By and large, companies in this cluster provide information or other niche services of value to a single industry. The narrower scope of this segment provides a smaller potential revenue base; 6 percent of its constituents have already failed.

Survival of the fittest
Constant change seems to be the only certainty in business today, and the e-marketplace phenomenon offers an example accelerated beyond even the normal hectic pace of our times. Out of the 1,802 e-marketplaces we profiled, dozens failed even as we compiled our survey. As in all periods of upheaval, failure will predominate, although some exchanges will succeed wildly. The three groups that have the most at stake in the coming shakeout--consortium participants, independent e-marketplaces and mid-sized corporate buyers and sellers--have different expectations of survival.

Consortium Participants: Immediate transaction volume from committed founders gives the consortium e-marketplaces an initial advantage, but two factors will drive their success or failure. First, a successful consortium will need to create an integrated suite of services that becomes the industry standard.

Second, a small set of founders must remain committed to the survival of the consortium and ensure the financing and usage fees that keep the e-marketplace afloat while it builds the desired capabilities. A small number of founders--such as the five large automotive OEMs backing Covisint--offers the greatest likelihood of committed support. On the other hand, packaged-goods e-marketplace Transora, with 49 founders, risks dilution.

Alternatively, there?s a breakaway strategy that redefines the industry. Imagine a consolidation among the multiple exchanges in the retail industry in conjunction with a third-party logistics provider to tackle services beyond the software tools described previously. Such a combined entity could offer to take control of the full distribution network and logistics between consumer-products manufacturers and major retailers and create a new entity--one offering digital and physical outsourcing of the goods along the chain. The combined entity could eliminate hundreds of separate distribution centers operated independently by the manufacturers and retailers. Such a move would be riskier than the shared resource model, but could offer rich rewards by freeing billions of dollars in assets for the retailers and manufacturers.

Independent e-marketplaces: With venture capitalists now more cautious and the IPO market effectively closed, independent e-marketplaces must become focused on the bottom line to conserve cash. Launching new services in a field-of-dreams model is no longer affordable. In fact, even sustaining some services may destroy value. Auction services continue to offer the most immediate returns to customers, and the best chance for extracting value in the short term. Unfortunately, online auction systems and support face rapid commoditization, making them increasingly tenuous revenue streams over the long run unless an e-marketplace has built industry expertise that is deep enough to differentiate it from the competition.

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We do not believe that independent e-marketplaces can succeed in the Full Service model. Though some consortia may eventually create seamless links among the services and thereby dominate an industry, such aspirations would be impossible for an independent. Even the Total Procurement players may discover that they have bitten off more than they can chew, largely because the transactional focus of digital catalogs requires a great deal of investment but delivers relatively low benefits.

Among independents, niche players should have the best chance of survival. If an independent lacks a strong membership and offers a vague value proposition, we recommend seeking a deep-pocketed consortium, ideally one in need of fresh resources looking to embark on a breakaway strategy.

Mid-sized corporate buyers and sellers: Most mid-sized companies sat on the sidelines as the initial e-marketplace game unfolded, and their conservatism has paid off. The time is ripe to exploit the e-marketplace investments financed by the venture capitalists, software vendors and corporate behemoths. Even the successful e-marketplaces need more buyers to take advantage of the increasing returns and scale advantages available in many e-business platforms.

A savvy mid-sized company should be able to extract favorable terms from competitors seeking to expand. At the same time, committing to a particular e-marketplace requires a fair amount of due diligence. Joining any e-marketplace implies significant investment in changing internal practices to extract the real value. Reengineering a business to work with an e-marketplace that goes under in six months will prove to be a worthless investment.

Similarly, many mid-sized companies have gotten the short stick as a seller in an e-marketplace. Though most have suffered through margin pressures from online auctions and consortium buying programs, the tide is turning. The large corporate buyers now recognize that online auctions will yield decreasing returns over time and may even become disadvantaged once weaker players exit and eliminate excess capacity. Accordingly, e-marketplaces have shifted their focus from aggressive procurement tactics to the collaborative tools supporting supply-chain management and joint product design. These provide opportunities for mutual gain through waste elimination rather than simple margin shifting.

You can expect greater adoption of independent seller-driven solutions in the future, particularly by mid-sized companies that avoided the hype of e-procurement but now see the potential benefit.

Next steps
In the end, companies large and small need to step back and rethink their e-business strategies and the role of e-marketplaces.

The early participants made major investments in a market lottery that appeared to produce only winners, but now companies need to return to the more pedestrian task of implementing the powerful technology of the Internet.

Armed with clear strategies, independents can pick their spots or exit gracefully, as appropriate. Mid-sized companies must accept that e-marketplaces represent more than a passing fancy and develop clear strategies to win as both buyer and seller in this new world.

In all cases, the answer lies in the economics and industry dynamics as uncovered in a thoughtful and well-executed business strategy, and not in the media or the market, both prone to overreact to the momentum of the times.

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Reprinted with permission from strategy+business, a quarterly management magazine published by Booz Allen Hamilton.