The unexpected return of B2B

Business-to-business exchanges are making a comeback--though not everyone is cheering.

Burned by pricing and other concessions and still waiting to see the promised volume and liquidity levels, many suppliers are wary of further involvement in electronic marketplaces. This time around, however, suppliers may actually find a variety of ways to benefit from participating in them. What has changed the equation is the emergence of private exchanges: invitation-only networks that connect a single company to its customers, suppliers, or both.

Private exchanges can do what their open precursors could not: By providing secure, one-on-one communication, they enhance shared supply chain processes, such as inventory management, production planning and order fulfillment. Some suppliers are using the process improvements generated by their participation in exchanges they don't own to build closer relationships with customers. Others are going a step further and launching their own exchanges.

So far, 15 percent of all Fortune 2000 companies have set up private exchanges, and an additional 28 percent plan to have one by the end of 2003, according to AMR Research. Many more report that they intend to follow suit. Researchers predict that private exchanges will garner up to 90 percent of the investment in new e-marketplace infrastructure over the next three years.

Our own research suggests that private exchanges can offer competitive advantages to most large suppliers if companies understand what these networks offer and what they demand in return. Of course, most companies are both buyers and sellers of goods. For this study, however, we define suppliers as companies that sell the bulk of their goods or services to a relatively narrow group of customers (automotive original-equipment manufacturers, for example) and buyers as companies that sell finished products into a broader market--typically, to end users.

What an exchange can do
Private exchanges resemble electronic data interchange (EDI) systems--the mainframe-based applications that large companies have long used to exchange purchase orders, inventory reports and other information electronically. Like EDI networks, private exchanges reduce the time and cost of interaction, but they also improve on EDI by enabling partners to share documents, drawings, spreadsheets and product designs in standard formats and in real time, thereby facilitating closer collaboration. Private exchanges thus combine the functions of Internet-based platforms with the security of EDI systems.

Private exchanges combine the functions of Internet-based platforms with the security of EDI systems.

Unlike open B2B marketplaces (orchestrated by third parties) and industry consortia (jointly owned by groups of buyers, suppliers, or both), private exchanges keep control in the hands of an active participant--an arrangement that helps focus activity on process rather than price. Because suppliers on a private exchange are either invited guests or hosts, buyers have already chosen to do business with them and might even have negotiated prices offline. In fact, a private exchange is chiefly an information exchange: Though buyers can shop for a better price elsewhere, we have found that they are rarely inclined to do so. Customer relationships built on trust (and supported by nondisclosure agreements) are essential if, for example, suppliers are to monitor a customer's sales and inventory levels, to forecast product demand and to assure the delivery of goods or services as needed.

Dow Chemical, for instance, launched its private exchange, which is called MyAccount@Dow, in 1999. Initially a pilot serving 200 customers, primarily in Latin America, it now has more than 8,000 registered users in 35 countries, captures 40 percent of the company's total sales volume in Latin America, and (as of late 2001) reportedly generated about $100 million in revenue a month. The exchange allows customers to review their account histories, to check the availability of products and to manage their order-delivery schedules. Such capabilities give the supplier, in turn, a clearer picture of its customers? inventory levels and buying patterns--information that permits it to manage its own inventory more efficiently and to book its customers' orders with greater certainty.

The exchange, which is linked to Dow's internal systems, tracks all interactions with customers, by telephone, fax or computer, cutting the company's cost per transaction to about $1, from $50 to $100. Overall, the company claims to have wrested more than $30 million a year in productivity improvements from its self-service system. These processes could not have been automated through less flexible EDI networks or less closely controlled open e-markets.

Not every supplier is powerful enough to launch its own exchange: In some cases, customers simply wouldn't sign up. Such companies are more likely to be invited to participate in exchanges launched by customers. Participation in such an exchange deepens relationships with the buyer and can produce a 15 percent increase in the duration of contracts. That can in turn generate a substantial increase in a company's incremental revenue.

While conferring fewer strategic and logistical advantages than ownership, participation costs less and still carries powerful benefits: through direct links to buyers, for example, suppliers can respond more quickly to their customers' demands, manage supply chain and internal processes more efficiently, and in general gain privileged access to their most important customers.

Deciding whether to get involved
So much for the potential benefits of involvement in a private exchange. Before founding or joining one, a supplier must ponder two important questions: What will it cost, and is the effort worthwhile?

Internet-based technologies have been standardized, but each customer's terminology, part numbers and information requirements can vary, and these variations generate headaches and expenses for suppliers that must join a multitude of exchanges. Indeed, suppliers joining customer-owned exchanges face integration and system-management costs of $50,000 to $100,000 a year for each customer served.

Setting up a network costs much more. A Fortune 500 company, for example, should be prepared to spend $60 million to $80 million to build an exchange and will have to meet annual operating expenses of perhaps 20 percent of the launch cost. In return for this investment, the company gets to select the technical protocols and information formats the exchange will use and can build the exchange around its own system, so that each new trading partner can be connected at a low incremental cost.

A large supplier, like Dow, that serves hundreds of customers online might conduct millions of interactions a year--a volume of business that would be hard to manage if the company didn't control its own trading platform. Furthermore, a company that has its own exchange can decide where to focus (inventory management, for instance, or product design), depending on its competitive strengths.

One supplier with $2 billion in revenue expects to add $20 million a year to its bottom line through real-time invoicing and payment.

A straightforward return-on-investment analysis establishes whether the investment is worthwhile. The analysis should take into account both the value of a customer's business and the indirect long-term benefits of participating in an exchange. The companies we studied--both those that ran their own exchanges and those that participated in the exchanges of other companies--reduced their product cycle times by an average of 5 percent to 15 percent and their inventory levels by an average of 5 percent through the use of demand forecasting, production planning, decision support and other collaborative tools, whose benefits accrue across the supply chain.

As the frequency and scope of interaction rose, most suppliers also reported signing longer-term contracts with key customers and enjoying higher volumes of business with them. Other benefits are less intuitive. One supplier with $2 billion in revenue expects to add $20 million a year to its bottom line by using its system's real-time invoicing and payment functions to capture the float previously lost to customers.

Given the potential benefits, most large suppliers would gain from participating in an exchange. For 59 percent of participants--exchange owners and their trading partners alike--the average payback period is less than 18 months, according to AMR.

Deciding how to get involved
Once a supplier decides to participate in a private exchange, it must decide whether to join one that belongs to a customer or to build its own. In making this decision, the company must consider two important factors: its online interaction capabilities and its power within the supply chain.

The online interaction capabilities of a supplier depend mainly on its systems and technical proficiency. Dow's success, for example, resulted from strong systems and support. The greatest and most costly technical challenge is managing catalog content--the publishing, reconciliation and frequent updating, across many exchanges and formats, of the specifications, prices and availability of products. Without sophisticated data-management systems, the posting of such content becomes a tedious manual task. Moreover, if a supplier can't share data across its own functional departments, subsidiaries and work sites, it probably won't be able to share data with customers, whose expectations therefore won't be met.

Companies that don't have strong enterprise systems, which can cost some $100 million and take three years to implement, are unlikely to experience the full benefit of a private exchange. But for companies that already have (or are considering investments in) these systems, participation in private exchanges can help capture additional value and recoup a share of the cost.

Technological capabilities are not the only component of good online interaction. We also found that organizations with experience serving customers online can more easily overcome the cultural and political (as well as the technical) hurdles to establishing private exchanges. And successful implementation requires the support of frontline as well as senior managers.

Cummins built its exchange around an online design tool, which helped drive new business and deeper relationships with existing customers.

As for the second factor--the power a supplier wields in the supply chain--it depends, among other things, on the percentage of the value of a customer's product or service for which the supplier is responsible, the availability of other sources for the supplier's inputs and the cost of disruption. If a customer had to find alternative suppliers, would its production schedule be interrupted for 10 minutes or 10 days? Clearly, the longer the interruption, the more powerful the supplier.

Once a company has considered these two factors, a simple framework can suggest the best way to proceed. Suppliers thus have flexibility in choosing a private-exchange strategy that balances the needs of the market, on the one hand, and their own power and capabilities, on the other.

There are four ways to play.

1. Build an exchange
In each industry, a handful of suppliers have the value chain power and the interaction capabilities to draw custmers to their own exchanges. Cummins, General Electric and Honeywell are among the companies that have consolidated such advantages in this way.

Cummins set up a network in 1999, inviting key buyers, including Kenworth and Peterbilt, to collaborate in its development. With only two primary North American competitors, Cummins already occupied a privileged position in its customers' supply chains. It also had well-integrated IT systems and data-management skills. Seeing that its customers needed more efficient engine-design capabilities, Cummins built its exchange around an online design tool, which has become an important driver of new business with existing customers and has helped forge deeper relationships with them--for example, by making it easier for customers to work with the company.

The network has increased its sales, helped it win market share from its major competitors, and cut transaction and development costs for the company and its customers alike. Moreover, Cummins' strength in the supply chain made it economical for customers to help finance the exchange.

2. Join a customer?s exchange
A supplier that has good interaction skills but lacks a privileged position in the supply chains of its customers can benefit from joining exchanges they set up. One produce supplier, for example, improved its standing with a key retail customer by using the customer's exchange as a venue for exploiting its superior skills in managing product data. The collaborative forecasting, planning and replenishment capabilities of the supplier enabled it to fill the customer's store shelves more quickly than its competitors could, and it was rewarded with a doubling of orders, some from stores outside its regional footprint. Indeed, the customer now purchases some items of produce solely from this supplier. Such benefits more than offset the cost--less than $100,000 a year--of serving the customer online.

Suppliers that use technological know-how in this way can outperform their competitors on a customer's private exchange and so increase their market power. Eventually, they might even establish enough of it to run their own exchanges.

3. Launch an enterprise portal
Many suppliers can meet their customers' requirements, provide special expertise or otherwise establish their supply chain power in the offline world, but if they lack strong IT capabilities they are unlikely to excel at running their own private exchanges. A company that has substantial supply chain power but not the necessary interaction

A portal lets a company build on its brand name, establish an online presence and manage a single site rather than a number of connections to buyers' exchanges.

skills could, as an alternative, launch an enterprise portal--for instance, an intranet for employees and a password-protected extranet that not only would give customers access to order histories and project reports but also would cost less to build than a private exchange. A portal, moreover, enables a company to build on its brand name, to establish an online presence, and to manage a single site rather than a number of connections to buyers' exchanges.

One large electrical-services supplier, which was typical of most of the companies we studied, is developing such an enterprise portal. The initial outlay comes to about $600,000, and the company anticipates operating expenses of about $180,000 a year--roughly the cost of serving just three customers on an exchange if the company had the systems to do so. The disadvantage of portals is that most of them don't support direct-sales transactions or allow partners to work together in real time (for instance, by participating in collaborative forecasting, planning and replenishment).

A company that has powerful customer relationships can draw buyers to its portal but should decline invitations to join any customer's exchange until it has gained online experience and improved its internal processes.

4. Choose an intermediary
Suppliers that have little supply chain power--makers of commodity products, for instance--and that lack the skill to interact online are in a difficult position: They give up process savings and customer loyalty if they don't participate in an exchange, yet face huge costs to upgrade their skills and systems if they do.

The best course for these companies is to use intermediaries to manage their online relationships. Order-content publishing hubs, operated by third-party providers such as EC Outlook, Ironside Technologies and Trigo Technologies, can hook suppliers into their customers' exchanges as well as take and acknowledge orders, get in touch with customers and confirm terms--all on the third-party network. These intermediaries, which work well for selling commodities, can cost the user as little as $2,000 a year per customer in all.

Shell Oil Products Europe, for example, employs one: the Ariba Supplier Network. SOPE feeds product information (notably, frequent price changes) to Ariba, which provides an interface to customers. The intermediary has helped SOPE increase its sales to existing customers, expand into new geographic markets and cut the cost of acquiring new customers by 80 percent compared with the offline alternatives (sales calls, market research and advertising).

Companies that lack the ability to participate directly in their customers' exchanges should use intermediaries to build online trading relationships, gain online experience and show senior management that playing a role in a private exchange can pay off in the long run. But while this arrangement lends itself particularly well to commodity sales, it is less suited to more complicated one-off products (such as a turbine for a power plant) or to other forms of collaboration.

Managing the process
Moving business to a private exchange requires the support of at least three departments: IT, which is often expected to implement and operate the exchange; purchasing, which must assure the timely delivery of goods and services to meet commitments to customers; and sales, which has a powerful incentive to control the channel (and to take the credit for increased revenue).

An exchange draws on relationships built through years of effort by people in all parts of the organization, so participation becomes a strategic issue.

The best way to provide such diverse constituencies with the training, incentives, oversight and strategic perspective they need is to put these responsibilities in the hands of an e-commerce team or an e-business unit created for that particular purpose. The team must have the visible support of corporate management and the clout to establish goals and deliver resources. Team members can then act to bring various departments on board, to assist outside partners with implementation, to help identify the needs of customers and to specify the system's capabilities. In short, the team links sales to IT--those who know customers to those who know how to serve them.

But when suppliers invest in private exchanges, those suppliers are buying more than an option on a new sales channel; participation affects vital business processes involving their most important customers. The exchange draws on relationships built through years of effort by people in all parts of the organization, so participation becomes a strategic and not just an operational issue.

A supplier that has invested in strong enterprise systems and leads its markets can extend such advantages by launching its own exchange. A supplier with strong technical abilities can increase its supply chain power by using its skills on a customer's private exchange. But, until they have improved their systems and technical skills, other suppliers may be forced to walk away from business they can't conduct profitably online. The best bet for such a company is to treat the capabilities of private exchanges as the standard for measuring its own alternatives to them--for example, by simulating many of their features.

The move to private exchanges is still in the early going. Yet even now, they offer suppliers an opportunity to gain privileged access to customers.

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