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Will B2B exchange e2open.com succeed?

Will the exchange founded by IBM and other tech heavyweights achieve its founders' vision? The answer, according to experts including Wharton professors, is: That depends.

Business-to-business relationships on the Internet have lately gravitated toward the formation of giant exchanges.

Competitors in industries such as automobiles, aerospace and chemicals have come together to establish massive electronic marketplaces aimed at reducing the inefficiencies and slashing the costs of dealing with suppliers.

IBM and several telecommunications and electronics giants made the most recent splash in this field June 7, when they announced the creation of e2open.com, a giant exchange for the computer, electronics and telecommunications industries. Will this exchange achieve its founders' vision? The answer, according to experts including Wharton professors, is: That depends.

Launching in mid-July, e2open clearly has huge potential. In addition to IBM, its founders include Hitachi, Matsushita, LG Electronics, Nortel Networks, Seagate Technology, Solectron and Toshiba. Technology powering the exchange will come from Ariba and i2 Technologies, two leading business-to-business e-commerce technology providers, in addition to IBM.

e2open's financial and advisory partners include Crosspoint Venture Partners, a Silicon Valley venture firm; investment firm Morgan Stanley Dean Witter; and consulting firm McKinsey.

The founders say the goal of the electronic marketplace is to bring together thousands of computer, electronics and telecom companies around the world to do transactions over the Internet. e2open's participants account for some "$700 billion in goods and services bought and sold in the worldwide electronics industry's supply chain."

While IBM spokeswoman Carol Makovich declines to guess the volume of goods and services that will be traded through e2open, analysts see enormous potential. They expect the electronics sector to account for online business-to-business purchases of almost $600 billion by 2004, of which almost $450 billion will be sourced from online exchanges like e2open. In comparison, the auto online exchange of Detroit's "Big Three"--called Covisint--is expected to handle the bulk of those companies' $200 billion in annual purchasing.

John Mumford, a founding partner of Crosspoint Ventures and acting CEO of e2open, says that three factors make this exchange different from other electronic marketplaces.

"First, we're already in business and working together as partners," he said. "Second, we have a clear strategy to move forward, as evidenced by our decisions to build this e-marketplace on the technologies of Ariba, IBM and i2. And third, we are well financed, with more than $200 million of financing commitments from the founding partners and our financial partners, Crosspoint Venture Partners and Morgan Stanley Dean Witter."

Wharton faculty members point out, however, that the success of the e2open exchange will depend on several factors.

"A B2B exchange needs high penetration in the market. It is useless if only the small players or just a few players are involved in the exchange," said Morris Cohen, co-director of the Fishman-Davidson Center for Service and Operations Management. Having roped in the major players like Hitachi, Matsushita and Nortel, there might appear to be little fear that e2open will end up as a marginal player among online telecom and electronic exchanges.

Interestingly, while e2open includes several top names from the world of computers and electronics, there also are some significant omissions. Some press reports had suggested that Nokia, Motorola, Ericsson and Philips might join the exchange; the official announcement does not mention their participation, however.

Said Makovich: "We have talked to many companies and continue to talk to many others. There may be other companies who may join as founders. We have to wait and see."

Moving the goods
Another factor that will affect the success of online exchanges is the degree to which goods can be sold as commodities.

"It is difficult to sell sophisticated goods through exchanges," said G. Anandalingam, who teaches operations and information management at Wharton. He said that only for goods that are commodities or are fast becoming commodities will such online exchanges work.

"Cellular handsets, for example, are fast becoming commodities," he said. "For such equipment, the use of online purchasing exchange can be useful to lower costs and order standard equipment. In such cases, the company-vendor relationships will become very fluid, with vendors competing mainly on price and quality.

"But I cannot visualize (how) sophisticated optical networking equipment, which needs to be customized for the user, will be sold through such an exchange."

Cohen, however, said that high-value, low-volume transactions can be funneled through online exchanges, and for high-volume transactions, companies are likely to stick to fixed suppliers. He added that not all company and vendor relationships would become fluid.

"Companies do need special relationships with vendors. Inputs need to be customized, and standards have to be adhered to, so I do not think that companies will give up long-term vendor relationships," Cohen said.

Companies like Dell Computer practice just-in-time inventory management, which involves sourcing equipment from vendors when orders are received to maximize customization. Cohen said that companies using online exchanges would have to figure out how to do this.

Making logistics work
Although exchanges greatly lower transaction costs, companies have to be careful about inbound and outbound logistics costs. In other words, many companies have vendors near their factories to ensure low transport costs of raw materials and finished goods. These benefits may be lost when trading on an online exchange.

Initially, at least, companies are likely to use online exchanges to try to fix unexpected shortages or gluts. Moreover, for spot purchases arising from a sudden increase in demand, companies may increasingly look at online exchanges instead of going through intermediaries, such as distributors who buy excess supplies.

This is precisely what has been happening in commodified exchanges such as MetalSite and e-Steel, two exchanges aimed at the steel market. Steel companies use these exchanges to unload excess product, while small buyers have the chance to do business with the big boys in the steel business--without having to depend on sales executives or rounds of golf with "Big Steel" executives.

The success of a business-to-business exchange also depends on how well its standard software can be integrated with a company's supply-chain management. Hubert Vaz-Nayak, director of KPMG's telecommunications unit, said that online exchanges will dramatically change the way business is organized across industries if supply-chain management can be integrated into the online exchanges.

Already, initiatives like RosettaNet, an independent, self-funded, nonprofit consortium, are trying to develop and launch standard electronic business interfaces. These standards form a common e-business language, aligning processes between supply-chain partners on a global basis.

"If you have an open standard like RosettaNet, it is easy to link to outsourcers because everybody is operating on the same standard. As a result, it becomes much easier to exchange information," Vaz-Nayak said.

Added Makovich: "We believe there is ample room for multiple exchanges; in fact, in the future, they may interact quite a bit. There will be the ability for members of one exchange to be interoperable with members on other exchanges."

The establishment of common standards within business-to-business exchanges will let companies juggle their suppliers, depending on who has what supplies available. Such online exchanges can then be used to pinpoint excess capacities and use them.

Vaz-Nayak used the example of electronic chips to illustrate his point. Although the lead time for increasing the production of chips could be as high as 12 to 14 months because the semiconductor industry works on a three- to five-year capacity expansion plan, a buyer could potentially cope with a huge increase in its demand by using an online exchange to ascertain which chipmaker, if any, has the capacity to fill a new order.

No clear leader
It is still too early to say whether e2open or any of the other 500 exchanges will succeed. Most industries, such as steel or aircraft manufacturing, tend to have at least three or more different exchanges that are slugging it out to emerge as the primary exchange for that industry.

Even in the electronics and telecommunications industries--apart from e2open, which is not yet operational--i2 has promoted Hightech Exchange. Compaq Computer and Hewlett-Packard also have planned an exchange.

Still, online exchanges are undoubtedly changing the way industries and companies operate. Intermediaries such as wholesalers and distributors are slowly being eased out or are realizing that their roles will have to change if they want to survive in the supply chain. Vendors in tough competition with one another, and without the advantage of cozy relationships with their buyers, could also suffer from lower margins as prices are squeezed through bids and auctions.

"Vendors will be concerned (about a profit squeeze), especially if the industry goes through bad times," Vaz-Nayak said. "Well, it's all part of this new drive toward electronic-induced efficiency."

e2open has as good a shot as any of profiting from it.

 
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