E-marketplace survival strategies

Internet visionaries once prophesied a frictionless electronic marketplace where companies would communicate directly with customers and suppliers around the globe. The super-heated capital markets then made the dream reality, financing the creation of business-to-business Web exchanges in industry after industry.

When the Internet bubble burst in 2001, what had seemed a dream became, for most such e-marketplaces, a hallucination--or at best a fantasy yet to be realized.

In early 2001, we began studying B2B e-marketplaces, eventually profiling 1,802 existing and announced exchanges. Our research documented six basic service offerings across 24 traditional industry segments, and three different ownership models, as a first step toward uncovering the common ingredients of success and the conditions that lead to failure.

This task was--and remains--daunting. Even with our extensive database, which captures a variety of critical variables, it is difficult to distinguish long-term survivors from those barely hanging on and to discern a pattern in the failures at the macro level. Only a detailed look at the survivors along many simultaneous dimensions offers any insight into drivers of success. Despite a staggering 45 percent failure rate overall, hundreds of e-marketplaces continue to operate--and a few even thrive.

Investigating survivors and victims alike, we have concluded that the surest path to e-marketplace endurance follows a rather traditional route. The clearest successes appear to have taken a traditional business in a fragmented industry--for example, custom printing--and offered it to targeted customers via the Internet.

Other sites have succeeded by abandoning many of their marketplace functions and transforming into application service providers (ASPs), which sell exchange-facilitation software. Finally, a small number of successful e-marketplaces remain true to the original vision: serving as intermediaries in the vast network of B2B transactions. It now appears clear that most of the entities succeeding with this original model will be backed by some sort of consortium.

Where we started
Booz Allen Hamilton began compiling a global list of B2B e-marketplaces in early 2001. Our research was based upon press releases, published reports and simple Web surfing. Our initial results, published last year as "B2B Benchmark: The State of Electronic Exchanges," examined more than 1,800 B2B e-marketplaces.

That initial report remains the most comprehensive baseline study of online B2B commerce. The hard statistics demonstrated that the United States and Europe had spawned the vast majority of B2B e-marketplaces. It also documented the existence of three ownership models. While the most prevalent one was independent entities funded by venture capitalists, our study highlighted an emerging group, e-marketplace consortia--collectives of erstwhile competitors aiming to cash in on the B2B frenzy in the capital markets. Our research also found numerous private e-marketplaces operated by individual companies seeking revenue growth and/or efficiency rather than IPO riches.

Different e-marketplace ownership models have experienced different failure rates.

"B2B Benchmark" also documented six services offered, singly or in combination, by e-marketplaces. These are information exchange, digital catalogs, online auctions, logistics services, supply chain planning, and design collaboration. Our cluster analysis further segmented the e-marketplaces according to the mix of services provided.

Total procurement was the largest segment, covering 32 percent of the entities and encompassing companies that offered both digital catalogs and online auctions, and, occasionally, logistics services, but not such services as collaborative supply chain planning and design collaboration. Twenty-seven percent were classified as catalog buying operations that did not offer online auctions. Conversely, 19 percent were identified as auction houses, which focused on auctions and eschewed fixed-price digital catalogs. Collaboration facilitators, making up roughly 3 percent of the entities, focused on supply chain planning and design collaboration. Full service exchanges, which offered all the core services, represented another 5 percent. A final segment, specialty services (14 percent), offered none of the core services and was dropped from this year's second phase of analysis.

With the help of the Darden Graduate School of Business at the University of Virginia, Booz Allen revisited a large sample of the e-marketplace sites--approximately 1,100 of the 1,802--to document the failure rates.

In more than 200 cases, the e-marketplace had clearly failed: The Web address no longer exists and the Web browser returned an error message stating that the URL could not be found. For another 50-plus sites, the address routed to a generic Web site that offers to sell URLs. In six instances, we were routed to a pornographic Web site that had apparently acquired the name of a defunct e-marketplace to capture unsuspecting potential customers.

In the end, of our original 2001 sample of 1,802 sites, we've been able to classify 1,100 as either dead, active or merged/acquired.

What went wrong?
Different e-marketplace ownership models have experienced different failure rates. Of the full sample of exchanges, 45 percent have disappeared. Of the e-marketplaces in the consortium-backed category, however, only 21 percent have failed. Yet it's difficult to discern the reasons for that qualified success. Some might argue that the lower failure rate proves the advantage of the immediate liquidity provided by established owner-customers. Others would say that because consortium exchanges were launched later, on average, than "pure play" sites, and backed by greater funding, they've been better positioned to withstand the collapse of e-business and the disappearance of venture capital financiers.

What's more, 15 percent of the consortium marketplaces we examined merged with or were acquired by others. With the average merger/acquisition rate for the total sample running at only 7 percent, this suggests that the consortia have recognized the value of standardization within an industry, and may indicate further consolidation in the months and years ahead.

Among the venture capitalist-funded independent e-marketplaces that have remained in private hands, the failure rate has slightly exceeded the overall average of 45 percent. Those that went public prior to the market peak managed to achieve a somewhat better success rate: A "mere" 38 percent of those failed. Observers ought to be careful not to conflate survival and success. Iprint Technologies, which offers printed promotional material via the Web, went public on the Nasdaq in March 2000 at $20 to $25 per share but hovered below 25 cents per share throughout this year, going as low as 6 cents in July 2002.

We also looked for differences across regions, but found little: Failure rates across North America, Europe and the Asia-Pacific region varied by less than one percentage point.

What went right?
The advertising/media and textiles industry e-marketplaces each generated failure rates in excess of 60 percent. On the positive side, aerospace, financial services, and paper and printing all produced failure rates below 35 percent. The generalist e-marketplaces that lacked a focus on any particular industry failed at the average rate of 45 percent--despite our prediction a year ago that they were at the greatest risk.

In one notable change, many e-marketplaces now market themselves as technology/software providers, rather than as intermediaries in an existing supply chain.

When we looked at our data from the perspective of service-offering segmentation, the highest failure rate occurred among the total procurement e-marketplaces--those offering digital catalogs and online auction services. Since this category was the largest segment in our sample, perhaps the model was too common to allow the players to demonstrate a differentiated position. The lowest failure rates came from the full service and catalog buying segments. Auction houses, which we had expected to suffer the most, performed no better or worse than the overall sample.

Only a handful of e-marketplaces appear to be on track to fulfill the original promise of revolutionizing industries by becoming new intermediaries in the value chain. These full service e-marketplaces must be highly customized to the needs of the industry they serve, and quickly gain the transaction volume needed to support the massive infrastructure investment.

Ultimately, we believe successful e-marketplaces will be those that find the combination of ownership model and service-offering mix appropriate to their industry.

Across industries, we predict that full service consortia will continue to demonstrate the highest survival rate. Only one of the 11 from our sample has failed. Catalog buying sites, whatever their ownership, should also continue their positive trajectory. Many e-marketplaces will ultimately reposition themselves as ASPs, selling services to individual companies rather than seeking a place as an ongoing transactional marketplace.

Others will continue to seek success by exploring a range of options in hopes of finding a clear path. "We are still actively using the technology and the Internet to generate sales in the swine and cattle business," Joe Dales, a co-founder and vice president for business development at Farms.com, a North Carolina e-marketplace, wrote us in an e-mail. "The adoption, which has been slow, continues to progress and more customers are online and becoming familiar with the technology."

Farms.com has covered its bets by purchasing several traditional software companies with products, sales, and staff, and is about to launch new Web-enabled applications for feed and grain procurement as well as swine production management. The acquisitions have provided cash flow and additional expertise. By reducing its marketing, business development, and programming expenses, Farms.com has finally achieved profitability.

"We are still excited about the future prospects but are more realistic in regards to market potential and timelines," Dales wrote, expressing sentiments undoubtedly echoed by many e-marketplace principals. "This past year has been a great learning experience, but I don't think I would want to do it again."

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