Next-Generation B2B Solutions

By Ravi Kalakota -- Supply Chain Management Review, 7/1/2000

Business as usual? The emergence of the Internet as a ubiquitous and inexpensive networking platform for electronic commerce has touched off a revolution in the way corporations buy from and sell to each other. In a poll of more than 500 corporate leaders, Forrester Research found that 71 percent planned to extend their business processes to e-marketplaces—online venues that enable multiple buyers and sellers to conduct commerce—by 2001.¹ The key driver of business-to-business (B2B) commerce is the simple fact that purchasing online saves big bucks. Every purchase—from paper clips to light bulbs to floor wax—on average costs somewhere between $85 and $120 in processing and administrative costs alone. Historically, it's been a cumbersome, labor-intensive, paper-based process. And we're just talking about small operating supply purchases.

But it was these small operating supply purchases that gave first-generation B2B purchasing solutions a strong business case for creating enormous savings for the Global 2000, the world's largest corporations. Although second-generation e-marketplaces have benefited from their predecessors' lessons, major gaps in critical functionality remain. Despite the current hype, the market is still in its infancy. Now, even these solutions face challenges that pose a threat to their existence. With a slew of digital start-ups and rival joint ventures forming to create e-marketplaces, it is impossible for all of these ventures to co-exist and still gain benefits from economies of scale. When the dust settles, the survivors actually will be a new breed of e-marketplaces known as the "next generation."

What defines a next-generation e-marketplace? Will pricing models change? And when should a buyer, supplier, franchisor, or investor become involved in the phenomenon? Who will be the winners? Companies across the board are beginning to understand that the challenge is not simply to reduce costs but to make procurement truly strategic. Maximize organizational effectiveness. Increase contract leverage. Improve supplier performance. Eliminate non—value-added activities. And drive continuous improvement. However, before you can understand the next generation, you have to understand the progression of each model.

The first-generation e-procurement phenomenon started with buy-side solutions implemented for Global 2000 companies by software companies like Ariba, Intelisys, and Commerce One. Recognizing that the Internet could serve as a tool to streamline their inefficient procurement processes, these companies began massive implementations. Some obvious benefits promised big returns on investment.

First-generation applications help reduce costs by removing the manual, paper-based elements inherent in today's purchasing systems and using the power of the Internet and corporate intranets to link employees directly with suppliers from their desktops. How do they do it? The first-generation procurement software companies essentially aggregate a pre-selected group of suppliers for one particular Global 2000 customer. Any company employee can browse a customized catalog of goods and services from those pre-approved suppliers, then send an electronic purchase order over the Internet. If management approval is needed, the order is routed automatically through the proper channels. Companies save money by:

• Eliminating labor-intensive, paper-based requisition systems—freeing purchasing agents to focus on strategic procurement and supplier relations.
• Reducing or eliminating off-contract buying.
• Consolidating their purchasing power with selected suppliers, which usually offer lower prices for higher volumes.
• Improving purchase decision-support techniques.
• Significantly decreasing the time and cost to complete transactions.

There are, however, several drawbacks to these applications. The solutions can be costly to implement and thus unattainable for most companies outside of the Global 2000. Software licenses can run into the millions of dollars, installations can take a year or longer, and the disruptions to a business can be significant.

Further, because these solutions consolidate purchasing between one company and its supplier network, they address only the "buy side" of the equation: purchasing, which is simply one part of the whole procurement puzzle. Though the terms often are used interchangeably, purchasing refers only to the tactical, actual buying of materials and those activities associated with the buying process. Procurement, on the other hand, has a broader meaning that comprehends strategic integration of the supply chain, including purchasing, transportation, warehousing, and inbound receiving. It is a closed-loop process that begins with the requisition and ends with payment. Additionally, there are the issues surrounding reporting.

Most companies still do not have the kind of strategic purchasing system in place that will tell them how much they are spending and with whom—much less enable them to quantify the hidden costs inherent in the supply of goods and services that result from extended leadtimes, poor quality, and bad customer service. So there are some significant flaws in the first-generation solutions that shed light on the recent acquisitions first-generation companies have made.² To some extent, these first-generation entrants must reinvent themselves to remain competitive, especially with the emergence of digital marketplaces.

A second phase of the procurement revolution is happening now. There is a rapid adoption of new digital marketplace models where multiple buyers and sellers can conduct commerce without heavy implementation fees. Whether they are called e-procurement marketplaces, vertical e-marketplaces, trading exchanges, or e-business portals, these digital marketplaces have quickly become a part of the New Economy landscape.

Two digital marketplace models dominate the scene. The first to appear were start-ups typically built by people with domain expertise in that vertical's industry—people who knew the inefficiencies and saw an opportunity to make it better. These companies play a neutral, third-party, objective role between buyer and supplier. The second model is based on a joint venture formed by two or more of an industry's top companies or franchises. One of the first announced was GM and Ford's joint venture with DaimlerChrysler in February 2000 to form a digital marketplace. These joint venture marketplaces face far bigger obstacles than the start-ups, which really broadened the possibilities of B2B e-commerce.

Unlike first-generation solutions, which are geared toward large companies with considerable supplier bases, start-up digital marketplaces allow smaller buyers and suppliers to compete side-by-side with their larger counterparts for deals. For the first time, the small companies are on an equal footing with large companies, erasing geographic boundaries and realigning buyer-seller relationships within a common industry. Instead of requiring expensive software and time-consuming implementations, a simple Web browser facilitates low-cost access to these marketplaces. These digital marketplaces didn't just broaden who could play in the B2B revolution; they also broadened how you can play.

Unlike first-generation solutions that are exclusively catalog-based, these new trading portals offer a variety of ways to buy and sell goods in the marketplace. Transaction methods range from fixed-price online catalogs to dynamic pricing mechanisms, such as auctions, reverse auctions, or exchanges. Consider the benefits this could have for a product's life cycle: A new product could start off in a fixed-price arena when demand is at its highest, and then, after time, move to an exchange, and finally to a reverse auction when the inventory becomes outdated.

Because digital marketplaces often are managed by a neutral and unbiased third party, they can offer extremely valuable reporting information to both buyers and suppliers on the activity in their marketplace. For example, suppliers may find that they consistently have been losing deals to more nimble competitors because of lengthy delivery times. Buyers can easily find out if they are getting a fair price through side-by-side product comparisons. Such information has huge implications for the new Internet economy.

From a business viewpoint, the advantages are compelling. Open, Internet-based access to larger markets provides buyers and suppliers with new efficiencies, new market opportunities, greater choice, and competitive advantage. However, does it solve all the difficulties in the procurement process for any one user group?

Like first-generation solutions, digital marketplaces are primarily matchmakers that simply bring buyers and sellers together, impose a transaction fee, and then bow out of the process. Although facilitating the match certainly has value, it is not an end-to-end procurement solution. "The reality is that while ITEs [Independent Trading Exchanges] provide value through technology, they don't provide the more important side of the equation: supply chain execution," states AMR Research.³ Buyers and sellers still must manage the back end of the transaction themselves—delivery, invoicing, accounting, customer service, and so on. This failure to address the most challenging aspects of procurement dilutes the benefits of online purchasing and can result in increased costs.

With all of the challenges start-ups face, why would top industry corporations want to create their own e-marketplaces in tandem with their rivals? The answer: tremendous opportunity. Analysts have made billion-, even trillion-, dollar projections for business-to-business purchasing done via the Internet. No one questions the potential of the market.

Could this be the winning model? The B2B Internet community is doubtful and has been quick to criticize. Why? Joint ventures, especially among competitors, face more risks of failure. There are myriad resource and execution issues that these joint ventures must contend with that the start-ups don't. For example, who funds how much of what and how will the revenue be shared? Bricks-and-mortar companies are not experienced in this fast-moving Internet environment. They are late to arrive on the scene. So the more nimble start-up is at a significant advantage. And on top of that, this joint venture model is shaky on whether it can truly build marketplace liquidity (a critical mass of buyers and sellers conducting commerce on the system).

Why would another competitor want to participate in this type of marketplace—one in which its rival is controlling the pricing? Why would that same competitor have any incentive to share purchasing habits and budgetary information with a marketplace that's run by a direct competitor? Notions of fairness, neutrality, and confidentiality are going to be big considerations for customers.

Rival joint ventures also will face federal scrutiny surrounding antitrust and competitive issues much faster than neutral third parties will. In fact, the Federal Trade Commission is already looking at the Ford, GM, DaimlerChrysler e-marketplace.

Joint ventures backed by competing franchisors, such as Marriott and Hyatt, face these same obstacles and even more complications. In many cases, franchisors only have control over the quality of the supplies, not whom their franchisees buy from. Consequently, the supplier source is extremely fragmented. There's typically little trust in the franchisor/franchisee relationship. So if a franchisee is getting, or can get, better service or prices via another e-marketplace, it is unlikely to be loyal to the franchisor.

Both start-ups and rival joint ventures that base their profits on transaction fees are receiving a great deal of criticism from both buyers and suppliers. Keep in mind, as well, that having a Web site and storefront does not mean buyers and sellers are making transactions. Adoption is very slow. Also, buyers and sellers are asking themselves, Where's the value? They know they can avoid the matchmaker and the fees if they continue to manage all aspects of fulfillment and payment between themselves. For this reason, the future of transaction fees will be short lived. A marketplace's revenue model, how it makes its money, is going to be key to its success. (For an overview of how the different models make money, see Exhibit 1.) A report issued by Morgan Stanley Dean Witter sums it up best, "Many B2B business models look suspect and most probably will fail ... [Those] planning to survive off trading volume are in for a rude awakening."⁴ And it will be difficult for those e-marketplaces to switch their technology to accommodate new revenue models. It's not a quick fix.

The Next Generation: The Entire Transaction

Consolidation is around the corner. Though both start-up and joint venture digital marketplaces continue to be rolled out at breathtaking speed, it has become increasingly clear that not all will survive. "Three companies in each segment usually pull in 70 percent of the market share in technology markets," notes Morgan Stanley.⁵ In some industries there are as many as 60 digital markets. Who will be the winners? The next generation—the ultimate winners of the shakeout—will provide a total e-procurement solution. Instead of simply providing a common technology platform to a portfolio of buyers and sellers, the next generation will provide a total procurement solution that manages the buyer's procurement experience across an entire supply chain—from requisition to fulfillment to payment. This total procurement solution will be customizable to satisfy different customer needs, but overall the marketplace will be an integrated business process.

Next-generation solutions will deliver more than just the sale; they will manage the entire transaction from search and select, to order and delivery, to settlement and accounting—providing complete customer care throughout the process. Buying products at low prices means little if orders are lost or deliveries are consistently late. Next-generation procurement solutions will go beyond merely facilitating transactions or charging for the right to participate. Rather, they will combine the benefits of earlier solutions of a customized marketplace with significant supply chain management activities. Buyers will look to one resource to:

• Provide competitive prices.
• Aggregate multiple suppliers into a single, customized catalog.
• Provide one point of contact for customer care across a range of suppliers.
• Consolidate reporting and accounting across multiple corporate entities.
• Offer a single point of payment.
• Create supplier/buyer collaboration to help the marketplace evolve and keep content accurate.

Because each industry is different to some extent, the management teams of next-generation companies will need to have extensive backgrounds in both e-commerce and the vertical in which they operate. The only way you can truly understand the issues surrounding an industry's supply chain is to have faced the obstacles yourself. Distant suppliers, limited time to research purchasing alternatives, middlemen who keep a tight lid on information and add cost to the process, and cumbersome approval and accounting controls—all of these factors make purchasing more complex and costly than it should be. The time spent finding the best deal in order to save money actually costs money.

People will turn to the e-marketplaces that have the industry expertise to identify these issues and create value. Another trend to note: Some marketplaces that were once in a single vertical are now moving into multiple verticals. To be successful as a horizontal offering, you must have industry experts who understand the pain points and requirements associated with managing each marketplace.

Though the value proposition must address the unique needs of the industry, there are some common similarities among net markets in general. Key elements of the next-generation model include:

A Single Point of Contact/Customer Care

The marketplace must enable procurement professionals to search for, select, and order products from a variety of suppliers through a single, customized catalog. The system also offers consolidated purchase orders and payment settlement. Procurement professionals have to manage only one purchase order and one payment. For customer-service needs, one phone call connects the purchasing manager to a personal customer-care associate who can assist in resolving fulfillment concerns. Few vertical marketplaces have taken on the critical customer-service portion of the procurement process.

No Transaction Fees

"Hunting for high gross margins is key," states Morgan Stanley.⁶ The winners will be companies that generate revenue by reselling products sourced from multiple distributors to their customers. The reseller margin created is the profit. The supplier will sell its products at a lower price to the marketplace because it takes away sales, marketing, accounting, and customer-care costs, while improving the inventory management and logistics capabilities of its distribution partners. The marketplace ultimately removes expenses on the supply side and creates profit opportunities for itself when it resells products on the buy side. Because of the marketplace's ability to buy in volume, the buyer receives the same prices it could obtain on its own—or perhaps even lower prices. What results is revolutionary. In order to be successful, the marketplace must create a more efficient distribution solution that eliminates redundant costs and creates margin.

A Shortened Supply Chain

The next-generation marketplace will have to act as a virtual nonstocking distributor. Although that marketplace does not inventory, warehouse, or transport physical goods, it has developed unique strategic relationships with suppliers who are responsible for pick, pack, and ship operations. The marketplace must build a series of national and then international e-commerce distribution networks to optimize fulfillment operations and reduce costs.

Customized Reporting

Early marketplaces will find that simply providing the data they've collected will not be enough. Next-generation marketplaces will strive to provide buyers and suppliers with customized reports on their buying and selling habits. They also will find ways to connect with their customers' accounting systems to add significant value in the areas of invoicing, reconciliation, and budgeting. Next-generation marketplaces must be neutral, objective, third-party players.

From the buyer's perspective, what the next-generation model must deliver is simplified, lower-cost purchasing; improved management and operating control; low cost of participation; and improved supply chain efficiency. Buyers reap huge benefits from a single point of contact. Instead of building relationships with more than a dozen suppliers, they can turn to just one resource for all their needs. The buyers easily identify the products they need, establish purchase orders, obtain the requisite approvals, and settle with unparalleled speed and efficiency.

Next-generation models also will offer buyers customized online marketplaces with brand-specific interfaces. These customized sites will feature products and supplies that meet the various quality standards and requirements of the buyer's company or franchise. Such personalization is key. Searching through endless, irrelevant product listings must be eliminated. In addition, online order flow must be tailored to reflect the organization's established internal approval and work-flow routing processes.

The buyer's company also benefits from the technology. Both cost and time savings are realized from the Web-based solution without additional investment in equipment or software. And future innovations certainly will make the next-generation marketplace's service accessible by hand-held mobile devices. The new wireless capability will enable busy executives to make, approve, and check the status of orders instantly—all without having to rely on a PC.

For suppliers, the next-generation marketplace serves as an efficient sales channel that allows suppliers to expand their market reach and reduce customer-acquisition and order-processing costs. Suppliers get a complete e-commerce solution and electronic connectivity to their customers as the marketplace handles hosting and maintenance costs as well as customer-service issues. Additionally, the next-generation marketplace will issue payment for all orders directly to the supplier and will assume responsibility for collection from the buyer. As a result, the supplier enjoys both significantly reduced credit risk and a defined payables schedule it can count on from one customer—the marketplace—rather than from multiple buyers.

The next-generation solution also will advise distributors on supply chain inefficiencies and bring new solutions to the table on better warehousing and distribution methods. For example, the e-marketplace supplier experts will point out savings that could take place in deploying the distributor's trucking fleet by a new method they hadn't thought of before. The successful e-marketplaces will provide partnerships with third-party shippers that distributors can utilize where it's cost effective to do so. And by setting up a distribution network with a preferred territory, the distributor has an instant customer base in a multiple-state region that he doesn't have to market or sell to directly.

The marketplace that can create this win-win effect for buyers and sellers ultimately will win the showdown. Place your bets on those companies that provide the total solution. They will be the ones left standing.

The Internet has changed procurement forever by allowing companies to connect buyers and suppliers via a simple browser—making it possible to streamline and automate purchasing across departments, business units, divisions, and continents. A Forrester Research report notes, "e-Marketplaces will become an enduring reality in the business landscape. While the growth of these venues will spur continuous change, firms shouldn't wait any longer to jump in."⁷ Regardless of whether you are a buyer, supplier, investor, or franchisor, digital marketplaces are key to streamlining business operations. But companies need to make educated decisions about e-marketplaces, and they need to understand the characteristics of the different business models. (See Exhibit 2.) Here are some tips:

• Don't build it yourself if this isn't your business's core competency. Digital marketplaces continually require new features and functionality. It will be difficult to keep pace with the technology in a cost-effective manner.
• Marketplaces that generate revenue through transaction fees shortchange buyers and suppliers because they merely facilitate the purchase, ignoring back-end fulfillment and reconciliation. Next-generation e-marketplaces assume responsibility for the entire procurement process.
• Joint ventures, especially among competitors, may be setting themselves up for failure. The joint venture model is shaky in terms of its ability to build critical mass and establish trust among participants. Reaping the full benefits of data mining requires a level of disclosure best managed by an independent third party.

The next-generation approach takes the best features of automated purchasing applications and combines them with the dynamism of digital markets. The result? A revolutionary way for procurement professionals to identify, purchase, receive, process payment for, and manage the goods and services they need to run their business.