To learn the future of e-commerce, keep an eye on the chemical industry. By 2004, this $1.7 trillion industry will account for a quarter of all business-to-business (B2B) e-commerce, making it not only the world's biggest industry but also its biggest e-industry. The quickly evolving chemical sector is creating an array of innovations that will profoundly affect all kinds of B2B players.

That chemical companies should lead the way for e-commerce has surprised many market observers. Traditionally, the industry had been perceived as a slow-moving global giant: asset intensive, with a "keep the plants running at all costs" mentality, it moved products through long-term supply contracts within closed, illiquid markets. Business challenges, including commoditization and crushing competition, exacerbated the industry's notorious cycle of peaks and valleys, creating extreme earnings volatility and low earnings multiples and limiting value-creating opportunities.

Over the past decade, however, chemical companies have made many large-scale changes to improve performance, including business process reengineering and consolidation via mergers, acquisitions, and alliances. The most far-reaching change, however, has been chemical companies' huge investment in enterprise resource planning (ERP) systems, such as SAP, and other information technology in order to integrate internal supply chains. Now, that huge investment is poised to pay off by giving chemical concerns the strong technology backbone needed to build successful e-commerce operations that can further integrate supply chains.

With the entire industry attuned to ERP technology and supply chain integration, chemical companies were ready for the Internet. Driven by e-commerce, the chemical industry is expanding beyond the traditional high-value-integrated-direct and low-cost-to-serve business channels to take advantage of emerging intermediary channels.

One of these emerging channels is e-procurement, which aggregates products and services from multiple suppliers into a single online catalog. Examples are SciQuest, Chemdex, e-Chemicals, and PlasticsNet. Another is virtual marketplace, a dynamic channel that matches buyers and sellers in an anonymous, real-time environment. Besides allowing market forces such as bidding to set price and terms, a virtual marketplace adds value by aggregating services (for example, logistics) and other information as well as products and services from multiple suppliers. In the chemical industry, ChemConnect is the most substantive example of this type of channel.

The other emerging channel consists of spot auction and reverse bidding, event-driven buying and selling activities in which prequalified buyers bid to purchase suppliers' products and services or sellers bid to fulfill customers' product and service requirements. ChemConnect, a good example of this type of channel, is the only auction-oriented site for the chemical industry.

The most effective e-commerce strategies target all of these channels rather than focusing on one or two. Emerging eChannels are expected to account for a substantial volume of chemical transactions. Of those, about 30 percent—or $250 billion—will be the province of intermediary channels, also called exchanges. These channels represent a relatively small yet highly significant segment that is fundamentally altering how businesses function.

As more people grasp the potential of e-commerce in the chemical industry, more exchanges have been created. Some embrace a catalog model that provides transaction efficiency and savings on small quantities or hard-to-find items. Others act as auctions aimed at achieving the lowest purchase price. These models primarily benefit buyers.

A true exchange seeks to benefit both buyers and sellers and employs either a closed or an open product platform. In a closed version, an exchange sets a high cost for companies to join and restricts the number and type of products it carries. In an open version, the cost to join is low to encourage broad membership, and a wide variety of chemical products is accepted for trading. ChemConnect is an example of an open exchange.

Exchanges bring buyers and sellers together in an open, neutral market that allows them to conduct real-time, online transactions. So, unlike most catalog and auction models, exchanges offer more than just transaction efficiency:

• Price transparency. Online exchange floors give buyers and sellers a fast and easy way to check real-time market activity and prevailing prices before entering negotiations.
• Risk management. Chemical companies can go online to assess demand and plan capacity and production accordingly.

These two additional abilities are affecting not only the e-market but also the entire chemical industry. Until now, a lack of open markets meant pricing was a mystery, with built-in inefficiencies as companies used their best estimates based on limited data. Also, without an exchange to aggregate demand, companies had trouble understanding overall market demand, let alone preparing to meet it.

Today, however, both buyers and sellers must reckon with trading partners who are better informed, even for offline transactions. While raising concerns that buyers will erode margins as they pummel providers to get the lowest price, exchanges actually cut both ways, working to the benefit of both buyers and sellers, as shown by results from ChemConnect's World Chemical Exchange:

• When a major European chemical company posted 1,000 metric tons of styrene for sale, it got global reach and capitalized on rising prices. In just 30 minutes, it received and accepted an attractive offer from a leading U.S. company and had other potential buyers clamoring for further postings.
• A top chemical company that wanted to buy 4,500 tons of liquid carbon dioxide to meet its spot requirement for the next six months invited its current supplier and five other companies to an online corporate trading room to vie for the business. Instead of the usual three months of phone calls, faxes, and multiple rounds of negotiations, the company spent just one week on the process and saved more than 10 percent when it split the business between its current supplier and a new one.
• For years, purchasing agents for a leading company had bought palmitic acid every month from the same major supplier, paying about $0.50 per pound. When the agents recently posted a request for 405,000 pounds of the material, they found themselves watching an online bidding war among sellers. The result? A new supplier and a price of just $0.33 per pound—a 34-percent reduction that saved the company $70,000.
• Because it was aware of only one source for polypropylene scrap, a manufacturer that buys this material regularly often ran short. Through the exchange, the company found two new suppliers that have eliminated its prior purchasing limitations.
• When a U.S. recycling company posted an offer to buy polypropylene scrap, the exchange's customer-service department expedited the process by researching expired offers to sell scrap and then contacting the sellers. The result: The recycling company got the materials it required at a competitive price, and the seller easily acquired a new customer.

Exchanges are setting the stage for a crop of even more compelling changes that will keep chemical companies in the lead of innovation. The next few years are expected to bring the following changes:

• Even more e-business as new entrants and existing chemical concerns jump into online trading to capitalize on the chemical industry's sheer size and opportunity.
• Significant disruption of the marketplace as e-commerce shakes up the way business is done and shakes out companies that can't or won't seize online opportunities. Specialty products such as plant-based plastics and commodities within mature product segments will see incremental effects via further price efficiency and increased ability to reach customers, while industry segments that are at or near commoditization but have not yet consolidated will see severe effects.
• A shift in supply chain focus from integrating internally to integrating across overall enterprises, from supplier to end-customer.
• A change in the volume of chemical spot purchases, with the longstanding ratio of 90 percent long-term contract purchases to 10 percent spot purchases evolving over the next five years as the $50 billion spot market grows as much as 5 percent.
• Decreased volatility that lets chemical companies make better business decisions and deliver more consistently on promises to shareholders. The end result will be new respect for chemical stocks, with investors buying them for market growth, not just dividends.
• A futures market that will evolve to further aid risk management, thanks to increased aggregated product liquidity.
• Declining vendor switching costs as market forces erode and eventually eliminate the industry's current high price of changing vendors.
• One-touch trading as technology eliminates manual intervention and delivers on the long-elusive promise of hands-free procurement.
• Integration of value-added services as the market expands beyond products.

Most exciting, however, is the potential to eliminate electronic data interchange (EDI) and leverage chemical companies' ERP systems to further improve supply chains. Soon, ERP applications will be able to post inventory to an exchange automatically when it reaches a certain age and automatically accept bids that fall within a certain percentage of the asking price. ChemConnect has taken an early lead in this effort by moving at e-speed to build integrated linkages with its top trading members.