Almost everyone agrees that business-to-business (B2B) exchanges will be a powerful force in the commerce of the new century. Electronic marketplaces allow companies to put a part, component, or service out for bid on the Internet. Any qualified supplier can bid. Success stories are widespread, with prices declining as much as 25 percent from previous levels.

Like all online commerce, however, B2B exchanges present not only tremendous opportunities but also tremendous risks. This article will discuss the promise and risks associated with exchanges and other dimensions of the B2B space.

Think of all the ways a company interacts with its suppliers, and you begin to see the scope of B2B activity. Here are some examples:

• Ariba (www. ariba.com): an electronic marketplace for maintenance, repair, and operating (MRO) supplies.
• Agilesoft's Digital Market (www.agilesoft.com): a marketplace for purchasing product components. FreeMarkets (www.freemarkets.com) and B2BRAP (www.b2brap.com) are among the many competitors in this space.
• Parbuckle: an exchange to help suppliers navigate government procurement regulations. Parbuckle, which is so new that it does not yet have a Web site, also aims to provide government buyers with easy access to its own and other exchanges.
• Agilesoft and MatrixOne (www. matrixone.com): exchanges that manage bills of materials and engineering change orders across multiple companies.
• i2 (www.i2.com): an exchange for multicompany production planning.
• Syncra (www.syncra.com): an exchange for collaborative forecasting and inventory management.

Even this short list shows the many, many buyer and supplier functions that can be executed online. This article will discuss trading exchanges and other B2B applications and describe ways in which supply chain managers can choose exchanges to match their company's strategic goals.

Trading exchanges, or Internet marketplaces, offer two fundamental advantages: process cost savings and unit cost reductions. Process costs include developing supplier relationships, handling proposals and quotations, and processing purchase orders. To the extent a company can automate procurement, it saves time, needs fewer people, and makes fewer errors. For example, B2BRAP claims a telecom company using B2BRAP has been able to shift one person from purchasing to another function. So, as you can see, the long-term savings are potentially huge.

Unit cost savings arise when a company solicits bids from multiple suppliers, rather than repeatedly awarding the contract to the same one or two companies. For example, FreeMarkets claims that its clients have saved from 2 to 25 percent of unit cost. If a company can attract bids from 25 suppliers rather than 5 and, if suppliers can see the bidding real time, the market appears to approach the economists' ideal of perfect competition.

The potential for cost savings is leading to more and more exchanges. For example, the Big Three automakers have agreed to join with Oracle and CommerceOne to create an industrywide exchange. At this writing, it is not clear whether the Justice Department will allow these companies to cooperate, but it is clear that exchanges will play a major role in the automotive supply chain.

This focus on exchanges may seem surprising, in light of the importance of strategic alliances to the auto industry. Long-term relationships can have many benefits, including improved new product introductions due to early supplier involvement; lower cost and better supply chain efficiencies due to sharing of demand and production information; and improved quality through sharing of product information. Unfortunately, strategic alliances can eventually hamper competition and slow product improvements because of reduced competition.

Fortunately, supply chain managers can tap into the efficiencies created by exchanges and still benefit from the advantages of strategic partnerships. Here's how:

• Use the Internet to facilitate strategic alliances
• Look beyond price when evaluating and working with suppliers
• Align supplier relationships with the characteristics of the purchased component and of the marketplace

Use the Internet to facilitate strategic alliances

Digital Market and others allow the user to specify preferred suppliers, the number of qualified suppliers, and so on. With this purchasing model, the Internet replaces phone, fax, and email, thereby saving procurement management costs, but is not used to generate competitive bids.

In fact, supply chain managers must examine some important issues before deciding to hold Internet auctions. Auctions can actually increase the amount of time and effort spent by procurement personnel. In the old days, a company may have invited bids from only three familiar suppliers. The company could clarify vague specs later, and the long-term relationship between the buyer and the supplier facilitated communication. Today's Internet auctions require very tight specifications, particularly if new suppliers are bidding. Previously, the company may have given two suppliers blanket orders for a year's worth of supply. Regular auctions usually require more frequent attention than long-term contracts. Therefore, managers should track total procurement costs, including management time, and be certain that auctions deliver real savings before choosing them.

Look beyond price when evaluating and working with suppliers

Exchanges can be used, and, in fact, are used, to pit suppliers against one another. If there is a lot of fat in the system, exchanges should create real and long-term supply chain savings. However, as GM learned from the famous Lopez period in the early 1990s, beating up suppliers can create an unrelentingly antagonistic relationship and lingering animosity. Even today, many automotive suppliers describe themselves as more responsive to Chrysler's needs than to GM's because of how they are, or were, treated.

Managers using exchanges should take care not to alienate suppliers with whom they want long-term relationships. For example, a company could restrict the number of bidders or reserve a portion of the volume for select suppliers, even if their prices are slightly higher. The bidding information can be a basis for discussions about price reduction, but it is important that purchasers use exchanges to support their strategy, not to undermine supplier relationships.

Similarly, purchasers should take a long-term view if suppliers' capabilities are important. Suppliers constantly forced to lower prices may neglect to invest in new technology, training, or process improvements. Suppliers who continue to invest despite price pressure may lose bids, eventually impairing their ability to invest and even going bankrupt.

Align supplier relationships with the characteristics of the purchased component and of the marketplace

Exhibit 1 describes five types of supplier relationships, moving from most transaction based to most relationship based:

• buy the market
• ongoing relationships
• partnerships
• strategic alliances
• backward integration

Transaction-based relationships focus on price. Companies that seek the low-cost provider expect little or no variation in performance from one supplier to another. This model makes sense when buying reliable, standard products like commodity telephone time, for example.

Companies that need deeper and broader interaction with the vendor move toward ongoing relationships and partnerships. For example, Air Products and Chemicals, a global manufacturer of chemicals, gas, and equipment, rates vendors' performance and then rewards outstanding suppliers with long-term contracts and increased business. Contrast this strategy with that of a outdoor apparel company that competes, in part, on high quality. The company's buy-the-market sourcing strategy created uncertainty about product quality. The importance of product quality suggests that the company should have developed an ongoing relationship with a set of vendors.

Strategic alliances extend partnerships to a deeper level. For example, Boeing's strategic alliances with three engine manufacturers—GE, Rolls Royce PLC, and Pratt & Whitney Co.—reduce the financial risk of new airplane programs. In addition, these alliances make it possible to manage the complex design interfaces between the engine and the airframe.

When relationships are extremely complex, uncertainty is high, and the production components have key strategic significance, even strategic alliances may not be adequate. So companies may choose to produce components internally (backward integration). Exhibit 2 shows how buyer-supplier relationships should be driven by strategic considerations.

Managers deciding where their companies belong on the continuum in Exhibit 1 should examine four fundamental factors that drive purchasers toward closer relationships with suppliers:

• The strategic importance of the purchased component. If the component is critical to competitive differentiation or involves proprietary know-how, it is best to manufacture it in-house or to form a close alliance with suppliers, as Boeing has done.
• The number of suppliers that can provide the component or service. If only one supplier is available, the company may need to maintain close relationships with it.
• The complexity of the interfaces of the component with the rest of the final product and of the logistics involved. As described above, the complex interaction of engines with other components in the airplane drives Boeing to maintain extremely close alliances with its major vendors.
• Uncertainty. If a sourcing relationship creates high uncertainty about objectives that are important to the buyer, the buyer should develop closer relationships with its suppliers. Managers should examine and rank the four operations objectives of cost, quality, delivery, and flexibility (Exhibit 2) and relate them to decisions about supplier relationships. For example, the cost and availability of oil was highly uncertain during the 1970s. Because DuPont relied on oil as a primary feedstock for many of its products, DuPont backward-integrated with the purchase of Conoco, primarily to reduce this uncertainty.

Exhibit 3 shows how different B2B software products support different supplier relationship models:

• Enterprise Resource Planning (ERP) systems, such as SAP and Baan, are generally focused within the individual company. They facilitate international communication and information-sharing within the confines of a multinational company.
• Ariba supports a buy-the-market relationship. MRO supplies are rarely differentiated by quality or new-product innovation; cost is the key driver. Using an auction to purchase MRO seems entirely appropriate.
• Digital Market supports multiple bids in the buy-the-market style but also allows a company to define preferred suppliers. With preferred suppliers, the software might save processing costs but would not reduce unit costs.
• Agile software is most useful for purchasers who introduce new products or change designs frequently. Agile facilitates communication among multiple supply chain partners about bills of materials, engineering change orders, and so on. The implied relationship between buyer and supplier is quite close.

B2B markets can create enormous supply chain savings. Unfortunately, B2B products can also increase total procurement costs and even destroy supplier relationships and harm supplier capabilities. Managers should take care not to employ the B2B products in ways that disrupt existing, successful relationships or that create unnecessary confusion in the supply chain.

Companies should pursue B2B initiatives that align with the types of supplier relationships they follow. A company can concurrently use many different B2B products with many different suppliers, some, close partners, others, distant sellers. As the B2B industry consolidates, companies will be able to use one product to support multiple styles of relationship.

Before choosing software and making decisions about exchanges, wise supply chain managers will carefully determine the type or types of supplier relationships that generate competitive success and then use the software products to support those relationships.