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March 27, 2000

Online Marketplaces:
Construction Boom
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Illustration by Dennis Harms

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New Market Makers (3/13/00)

Marketplaces Bring Order And Efficiency To Supply Chains (2/28/00)

Health-Care Replenishment Online (1/17/00)

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How much funding is enough? Most experts say starting a marketplace with less than $10 million is risky; $3 million to $4 million is considered the bare minimum, says Arthur Andersen's Costello. "You can't do this on the cheap," he says, "but get money that's smart money. Find a venture firm with business-to-business expertise."

The marketplace market is clearly an attractive area for venture capital right now, and many venture-capital firms are starting to specialize in business-to-business exchanges. Among them are Benchmark Capital, Crosspoint Venture Partners, Draper Fisher Jurvetson, and Internet Capital Group.

The funding question puts a spotlight on another important issue: equity ownership. Marketplaces are starting to feature a wide range of ownership structures, and where the money comes from can send strong signals--positive or negative--to the customers a marketplace is trying to attract. Petrocosm, a Chevron Corp.-founded marketplace for procurement in the oil and gas industry launching this spring, has an innovative ownership model that includes competing oil companies, venture capitalists, marketplace participants, and business management (see chart, below).

"Cash is really a commodity," says Jerry Jacobson, manager of global procurement IT at Chevron, who's in charge of operations for Petrocosm. "You have to decide where you want the cash to come from and what message that sends. If Chevron provided the most cash, that wouldn't send the right message of neutrality to the market." Instead, Chevron is one of several founders that own a combined 25% stake in the venture.

Many independent marketplaces are selling equity positions to established brick-and-mortar companies in order to gain industry credibility as well as capital. Prominent recent examples include U.S. Steel's stake in steel marketplace E-Steel and investments from Dow Chemical, Eastman Chemical, Rohm & Haas, and other major chemicals producers in ChemConnect Inc. But none of these investments is a majority stake, because of the important message of neutrality cited by Jacobson.

For brick-and-mortar companies building marketplaces for their industries, the perception of objectivity isn't the only challenge. There's also the danger of getting bogged down in corporate bureaucracy and procedures. A successful marketplace will cause real, transformational change in its industry, and that can be a threat even within the company building the exchange.

"The worst thing that can happen is you're viewed as somebody's pet project within the organization," says WaterDesk.com's Wasden. "You have to be separate. We've asked our parent company to treat us like any venture-capital investor would."

That separation can take different forms, such as a joint venture, a spin-off, or even a separately traded tracking stock. WaterDesk.com is an independent business unit set up by Azurix Corp., a global water-services company in Houston that also has a unit running Water2Water.com, a site for the online exchange of actual water supplies ("Business Booms For Specialized Web Marketplaces"). WaterDesk.com, scheduled to launch later this year, will be a complementary exchange for water-treatment equipment and water-delivery infrastructure.

Transaction fees are the most common revenue source, with the marketplace operator generally taking 0.5% to 5% of each sale or transaction. But the most important aspect of any revenue model is flexibility. Despite all the activity, E-marketplaces are still a nascent phenomenon, and their long-term effect on any vertical industry's business practices is largely unknown. What companies are willing to pay for can change. PlasticsNet.Com, for example, began with an advertising-supported revenue model, but is moving to transaction fees.

Marketplace business models should never be static. Like all successful innovators, marketplace operators must continue to move forward and embrace new opportunities before competitors do. Case in point: industrial-parts supplier W.W. Grainger Inc. in Chicago. Grainger was the first large distributor to launch an online marketplace--Grainger.com--in 1997. It has since extended its online reach with OrderZone.com, a marketplace that includes other suppliers; FindMRO.com, an online service to help buyers locate hard-to-find products not listed on Grainger's marketplaces; and TotalMRO.com, a site to be unveiled next month that will list an unprecedented 10 million maintenance, repair, and operations products.

"We believe that you have to keep moving," says Grainger group president Don Bielinski. "If there are 10 million MRO products out there, we think they should be available in one place."

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