InformationWeek

Asked how his company will choose its 57th community to cultivate, VerticalNet chairman and CEO Mark Walsh laughs. "See, we have this big dartboard," he says. The joke is typical for Walsh, but it underscores the question at the heart of VerticalNet's current success and concerns about its future: Can a single company really sustain E-marketplaces in scores of different, unrelated industries?

So far, the answer is yes. VerticalNet has created business-to-business communities in a dozen industries that carry products from more than 3,500 suppliers. In the process, the company generated "buy" recommendations from Wall Street analysts-not to mention $100 million in funding from Microsoft and a market valuation that approaches $100 billion.

But outside the investment community, some analysts say VerticalNet's broad-swath approach has made it difficult for the company to get traction in an increasingly competitive business-to-business environment. VerticalNet collected $27.5 million in revenue during the first quarter-an increase of 172% over the previous year-but showed an operating loss of more than $5.6 million. VerticalNet's business model, which initially relied more on advertising fees than business-to-business transaction fees, might not be sustainable, pundits warn.

So is VerticalNet's success a model for future E-businesses or a mere flash in the pan? A look at its history may provide the answers. VerticalNet was founded in 1995, years before business-to-business exchanges began popping up in every industry like so many ears of corn. Unlike most newer exchanges, which typically aggregate buyers in an effort to lower supplier prices, VerticalNet set out to aggregate suppliers and build communities of interest. The company also developed software so companies could build storefronts and gated communities to support E-commerce.

"We didn't go in chasing one vertical industry or one group of buyers and suppliers," Walsh says. "We felt that the technology would be useful in a lot of different markets."

VerticalNet also differed because its revenue model was not built entirely around transaction fees. In fact, many VerticalNet communities, such as Nurses.com, still have not evolved into trading exchanges at all. They provide a forum for related groups of professionals to exchange information, and VerticalNet makes most of its revenue providing ads and sales leads to companies that want to reach those professionals. "We've never wanted to rely on one revenue stream. Advertising still is a significant part of our business," Walsh says. In the first quarter, advertising and E-commerce sales leads accounted for more than $12 million of VerticalNet's operating income, while exchange revenue accounted for about $14.5 million.

VerticalNet has developed sophisticated criteria for determining which markets it will approach as potential business-to-business communities. A VerticalNet industry must be big-$8 billion or more in domestic revenue-and have at least 2,000 vendors, 30,000 buyers, and strong cross-border data flow. Companies must also have a high level of Internet-connected PCs.

Once it has selected an industry segment, VerticalNet builds a hosted infrastructure for the community-typically a set of servers co-located at sites hosted by Exodus Communications Inc.-and helps suppliers and buyers connect to it. In many cases, VerticalNet will also assist suppliers implementing E-commerce through its Storefront software, which helps businesses sell over the Web, or its E-Commerce Center software, so they can connect with partners and suppliers. Sales of Storefront and ECC made up the other $1 million of VerticalNet's revenue in the first quarter.

VerticalNet customers say the business-to-business communities and software have made a difference in their businesses. "We've received a number of orders that I know we wouldn't have received if we hadn't been on the VerticalNet exchanges," says Mary Beth DiEleonora, Webmaster and marketing communications manager at Brooks Instrument, a maker of test and measurement tools that participates in three of VerticalNet's communities.

Like many small and midsize businesses, Brooks Instrument doesn't have the staff or the resources to build its own E-commerce program, so it has contracted with VerticalNet for Storefront software as well as interfaces to several exchanges. "We've even shared a booth with VerticalNet at a couple of industry trade shows, because they help me look like I'm on the bleeding edge of technology, and I help them gain access to an industry where they don't have much experience," DiEleonora says.

In larger customer environments, VerticalNet also helps companies integrate data collected on the exchanges with back-end applications. But it doesn't have to do as much back-end transaction data integration as some business-to-business marketplaces that handle procurement and distribution, because VerticalNet doesn't take title to any items sold through its communities.

Despite its relative success, critics say, VerticalNet lacks expertise in the 56 industries it supports, making it difficult for the company to advance beyond simple portal capabilities. VerticalNet "has struggled because of a lack of industry focus and transaction and integration capability," says Scott Latham, an analyst at AMR Research. In a report earlier this year, AMR ranked VerticalNet 20th among the independent trading exchanges, marking it down for its relative lack of interactive transaction functionality and a shortage of value-added services such as financing.

But VerticalNet has been busy addressing these shortcomings. In March, it acquired Tradeum, a maker of transaction software for business-to-business marketplaces. Tradeum, which had struggled against better-known market-maker software vendors such as Ariba Inc. and Commerce One Inc., is helping VerticalNet build procurement and exchange technology into its online communities. In May, Tradeum unveiled eMarketplace Suite, which provides the software platform for public and private trading hubs.

VerticalNet also is expanding through acquisitions. In late 1999, the company purchased NECX.com, a major electronics exchange. NECX.com has gone on to make several partnerships and acquisitions that have enabled VerticalNet to gain business in the electronics industry, one of the richest fields for business-to-business technology.

During the last four months, VerticalNet has purchased exchanges in the textile and federal-government procurement sectors and has formed alliances with exchanges, such as Neoforma.com Inc., a business-to-business marketplace for the health-care industry, and PaperExchange.com.

One of VerticalNet's most intriguing partnerships is with Microsoft, which in April said it will invest $100 million for a stake in VerticalNet's technology. Microsoft says it will purchase at least 80,000 Storefront and ECC software packages and distribute them to third-party businesses. VerticalNet will build the storefronts, incorporate them with Microsoft services such as sales-lead generation, and place them in its 56 business-to-business communities, the partners say.

The $100 million investment is part of Microsoft's business E-commerce initiative. Microsoft officials declined to be interviewed, but analysts say the equity investment will help VerticalNet expand its technology and exchange acquisition strategies. The funding "will fuel strategic acquisitions for VerticalNet," Latham says.

VerticalNet also is developing and purchasing technologies that will help expand the services offered by its business-to-business communities. In the last four months, the company has unveiled partnerships with Wiznet for catalog and content management; American Business Financial Services for online credit; and CyberSource to provide credit-card authorization, payment, and sales-tax calculation services.

The company also will provide indirect materials procurement for all its sites, letting its communities purchase office supplies and other commonly needed items from a central marketplace, says Dean Sivley, senior VP for product development and E-commerce at VerticalNet.