July 24, 2000

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Redefining Business:
Proving Grounds: Make Way For The 'Cliques Of Mortars'

As business-to-business marketplaces become pervasive, look for like-minded brick-and-mortars to lead pure Internet plays

By James K. Watson Jr., John Balla, and Joe Fenner

ith so many business-to-business exchanges entering the market against the backdrop of so much hoopla, one starts to wonder how many marketplaces the world really needs. While many of the early business-to-business marketplace success stories were pure Internet plays, we've since seen competing marketplaces launched by distributors, manufacturers, trade associations, and even alliances of would-be competitors.

Marketplace shakeout is inevitable, and it will be interesting to see who's left standing in another year or two. In our opinion, the business-to-business marketplaces with the best chance of survival are those formed by strategic alliances of politically like-minded brick-and-mortar companies that understand the economics of competition.

Even more important, these companies understand the process of selling, contracting, and servicing complex ongoing relationships, often through multi-tier distribution channels. These "cliques of mortars" have a number of advantages over the Internet pure-plays.

For one thing, the first-mover advantage of the Web-only marketplaces is proving less significant than many had believed. The first-mover advantage is lost unless a marketplace can quickly build capacity to service the expanding demand, as well as innovate new offerings and create switching costs that help them hang on to customers while creating barriers for competitors.

The early Web-only marketplaces are still trying to attract market participants and keep them hooked. The difficulty is that most business-to-business trading hubs are still spot markets, so there isn't much preventing participants from taking their commerce elsewhere. In addition, few first movers have built enough market share to discourage others from launching competing exchanges.

A well-organized and well-funded clique is actually in a better position than a Web-only exchange to quickly dominate a vertical indus-try. For example, steel industry heavyweights Cargill Steel, Duferco, Samsung, and TradeArbed have said they will jointly enter the crowded market for steel exchanges, and DaimlerChrylser, Ford, and General Motors announced plans to form a business-to-business integrated supplier exchange called Covisint.

When such groups form a business-to-business marketplace, they come to the table with participants that already carry out the majority of the industry's commerce in the brick-and-mortar world. They bring the strong brand names and industry experience of the participants. And they bring along balance sheets that will enable them to capture business through marketing, promotions, aggressive pricing, or acquisition, as they see fit.

Thus, a well-formed clique could quickly capture 30% to 70% of its industry's Web sales, while creating an awfully tough playing field for competitors. For buyers and sellers within marketplaces, this could be good news because it paves the way for free marketplaces in which the market-makers don't charge for participation. As the cliques pour marketing dollars into their sites (essentially buying the business), the Web pure-plays will be forced to eliminate many participation charges to compete.

The clique members can make money by selling their products and therefore will be willing to run in an ultra-low or even no-commission market. Marketplaces that don't provide their own products must find other revenue models, namely transaction fees.

In the near future, business-to-business exchanges might be as free as the air we breathe. Any business-to-business marketplace startup that wants to take on a heavily funded competitor in a marketing war might as well register its site as a dot-org instead of a dot-com because it won't be profitable for years (just as we're seeing in the business-to-consumer space with such companies as online retailer Amazon.com).

This isn't to say that the cliques have an easy road ahead. Large companies that expect to show up with an impressive consortium and win will face a harsh reality. On the contrary, creating barriers to competitors' entries in the business-to-business Web economy means keeping competitors that are flush with venture-capital money from steamrolling into a vertical market space.

Creating barriers is a fundamental challenge in any business. In fact, the Internet economy in general has shown a poor ability to create barriers against this sort of competitive threat. Just look at how many chemical and metal exchanges there are. In the chemical industry, competitors include ChemACX, ChemComEx, ChemConnect, Chemdex, and Chemweb. The metal competition includes E-Steel, MetalSite, MetalSpectrum, MetalWorld, and WorldMetal, in addition to the coming industry consortium of Cargill, et al.

The cliques in these markets could easily prevail through sheer muscle but unless they get their acts together, the door remains open for outside competitors. One reason for this is the nature of the Web. Online exchanges depend on an open, standards-based digital medium that makes it simple for anyone to open up shop; more difficult is getting and keeping customers.

Another challenge for the cliques is that the consortium model risks changing the competitive dynamics of a market. By making competitors into partners, marketplaces run the risk of collusion on pricing or of controlling supply.

Avoiding antitrust issues will be critical to a clique's success. Even the appearance of impropriety will cre-ate a public-relations backlash, to say nothing of the legal ramifications of actual impropriety. Exchanges will need to build safeguards into their partnership agreements to avoid ille-gally squeezing competitors.

Most of these cliques of mortar business-to-business marketplaces have yet to prove whether they can live up to their potential since they're only now creating their operating framework. The Web sites for Covisint in the automotive industry and Orbitz in the airline indus-try promise that the benefits are coming soon.

The steel site that includes Cargill is aiming to launch later this year. And an ambitious effort in the consumer-products industry--including about fifty top manufacturers such as Coca-Cola, Procter & Gamble, and Sara Lee--just hired a CEO earlier this month, luring Judith Sprieser from Sara Lee.

Ultimately, the biggest hurdle for the cliques may be the participants' ability to get along with one another. While there's power in combining resources, animosity among the partners can be the undoing of a clique. It's yet to be determined, for example, whether the Big Three automakers can, in fact, cooperate well enough and long enough to create an effective clique.

However, cooperation isn't without precedent: In negotiating contracts with the United Auto Workers (the union that represents workers from each company), the Big Three use pattern-bargaining in which they work from the same basic contract. But the clique members are still competitors and will be hesitant to let their best and highest-priced talent work at a joint venture that will, at least in part, benefit the competition. It's one thing to kick in some dollars, but the real test is whether they contribute intellectual and technical assets--especially with so many projects back at the home office demanding attention.

While you're waiting for the marketplace cliques to create some truly innovative technological and service solutions that put them ahead of the competition, the parade of Web-only startups continues--at least until the individuals within the cliques learn to play nicely with one another, clear their legal hurdles, and capitalize on this opportunity.

James K. Watson Jr. is president, John Balla is a senior analyst, and Joe Fenner is a senior technical writer at Doculabs, an independent advisory firm on E-business technology. They can be reached at http://www.doculabs.com or at info@doculabs.com

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