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This B2B Is in the Chips

Mike Wood, head of an online business-to-business (B2B) exchange where electronic chips are bought and sold, figures he has the tech downturn in perspective. In the face of a semiconductor parts market that has fallen from $220 billion last year to an estimated $170 billion this year, he says, "That's certainly a slump, but we're not talking about going from riches to rags."

As CEO of Virtual Chip Exchange, Wood saw his company go from startup to profitability in three years during the late '90s tech boom. Revenues were $102 million last year, he says, and although he declines to give specific profit figures or revenue forecasts, Wood says he's certain of being in the black this year. He believes the tech industry is going through a "short-term correction," and that it's not necessarily a bad thing that inventories stay on the Virtual Chip Exchange market longer than they did last year, when they might have been sold in an hour.

After working in purchasing for IBM in Silicon Valley, then for Siemens in Germany and Singapore, Wood, 43, was approached by Consumer Electronic in Munich, a European chip-trading company, where he learned the open-market side of the chip business. Consumer Electronic, along with distributor Arrow Electronics and software company Mediagrif Interactive Technologies founded Virtual Chip Exchange in 1997. Operating out of four offices in three countries and with about 50 employees, Virtual Chip has so far signed up 4,800 members across 40 countries.

BusinessWeek Online reporter Theresa Forsman recently talked to Wood talks about Virtual Chip's niche in today's online B2B marketplace. Here are edited excerpts of their conversation:

Q: How did the idea for Virtual Chip Exchange come about?

A: In 1997, I sat down with a gentlemen from a software company, Mediagrif. I had an idea about creating a marketplace for OEMs [original equipment manufacturers] to sell their excess chip inventory, and Mediagrif was looking for vertical markets for its B2B software. It was a lucky match of people with similar thoughts. I had been a purchasing manager at IBM and Siemens, so I had firsthand knowledge of the pain and problems of excess inventory. I thought if we could use the Internet to link people and to provide transparency, the business would work.

Q: Aren't you in direct competition with broker Consumer Electronic, one of the founders? Why use a broker if I can use an exchange?

A: Virtual Chip Exchange is essentially an improved communications media. A chip broker is focused on building a very close relationship with a small number of customers and servicing them based on an intimate knowledge of their needs. It's a question of how much understanding of the marketplace -- the prices out there -- you wish to have. I'd prefer to understand the market. We've provided an alternative for those customers who want to maximize their profits on both sell and buy side. We have created a platform where OEMs can place their excess inventory in view of all the members we have around the world.

Q: What does it take to be a member?

A: Any OEM can go to the Web site and sign themselves up. Only OEMs -- no brokers -- allowed. We want this to be a principal-to-principal transaction. Keeping brokers out gets rid of the speculative aspect. With 4,800 members in 40 countries, you get true liquidity, which is important. Semiconductors are a commodity product. One used in a cell phone might be used, in a different electrical application, in a space shuttle. When there is a production plan change or a model change, it calls for a different chip. The leftovers can go to someone in a completely different industry.

Q: How did you get so many members so quickly?

A: I initially targeted Siemens, my former employer. I had an understanding of how that company worked, and I was able to personally present the software to the CEO. We then used Siemens as a keystone customer when we went out to others.

Q: Do you want to name some of the others?

A: Anonymity is one of the advantages of the Web site. You don't want your competitors to know you have excess inventory.

Q: So how does it work?

A: As a member, you transmit information about the inventory you want to sell. You identify the chip, the manufacturer, the date code, and the price you'd like to have. The site has a benchmarking service, which will give you feedback, if you want it, on the price you should be asking. We also offer information on market prices at the Web site, an average of the overall prices in Europe, Asia, and the U.S.

The buyer goes in and starts to search for what he needs. Right now, we have $750 million in inventory. The site will tell him what products are available and whether they're coming from the Asian, European, or North American market. We work on a bid-ask system, relaying information between prospective buyer and seller. No one knows who's selling or buying. We guarantee both the quality of the product and the financial transaction. You send the product to us, we verify it by quantity and quality, then get the money and pass it on.

Q: You get a commission?

A: We take a piece of the transaction. On average, it's 8.5%, but it's negotiated individually with each transaction.

Q: Why would I go to you rather than another chip exchange?

A: Most others use auction models. I don't believe in auction models for any type of a manufacturing component. If you're participating in an auction and you've got an assembly line going, what happens if you don't win? You lose -- not only time on the assembly line but probably also your job. In a bid-ask system, the time frame is dependent on the customer.

Q: Why would I buy through you rather than directly from the manufacturer?

A: Manufacturers directly support only 10% to 15% of buyers, and they're big buyers. Virtual Chip Exchange creates an equal footing for small business. If you're a small company, who would normally have to buy from a distributor, you can compete with large buyers at an online exchange. No one knows who you are. The Internet is this great equalizer: Big or small, everyone is a 17-inch company, the size of the screen.

Q: Why don't you have more competition that's just like you?

A: You need to have industry buy-in. You have to understand the marketplace in which you want to do business. Our founders are industry experts. At the peak of Internet mania, people thought they could buy auction software off the shelf, and the buyers would come.

The Internet is not a panacea. It is simply an improved communications tool. It has given us scale and a much broader reach. But when it comes down to a transaction, our process is very traditional. You offer products for sale, you ask for a quotation, you confirm the purchase order. It's hard enough to ask people to change communication media without also asking them to change their business process. And, if at any point during the transaction, you're uncomfortable, you can push the "call me" button. We offer multilingual customer support.

Q: What's next for Virtual Chip?

A: We continue to move toward more automation of the transaction. We are working on what we call IQ, Instant Quote. It will allow someone to go to the Web site, click on the part they want, and have the price in front of them. What we'd like to get to is a self-service model for all of the people who want to do that.

Q: If OEMs are working with fewer suppliers, who are able to look at their order-management system and forecast their specific needs, why would they have to buy on the spot market?

A: We believe the spot market is about $40 billion, 20% of the total business. A market this big is inherently inefficient. Ideally, you would never have to buy on the spot market. If you are a large enough customer and the manufacturers never have a glitch in the system, you should never have to buy on the spot market. If you're not one of the privileged few who get to buy from a chip manufacturer, you have more variability. Small and midsize businesses make up the bulk of our customer base. Here we are in 2001 with a serious supply-demand imbalance. I don't see any reason for it to change.

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