By Karen E. Klein Q: My partner and I have an idea for a B2B exchange, but have been told repeatedly that digital exchanges are dead. I am curious as to why. Besides the obvious problems like underfunding, bad leadership, and stupid business models, are there inherent flaws in the idea? I'd appreciate additional input from your experts. -- M.A., Orinda, Calif.
A: Our experts agree with your advisers: The public B2B exchanges that a few years ago were touted as the new way of doing business have failed to prove themselves. In fact, most of the large, independent digital exchanges have disappeared, says Eric Brown of Forrester Research in Cambridge, Mass. "A lot of the ambitious, vertical exchanges in the chemicals, automobile service and aftermarket, aerospace, heavy equipment, and construction areas have closed," he notes.
There have been some survivors in global retail exchanges, says Dan Garretson, a Forrester senior analyst, but most of those were formed by industry participants rather than third parties -- and even they are finding that the business model is a struggle to keep alive.
MINIMAL RETURNS. "The major problem the digital exchanges ran into immediately was getting participation from both buyers and sellers," Garretson explains. "It was a chicken-and-egg thing, because you couldn't attract sellers without buyers, but buyers weren't attracted if there weren't enough sellers." When suppliers did participate, he adds, they found themselves in the unhappy position of being in a competitive environment where they couldn't adequately differentiate themselves by quality or added services.
"Another downfall for digital exchanges is that many companies simply weren't ready to participate, both in terms of having the necessary technology and having uniform content prepared on their pricing, contract, and systems information," Garretson explains. When third-party exchanges did attract enough qualified suppliers and buyers to begin doing business, they quickly found that a huge volume of transactions was required in order to be profitable. "Some tried to start off with higher margins," says Garretson, "but they realized they had to make them low, or even negative, to get the volume they needed."
Because the digital-exchange concept involved radically changing the way companies had always done business, there was built-in opposition to it immediately. "Not only was [participating in a digital exchange] expensive, but persuading companies that the exchange could streamline the buying and selling process, and do it better than they did themselves, was a very tough argument," Garretson says. "Only in the case of companies that did large volumes of transactions was it really cheaper to do it through an exchange, and those large buyers and suppliers were big enough to establish their own private supply hubs or install automation in-house, where they could customize it, have control over the process and the information, and teach their employees to use it."
BRANCHING OUT. While some industry-consortia exchanges still exist, he says, most have branched out into supply-chain coordination. They stay in business because they have had substantial investments and commitments from the participants themselves. He cites automotive e-business exchange Covisint.com as one of the industry-driven exchanges that has flourished despite the hardships.
"If you have a really great idea for an exchange, try developing it as a software application and selling it to a software company, or hosting it on the Net as an ASP," Garretson advises. "The notion of a portal-type exchange is not a good one at this point, unless you have a huge commitment from industry insiders going in." Have a question about running your business? Ask our small-business experts. Send us an e-mail at email@example.com, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.