Why B2 B Is A Scary Place To Be
On July 11, Chuck Steinberger summoned the 31 employees of his Internet company to give them bad news: The company was closing--immediately. A planned merger had fallen through, and venture capitalists had pulled $10 million in promised funding. But this wasn't the predictable demise of another pet-supply or teen-wear site. Industrialvortex.com was a business-to-business (B2B) exchange serving the $300 billion market for motors, valves, timers, and other industrial parts.
Get ready for the Great Internet Shakeout, Part 2. The competitive forces that have ripped through the business-to-consumer market are now wending their way through one of the Web's supposedly unassailable segments: the B2B exchange market. Too many similar sites are chasing after too few dollars, and too many operate under misguided strategies and poor management. "Frankly, a lot of business models that don't make sense got funded to try to capitalize on the huge stock market valuations," says Steven J. Kafka, senior analyst at Forrester Research Inc.
The result: The same crash-and-burn financing cycle that mowed down consumer sites is now decimating B2B exchanges. After running up to stratospheric levels in the first quarter of this year, the typical B2B stock is down by 70% to 90%. And private venture-capital funding is quickly drying up as well.
That wasn't the plan. Just like early consumer retail ventures on the Net, e-marketplaces for businesses showed huge promise. They are supposed to help buyers slash purchasing costs and discover new suppliers, products, and lower prices. Even better, business has been expected to snowball as suppliers are turned on to new buyers.
The long-term prospects are still enormous. Sure, B2B e-commerce is embryonic today, accounting for a mere $215 million in 1999, or 1.4% of all commercial transactions, according to AMR Research Inc. But it is expected to explode: B2B e-commerce could reach $5.7 trillion by the end of 2004, and fully half of that will flow through exchanges.
But the race to stake out that turf has led to a weed-like profusion of players. While it's hard to pin down the exact number of online marketplaces, analysts say there are some 800 to 1,400 of these exchanges. In the chemical industry alone, more than 15 exchanges are scrapping away. And every industry, from aerospace to electronics to medical supplies, has seen dozens of exchanges pop up the past few months.
With the sector's crash, that seems to have peaked. Back in March, venture capitalists poured $800 million into 77 exchanges. Since then, investment in e-marketplaces has slowed. Four months later, in August, 35 exchanges got $500 million in funding, according to New York-based VentureWire, a newsletter that tracks the venture-capital industry.
That has meant a multitude of sites fighting for more limited investment dollars and opportunities for sales. When the smoke clears three years from now, analysts predict a massive consolidation with 200 to 300 survivors. "There will be only two to three winners in each space," says John Ekoniak, a senior analyst at U.S. Bancorp Piper Jaffray. "It's going to be survival of the fittest."
The likely end for those that can't make it alone? Being gobbled up by a big fish. So far this year, Deloitte Consulting says that 33 e-marketplaces have already merged or been acquired.
The B2B chemicals sector is a perfect example of that drama in action. An estimated $1.6 trillion market that is technologically sophisticated, with lots of buyers and sellers and a complex supply chain, chemical markets would seem ripe for e-commerce. But with at least 15 different marketplaces, the exchanges have failed to generate significant transactions, and none has yet emerged a winner.
Too many sites isn't the only problem. Some are having a hard time getting suppliers to join. Net competition has some manufacturers shunning the exchanges. When Industrialvortex.com tried to aggregate products from thousands of suppliers, for example, many refused to participate. They feared that parts buyers would suddenly have easy access to cheaper suppliers.
The rise of sites backed by big bricks-and-mortar players in many traditional industries has also stymied many of the independent sites. Although many of them were early to launch exchanges, bricks-and-mortar rivals have had a much easier time connecting with traditional suppliers. Indie ChemConnect Inc. got off to an early start in 1995. In the past year, though, it has been hampered by the formation of three exchanges--Elemica, Omnexus, and Envera--backed by Bayer, Dupont, and Dow Chemical. "The [consortiums] have frozen the market," says U.S. Bancorp's Ekoniak.
The result: Even though 11,000 buyers and sellers have joined ChemConnect, only a third of them have completed transactions.
That's not to say that industry-backed exchanges are having a smooth ride. With so many established companies coming together to create an exchange, some sites simply have too many cooks in the kitchen. Covisint, the auto-industry exchange backed by Ford Motor, General Motors, and DaimlerChrysler, has four co-CEOs. The carmakers are such fierce rivals that choosing a name took nearly three months. Similar battles took place over what technologies they should use. Moreover, worries about anticompetitive behavior--Covisint faces an ongoing Federal Trade Commission probe into possible collusion--has slowed the service's launch. "Trying to organize [as many as] 40 to 50 companies is not a winning strategy," says Glenn T. Meakem, CEO of FreeMarkets Inc., one of the few indies that are aggregating significant transaction volume.
Still, despite the challenges bricks-and-mortar-backed exchanges face, most analysts are betting that their deep pockets will keep them in the driver's seat. Why? Investor skepticism about the sector means that most indie marketplaces will have no alternative to bankruptcy or being bought out after they run out of venture capital, which generally lasts just 6 to 12 months. The market for initial public offerings appears shut for now. Already, there are five B2B exchanges, including Commerx Inc. and PaperExchange.com, that have filed and so far failed to raise money from public investors. "B2B is a poison well for IPOs," says David Menlow, president of IPO Financial.com.
That's why market watchers expect that by next spring, leaders should have separated from the pack. Already, one formula--being a cross-industry generalist--seems to be the best bet. VerticalNet Inc. in Horsham, Pa., has established a lead with a catchall strategy. Despite the sector's nosedive, VerticalNet still boasts a market capitalization of $4.5 billion. Why? It reported $53.6 million in revenue for the second quarter. The company, which makes money from transactions, ads, and e-commerce fees, has created 57 different marketplaces for industries from energy to food.
Then there's auctioneer FreeMarkets. By this year's second quarter, the Pittsburgh-based company had conducted 1,400 B2B auctions worth $2.2 billion, enabling it to report $19.4 million in revenue last quarter.
And despite the market gloom, optimism abounds. Chuck Steinberger, for one, isn't sweating the failure of Industrialvortex.com. He got six job offers from other indie marketplaces. And 30 of his 31 employees have been snapped up by other B2Bs. "We were all in competition to see how many offers we could get," says Steinberger. Of course, chances are, they'll all be job-hunting a year or two from now.
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