B2B, Take 2

After the dot-com bust, the few surviving exchanges have emerged with strong corporate ties, sharpened relevance, and powerful converts

Neoforma (NEOF ), an online business-to-business (B2B) exchange that links buyers with sellers of hospital equipment and supplies, used to be hot stuff back at the turn of the century. It was a leading contender among some 100-plus players that squared off in the online hospital-supply market. It was also one of the lucky few to hit a home run with an initial public offering (IPO), in January, 2000: Its shares rose from $48.50 to $73 in less than a month. And then came the dot-com bust.

Suddenly, investors began to worry about Neoforma's financial deficits and lack of customers. As quickly as its stock had shot up, it slipped into the single digits. To survive, Neoforma embarked on a transformation that was the equivalent of a hippy donning a business suit: It gave a 46% stake to privately held hospital group Novation and agreed to facilitate transactions only for Novation's 2,000 hospitals and suppliers. The move has proven to be Neoforma's salvation. This year, it will handle $8 billion worth of business, says Dan Eckert, Neoforma's president. It's also cash-flow-positive -- while most of its rivals are dead.


  The B2B landscape is littered with carcasses, where startups and fortunes once grew overnight. Of the 1,500 independent business exchanges -- ones not affiliated with a particular company -- that existed in 2001, less than 200 should remain as of the end of 2003, according to a November, 2002, study by the University of Pennsylvania's Wharton School and Pembroke Consulting, a management consultant in Philadelphia.

Yet, as Neoforma has proven, the concept of B2B is far from dead: It's simply changing shape. The original exchanges "had delusions of glory," says Adam Fein, Pembroke's president. One delusion was that companies would choose a Web site to be their go-between with buyers or suppliers. It turned out that buyers believed in the old-fashioned handshake -- and wanted to work mainly with the middlemen and suppliers they already knew.

What they really wanted from the Web was a technology that would make their existing interactions more efficient. The effort to deliver that has created a second wave of B2B, comprising private exchanges such as Neoforma, plus B2B exchanges run by industry alliances.

The strength of this comeback is difficult to measure. But what's known is that buyers have picked up assets of the departed public B2B exchanges on the cheap -- for as little as 10% of what it cost to create them, experts say. And corporate info-tech departments now expect to find B2B functionality -- including such features as electronic invoicing -- in other software products they buy, says Frank Kenny, an analyst with market consultancy Gartner. Thus, "in every IT investment, B2B will have some importance," he says.


  That's because it cuts out costs, such as the fees many manufacturers pay to so-called value-added networks (VAN,) which for 30 years have facilitated communication between them and their suppliers via dedicated communication systems. Kenny estimates that a business with 50 suppliers could be spending $1.2 million a year on running transactions through VANs administered by the likes of Sterling Commerce, a subsidiary of phone company SBC Communications (SBC ).

Thanks to recent improvements, Web-based B2B software is more advanced, available in many languages -- a major plus, considering the supply chain's global sprawl -- and cheaper than it used to be. And it offers major cost savings compared with VANs.

A manufacturer with 50 partners can install B2B software for an initial investment of $125,000, plus a recurring annual cost of $85,000, estimates Kenney. Thus, it can recoup its investment within months. This math is so compelling that buyers are starting to push the software's adoption, so while their suppliers now get 13% of their revenues online, that percentage should reach 36% by 2008, says Fein.


  What's more, the approximately 300,000 traditional intermediaries in the U.S. -- from whom the original exchanges hoped to steal customers -- are spending more on B2B software as well. Fewer than 25% of small distributors, with sales of less than $25 million a year -- these constitute the bulk of the industry -- have invested in the technology today. But 8 out of 10 will offer online B2B by 2008, predicts Fein.

Companies are counting on B2B to allow them to fill out purchase orders and issue invoices electronically -- and hasten receipt of payments and delivery of goods. IBM's (IBM ) WebSphere products now even let companies measure a supplier's performance against benchmarks. Big Blue also markets so-called dashboard features, which present a purchasing manager or a chief financial officer with a daily list of indicators such as cash on hand and parts in inventory, says Paraic Sweeney, a vice-president at IBM.

The opportunity for software and service outfits is huge, since distributors alone account for $1 of every $5 spent on technology in the U.S., says Fein. That's why, in addition to specialized suppliers -- many of whom are former B2B exchanges turned software companies -- traditional sellers of corporate software, such as SAP (SAP ) and IBM, have jumped into the market with B2B offerings, usually as part of larger software suites.


  B2B services, on which U.S. businesses spend $7.3 billion each year, according to tech consultancy Forrester Research, is the plum most competitors are seeking. B2B services involve such work as recruiting and validating suppliers in India and China, says Dave McCormick, president and CEO of B2B software and services provider FreeMarkets (FMKT ), whose revenues grew 14%, to $182 million, from 2001 to 2002. After finding suppliers, FreeMarkets then hooks them onto its B2B system, so they can talk to buyers in the U.S. Suppliers -- who historically have been loath to use online B2B technology because of the large extra investment it entails -- are finally coming round, thanks to the demands of outfits such as the world's largest retailer. About a year ago, Wal-Mart (WMT ) announced that it will gradually start requiring its vendors to use Web-based B2B (as opposed to VANs). Other retailers, such as Target (TGT ), Kmart (KMRT ), and Lowe's (LOW ), are following suit. Leading the charge are also players from other industries, such as microprocessor king Intel (INTC ). "It's going to be a snowballing effect," says Kenney.

The involvement of such heavyweights is especially significant because it's leading to the adoption of industrywide standards for online B2B, says Shawn Willett, an analyst at technology consultancy Current Analysis in Sterling, Va. The standards govern security and format of messages sent between buyers and sellers. They also provide for detailed descriptions of products -- so buyers know exactly what they're purchasing.

Such standardization is showing up first in the supercompetitive retail, health-care, and financial-services industries. And it will eventually allow suppliers to use a single B2B setup to deal with all types of customers -- making technology investments go further, Willett says.


  At the same time, some exchanges supported by industry alliances are making extra investments by suppliers almost unnecessary. Take the automotive industry exchange Covisint, whose investors include carmakers General Motors (GM ) and Ford (F ). Starting Nov. 30, it will allow suppliers to use their traditional VAN networks while, at the same time, letting buyers use the systems of their choice. The exchange will facilitate conversations between these systems -- in effect, becoming "the automotive industry's operating system," says Paul Manns, Covisint's director of marketing. The exchange, which connects more than 22,000 companies, is crucial to running auto plants, which only keep two to three hours' worth of parts on hand.

Other industry exchanges are offering niftier features, too. There's ChemConnect, whose investors include drug company Abbott Labs (ABT ) and chemicals manufacturers BASF (BF ) and Dow Chemical (DOW ), and which sells 60,000 different chemicals in transactions adding up to more than $8 billion a year. It plans to offer a special financial-clearing service starting in December, says Eric Paulsen, ChemConnect's vice-president for commodity markets.

Through a partner, ChemConnect will check the credit of propane and ethane buyers and sellers before they can transact with each other online. The system can also trigger money movements -- replacing the old process in which paperwork had to be signed and mailed, Paulsen explains. Those features are of huge importance in an industry rattled by bankrupt energy giant Enron, which collapsed suddenly and without paying all its bills.


  Finally, some industry-run exchanges help make their members more competitive with the largest players in their business. Among the most prominent of these is the WorldWide Retail Exchange, whose participants include electronics retailer Best Buy (BBY ), grocery chain Albertson's (ABS ), and pharmacy CVS (CVS ), says CEO Colin Dyer. Over the past 2 1/2 years, the exchange has facilitated transactions involving everything from food to drugs -- and it's growing at a double-digit rate, Dyer says. It hopes to break even in 2004, he adds.

Of course, a handful of independent public B2B exchanges remain unaffiliated with industrial conglomerates. But most of them are looking for new business models. Take privately held, Dallas-based Bid Freight Logistics, a tiny exchange that matches shippers with trucking companies. At the end of 2004, it plans to start selling a global positioning system-enabled device to be installed in truck cabs. Incorporating Bid Freight exchange software, it will not only help truckers plot their routes but also look up freight orders in the areas they're passing through -- a useful feature for independent owner-operators, explains Chris Panczuk, a Freight Logistics account executive.

What's for sure is that B2B exchanges have learned their lesson. "We can't force adoption," says ChemConnect's Paulsen. "We're just going to help companies manage change," such as dealing with falling margins and increased competitive pressure. With an attitude like that, the latest incarnation of online B2B should do just fine.

By Olga Kharif in Portland, Ore.

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