IT - Enabled B2B Markets Courtesy of Professor Ravi Aron, Wharton

B2B – Markets Aggregation and Matching Biased and Neutral Markets Manufacturing and Operating Inputs Forward and Reverse Aggregators Revenue Implications – End-to-End Automated Models – Shallow Linked Portals Acknowledgement: Some of the contents of this presentation were extracted from the Article – “E-Hubs: The New B2B Marketplaces” by Steven Kaplan and Mohanbir Sawhney in HBR May – June 2000.

Business to Business Markets Covisint, FairMarkets, FreeMarkets Ariba, CommerceOne (enablers) VerticalNet, Pantellos, GlobalNetExchange SciQuest.com, Rubbernetwork Plasticsnet.com, GCE Market

Why do Business on the Web? Stuff you’ve heard before Greater Choice to buyers and sellers Reduction in transaction costs Different ways of enabling price discovery Here’s a new one: Because the marketplaces are digital and not made of bricks and mortar, they can scale upwards with minimal incremental investment. Suggested Terminology for B2B Mkts. e-hubs.

How do B2B Mkts. Create Value? Two basic sources of value creation – Aggregation and Matching. Aggregation: – Internal Aggregation – Processes inside the firm – Market Aggregation – Meta-Catalogs Internal Aggregation: – Decrease the extent of human intervention – 80 – 20 rule: the MRO Problem

Aggregation Market Aggregation: –Bring many buyers and sellers to the same, shared market space. –Transaction costs are reduced by providing multiple products in the same market. – The infostrcutre: – 4 information components Product features, Price, Quality and reliability (reputation and order fulfillment). Prices are pre-negotiated. Deep Linking

Enabling Deep Linking – Firm Wide IT Architecture Copyright © Ravi Aron

Aggregation When does Aggregation work best? The cost of processing a purchase order is high relative to the cost of items bought. Specialized products (non commodities). Large number of products. Suppliers are highly fragmented. Easy to create a metacatalog the offerings of a large number of sellers. Ex: Plasticsnet.com, SciQuest.com Pricing: Subscriptions, Listing fees, tertiary revenue

Matching Bring buyers and sellers together and allow dynamic price discovery. Spot Sourcing, Auctions are examples of matching mechanisms. It (generally) creates greater value than Aggregation – however it is far more complex. Ex: Altra-Energy Pricing: commissions, subscriptions, listing fees, subscription + commission, multi-part tariff

Optimal Conditions for the Matching Mechanism Minimal product differentiation Buyers and sellers understand dynamic pricing. Demand (and therefore), Price volatility in the market. Companies can use spot purchasing to achieve demand smoothing. Trade sizes (dollar value) are massive compared to trade costs.

B2B Markets: Products Products that are sold on e-Hubs can be classified into manufacturing inputs and operating inputs. Manufacturing Inputs are raw materials that go into the creation of a product. These goods vary considerably from one industry to another. They are usually purchased from industry specific suppliers (does O&M buy HNO 3 ?) Tend to require specialized logistics and delivery systems. UPS does not deliver Raw Steel (yet).

Operating Inputs These are not raw materials. Often used for Maintenance, Repair and Operational purposes – MRO Goods. Ex: Office Supplies Airline Tickets, Diskettes etc. Often bought from Horizontal Suppliers – such as Staples, Travlocity, American Express. Logistics and Delivery can be handled by generalists.

How do They Sell? Two forms of B2B buying. Spot Sourcing and Systematic Outsourcing. Spot Sourcing: –Satisfy demand at lowest possible cost. –Usually buy to meet an immediate need. –Commodity Transactions: Oil, Steel, Energy. –Almost never involve long term relationship with suppliers. Systematic Outsourcing: –Involves longer term supplier-buyer relationships. –Specialized products and customization. –Negotiated prices that are usually not changed based on prevailing Supply-Demand imbalances.

Four Mkts. and a Matrix

Classifying B2B markets E-Hubs can be classified into four categories MRO hubs: –Horizontal mkts.that enable systematic outsourcing of Operating Inputs – Ex. CommerceOne.com Yield managers: – Horizontal mkts. that enable spot sourcing of Operating Inputs – Ex. FairMarkets.com Exchanges: –Vertical mkts. enable spot sourcing of Manufacturing Inputs – Ex. CommerceOne.com,VerticalNet.com Catalog hubs: –Vertical mkts that enable systematic outsourcing of Manufacturing Inputs- Ex. PlasticsNet.com Ariba.Com, GCEMarket.com

Whose Mkt. is it Anyway? Biased and Neutral B2B mkts. When an e-hub is run by independent third parties and does not favor buyers over sellers or vice versa, it is called a neutral mkt. Seller Bias: The e-hub acts as a forward aggregator that amasses supply and acts downstream in a supply chain. Ex: Ingram Micro: Forward aggregator in the Computer industry. TradeOut.com acts as a forward auctioneer of excess inventory. Objective: Increase the seller’s pricing power.

Forward Aggregators

Reverse Aggregators E-Hubs that favor buyers act as Reverse Aggregators. What do Reverse Aggregators do: –Attract large number of buyers –Bargain on their behalf –Therefore limit the seller’s pricing power. Face higher marketing and operational costs – since they focus on small buyers. They are not particularly attractive to large buyers who already enjoy discounts. Ex: FreeMarkets.com - a reverse Auctioneer (serves Fortune 500 companies) and FOB.com reverse aggregator of buyers in the chemicals mkt.

Reverse Aggregators

Neutral Markets E-Hub run by third parties, attempt to favor neither side (to the transaction). Suppliers on Neutral Aggregators often face channel conflict. They participate at the expense of the ‘normal’ distribution channels. Ex. Chemdex partnered with VWR. Poor Liquidity: –Buyers don’t want to enter unless there are suppliers - who in turn don’t want to enter the mkt. unless there are buyers (did somebody say “Chicken and egg?”). –Biased e-hubs have no such problems – they are aligned with the stronger side and motivate its participation. Neutral e-Hubs are most successful in mkts. that are fragmented on both sides while biased e-hubs add the greatest value when the mkt. is fragmented on one of the two sides.

The Business Portal Model Copyright © Ravi Aron

End-to-End Linked Market Copyright © Ravi Aron

Public Markets, Consortia and Private Markets Independent Public Markets suffer from poor liquidity. To be successfull they need to move from the Business Portal Model to the Deep Linked Market. –To do this they have to attract large upfront investment –They need buyers and sellers that will make this investment They rarely succeed Consortia-driven markets: Several large B2B companies form a B2B consortium and run it to favor them –Many companies commit to usage – therefore, they have some liquidity. They are large enough to define and enforce standards If their members are strong enough they can force the other side (suppliers) to sign up.

Limitations of Consortia Prospect of Collusion between members. They favor one party (usually, buyers) disproportionately to the detriment of another (usually suppliers). The profit of the consortium may often come at the expense of the owners and the market participants. If several firms team up and form a consortium – then all will benefit from the efficiencies but none will gain an advantage over their competitors. Firms are also often unwilling to reveal proprietary information to rivals through these markets.

Benefits of Private Exchanges The benefits of private exchanges: –Provide liquidity –Improved Efficiency – IBM – saved $ 370 million (in 2000). –Minimize Quality Risks Admit only those vendors with proven records Strategic Benefits: –If a buyer consortium becomes disproportionately strong – suppliers may resort to running a private exchange to control the market mechanism. –A Divide and Conquer device. Tighter IT-enabled integration between buyer and seller.

Revenue Models:The Portal Model Subscriptions Listing fees Tertiary revenue becomes crucial –Advertising –Commissions from third party order fulfillment services – shippers etc. –Commissions from third party financial services (escrow, loan origination, insurance) The portal is only as good as the information that it provides - dependence on information providers such as OpenRatings and industrial product rating services Ex: VerticalNet: Is the revenue model robust and sustainable?

Revenue Models: Deep Linked Markets The End-to-End Automated market Revenue from a variety of sources – Subscriptions & Listing fees –Commissions: Flat rate commission Two part tariffs, multi-part tariffs –Less dependence on tertiary revenues –Extent of lock-in may determine if revenues are sustainable Costs: Adoption subsidies & Upfront costs IT usage intensive – revenues slow to build up No example yet of a successful fully functional Catalog Hub. Contrary to hype in the business press the major source of revenue is not auction (or market mechanism) related.

B2B: Markets – Revenue Models The Portal Model Subscriptions – Listing fees – Tertiary revenue becomes crucial – VerticalNet The End-to-End Automated market – Subscriptions & Listing fees – Two part tariffs, multi-part tariffs – Adoption subsidies & Upfront costs – Lock-in may offer sustainable revenues

Summary B2B – hubs create value by matching and aggregation. They can be biased or neutral. B2B hubs are biased towards the party that they seek to aggregate. They seek to increase that party’s buying power. Two forms of sourcing: Spot sourcing and Systematic Outsourcing. Two forms of goods: MRO goods and Manufacturing inputs.

Strategic Auction Markets When buyers or suppliers wield disproportionate clout, they set up auction markets to maximize gains. Buyer driven auction markets –Set up competition between suppliers. –Minimize suppliers’ pricing power. –Suppliers Bid for supply contract. –Descending Bid/ Sealed Bid format. –Lock-in & Switching Costs can play very important roles.

Buyer Run Auction Markets MRO GoodsManufacturing Inputs Spot Sourcing Maximum Gains suppliers will attempt to aggregate. Presence of a few large buyers can easily neutralize seller aggregation. Reverse Auction. Buyers can create switching costs to lock in suppliers. Buyers’ supply risk can help suppliers protect profits. Sealed Bid – Reverse Auction. Systematic Outsourcing Buyers’ power diminishes as level of customization increases. Order fulfillment complexity offers suppliers opportunity to customize – “Deep Linking”. Reverse Auction for long term supply contracts – followed by stable prices. Suppliers are strong. Buyer focus will be on mitigating supply risks. Buyers’ power decreases with increase in product complexity and specificity.

Supplier Run Auction Markets Objective: Set up a bidding war between buyers. Factors that determine outcome – Supply Risks faced by buyers – Extent of buyer fragmentation –Asset specificity and extent of customization required – Presence of Reverse Aggregators

Supplier Run Auction Markets MRO GoodsManufacturing Inputs Spot Sourcing Buyers are very strong. Presence of Spot Markets can weaken seller’s pricing power. Suppliers will prefer to set up ascending auctions / first price sealed bid auction. Buyers’ supply Risks may determine extent of seller gains. Descending Bid Auctions. Systematic Outsourcing Suppliers’ pricing power increases with extent of customization. Suppliers will attempt to erect entry barriers for other suppliers. Production capacity constraints may be the chief reason for auctions. Large, monopolistic suppliers will gain disproportionate revenue. Suppliers’ gain increases with increase in product complexity and specificity. Buyer focus will be on mitigating supply risks. Descending bid / First Price Sealed Bid auctions for long term contracts – or multi-tier auctions.

A Summary of Auctions in B2B Markets MRO GoodsManufacturing Inputs Spot Sourcing Buyers are relatively strongest. Reverse Auctions – Sealed Bid favor buyers. Limits to the effectiveness of Forward Aggregators. Buyers stand to gain more than suppliers. Buyers  Reverse Auctions Suppliers  Descending Bid Auctions / Multi-tier English Auctions. Extent of supply volatility may determine buyer / seller gains. Systematic Outsourcing Suppliers’ pricing power increases with extent of customization. Sealed bid reverse auctions for longer term contracts favors buyers. Opportunity for Forward Aggregators. Suppliers’ pricing power is greatest. Descending Bid auctions. Product Specificity and Customization determine seller gains. Opportunity for Reverse Aggregators.