B-to-B: Evolution, Not Revolution
Online marketplaces are getting squeezed from all sides. Now some are transforming themselves into application service providers.
By Mark Roberti
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NEW YORK – Electronic marketplaces always seem to launch with the promise of revolutionizing business. These days, though, the talk is more likely to be about changing the way the exchanges do business.
Most independent marketplaces are struggling. Even if they've signed buyers and suppliers, they still haven't managed to get their members to do much business online. That's no small problem; the marketplaces get much of their revenue from transaction fees. To make matters worse, in many industries major buyers or suppliers have joined forces to build their own marketplaces, putting the squeeze on the startups.
With venture capitalists and Wall Street looking for profits – or at least the prospect of profits – independent market makers need to find new sources of revenue. The answer, for some at least, is to transform themselves into application service providers. More and more exchanges now rent their software to small and midsize companies that don't want to build their own e-business applications, or they license e-marketplaces to big companies looking to run private exchanges for their suppliers.
ForRetail.com, a San Francisco-based marketplace for the home-furnishings and giftware industry, was recently forced to tinker with its business model. The company signed up 400 manufacturers and 25,000 retailers but wasn't getting much revenue from the 5 percent transaction fee it charged vendors. When ForRetail began contacting venture capitalists about a second round of funding in July, it quickly became clear that the VCs had less than no interest in business-to-business exchanges.
"They're toxic waste when you try to raise money," says J.R. Matthews, a partner at Net Market Partners, an incubator working with ForRetail. "No one wants to touch them."
ForRetail had to show potential investors it wasn't completely dependent on transaction fees. The company hit on the idea of repackaging its e-commerce applications that could handle and track transactions so it could rent them to vendors that wanted to sell through their own Web site. ForRetail's first customer, Inkadinkado, a decorative-stamp manufacturer based in Woburn, Mass., will be up and running by the end of the month.
CEO and co-founder Michael Burgess says he still sees the marketplace as a key part of his company's business, but he adds that the new ASP service "is going to drive a lot of revenue."
Revenue is what the company needs right now. It will try to sign up several more giftware vendors, demonstrate that the business model is viable, then go back to venture capitalists by the end of September.
At least one company is completely dropping its exchange in favor of renting applications. AviationX of Arlington, Va., planned to build an online marketplace for the aviation industry. In July, it revealed that it's focusing solely on providing applications for buying and tracking spare airplane parts for regional airlines that can't afford to build their own e-procurement systems.
Like Burgess of ForRetail, AviationX's Chairman and CEO Henrik Schröder found venture capitalists in no mood to back a marketplace. But Schröder had another problem: The airlines – including one group led by Air Canada (ACNAF) , Lufthansa and Singapore Airlines and another backed by American, Delta and United Airlines – had hijacked the marketplace concept.
So Schröder was forced to change course. AviationX is working with three regional airlines – Mesaba of Minneapolis, Chautauqua of Indianapolis and Express Airlines I of Memphis, Tenn. – to develop
the applications. Schröder says AviationX has enough money to last through the end of the year. By then, he hopes, the three airline customers will be willing to pay monthly fees to use the applications. Then, he'll go back to the VCs with the new model.
AviationX isn't the only marketplace that found itself squeezed into a niche. E-Chemicals, an exchange launched in 1998 in Ann Arbor, Mich., competed against a handful of similar chemical industry marketplaces, none of which was generating enough liquidity to survive. So the company shifted its emphasis toward developing software that lets chemical buyers and suppliers move contractual relationships online.
As a result, e-Chemicals is in a good position to work alongside, rather than compete with, industry coalition marketplaces being built by several giant chemical companies. Now, those marketplaces can get to market faster by partnering with e-Chemicals.
One irony of the b-to-b transformations is that brick-and-mortar companies may wind up saving the online marketplaces that they once found so threatening. Many old-economy companies were leery of exchanges because they didn't want to compete only on price. But in the scramble to come up with their own e-commerce strategies, they're turning to online marketplaces.
E-Steel of New York has signed deals to host marketplaces for Ford and BHP Steel, the largest producer in Australia. E-Steel is tailoring the marketplace infrastructure for Ford and BHP. It will charge the two companies' subscription fees and get a small cut of transactions on the private exchanges. E-Steel also gets consulting fees for tweaking the software and for connecting the private markets to back-office applications at Ford and BHP.
"When we started out, we thought the value was going to be in providing an online marketplace that lets small companies connect to each other," says Ken Thompson, e-Steel's president and COO. "Now, we're seeing that the big companies want to connect tightly with other companies, and they see tremendous value in integrating their supply chain and bringing it online."
Thompson says e-Steel will announce deals with other large old-economy companies over the next few months. He anticipates that in the next couple of years, about half the company's revenue will come from hosting private markets for large brick-and-mortar companies.
Other marketplaces are making similar moves. Foodtrader.com, a Miami, Fla.-based online marketplace for the food and agricultural industry, is trying to do for large supermarket chains and food processors what AviationX is doing for the regional airlines. BuildPoint, a Redwood City, Calif.-based marketplace for the construction industry, recently signed a deal to provide the e-commerce component for McGraw-Hill's Construction.com Web site.
PurchasePro.com (PPRO) of Las Vegas is running 33 co-branded Web sites for companies such as Office Depot (ODP) and Sprint (FON) . This quarter, the company expects to sign another 25 customers who want hosted marketplaces. "There's a lot of demand for this," says Chris Benyo, senior VP of marketing for PurchasePro. "It's a very robust piece of our business."
Many independent marketplaces raised buckets of money when b-to-b was hot earlier this year, so most have enough cash on hand to survive for a while. But there's going to be a Darwinian struggle over the next 12 months – and those marketplaces that adapt quickly and provide applications that industries need are most likely to survive.
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