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This chapter is from the book

The Future of e-markets

In fact, so popular and lucrative has the entire market become that there has arisen a number of third-party vendors that specialize in building and operating e-markets, boasting that a basic trading hub can be set up in three to six weeks for a few hundred thousand dollars. This has meant that many people with an entrepreneurial flair and a good working knowledge of a vertical industry supply chain have been tempted to plunge into the market with their own trading hub. Venture capitalists, understanding the popularity and the potential "winner-take-all" scenario for those entering these e-marketplaces, have been only too keen to provide the funding.

There are drawbacks, of course. As with any independent many-to-many portal at this time, both suppliers and buyers still have to update their internal systems manually with each transaction. Although obviously the trend is toward full integration, there are currently any number of differences—in buying parameters, payment systems, shipping and delivery techniques—that mean that purchasing through an e-market is still not much different (at least in terms of process efficiencies) from negotiating price over the telephone. This leaves the "e-market revolution" much less revolutionary than its proponents claim, in that neither the buyer nor the seller are fundamentally changing anything about their businesses.

However, many industry watchers and software vendors would counter that it is only a matter of time before that higher level of integration is provided by the e-market portal owners. In fact, this need has already been partly addressed by a whole new platform of third-party integration software known as connectors (see "Translation and Connectivity" in Chapter 5).

Many of the early exchanges and auctions that focused on spot markets found that they were soon overtaken by larger, better-funded trading communities sponsored by alliances between market creators and the large software companies. Moreover, many of the smaller auction sites have found that contractual details and performance guarantees, necessary to ensure that buyers won't get burned badly by participating, require software and processes that incorporate a sophisticated and detailed approach to automated bidding—levels of expertise that they do not have and software that very few of them can either build themselves or afford to buy.

But of all the controversial issues that this revolutionary shift toward trading hubs raises, one of the most important is that it runs completely counter to the prevailing wisdom—that has been gaining momentum over the past decade—of the value of strategic sourcing. The idea behind strategic sourcing is that a few, preselected, tested, and trusted vendor partnerships are far more cost-effective—because of familiarity with processes and expectations, negotiated discounts, and ability to be trusted with secure information—than many partnerships with unknown or untested vendors, even if they are offering one-off low prices for their goods. Dedication to this premise is, according to many, the very reason why companies want and need to digitize their procurement systems, in that once their procurement specialists are no longer laboring with low-cost, high-volume indirect goods, they can spend their time much more valuably in developing closer, tightly-negotiated arrangements with a few highly-trusted partners.

Over the past several years, for example, IBM has significantly reduced the number of vendors from which they purchase ORM materials. In Europe, only 10 suppliers provide the company with some three-quarters of all of its purchases. But this vendor rationalization is not as straightforward as it might appear. The ultimate number of suppliers may well be what it was before consolidation. It is simply that IBM has, because of its considerable market leverage, been able to force the costly and cumbersome responsibility for negotiating and buying from thousands of suppliers down one level to its selected and trusted "clearinghouse"-type partners. It is a form of strategic sourcing, but not one that is easily adopted by smaller, less influential buyers.

On the other hand, many procurement specialists—both buyers and sellers—assert that spot markets, auctions, and many-to-many exchanges completely undermine the trusted one-to-one relationship that is at the heart of the strategic sourcing movement. On the contrary, at least until these e-market portals can be closely and securely integrated with a buying company's ERP and back-end systems, item price becomes the single most important criteria for trading with a particular vendor, which may be one of thousands of suppliers, each one selling on multiple horizontal and vertical industry e-markets. It is an unexpected strategic paradox that promises to divide the procurement community.

In the end, of course, it is the very fears expressed by industry watchers that a single e-marketplace will become dominant (winner take all) that are part of the motivation for venture capitalists to risk money backing a myriad of these e-marketplace startups. So volatile is this portion of the economy that there is some merit in spreading your risk. But there can be little doubt that the vast majority of startup exchanges will rapidly collapse as they are tested in the rough-and-tumble of the day-to-day procurement market. Customers will increasingly demand higher levels of service and integrated functionality from trading hubs, forcing a form of natural selection to take place in each industry vertical.

Much in the same way, there is also little doubt that customer demand, legal barriers permitting, will soon force these multiple and competing groups—e-procurement software vendors, ERP firms, market creators, auctions, exchanges, ASPs—toward consolidation. Customers are already demonstrating that they don't want to have to deal with a myriad of different vertical and horizontal suppliers. They want one or two organizations that can provide centralized sourcing for them. Many research groups contend that the need for a single, integrated solution for the full e-procurement process—for both indirect and direct materials and with an acceptable balance of systems integration capability and security—will quickly force a consolidation of the now fragmented e-procurement marketplace.

No longer able to focus on simply providing buyers with purchasing leverage and sellers with a broader market, those that survive, claim analysts, are being forced to add value by offering supply chain management expertise, back-end systems integration, integrated banking, and data security protection, all in a single, cost-effective offering. This will mean that when market forces take their course, according to the Gartner Group, there will only be room for about three vertical portals in each industry. The others will go the way of the e-commerce dotcom startups of the past several years.

There is already evidence that that vertical industry shakeout has begun. One good example is EFDEX, the e-market that had hoped to become the dominant exchange in the catering industry, bringing together online restaurants and hotels with catering suppliers for food and drink. At one point, their staff had jumped from 20 to 200, but in the end, investor concerns about cost and the site's ability to attract the number of users necessary meant that EFDEX failed to secure the necessary funding to even go live.

Similarly, IndustrialVortex, the industrial automation product e-exchange, collapsed after only six months of trading, despite more than $20 million in RFQs processed in a single month in the summer of 2000. Neoforma, a highly praised health care exchange, was forced to lay off 25% of its workforce, its stock price dropping from $60 to $3.508.

Most spectacularly, Ventro, which operates many different marketplaces, was forced to close two of its once most promising vertical exchanges. Chemdex, a market site for medical products, and Promedix, which provided an exchange for specialty medical products, were both at one time cited as sterling examples of the promise of vertical markets, but ultimately failed to attract enough participants or make enough money to survive.

It may well be that if only as a matter of survival, as some argue, e-markets will move quickly to build in the third-party delivery and quality assurance services necessary to reassure buyers. The larger and more progressive trading communities—and this is where things become potentially revolutionary—are already providing a marketplace for direct materials, creating a much closer integration of supply chain systems than could have been contemplated only two years ago. There are many reasons for this, not least that the potential earnings are so good that the e-procurement and ERP software groups are scrambling to reshape themselves as partners in these hubs and exchanges, and are bringing valuable procurement expertise to add on to the features of the industry focus.

The reason that these types of Internet-based markets are so important, then, is that they may well be the catalyst that will push e-procurement away from the limited one-to-many extranet model, focused on a single buyer and several preferred vendors, toward a many-to-many arrangement where, even for many direct materials, buyers will go to a single online portal in order to bid on materials being sold on a real-time market.

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