What to do when electronic exchange comes

April 24, 2000

BY MICHAEL KRAUSS

"What do you do when an electronic exchange appears in your industry?" I asked.

"Change your business model," was George Derby's reply.

Derby, chief strategy officer of Net: Ratio, a Hewlett-Packard-backed, San Jose, Calif.-based start-up, establishes electronic exchanges for niche markets. We were talking in March over lunch at Esther Dyson's PC Forum.

"Say you're a small printing company," Derby went on. "Over the years, you've marketed your services through a small sales force to a handful of loyal customers. Suddenly, I come along and establish an electronic exchange where midsize buyers and suppliers can trade online."

"You've got to totally rethink your business," he said.

Compelling, yet vague. I knew intuitively that Derby was right, but what would I do if the electronic exchange phenomenon hit my hypothetical printing business, as it clearly is hitting most businesses today?

I would hope to avoid denial, seek to understand the phenomenon, set a game plan, and act quickly. So should you.

If you're a marketing or sales VP of a midsize company in an industry facing a new electronic exchange, accept the fact now that electronic exchanges will be a way of life. Learn about them and welcome them even if the change is uncomfortable; remember, in the new economy, the winners are those who move first.

Online business-to-business trading comes in various forms, but there are essentially three core varieties:

• Forward auctions: These are seller-controlled, electronic markets in which the seller entertains bids from many buyers.
  
• Reverse auctions: These are buyer-controlled, in which a buyer gets offers electronically from many sellers.
  
• Internet exchanges: These are electronic markets in which many buyers and sellers interact to define prices and trade goods and services.

The simple reason, though not the only reason, these exchanges are appearing is that they help drive down costs, particularly search and sales cost. Creating totally new products and services and new wealth is another reason. To understand the wealth-creating power of an Internet exchange, consider the value of three different kinds of networks: a broadcast model, a telephone model and the eBay model.

In the '60s and '70s, CBS, NBC and ABC were potent market forces holding power and creating wealth because they controlled the ability to communicate from one fixed point to 80 million television households. Not a bad way to make a buck based on a "one-to-many" broadcast model.

Meanwhile, just across the Hudson River in New Jersey, AT&T executives know that the value of their network is a function of the number of users or members on it. The key value driver to these "any-to-any" networks is scale and the fact that anyone on the network can communicate with anyone else in an individual conversation. Telephone and cable TV companies are valued by Wall Street based upon a value-per-subscriber approach.

Jetting to the left coast, consider Pierre Omidyar and his goal of creating an online exchange to trade Pez dispensers for his girlfriend. This foray became eBay.

eBay is a "many-to-many" trading network earning "rents" or fees on each transaction, and any eBay member effectively can trade with all other eBay members. These many-to-many trading networks offer the most potential connections or permutations, and they're the reason suppliers and providers are scrambling to own online b-to-b exchanges in vertical industries. If you own the exchange, you get a piece of each transaction-and that's a pretty lucrative deal.

But there's more: By building the electronic exchange, you may set the stage for creating derivative products and services even more valuable than the core product. Consider that when broadcast television was commercialized in the '50s and '60s, the network owners became wealthy, but it made the publisher of a small print publication known as TV Guide far wealthier.

And the marketing executive of that hypothetical midsize printing company might consider setting up his own electronic exchange or team with others to set one up. That's what Michael Levin, a 26-year veteran of the steel business did last year when he became CEO of the online exchange e-Steel. Even if the big players already have moved into your market, you can set up partnerships and relationships and learn how to transact business most effectively online. For example, VerticalNet Inc., an operator of several dozen online exchanges in vertical industries, and other firms like it allow companies to set up "electronic storefronts" to transact business.

Of course, such exchanges don't eliminate personal relationships, as buyers and sellers often establish track records and develop ratings (as avid eBay traders know). In fact, one of the hottest new start-ups debuting at PC Forum this year was a company called Open Ratings, led by MIT Media Lab Professor Pattie Maes, which may become the Web version of TV Guide. Open Ratings will provide the technology infrastructure to trading exchanges and other Web sites for buyers and sellers to share information about each other. Therefore, one key strategy of your online buying and selling efforts should be to establish a solid rating or track record as a seller or buyer.

Perhaps the hardest part of adjusting to the new online exchange phenomenon will be the cultural and organizational adjustment. The midsize printing company may need more computer terminals and executives who understand Internet protocol and fewer affable sales reps. The corporate culture issues can be the greatest inhibitor to success, which is why setting a game plan is so important.

That brings us full circle to what Derby was saying about creating a new business model.

Once you have recognized that the future is here, once you have gathered knowledge and understanding about electronic exchanges, and once you've set a game plan for the future, you may find that you've significantly changed your original business model and the whole way you provide value. All of that is OK, so long as you do it quickly before the midsize printing company next door figures out the game and puts you out of business.

I guess Derby's point wasn't so vague after all.

Michael Krauss is a partner with Diamond Technology Partners in Chicago.
He can be reached at news@ama.org.

Sidebar: The corporate culture issues can be the greatest inhibitor to success, which is why a game plan is so important.