Booz·Allen says market exchanges are here to stay

By Staff -- Purchasing, 7/13/2000

Buyers with substantial buying clout have an opportunity to build electronic market exchanges, according to a viewpoint paper published recently by Booz, Allen & Hamilton of New York.

Noting that companies such as Ford, GM, DaimlerChrysler, Boeing, British Telecom, Deutsche Telecom, Weyerhauser, and Chevron are all pursuing this emerging opportunity, the consultants observe that if properly applied, market exchanges, whether vertical, horizontal or diagonal, can eliminate waste and improve product and service performance at every tier of each industry's supply chain.

As viewpoint co-author, C.V. Ram-achandran sees it: "The initial reaction for traditional bricks & mortar companies may be to say 'That's not our core business. We're not in the business of making market exchanges.' But dominant players already have liquidity and Web-based technologies give them an opportunity to influence the structure and efficiency of their supply industries."

In the short run, market exchanges may allow the founders to generate revenue via transaction fees. Ramachandran concedes, however, that the potential for earning transaction fees may be short-lived. "As Net markets evolve more toward true exchanges, transaction fees will be bid down to zero. We're already seeing this happen." Longer term, the exchanges will drive sustainable benefits by streamlining the flow of information needed to eliminate inefficiencies throughout the supply chain, for example, lower inventories, higher utilization and better matching of specifications to customer requirements.

The benefits apply to both the founding companies and others who may wish to participate in an exchange. "Smaller-scale buyers may not obtain the same pricing as the market makers," Ramachandran notes, "but they will still be better off." Example: A small-scale buyer pays $100/lb for raw material input compared to $60/lb paid by the dominant player. By participating in the virtual market exchange, this buyer can pay $80 to the supplier, and $10 to the market exchange, pocketing the remaining $10/lb. Competitive suppliers win by gaining demand predictability, achieving more efficient production runs, and lower sales costs-at the expense of less efficient, less innovative suppliers.

An alternate strategy is for buying organizations to commit their liquidity to existing or announced market exchanges in return for equity stakes from the founding members-who are often either technology companies such as Ariba or Commerce One or specialists like ICGE/Vertical Net. "However, by going down this path," Ramachandran says, "dominant players may miss an opportunity to remake industry structures in the image that best suit their long-term supply management strategies." For example, he says an industry leader might use market exchanges to limit traditional distributors to narrower roles, consolidating and deploying inventory of only slow-moving items, for example.

Ramachandran suspects that progress toward vertical market exchanges could be slowed by the threat of federal antitrust scrutiny. "So far, it looks like the FTC is not going to be concerned if the buying power in the market exchange represents less than 20% of the total industry. But if it's above 30%, they're going to be lowering the boom. In terms of the potential for price signaling within market exchanges, companies are being very careful to erect high Chinese walls that assure that data will not be traded back and forth." For example, he notes, auto companies have said they will not use their exchange to pool purchases but rather as a way to eliminate transaction costs and disseminate information. Their suppliers, however, remain suspicious.

Despite the blizzard of activity that has already taken place in Net market exchange making, Ramachandran says that it's not too late to jump into the game.

"In most major industries, the major players have announced exchanges. Now it's time to think about all the sub-industries that support the industry leaders. Suppliers should be aggressive to embark on exchange opportunities that make the most sense for them."