Racing Uncertainty

Racing Uncertainty

Copyright 2002, Traffic World, Inc.

For most dot-coms the race to become viable was over in a blink. Few survived long enough to enjoy the possibility of becoming thoroughbreds.

Industry forecasts suggest that there will be only 180 Internet exchanges left standing by mid-2003, in which case this boom-and-bust cycle "will span a mere five years, clocking a pace that is five to 10 times as fast as in the old economy," according to a new report on the lessons learned from the episode. One lesson that stands out is that dot-coms and their investors failed to tell the difference between a true market breakthrough and a rehash of what was already in place.

"Shakeouts in Digital Markets: Lessons from B2B Exchanges" was written by George S. Day, the Geoffrey T. Boisi professor at the Wharton School of the University of Pennsylvania; Adam J. Fein, president of Philadelphia-based research and consulting firm Pembroke Consulting Inc.; and Gregg Ruppersberger, a senior analyst at Pembroke.

At its peak the dot-com craze spawned 1,520 online business-to-business exchanges, the report estimated. Most entrants were pure-plays that touted the benefits of matching buyers and sellers in large markets. Their offerings were variations on six basic themes: information exchange, digital catalogs, auctions, logistics services, collaborative planning and value-added services such as design collaboration.

By late spring 2000 there was a glut of independent exchanges, said the report. For example, there were 140 startups in the industrial supplies industry. Venture capital was plentiful and the investors that supplied it were concerned primarily with cashing out. The brakes were applied when cash supplies dwindled. According to a study of eight industries carried out by the authors, "only 43 percent of the independent exchanges survived to July 2002."

Most independents - an estimated 31 percent - exited after being acquired by another exchange, while 26 percent ceased operations. Investors became disillusioned when it was apparent that many exchanges would not achieve a critical mass of vendors and buyers. Also, the technology often failed to deliver on service promises, the report pointed out. Other killer blows were the emergence of exchanges backed by industrywide consortia, and latterly, the growth in private exchanges.

A plausible scenario, said the report, "is that each industry will eventually have one or two public exchanges to simply help buyers and sellers find each other." Private networks will handle transaction traffic and facilitate logistics operations and information exchanges. "In short the supply chain will be more efficient but the market landscape would look much as it did before the boom in independent exchanges."

This latter observation is one of the key learnings described by the report. Said the authors: "Advances in technology have historically created two kinds of market opportunities: some are real breakthroughs that were previously not possible, but most are reformulations of existing ideas." Most startups put themselves in the "breakthrough" category when the reality turned out to be more modest. According to the report, the reality is an amalgam "with a few breakthroughs such as portals and auctions close to one end and most applications bunched at the reformed end."

Another reality is that in reformed markets customers tend to stick with existing buying habits. Moreover, one of the chief lures of the digital exchange model, that it was able to slash costs, was less potent than assumed. "During the past 10 years, industrial customers have been focusing on improving efficiencies in their supply chains by consolidating supply contracts and reducing the number of suppliers," the report said. The lowest price - a chief competitive weapon used by e-marketplaces - is often less important to a buyer than consistent service levels.

This preference for familiar well-established brands and relationships handed incumbent businesses an important advantage. Their financial clout and systems that could be adapted to the Internet widened the credibility gap even further. "This is why Office Depot, which sells everything from paper clips to computers, has become the second largest online retailer in the world" behind Amazon.com, the report said.

The authors described other limitations that helped trip up the pure-plays. For some products the digital medium is unsuitable for conveying important qualities such as reliability. Also, the transaction fees that online markets relied on dropped as the competition became fiercer. "Some exchanges saw transaction fees drop to as low as one-quarter of 1 percent, which is not enough to cover operating and capital expenses, and made a mockery of their profit forecasts," it said.

Based on their research the authors suggested that prospective winners would fall into three camps. They will be adaptive survivors in niche markets, acquisitive incumbents that have acquired troubled dot-coms at bargain-basement prices, or "pure-play startups that capitalize on their early mover advantages in breakthrough markets."

As the authors pointed out, if a new technology reforms existing markets, then the incumbents eventually will prevail, but if it is a true breakthrough, then startups and new entrants have a chance to survive. "The eventual winners will be those that prevail in the competitive battle by exploiting their first-mover advantages and adapting to a slower-growth market that puts a premium on operational excellence instead of entrepreneurial drive," the report concluded.