B2B or Boom 2 Bust?

Of an estimated 1,500 B2B exchanges operating in 2000, only about 200 will survive through 2003 if the current shakeout trend continues, according to a new research study.

The study, entitled “Shakeouts in Digital Markets: Lessons from B2B Exchanges,” tracks what it calls the “amazingly compressed boom-to-bust cycle” for Internet startups in B2B markets.

The research report was prepared by Prof. George S. Day of the Wharton School of the University of Pennsylvania and Pembroke Consulting President Adam J. Fein.

“Our study of eight industries found only 43 percent of independent B2B exchanges survived between April 2000 and July 2002,” said Fein. “B2B exchanges thought they had a great value proposition but actually misdiagnosed their advantage versus existing ways of doing business.”

“One venture capitalist behind a prominent industrial supplies B2B exchange was reluctantly forced to admit: ‘We thought buyers would want to surf the Web for industrial supplies, but they had other priorities’,” Fein said. “This site was shut down after more than $50 million had been invested.”

What happened to burst this particular portion of the Internet bubble?

“B2B exchanges were late movers — not first movers,” Fein said. “They couldn’t replace longstanding relationships in the B2B supply chain between customers and their distributors.”

“B2B exchanges discovered that their greatest competition was not other exchanges, but rather existing ways of doing business,” Fein said. “Business customers are reluctant to disrupt systems that work, even if those systems are costly or inefficient.”

According to Fein a “first mover advantage” versus another exchange was relatively meaningless compared with the hurdle of competing against an in-place system of buyers, wholesaler-distributors, brokers, and other manufacturers.

“Business customers care more about getting the right product at the right time than about saving a few incremental percentage points on price by perusing an online site that lacks access to their preferred brands,” he said.

“Only a handful of exchanges (and suppliers) such as FreeMarkets … have capitalized on the breakthrough possibilities of the Internet,” Fein said.

FreeMarkets, whose software has been hailed for successfully enabling companies to save money on goods and services by aggregating big orders and purchasing online, recently reported its third-quarter net loss narrowed to $3 million, or 7 cents a share, from a loss of $7.9 million, or 20 cents a share a year ago.

Indeed, many B2B exchanges and related companies are just gone, and others are hanging on by their fingernails. Fairfield, Conn.-based General Electric sold off its GE Global eXchange Services B2B unit last June. And Goldman, Sachs at one point bravely predicted a $1.5 trillion B2B playing field in the United States by 2004.

And VerticalNet , for example, once a player in the business exchange software game, has recently seen its CEO and CFO step down and talk is the firm is looking for a buyer, according to a recent article at eMarketect.com.

Pierre Mitchell, an analyst at independent research and analysis firm AMR Research, goes on to say in his VerticalNet piece that “companies are buying tactically, and concerns about vendor viability indeed loom large.”

Who will the winners be?

Fein said that “our study identifies three winning types of players: adaptive survivors who find a protected niche by retooling their strategy for re-formed markets; … incumbents who acquire the assets of pure-play companies at steep discounts; and pure play start-ups that capitalize on their early mover advantages in breakthrough markets.”

The full results of the study will be published in a forthcoming edition of “California Management Review,” which is published by the Haas School of Business at the University of California Berkeley.

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