Beyond Exchanges

By Nicholas G. Carr

Earlier this month, a Wall Street analyst downgraded the stock of Commerce One , a leading builder of business-to-business exchanges. Investors reacted by hammering the valuations of all the big b-to-b players.

It's déjà vu. Just as everyone initially assumed that Web-based retailers would clean up in business-to-consumer commerce, so the conventional wisdom in the b-to-b sector has been that Web-based exchanges would practically mint money by skimming small commissions off huge volumes of trades.

But the exchanges, like their e-retailing cousins, have always had a dubious business model. They rely on transaction fees to turn a profit. The problem is, the transparency and efficiency of the Internet relentlessly push transaction costs toward zero. And no matter how many times you make zero dollars, you're still broke.

So is b-to-b a big bust? Not at all. Precisely because the Internet minimizes transaction costs, corporate buying and selling will continue to move online. And when you have that much money changing hands, there are bound to be attractive business opportunities. They just won't take the form everyone thought they would.

Two articles in the November-December issue of the Harvard Business Review re-examine the evolving b-to-b sector. In "Beyond the Exchange: The Future of B2B," management consultants Richard Wise and David Morrison make a compelling case that the b-to-b market will end up looking a lot like the financial services market.

The digitization of information, combined with the rise of high-speed networks, has revolutionized the financial services market. While exchanges still play a central role in the industry, they produce little economic value. Instead, profits flow to a wide array of specialists, from loan originators to packagers of derivatives. Rather than processing routine transactions, these companies have developed innovative business models that share one thing: the creative manipulation of information.

Wise and Morrison argue that the same shift in value, from transaction processors to information manipulators, is already beginning to occur in the b-to-b arena. "E-speculators," like Enron , are starting to make big trading profits by capitalizing on fluctuations in the prices of goods sold through online exchanges. "Sell-side asset traders," like AutoTradeCenter.com in the used-car business, are enabling suppliers to swap orders with one another to more efficiently use overall industry capacity. And an array of packagers and originators are emerging to help companies create the standards required to trade complex products and services.

As for the exchanges, the authors foresee them becoming very big – and not very profitable. In many cases, they'll be operated simply as nonprofit collectives. The value they provide will lie more in the information they generate about purchasing trends than in any transaction fees.

The second article, "The Napsterization of B2B," takes the argument further. Its author, Harvard professor Andrew McAfee, argues that peer-to-peer networking will render big centralized exchanges all but irrelevant. By allowing businesses to share richly detailed information about products and processes, he writes, sophisticated peer-to-peer networks "will enable all companies everywhere to locate trading partners on the fly and complete transactions swiftly, securely and efficiently, without the need for any central aggregator or facilitator. "

That's a radical notion, but it makes a lot of sense. As p-to-p software becomes more sophisticated and able to handle complex trades, the essential service provided by exchanges – bringing lots of companies together and providing a common platform for trading – will lose its value.

None of this means that exchange-focused companies are doomed. Their existing customer relationships and market knowledge are a real advantage. But they're going to have to look beyond the exchange if they want to thrive.

Amazon Honor System

The copyrighted content on this site is provided on the honor system. If it holds value for you, please pay a reasonable sum by clicking the above banner. If you are printing out the content or otherwise distributing it, you are required to pay a fee of $2.50 per article per copy. Thank you.