Why over-optimism over new online trading exchanges needs tempering

The frothy nature of the online trading exchange market is exciting, but partici-pants should enter the fray with their eyes open.

The announcement...

The frothy nature of the online trading exchange market is exciting, but partici-pants should enter the fray with their eyes open.

The announcement last week of yet another series of online trading exchanges has excited market interest in this growing space. Envera, an electronic chemical and petroleum trading exchange, is likely to go live in the third quarter this year thanks to backers including BF Goodrich, Castrol and Eastman Chemical.

Meanwhile, a group of financial and energy companies including Amoco, Deutsche Bank and Goldman Sachs announced plans to roll out InterContinental Exchange, a trading exchange specialising in wholesale energy and metals.

The interest in business-to-business e-commerce via Internet trading hubs centres on a number of different models.

Horizontal trading mechanisms such as Commerce One's MarketSite, Ariba's Network and Oracle Exchange specialise in hooking together firms that want to buy and sell indirect goods - the materials and services that keep businesses running on a daily basis. Get your paper-clips here.

Industry portals such as Chemdex focus on aggregating products and selling them on to buyers in a one-stop shop solution, like distributors in the physical world.

Direct commodity exchanges such as Esteel, for example, focus on hooking together buyers and sellers of vertical market product (in Esteel's case, industrial metals) who then conduct their purchases directly.

Join the club

Other models, which have gained particular popularity since the start of the year, involve companies that develop their own trading exchanges so that they can integrate with their suppliers and customers directly online within the vertical market. Such companies may also club together to form joint-venture exchanges to help attain a critical mass in the market, and to add leverage to their joint buying power.

The merger of the Ford and General Motors trading exchanges recently (see box) is a prime example of this. Spencer Marlow, European retail supply chain marketing manager for supply chain integration consultancy GE Global eXchange Services, explains that these models are developing from a one-to-many model into many-to-many trading communities. His company developed a one-to-many trading extranet for Tesco to connect to its business partners, based on the supermarket's early 1990s-based EDI system. "What we have seen emerging in the past few months is the concept of the exchange," he says, adding that these generally hook different suppliers and customers together in procurement relationships.

As with most emerging technology movements, the actual amount of business being done over these networks is minimal, says Chris Webster, head of supply chain integration at Cap Gemini, adding that within five years, it will grow to exceed expectations. The companies that are really capitalising on these developments are the horizontal suppliers mentioned above - Ariba, Oracle and Commerce One, SAP - which are selling the technologies underpinning their own exchanges to more specialised, vertical market players.

Watch your step

The idea of trading online with thousands of partners using an intuitive Web interface and electronically transmitted accounts information is superficially attractive. Nevertheless, it is important to remember some of the potential downfalls of such trading practices, especially when using technologies and trading models that are relatively immature.

One such danger is in trading on a many-to-many vertical exchange using a supposedly neutral service that has been started by a company with existing interests in that area. While such a company may try to erect Chinese walls between itself and traders on its site, some firms could still interpret its ownership of the firm as a potential conflict of interest. The closest physical analogy would be an airline owning a supposedly independent airport, for example - something that would concern other airlines vying for landing slots at the site.

Other challenges are more technical. One particular problem lies in the area of non-repudiation. In a business-to-consumer site, customers will generally order low-value goods and there won't be too much dispute over whether they purchased them or not. In a business-to-business environment, where purchases are of a higher value, it is important for an online exchange company to guarantee to a supplier that it can legally prove a purchaser's identity and activities in court.

Companies such as Ariba will talk about their ability to prove companies' identities using digital certificates and audit their activities online, but the question is, will such electronic certificates stand up in court? The UK Government's Electronic Communications Bill makes electronic certificates admissible, but it isn't law yet. And the international nature of these exchanges calls into question the applicability of local law to such issues.

Significantly, neither Commerce One nor supply chain integration company i2 have been able to guarantee 100% legally watertight non-repudiation on the phone, which is bound to worry some customers.

Stephen Weller of i2 argues that, for many exchanges, the onus will be on the creation of solid, long-term relationships for trading activities to work. "You can't work in the old-style antagonistic buyer-seller relationship," he says. "The way these things work for us is that the whole thing is based on collaborative planning." Nevertheless, for horizontal trading hubs, where companies are likely to buy on price, the ability to move away from long-term relationships and play the field will doubtless be a major attraction, and so non-repudiation will be at the top of the agenda.

Another problem that needs to be thrashed out is standards for information exchange. XML is an ideal solution for transmitting electronic procurement data, but attitudes towards it vary from supplier to supplier. Weller says that it isn't necessary to use XML to succeed in this market space. Customers can push other kinds of middleware protocol down the pipe to make their trades, he says.

Commerce One's marketing manager Chris Philips disagrees. "The alternative is that, if we want to do business as a buyer, we have to define upfront how a business document will look if we are to exchange it between our systems," he says. "What we don't do is mandate a particular XML standard."

As broad as data

But this is just the point; XML on its own is as broad as data itself. Specific XML Document Type Definitions (DTDs) and schemas must be set up for different industries, and while there are initiatives afoot to resolve these standards, there are many from which to choose.

Alec Beck, IT director at Merck, recently complained that one of the biggest obstacles to establishing his own trading network with customers stemmed from a myriad of different customer requirements regarding data protocols.

Because XML is still in its 1.0 revision, the signs are that the suppliers are still much more enthusiastic about it than the majority of users. Remember that there are still companies out there sending text files over systems network architecture. Even the typically gung-ho exchange vendors admit that not every exchange will work.

Commerce One's Philips adopts a realistic approach: "Some won't reach critical mass and, by critical mass, I mean the number of buyers and suppliers in the exchange. Those ones will die away," he says, adding that the more successful ones will reach a point at which it will become folly for firms not to join.

The development of different exchanges in the same vertical market will lead to a spate of merger and acquisition activity over the next 18 months.

The potential problems for these online exchanges shouldn't turn companies off exchanges altogether. They will experience a level of success, but as with most emerging technologies, we should take over-enthusiastic analysts' predictions with a pinch of salt.

Internet exchange developments over the past six months

A wealth of Internet-based trading exchanges has sprung up in recent months. Here are some of them:

September 1999: SAP launches MySAP.com, its business-to-business trading portal.

October 1999: Comdaq.net opens its doors. This is a sugar and coffee trading exchange that has just announced it will also begin cocoa trading in the next few months.

January 2000: Commerce One teams up with Shell to produce an oil and gas trading exchange.

Oracle officially launches its Oracle Exchange trading site, which offers horizontal trading services to partners. It announces that 950 companies have signed up for the service.

March 2000: Sears and Carrefour announce that they would serve the retail sector with GlobalNetXchange, an online trading exchange, linking thousands of suppliers via the Internet. Meanwhile, Wal-Mart's subsidiary McLane hooks up with Chevron and Oracle for a trading network called RetailersMarketExchange, aimed directly at convenience stores.

General Motors teamed with Ford and Daimler to merge their individual trading hubs, creating a joint venture for automobile part procurement.

Concert, the joint venture between BT and AT&T, announces plans to roll out a trading exchange along the lines of BT's Marketsite. Marketsite is a horizontal trading hub that connects into Commerce One's Global Trading Web.

Commerce One and Ipsat form alliance to offer a metals trading exchange.

Ariba signs with Cargill to work on Novopoint, a neutral industry exchange for food manufacturers and suppliers, to launch in the summer.

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