Cashing In On The E-Business Gold Rush

Dec. 21, 2004
Online-exchange founders won over skeptical manufacturers. Now can they weather the downturn?

They typically have some background in a vertical industry, often in some area of manufacturing, as well as some experience with technology companies. More often than not, they've got at least one start-up under their belts, so they're familiar with the funding game. They're often aggressive, sometimes brash, and they tend to be young -- usually in their 30s. executives? Not exactly, but close. They're the founders and creators of the new electronic marketplaces. And if they're worried about the downturn in their markets and the general dip in interest in the overall business concept underlying online exchanges, they aren't showing it. Clearly, it's the dollar sign that fueled the proliferation of online exchanges last year. "Their goal is to found a new company and make it rich," said Andreas Muther, an executive with SAPMarkets Inc., speaking on electronic marketplaces at a recent conference in San Francisco. The founders of these Levi Strausses of the latter-day e-exchange Gold Rush wouldn't challenge that statement, at least publicly. But most claim they first want to change the way manufacturers conduct business. "It's exciting -- it's a whole new way of doing business," says Jeff Lymburner, cofounder and CEO of Bid.Com International Inc., a maker of software that helps companies set up their own vertical exchanges to dispose of excess or unwanted assets. "Our technology lets them build their own proprietary type of exchange." For others, it was the challenge of doing something new that no one else had done, and that some said would fail. "The whole concept of a World Chemical Exchange was something new, because no one in the industry believed anyone would actually buy and sell chemicals over the Internet," says John Beasley, CEO and cofounder with two others of ChemConnect Inc., based in San Francisco. "Only a handful of people believed we could do this," he says. "In Europe, the president of a chemical company told me this will absolutely fail, that we had no chance to succeed." Beasley is one of those who has a deep connection to his vertical industry. "My grandfather sold DDT in 1927 out of the back of a pickup truck," he says. His father built the company into a manufacturing firm with $50 million in production. Beasley saw the opportunity for a chemical exchange when he realized that often chemical firms either had an excess of materials, or they badly needed more and had few sources from which to get them. What's more, he says, the global chemical industry is very fragmented, with hundreds of thousands of plants worldwide. Those factors led him to believe the chemical business was ripe for Internet-based trading. He got his early funding through his own savings and that of his two partners, Patrick van der Valk, a synthetic chemist, and Jay Hall. Early on they created a simple Internet-based bulletin board where chemical traders could do deals. Once they got rolling in the summer of 1995, ChemConnect was able to attract $4 million in venture funding. "This was before B2B was a term anyone even used," Beasley says. The company has since added some 45 investors from chemicals, financial services, and technology totaling $105 million. The son of a Marietta, Ga., physician, Beasley, 36, had pursued a career in health care before jumping to industry. He was head of mergers and acquisitions at First Physician Care, an Atlanta physician-practice-management firm, and before that had been the CFO at a medical group. He also served as CFO and controller of Talbott Recovery Systems in Atlanta. Another e-exchange entrepreneur, Brin McCagg, founder and chairman of Inc., initially saw an opportunity similar to that of eBay Inc., the online auction firm for consumers, but aimed instead at business. After "looking for an opportunity in the Internet space" for a year, he came across an S-1 form from eBay, which had filed with the SEC to go public. The document described eBay's concept, McCagg says, and the idea for TradeOut, hit him like a semi-load of unsold refractory bricks. "Whereas eBay 's idea was to create liquidity out of things in people's garages, my concept was the same for businesses," McCagg says. "Companies have billions in idle assets, including machine tools, furniture, overproduction of goods, overstocked items, you name it. All of this was being offered for sale over the phone or by fax, or was sold by liquidators who typically were able to extract substantial fees for their service." "I really wanted to start my own business," says McCagg, a 38-year-old Wharton School M.B.A. who spent two years on Wall Street as an analyst in corporate finance in the go-go M&A-laden 1980s, and later ran a hazardous-waste-recycling business. Funding to get TradeOut off the drawing board came from McCagg himself and 15 business colleagues and friends who each chipped in $100,000. Later rounds of venture capital totaled about $80 million, enabling the company to expand and bring major-league management talent aboard. McCagg brought in a pair of top-level, high-tech veterans in George Samenuk and James Mooney to run the company. (Samenuk, a former general manager of the Americas for IBM Corp., left his president and CEO position at TradeOut last month to become CEO of Network Associates Inc., Santa Clara, Calif.) Mooney, now CEO, is a former vice president and CFO for IBM in North America and an ex-CFO at Baan Co. (now part of Invensys PLC). The new management has helped shape McCagg's TradeOut into a virtual bazaar -- sans sights, smells, or sounds -- for buyers and sellers of excess inventory, unwanted assets, and other unused materials. Goods sold over TradeOut include machine tools, general merchandise computers, vehicles, and power-generation equipment. TradeOut never takes on the inventory, does not take title to any materials or products, and has no warehouses, explains Samenuk, who describes the venture as "practically the New York Stock Exchange for suppliers' excess assets in a $50 billion industry." For the service, sellers pay TradeOut anywhere from 5% to 10% of the sale price. "The financial model is very attractive," Samenuk adds. FreeMarkets Inc., a B2B electronic marketplace headquartered in Pittsburgh, was started by Glen Meakem and a partner, Sam Kinney Jr., in Meakem's basement in Connecticut in 1995. The pair had met while working at the consulting firm McKinsey & Co. "Glen is a classic entrepreneur," says David Becker, president and COO, who met Meakem when they were classmates at Harvard Business School. "He is of the Scott McNealy-Bill Gates class of entrepreneur -- that's what it takes to go from nothing to what this business is today." Becker adds that the company's business concept was way ahead of the market in 1995. "At that time, there were a lot of people who didn't have an Internet service provider and didn't have a browser." Becker himself wasn't sure if joining FreeMarkets was the best move for his career and his family. At the time he was manager of Dole Fresh Fruit International Ltd.'s worldwide logistics information network. "I knew Glen and I understood the concept and the idea, but I had a two-year-old and an infant baby. I also had a great career in an established company, so for me it was a big risk to drop all that and move to Pittsburgh. But I was convinced this business would set off a revolution in purchasing." Initial funding came from the company's first dozen or so employees, who all invested. The company later received capital infusions in three additional funding rounds from such financial heavyweights as Goldman Sachs & Co. and Kleiner Perkins Caufield & Byers. FreeMarkets entrepreneurs found the sledding tough in the early days. "We were still fighting the 'You guys have got to be nuts' attitude," Becker says. "We were thrown out by some companies. Even today, when people classify us as a, we cringe. We turned a profit in 1998, the year before we went public. We have none of the issues facing the dot.coms, such as lack of volume or liquidity." The business concept of FreeMarkets is similar to that of the financial exchanges, Becker explains. The company brings buyers and sellers of parts together, often in the reverse-auction format. "Purchasing organizations tend to buy on cost, not value," says Becker. Some 7,000 companies have bid to supply parts to 84 large industrial companies, he adds. Supplier companies are carefully qualified before being allowed to participate. Says Becker, "It's not an eBay where anybody can bid." FreeMarkets' customers have traded some $10.6 billion of goods to date, including $3 billion in 2000's third quarter, the latest for which numbers are available. The trading exchange's third-quarter 2000 revenues were $27 million, up 400% from a year earlier. "We rank second only to America Online Inc. in commercial commerce online," Becker points out. Even the founders of industry-based collaborative exchanges such as Covisint claim to have an altruistic objective. "Covisint is building a new way for the auto industry to conduct business," preaches Harold R. Kutner, group vice president for worldwide purchasing at General Motors Corp., one of the founders of the global automotive exchange. "If we could create a way for individual companies to work together in real-time collaboration, it would bring tremendous efficiencies to the supply chain and competitive advantages to those using it." So much for the altruism. And the self-interest? "We expect to generate a return to us and the partners in Covisint," Kutner adds. Laboring under a bloated supply chain that affects the entire auto industry, GM's stated goal is to use Covisint to wring some $15 billion out of a worldwide inventory valued at $30 billion. Dow Chemical Co., one of three chemical firms that established Elemica, a chemical exchange, did so to try to cash in on what is estimated to be $15 billion in potential savings that could be achieved through greater efficiencies in that industry. "There was a tremendous venture capital opportunity in the chemical industry," says Armin Pressler, chief technology officer of Dow's e-commerce group. "It was the gold rush of 1999." For Dow, of course, the bottom line was always paramount when considering participation in the venture. "The question was, can we at Dow Chemical create new business assets that make money?" Pressler asks. Ironically, though, a lack of dollars -- translated: volume -- is putting the brakes on the electronic exchange juggernaut and the entrepreneurs behind it. Still, judging from a prediction by AMR Research Inc. that some $3 trillion in goods will flow through exchanges by 2004, online manufacturing exchanges aren't likely to go away any time soon.

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