James Heppelmann thinks trading exchanges are the next big Internet opportunity. But it is not the buying or selling that has this executive at Parametric Technology Corp. (PTC) excited. It's the use of exchanges as a powerful strategic tool to improve product development and shorten time-to-market. "As exchanges develop new ways to link companies together, they are coming to represent the ideal platform to enable the B2B business processes that both precede and follow procurement, namely collaborative activities within the design and supply chain," says Heppelmann, executive vice president and general manager of Windchill Solutions, a unit of PTC. He sees the procurement function, today's dominant exchange focus, as far short of its strategic potential. "I think that if you look at procurement and supply-chain management, and even ERP, to some extent these initiatives are all about improving the efficiency of a business -- cutting costs, taking costs out of the business. That approach is good for the expense line, but it isn't actually doing much for the revenue line. "Consider a company that invested in business-to-business exchanges for procurement and supply-chain management," Heppelmann continues. "Maybe in the last few years it finished a global ERP implementation. It should be in position to dominate, but if its products aren't competitive, all those implementations are sort of irrelevant. I think that people are realizing, even after they and their competitors have done the [exchange] procurement thing, that everyone is back at parity again. After all that effort, they missed the real question of 'whose products are better?'" Heppelmann notes that manufacturing history is replete with competitive skirmishes where optimized business processes lose the market battle with those that compete with optimized products. He cites Motorola Inc. and its ongoing cellular phone battles as an example. "They once owned the business of analog phones, but lagged Nokia, Ericsson, and others in bringing digital models to market." The customer tends to "vote" on the tangibles of a product, he notes. Of course, it is more than coincidence that this viewpoint comes from a firm that positions itself as a product-development company. But he's not alone in his thinking. "The major software-solution providers, whether in product development or enterprise resource planning, are seizing the opportunity to add value to the exchange phenomenon," says Arthur B. Sculley, partner, Sculley Brothers LLC, New York, and co-author with W. William A. Woods of B2B Exchanges (2000, ISI publications Ltd., to be published next month in paperback by HarperBusiness). Sculley says the future success of the exchange phenomenon depends on an evolution beyond providing an efficient means of buying or selling products or services. "The successful independent exchanges will have a whole series of other products and services." But for most manufacturing companies, building a corporate strategy around exchange collaboration is not a priority. In a survey by AMR Research Inc., Boston, participants were asked to list 10 exchange capabilities in descending order of importance. "Collaboration was last on that list," says AMR's John Fontanella, service director, B2B marketplaces. But that may change. "I think when we take this survey again a year from now, product design will rise in the standings as people become more educated and more comfortable with the concept of an exchange. The other ingredient will be the emergence of supporting applications." At the top of the wish list is product search capability, followed by order status/tracking, product catalogs, vendor search capability, and supplier/buyer back-end integration. Fontanella believes exchanges will be an especially cost-effective route to the benefits of collaboration. "Supporting technology can be expensive and the exchange [model] is a way to spread the cost. If you are a large company buying components from many different vendors, you can have one application to support many different component buyers and the component-engineering organization. And your suppliers can use the same application rather than having to go out and purchase it." The challenge is today's relentless focus on the buyer-club kind of approach, says Joe Malloni, director of corporate strategic marketing, Structural Dynamics Research Corp. (SDRC), Milford, Ohio. The current fascination with procurement efficiencies is natural -- it represents the "low-hanging fruit" of opportunity, says Stephen M. Ward Jr., general manager, global industry sector, IBM Corp., White Plains, N.Y. He says IBM, which buys $40 billion worth of goods annually, avoids $1 billion in expense by using the Internet. "But I think that the ultimate goal for exchanges is not to try to squeeze another nickel out of every supplier," Ward observes. "It's to find ways to use the phenomenon to increase the closeness of the supplier." One example he emphasizes is design collaboration. Another is the simplification exchanges can put in place for suppliers. "Today suppliers have to contend with EDI transactions complicated by differing formats, numbering schemes, often requiring a lot of manual effort." On design collaboration, SDRC's Malloni is hopeful. "The consensus on exchanges is starting to shift from seeking tactical benefits [procurement efficiencies alone] to setting revenue-producing strategies," he adds. The trouble with focusing on pricing advantages is that it limits the benefits of exchanges to indirect goods such as office and factory supplies and other commodities, explains Heppelmann. In industries such as automotive, indirect goods account for a mere 14% of procurement expenditures, while direct commodity goods add only 20% more. The remaining 66% of total procurement dollars falls into yet another category beyond the reach of dynamic pricing: direct-engineered goods that are custom-designed through a collaborative-design-chain process involving both the buyer and the supplier (and potentially a network of others). Heppelmann wryly points out that it is difficult to hold a reverse auction to procure a part that has not yet been designed. Enhancing The Design Process The need for collaboration in what Waltham, Mass.-based PTC calls the design chain also is being driven by the ubiquitous trend toward outsourcing everything but a manufacturer's core competency. Volkswagen AG is an example cited by PTC's Bill Berutti, senior vice president, sales. "We learned that 80% of one VW model was designed in cooperation with suppliers. Our conclusion is that the whole idea of using exchanges to interact with suppliers has more to do with the design process, rather than just refreshing inventory. Design, the most important function of a manufacturing company, now becomes a B2B fundamental." The development process is no longer a group of engineers inside a company designing a product completely by themselves, Berutti points out. It is now a chain of people in a multitiered supply chain that have the development responsibility. "In order to be competitive," he says, "such companies need to be able to comprehensively address the potential of that design process. The first reason is that the design process determines how quickly they bring products to market. The second is that the design chain determines whether they bring the right product to market. Last, but not least, is the fact that a tremendous amount of the cost of a finished good -- some say as much as 80% -- is committed in the design process." Another factor contributing to the design-chain imperative is the globalization of manufacturing, where companies around the world may contribute to a design concept on virtually a 24/7 basis. With so much at stake, IW asked Heppelmann's advice on how beginners should get involved with exchanges. "If you're looking for a breakthrough strategy, a significant advantage vis vis your competition, look at the possibilities for collaboration via the design chain." (He defines the design chain as the early part of the supply chain where the focus is on intellectual property rather than physical property, which happens later.) "You can quickly get and incorporate the latest, greatest ideas of suppliers to maximize the most profitable part of the product's life cycle when the maker has a monopoly on unique features that result in a compelling product," he explains. "Would you rather chase expense reductions or revenue generation?" PTC's ability to deliver its just-introduced design-chain solution -- Windchill Netmarkets -- can be traced to the company's acquisition of rival Computervision Corp. in 1997. At that time Heppelmann had started Windchill, with majority funding by Computervision. Today the Windchill initiative is a wholly owned business unit of PTC. At its genesis the product was positioned as a solution for Internet/intranet collaboration within enterprises, says Heppelmann. Today Windchill Netmarkets is focused on providing a collaborative solution for consortia, independent, and private exchange models. "Some companies will buy it for internal use, but the intent is to offer a collaborative capability that breaks down the enterprise, geographical, and system boundaries that exist among design-chain partners," he adds. An early private-exchange adopter is SKF AB, Gteborg, Sweden, a global manufacturer of bearings and other products with more than 80 locations in 22 countries. The company is using Netmarkets to get closer to customers by participating in their design activity via the Internet. Heppelmann says Netmarkets makes it possible for SKF engineers to join the customer's design team. "Netmarkets is also making it possible for SKF customers to go online and collaborate on custom configurations." Adds Richard Olivecrona, group IT strategist at SKF: "Getting closer to our strategic customers and partners is critical to our transformation into a responsive, value-added solution provider. The creation of this private exchange is central to achieving this strategy." Among independent exchanges, Conferos (originally BuyPlastics.com), Cambridge, Mass., is using Netmarkets to provide design-chain collaboration for the plastics industry. Heppelmann explains that bringing a plastic part to market generally requires collaboration among the company that designs the part, another that designs the mold and production process, a third that provides the resin, and the customer. With Netmarkets the result is an e-community where the walls that separated partners no longer exist. "In yesterday's marketplace, OEMs were forced to select plastics processors and service providers from incongruent networks," says Chuck Hoar, president of Conferos. Clearly the challenge for manufacturers is to understand how the collaborative potential of exchanges could add strategic revenue-producing value to the procurement benefits. The trick is to achieve that understanding in advance of competitors. For solution and infrastructure providers, the race is on to provide new value and seamless integration for users. For example, PTC's Heppelmann says peer-to-peer (P2P) technology is beginning to impact exchanges. In the second quarter, Netmarkets will be both Web- and P2P-based (Web-based to collect, aggregate, and configure a repository of intellectual property, and P2P-based in the sense of co-authoring, reviewing, and actually generating that intellectual property in real time). PTC will implement the P2P platform from Groove Networks, Beverly, Mass., a start-up by Ray Ozzie, a founder of Lotus Notes. Also in the P2P market space is start-up Oculus Technologies Corp., Boston. Born from the brain trust of the Massachusetts Institute of Technology's CADlab, Oculus is designed to do more for exchanges than simply facilitate collaboration, says Christopher Williams, president. The software permits the propagation of data changes rather than just notification of data changes. "For example, link with a supplier and when a change is made, the supplier sees that in real time as opposed to everyone receiving an e-mail at the same time." Williams stresses security. "To minimize the risk to intellectual property Oculus allows users to share only individual data points." He also emphasizes ease of use. "The software will be familiar to anyone who has used a Web browser. Current solutions require either more steps or a centralized architecture. Oculus offers the benefits of a decentralized system." As manufacturing companies struggle to understand the evolving impact of trading exchanges, they ultimately must come to terms with a new business model that cannot be avoided. More than a technological phenomenon, exchanges should be viewed as the next step in the evolution of business. The result: a new way of sustaining competitiveness, profitability, and growth by collaborating to provide value to customers.