Exchange For The Better?

Dec. 21, 2004
Trading exchanges promise to streamline business and reduce waste across an entire value chain. But can the promise be kept?

In May, Hewlett-Packard Co., Compaq Computer Corp., Gateway Inc., and nine other high-tech OEMs, suppliers, and distributors launched an independent company to provide services for themselves and other industry players. This new company is called a trading exchange, a B2B electronic marketplace that allows multiple buyers and sellers to carry out sales and procurement activities using common, industry-wide computer systems accessed over the Internet. Initially the exchange will focus on reducing transaction costs between participants. Ultimately it will support collaborative product development and serve as a supply-chain central nervous system that links its members. The goal: To provide an avenue of communication and visibility up and down the entire value chain. Known as eHITEX, the trading exchange reflects another way the Internet is revolutionizing how businesses interact. "Moving to e-business strategies, many organizations will have to reengineer the way they manage their buyer and seller relationships," says Leif Eriksen, research director, process industries/process automation, AMR Research Inc., Boston. "In certain industries, trading exchanges will play a large part in that process." In March AMR counted 600 exchanges operating in the U.S. in a wide range of industries from metals to medical devices, chemicals, electronic components, food, and farm implements. Other exchanges slice across vertical manufacturing industries for telecommunications services, indirect materials (maintenance, repair, and operation), and capital equipment. In fact, the phenomenon is worldwide, with exchanges popping up in Europe, Asia, Latin America, and even South Africa. Sticky issues Despite their proliferation, trading exchanges face a number of challenges. Many have yet to record their first transaction; some to date have derived their revenues solely from banner advertising. Trading exchanges and industry marketplaces are under high-profile antitrust scrutiny by the FTC. Advantages of ownership -- by industry players vs independent entities -- and accessibility to proprietary information are ongoing issues. In industries where third-party, independent exchanges are trying to gain a foothold, leading companies are now establishing consortiums to form their own exchanges. Manufacturers wonder where to cast their lot. Suppliers of commodity products, or of products they fear could become commodities, are shaking in their boots at the idea that buying decisions could be made in online auctions. Out the window go profit margins, long-term relationships, and brand identity. The cost of handling transactions and of other services is likewise in a state of flux. Independent exchanges modeled on a transaction-fee basis are charging up to 7% of the value of the transaction depending on volume and the nature of the product. Those based on a subscription or license model might charge up to $5 million for a larger player to manage a whole community of suppliers, depending on the level of service, plus nominal transaction fees. Certainly one of the drivers of industry-consortium efforts to form exchanges is to minimize these costs. "The expectation for the fees of a consortium marketplace is that they will be well below 1%, in order to make the marketplace a valuable option," says Andy DuPont, director of electronic market channels, Dow Chemical Co., Midland, Mich. If the exchange is inefficient, however, costs will have to be passed along to users. At their worst, then, trading exchanges could be dens of shadowy deals and collusion, strewn with vendors who paid fees or commissions only to be stripped of profit margins. At their best they are two-way streets of information characterized by cost-efficient buyer/seller transactions and streamlined value chains where all participants, including end-use consumers, buy higher quality goods for less. When the dust settles, the latter scenario is more likely. Major corporations already are procuring goods via trading exchanges. Ford Motor Co., Dearborn, Mich., for instance, is preparing to route its worldwide procurement of steel for tier-one stampers via e-Steel, a trading exchange serving the steel industry. Currently Ford purchases steel worldwide on behalf of the stampers, totaling up to two-thirds of Ford's total steel procurement. To streamline this often complex and cumbersome process, e-Steel is developing an application on its site where the stampers will transact the business over the Web themselves. It's expected the exchange will account for the procurement of four to five million tons of steel over the next two and a half years. "There's an opportunity to make that process far more efficient by Web-enabling it, and that is just what e-Steel is in the process of doing for us," says Ford's Andrew Hinkly, director, raw material purchasing. Ford expects a big reduction in administrative costs for all stakeholders, better matching of suppliers with product specifications via improved data management, and less inventory cost by reducing complexity and increasing velocity through the supply chain. Ultimately, Ford and its stampers will access the e-Steel exchange through Covisint, the giant automotive industry trading exchange scheduled to debut later this year. E-Buying Also getting into the exchange act is PricewaterhouseCoopers, which has created a procurement consortium of current and past clients to consolidate their buying power. PwC negotiates volume-discounted contract prices from a handful of preferred providers for things like office supplies, temporary staffing, and travel-related services. Members of the consortium access the PwC e.conomy site to extract net savings, after transaction fees, of anywhere from 10% to 30% according to George Bailey, who holds the title of chief innovation zealot in PwC's San Francisco office. In operation for eight months, the program has attracted 350 members. Procurement by real-time reverse auction, run on sites such as FreeMarkets and, or by companies themselves, has generated much of the early trading exchange hoopla. Dana Corp., Toledo, Ohio, uses these sites to conduct auctions for commodities such as fasteners, castings, aluminum components, stampings, and electrical parts, realizing savings of 10% to 25% according to Doug Grimm, director, global strategic sourcing. Some automotive-industry suppliers are nervous about the prospect of Ford, General Motors Corp., Daimler/Chrysler AG, and others exercising their joint muscle to beat down prices of parts and components by auction. For example, five tire manufacturers participated in an auction earlier this year in which an initial bid was set by Ford and the tire suppliers then reverse bid downward to capture the business. "Twelve hours later they were still bidding," says Brian Buersmeyer, Ford's e-business strategic planning manager. "The suppliers kept lowering the cost. The market tension that created was dramatically different than the traditional buying process." But Buersmeyer and most other e-commerce cognoscenti recognize that if squeezing price is the most significant outcome of trading exchanges, then they have fallen light-years short of their potential. "These marketplaces have to go beyond just driving prices down to market levels, to something that is win-win-win for all participants, something that goes after waste and drives systemic costs out of the supply chain," says Ford's Hinkly. "That is where the long-term sustainability is, where the true value is going to be in the long term." Providing perhaps the best example of what an e-marketplace could be is Covisint, the exchange created for the automotive industry value chain, a melding of the original individual exchange initiatives of the Big Three automakers. Covisint is open to participation by all automotive OEMs, suppliers, partners, and dealers. "The big benefit for us (in linking into Covisint) will be getting information we don't get today, the result of real-time visibility up and down the supply chain," says Jim Woodward, Dana's vice president and director of e-business. "It could really reduce warranty costs, reduce inventory costs, and allow us to schedule our shops better so we get productivity improvements. That's where the big dollar savings will come from and where we can start driving to the five-day, highly customized vehicle. The idea is not only to better satisfy the customer with a rapid, made-to-order vehicle, but to reduce inventory at the dealer level, then incrementally back through the supply chain. What specific information OEMs decide to push through their own pipelines will determine competitive advantage."

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