San Francisco

If there is to be a definitive moment when the information technology tail could be said to have stopped wagging the corporate dog, history could well judge it to be a single phone call.

It was the day at the beginning of this year that Ford president Jac Nasser called his newly appointed counterpart at General Motors, Richard Wagoner to congratulate him on his appointment.

In the course of the conversation, the issue of the competing electronic marketplaces being constructed by the two companies since October was raised.

By the end of the call, the two had agreed it was in the interests of both businesses to combine their efforts. By the time they told the world of their agreement on February 25, DaimlerChrysler had agreed it, too, would join.

Internet-based markets for industrial goods and services have come a long way in a short time.

The pioneers, businesses such as Chemdex and E-Steel, had very simple visions. Just as eBay had employed the potential of the Internet for borderless communication to transform second-hand goods sales, they saw it as a platform to bring efficiency to the trade between businesses of specialised goods, such as industrial chemicals, or of surplus raw materials, such as metal.

The basic notion of electronic markets, or exchanges as they are also called, draws on the principles of Economics 101. They allow trading parties to approach a situation of near perfect information in an international, open market, something never before possible outside of closed networks. (see related article The Frictionless Economy)

They are sites where buyers and sellers can come together to trade goods and services, where buyers perhaps bargain with sellers over the price of generic products, or offer contracts for the supply of goods, specifying the performance criteria of the products at the same time.

The nearest analogy to this original vision is the marketplaces that once existed in the centre of every town. Producers or traders could enter the market and display their products for buyers to sample and make an offer on. Buyers could also go from merchant to merchant comparing the price each would charge for a special order, and assessing which of them was capable of fulfilling it.

Transactions could be completed on the spot.

The next stage of the evolution of e-markets was proliferation and specialisation. There are now about 600 and the Gartner Group has predicted there will be 4000 by 2004. The chief executive of Chemdex, now Ventro, has reportedly said he was approached by one promoter who wanted built an e-market for the global ferris wheel industry!

It Takes More Than Just a Trading Floor to Build a Bazaar
But there have been other important developments in the past six months. Firstly, e-markets have discovered that it takes more than just a trading floor to build a bazaar. It also requires value-added services that, for example, allow these marketplaces to make the trade in goods and services truly global.

General Motors, for example, had built into its exchange, a joint venture with Commerce One, the ability for designers and engineers to work on CAD/CAM models of automotive parts. Thus allowing work to go on through various international times zones and between workers in GM and its suppliers.

Secondly, the big industrial companies have realised that they don't need to dance to the tune of information technology companies. They can build these markets themselves - and own them.

And thirdly, there is the untold story of the failure that powers the latest trend.

The most powerful argument for the industrial giants to seize control of the developing on-line procurement industry can be summarised in three letters - ERP.

In the late 1990s, literally billions of dollars was invested in enterprise resource planning (ERP) software packages.

These giant software packages promised to transform the internal nervous systems of large corporations. They offered an information system so seamlessly unified that orders were automatically recorded in marketing, production, procurement and sales forecasts, for example. The promised efficiencies were so dramatic and seductive that the big three vendors of the software soared to become the hottest software stocks in the world.

There were only two problems. Firstly, the products didn't work. Secondly, the savings didn't come.

The first problem made fortunes for consulting firms who were called in to install the ERP programs and help companies adjust and adapt their business practices to make best use of them. By some estimates, the price of consulting services to make the software work was as much as 10 times that of the products themselves.

The failure of the savings to follow was an even greater disaster. Last year, Whirlpool and Hersey Foods blew the whistle on the ERP dream merchants within a week of each other when they blamed disappointing financial results on their experiences installing and trying to use ERP software.

These were not isolated examples. A survey released by the Boston Consulting Group in March found that only 52 per cent of companies that had installed enterprise software packages in the previous three years felt they had achieved their objectives and a mere 37 per cent could point to a tangible financial impact.

As a result, the entire ERP sector has fallen on difficult times. The producers of those packages, three or four years ago among the hottest stocks in the world, are being restructured or even taken over. The consulting industry today talks of expertise in "e-business" - helping companies move their information systems into the Internet rather than proprietary systems - not ERP integration.

Today's hottest new idea, Internet-based procurement markets, offer a dream even more powerful than the ERP vendors. E-markets have the potential to slice cost out of the purchase of non-proprietary items, things such as standard fittings or office supplies, simply by opening the market for them to all qualified bidders. In effect, it allows buyers to participate in a reverse auction, where anyone participating in the market can try to bid at the lowest price.

But they also promise to wire together supply chains in ways that are much more powerful than that. They promise to provide the platform to integrate supply chains in ways that corporate giants have been trying to achieve. Production lines are integrated to make genuine build to order processes possible (see related articles Ford Drives Motor Industry Innovation).

Beyond that, there is the vision of collaborative design between original equipment manufacturers and their suppliers, working 24 hours a day by leveraging the Internet's ability to bring the same document to desktop in any country, any time zone.

But with the lesson of the ERP revolution fresh in their minds, corporate leaders know that the bigger the vision, the bigger the price tag. And the more razor-sharp the line between success and failure, the higher the cost of stepping onto the wrong side of it.

The Path to Realisation
Little wonder then, that from late last year the off-line corporate world began to seize control of the evolution of the emerging new e-market business platforms.
First it was Ford and General Motors individually. Ford partnered with the established database software giant Oracle and GM with e-market builder upstart CommerceOne, each with the intention of creating a purpose-built marketplace for their procurement and design and development needs.

The deals sent an important signal that the investment markets took a little while to understand. A small group of electronic marketplace pioneers - Ariba, CommerceOne, VerticalNet and i2 among the leaders - had come from nowhere to be valued at billions of dollars in a couple of years. But their fundamental value was based on the once novel notion that the information about a product or service could be decoupled from the good or service itself and be traded separately. Their strategy was to build marketplaces and attract off-line companies to transact through the markets. For each transaction that passed through their exchange, they would take a fee.

But Motown realised that just because the information could be separated, it didn't have to enrich someone else.

True, to realise their full potential value, the e-markets needed to be built as discrete information companies that could be publicly listed in their own right. But the ownership of them did not have to be in the hands of information industries companies, or their specialist venture capital and investment banking backers.

In effect, Ford and GM declared that if they owned the supplier relationships, they wanted to capture a share of the value of the information exchange being built on those relationships. They needed to engage with information technology companies to build the information exchanges, but they could do it without handing away all of the value.

Their example set off a tidal wave of similar deals. Retailing giants Sears & Roebuck of the US and French counterpart Carrefour, announced GlobalNetXchange in February, followed within a month by a rival site, WorldWide Retail Exchange, by Kmart, Target Tesco and Safeway.

Aerospace leaders United Technologies and Honeywell engaged i2 to build MyAircraft.com to trade parts and provide technical advice and inventory management.

Who is Calling the Shots?
Some CEOs have made it clear that they intend to put the information technology suppliers firmly in their places as service providers. General Electric CEO Jack Welch was recently reported as declaring defiantly that GE saw information as being the core of its business and that no technology company would be separating it from the company. "A lot of smart young kids have capitalised on corporate America's misunderstanding of the Internet. But why would I ask a dotcom to come between me and my customers?"

These developments set apart the e-market revolution from the ERP wave. Technology companies cannot rely on the rest of the corporate world simply to be their willing customers. In some cases, the off-line economy is the competition.

As these markets have developed it has become clear that there is one thing above all that will determine who wins and who loses - the volume of transactions that flow through them.

That means the choice made by off-line companies as to which markets they join, holds the key to the value of these new information exchanges. Eric Upin, senior Internet research analyst with leading San Francisco high tech investment bank Robertson Stephens, says there is presently a land grab for corporate customers and transaction volume. The markets built by large off-line customers have a clear early advantage because their owners can bring their own transactions into the new market quickly, creating immediate volume.

But many among the IT community express confidence that they are ultimately in the strongest position. Veteran Silicon Valley venture capitalist Bill Mumford calls e-markets founded by off-line companies "buyer side exchanges" and argues suppliers will be suspicious of the motives of big customers in building them. VerticalNet CEO Mark Walsh dismisses them as "EDI (electronic data interchange) in drag", designed merely to screw down the prices of suppliers.

Ford, General Motors and DaimlerChrysler have sought to reassure suppliers that this is not the case by offering to share savings from efficiencies.

Nevertheless, it is clear that several models of e-markets are emerging, and that it will be many years until it becomes clear what model is the winner.

Upin argues that no one model will win. Issues such as the number of participants in an industry will determine how that industry eventually moves to on-line trading.

"These exchanges may take years to fully build. There's so many pieces. There's credit, insurance, there's import/export," says Upin.

"In some industries, you may actually have some of the off-line or legacy companies become the exchange. I think that's going to be rare. I think it's more the exception than the rule. I think it will work where you have very concentrated industries."

"If you're big enough, you can be the one buyer. Most industries don't have someone that is so big they can build their own exchange".

"Most exchanges, I think, will be new companies, third party, that build anonymous, neutral exchanges on the buyer side and on the seller side to have a real two-way exchange," Upin says.

Of course, one of the reasons venture capitalists and high tech investment banks are more enthusiastic about the pure-play market builders is that those built by companies with existing revenue have less need of their services. Venture capital got the new market builders started and investment banks underwrote their public listing.

But the fact that it is the volume of transactions rival exchanges attract that will determine who wins and who loses puts the off-line corporate community generally in a much stronger position to call the shots than it was at the height of the ERP era.

"In order to succeed today, you can't just be a pure web company and say, forget about the old world, we're just going to be a web company and do all this web stuff," Upin says.

It's just the opposite.

No one knows exactly what critical mass is, but what everyone does know is that you need to have a lot more stuff flowing through your exchange than any of your competitors. The way you do that is you sign up large industrial players, not only to have an equity position, but to agree to put so much of their supply on the exchange and to buy so much from the exchange.

Even those exchanges built by the start-up information industry specialists will have to enlist experienced managers from old economy industries to their management teams to help them both understand the needs of the business and sign up partners.

"You need to have a lot of off-line industry executives who have contacts in the industries."

Despite the fact that he thinks the markets will take years to build, Upin says the pace at which they will evolve will be breathtaking. "It's who will win the race. You have to sprint the marathon."

Michael Levin, the president of E-Steel, saw his business move closer to achieving critical mass, and market credibility, when US Steel joined its e-market late last year.

But attracting the commitment of that company demanded that E-Steel become much more than Levin originally imagined. "When I started this, it was buyer meets seller and goes home," he says.

"That's no longer interesting and it's no longer a sustainable competitive advantage."

The customers demand that markets provide a range of additional services, including international credit services, community features, supply chain management and a steel futures market.

Levin says his business has been "global from the get go".

"That's what the Internet is all about. The only question is how fast you market and how you target your markets."

The speed with which the industrial world is embracing the new models of organising themselves is "breathtakingly fast", disproving those who doubted E-Steel could win the support of an Old World industry, Levin says.

"Two or three years ago when I started talking to people about this, the general reaction was either that I'd been out in the sun too long or, maybe one day."

"Well it happened. It's not going to happen, it happened," he says.

Yes, the revolution is here. But this time, the arms merchants are not enjoying the easy money they have in previous times of upheaval. This time, the buyers want to make sure the plane will fly, and are wary of bankrolling another Spruce Goose.