Inside the Empire

[From iSource Business, December 2000] The online exchange phenomenon, and what to do about it, becomes perhaps one of the most intriguing and perplexing business issues facing the B2B buyer today. In theory, an online exchange can significantly reduce the cost of indirect and direct purchases as well as identify new suppliers and sourcing opportunities. Seen in this light, jumping into the online arena would appear to be a no-brainer. In reality, committing to one exchange over another does involve some costs, if not in money then in time and in lost opportunities elsewhere. Plus, what if a company has based its long-term procurement strategies on the longevity of one particular exchange, and then that exchange fails?

Traditional procurement in the foodservice and equipment supply (FES) industry a $16 billion annual business has never been a pretty sight. Outside of the usual transport and logistics providers and financial institutions that are an integral part of any supply chain in any industry, the FES supply line consists of restaurants, hotels, hospitals, manufacturers of everything from paper plates to institutional kitchenware and appliances, and these manufacturers' selling agents, dealers and distributors, service agents and product consultants. Such fragmentation might not be so bad, expect for the fact that the primary mode of communication has been the telephone, or for the more advanced, the fax machine.

"It was downright archaic," bluntly states Eric Boelter, who has worked in the industry for several years. It was only logical therefore that members of this disparate and disconnected group would turn to the new corporate god of efficiency the Internet for relief. Hence the birth of fsXchange: a B2B e-marketplace formed by more than 20 of America's leading food service companies.

Founded and run by CEO Boelter, along with Allan Keck, chairman of the board of directors and chief technical officer Mario Perez, fsXchange expects to snag a $4 billion piece of this market within two years, with projections rising to a whopping $12 billion by 2005. And they just might do it, too. Despite the fact that precious few B2B exchanges are making much money and many exchanges that are announced often don't get off the ground, and those that do find organizational problems more complicated than originally expected (witness the squabbling among members and suppliers in the auto exchange Covisint the granddaddy of all industry consortiums), fsXchange has one important fact going for it.

Unlike many exchange models, it's not designed to cut suppliers' margins to the quick in order to make a buck. Instead, the primary focus will be to push demand, supply and procurement data through the industry supply chain. Making a buck is part of the plan, of course, but more on how they plan to do that later.

For procurement professionals, the online exchange phenomenon, and what to do about it, is perhaps one of the most intriguing and perplexing business issues facing them today. In theory, an online exchange can significantly reduce the cost of indirect and direct purchases as well as identify new suppliers and sourcing opportunities. In this light jumping into the online arena would appear to be a no-brainer. In reality, committing to one exchange over another does involve some costs, if not in money then in time and in lost opportunities elsewhere. And if a company has based its long-term procurement strategies on the longevity of one particular exchange, then that exchange's failure could be particularly detrimental. And unfortunately, failure of an online exchange is a real possibility. Some industry analysts speculate that, at their peak, as many as 10,000 exchanges will exist, either in name or in actuality. Some may continue, but ossify into mere information channels or glorified bulletin boards. Others will merge into larger exchanges.

With these considerations in mind, iSource Business magazine has decided to examine the business model of one exchange in one industry. And since what is considered au courant in B2B changes by the month, sometimes it's best to go back to the basics. How does a particular exchange work? How will it make its money? Who participates and why? What value does it add? There are no guarantees in this industry. fsXchange could go belly-up by the time you read this (although we're betting they won't). But the lessons learned by B2B buyers will live on.

Come One, Come All

Basically, fsXchange will be a marketplace in which manufacturers, distributors, and buyers can come together to conduct transactions and access industry information. Its online catalog will offer all of the food service equipment and supply product groups available in the market. Perhaps most important to an industry that still conducts its transactions largely via paper, fsXchange's electronic interchange system is expected to significantly reduce operational costs for participants. Indeed Boelter forecasts a 50 percent reduction in procurement costs for participants.

In its full-blown incarnation, fsXchange plans to offer some very sophisticated functionality to its users: seamless procurement of goods, equipment and services; auction capabilities, standardized catalogs, payment and credit services and collaborative forums; product search and comparisons, reporting and analysis fulfillment and delivery; demand planning, order tracking, rebate monitoring and distributor visibility; returns management, inventory management, replenishment management and project management.

All very high-end, very robust functions. But to get a better understanding of the collaborative nature of fsXchange, one should look at the problems fsXchange wants to solve:

A hospital in Chicago needs to purchase 12 dozen sets of a particular style of flatware. "The manufacturer is in New Jersey, but contacting it and requesting an order of 12 dozen sets is not the most efficient way to make this purchase when there is a dealer in Chicago with 36 dozen ready to go," Boelter says.

Or: A restaurant knows it needs a dishwasher to handle its X amount of dirty plates every evening. "fsXchange can help it determine what piece of equipment can best meet its needs," Boelter says. "Traditionally buyers have been dependent on dealers and sales representatives to help them make these types of purchasing decisions."

Or: A hospitality chain is building a new hotel in a new city. That particular hotel "would be purchasing products from perhaps 40 different manufacturers," Boelter explains. "Everything from a gas range, to a stove, to commercial refrigeration. All of this is coming from 40 different locations, and all of it has to be delivered on the same day to coordinate with the electricians and plumbers." fsXchange's project management capabilities "would allow users to manage and monitor the logistical status of one project no matter how many suppliers are involved. It is a tremendous step forward in time savings."

Paperclip Revolution

Much is being written about which business model for B2B exchanges will ultimately triumph. And while it may be an exaggeration that this model changes every month, it's only a slight one. At the beginning of the year, the neutral or independent exchange exchanges run by third parties not connected to the buyers or sellers but who expect to earn revenue from creating a market was considered to be the winning model. Then came Covisint, an unexpected development that led industry watchers to speculate that successful marketplaces would be buyer-dominated enterprises, with suppliers reluctantly participating.

"When e-marketplaces became hot a year ago, the greatest expectation was the price savings, the reduction of procurement costs through group purchasing, the ability to negotiate discounts," says Len Prokopets, senior manager in Deloitte Consulting's B2B practice. "It all started with indirect materials. It was the revolution that started with a paper clip, basically."

Clearly these models change. But just for the record, the current thinking is that those exchanges that create value for all participants are the ones that will succeed. "Exchanges that focus on the value chain will find it easier to attract and retain buyers and sellers and gain critical mass and liquidity," Prokopets says. (See "Shoot-Out at the B2B Corral: Value-Added Net Markets.")

This is especially true in industries that are characterized by a great deal of fragmentation such as the food industry.

"A lot of exchange models that are being set up now especially those of larger companies really seem to have no other purpose than to squeeze the suppliers," says Chris Hutchins, co-founder and CEO of Edgewood Creek, a San Francisco based B2B exchange of specialty foods. This particular model would never work in the food industry, he says. "This industry is too fragmented for that type of model to ever develop. Even the distribution channels are fragmented."

Certainly fsXchange has honed in on this point. "We are building integration points between trading partners," Boelter says. "That is our primary value."

Revenues and Possible Barriers against Reaping Them

This is not to make fsXchange sound as though it were a nonprofit organization bent on helping this particular industry niche. On the contrary, members and participants are projecting some healthy revenue earnings. For the participants, Boelter says "conservatively we believe we can cut procurement costs by 50 percent." As for the exchange itself, there are a number of possible revenue streams, he says. There will be transaction fees for purchase orders, for example, which will range from between two to eight dollars, with the average being five dollars. There will also be licensing fees for certain applications, a subscription fee for the project management application as well as the advanced reporting function. Overall there will be nine or 10 different areas where fsXchange expects to earn revenues. "We will not be overly dependent on one stream," Boelter says.

But before Boelter et al can start counting their money, there will be a few hurdles to jump. To be sure, none of them have anything to do with fsXchange itself or even the food service and equipment supply industry. Rather they are common problems that every fledgling exchange must deal with in its own way.

First, there is the Federal Trade Commission, which is examining the anti-trust implications of these online industry consortiums. Boelter is concerned, naturally. As he says: "Anytime you bring competitors together, which is essentially what we have done, you have to think about that." But like many in the industry Boelter isn't excessively worried. "This is not something you can ignore, but we have worked closely with our legal counsel on this issue. There are ways to structure an exchange so anti trust is not an issue." Certainly a number of legal experts seem to agree with Boelter's stance. "My guess is that several of the [FTC and Justice Department] investigations will terminate with consent decrees, which will be the beginning of a set of guidelines for B2B practitioners," says Joel Mitnick, a partner with Brown & Wood LLP, a New York-based law firm whose specialities include e-commerce and antitrust issues, who has been active in B2B legal issues since the beginning.

Indeed, the biggest problems fsXchange will likely face are internal ones. For example, many analysts have cited the cumbersome approval processes industry consortiums have to go through among its members to implement a new procedure or strategy. While not addressing this topic directly, Boelter does note that there will be a balance on the Board of Directors. "Three of the directors will be from the manufacturing sector and three from the distribution sector as well as me."

Another potential stumbling block is technology, a fact that Boelter and Chief Technology Officer Mario Perez readily acknowledge. Many of the members of the food service and equipment supply industry do not even use ERP systems, Perez says. "There are even some companies that don't have a system to send information electronically. That is how ugly it can get."

Perez says he plans to take it one step at a time. "We will pick up one very thin line of the supply chain and automate it, starting with the purchase order. Then we will address another line, such as catalog integration. Then shipping and receiving, then payment." Line by line, he says "we will integrate everyone onto one platform." What makes it so much easier is that one platform is where everyone wants to be.

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