Go With the Current: How Net Markets Make Money

New economy or not, some of the old business rules still apply, even to Internet-based marketplaces. Rule Number 1, is that companies must generate revenues and, eventually, profits. But with B2B Net markets still in their infancy, a variety of revenue models have been implemented in the drive to profitability.

Revenue models  how Internet marketplaces earn their money  have evolved over the few years that companies have been doing business on the Web. As the B2B e-commerce market has developed, advertising has given way to markups and transaction fees, which have recently been supplemented by a variety of subscription and licensing fees. In the near future, analysts believe the marketplaces will generate income from ancillary services. Using the plastics market as the major example, the following is a primer on the various revenue models at work on the Web, where they have been, and where they are going.

The Age-Old Revenue Generator: Advertising
Advertising provided the initial revenue stream for vertical industry portals, or vortals, which specialized in providing information to companies operating in a particular vertical market. Commerx PlasticsNet, for example, started in 1995 providing information, forums and chat rooms for purchasers and other executives in the plastics industry. The site sold banner advertising space targeted at its Internet viewership in the same way that a magazine or trade publication runs ads targeting its readers.

While B2B marketplaces generally have moved on to other sources of revenue, some sites continue to supplement their income through advertising or marketing-type services. The online plastics market, fobplastics, which launched June 19, generates some ancillary revenue through advertising. In addition, although general access to the site is free for sellers, the market also offers suppliers the option of fee-based access to its marketplace for plastic resins, sheets and films. Paying for access gives increased visibility in the channel and information regarding the customers in the channel, according to Patrick J. Blake, CEO of fobplastics' parent company, fob.com.

However, overall, advertising has not proved effective at generating significant revenues for marketplaces, primarily because it is not cost-effective for the advertisers. You have to charge way too much, and your CPM [cost-per-thousand] rate has to be way higher than what people are willing to pay, says e-commerce analyst Vernon Keenan, CEO of San Francisco consulting firm Keenan Vision Inc.

It's Old-Fashioned, But it Works: Markups
While advertising has lost its attraction, some Net marketplaces are using the old-fashioned markup model. Markets that charge a markup are acting either as virtual distributors, buying goods from suppliers and then selling them at a profit; or as aggregators, bundling demand from smaller buyers in order to gain volume discounts from suppliers and then retaining part of the discount for themselves.

An example of the former, getPlastic.com, which began conducting transactions online June 13, sells plastic resins and also allows buyers to configure custom resin solutions. The site charges a markup on the plastic materials purchased through its site. The markup, which the company does not currently disclose, varies by product and volume, but the site's prices are competitive with those of other distributors according to purchasers who have used the site (see sidebar Revenue Models: The Purchaser's Perspective).

Fobplastics, however, acts as an aggregator. The site gets volume commitments from its buying customers, bundles the demand and leverages the volume to buy at a discount from suppliers. The company passes on part of the savings to its customers while retaining a percentage of the discount for itself. Blake says that the percentage varies, but fobplastics does not disclose the share of the volume discount it keeps.

Hanging on: Transaction Fees
Transaction fees came to predominate the marketplaces' revenue models during the explosive growth of B2B e-commerce that began in 1999. Marketplaces rushed to capture market share by pursuing visibility and liquidity, which meant drawing as many buyers and sellers to the marketplace and generating as many transactions and as much volume as possible. Transaction fees could be easily and rapidly implemented, allowing a Net marketplace to open for business quickly in a period when the first sites into a particular market were viewed as having enormous advantages over latecomers.

Whether the buyer or supplier (or both) paid the fee generally depended on each marketplace's calculation of who would derive the most value from the Web site. For example, Impresse.com, an Internet service for buyers and their printers to negotiate and manage commercial print projects, believed that a supplier-paid fee was the best way to bring the maximum number of buyers and suppliers to the table. According to company President and CEO Nimish Mehta: We had to find the path of least resistance to liquidity. The easiest way to do this was to charge the printers because they needed the buyers' business. The idea was to sell the buyer on the value of the system and then go to the printers and charge them one percent.

FreeMarkets.com, among the oldest online markets for industrial parts, raw materials, commodities and services on the Web, began with a supplier-paid fee in 1995 but moved to a buyer-paid model in 1997.

SupplierMarket.com, the reverse auction site for manufactured direct materials, that was acquired by Ariba in June, has maintained a supplier-paid model, charging sellers two percent of the value of a transaction.

During this liquidity-building phase, venture capital and high stock valuations kept marketplaces afloat while they strove to build sufficient transaction volume to produce a profit. But rising doubts on Wall Street about the long-term profitability of many Web marketplaces led to the rout on the stock exchanges early in 2000. Although concerns primarily focused on business-to-consumer ventures, investors also began taking a closer look at the B2B markets' prospects for profitability in the near term. Says Mehta: It used to be that in general the financial markets would accept eight to 12 quarters to profitability. Now the financial markets will not accept more than six quarters to profitability.

With the new focus on nearer-term profitability, executives at the Net markets took another look at their revenue models. For its part, impresse.com began shifting in the second quarter of this year to a model under which buyers will pay a transaction fee and commit to purchasing a certain volume of commercial printing through the marketplace. The fee will vary from 1.5 to three percent, depending on the size of a buyer's commitment.

Beyond Transactions: Subscriptions and Licensing FeesWhile many sites continue to charge transaction fees, many marketplaces have also sought to diversify their revenue streams. Numerous sites have begun charging subscriptions or licensing fees for the use of their supply chain or procurement solutions. These types of fees are attractive for the markets because they can provide steady income, which makes investors happy and helps a marketplace move away from dependency on transaction volume. Three examples from the plastics industry show the variety of approaches the marketplaces are taking.

Commerx, which operates Commerx PlasticsNet still lets buyers source products through its public marketplace, including through reverse auctions. But Commerx now offers Web-based, supply chain management applications that link buyers directly to their suppliers through a private trading network. Buying companies pay a set-up fee and an ongoing subscription for the trading network, which can include realt-time logistics and inventory management.

Commerx also offers a connectivity solution as part of the trading network. This lets buyers and suppliers in industrial processing markets communicate with each other electronically regardless of which technical or computer language they each use, be it EDI, XML, e-mail or fax. Commerx converts a message into the format necessary for transmission to the recipient and charges a translation fee. For their part, suppliers have the option of paying Commerx to set up and host a demand fulfillment center through which the suppliers can accept orders online.

Fobplastics charges buyers a licensing fee for the use of what Blake calls the fob toolkit, which includes an auction exchange, a substitution engine to identify material equivalents and buying groups, through which fobplastics.com aggregates buyers' demand to leverage lower prices from suppliers. The licensing fee ranges from $1,000 to $15,000 per month, depending on the size of the customer and the volume that the customer commits to buying through the exchange. Volume commitments range from $1 million to $20 million per year, according to Blake.

20TONS.com, an auction/reverse auction marketplace for secondary plastics that went online in May, currently charges both buyer and supplier a fee equal to 1.5 percent of the value of a transaction consummated on the site. The company is moving toward a service that it calls multiple attribute parametric matching, that is, matching buyers with sellers that can meet specific product requirements and contractual terms. But in the long term 20TONS plans to leverage the knowledge that it is gaining from operating its marketplace to become a subscription-based information service for the secondary plastics market. For example, subscribers to the service would be able to get real-time information on how much a particular secondary plastic resin is worth in the current market.

Looking DownstreamPeering into the future, analysts agree that the transaction fee is unlikely to disappear entirely. I would be surprised if it disappeared, says Keenan. However, I do see pressure on transaction fees to move the average from five percent to one percent.

Keenan believes that success for the Net markets will depend on their ability to make themselves an integral part of the way their customers do business. Exchanges need to embed themselves into the business processes of the exchange members in order to provide the service level that people expect, he says. They have to extend their service to encompass many additional facets of the trading process, for example, settlements and clearing, fulfillment, shipping and logistics.

In fact, Keenan's consulting firm issued a report in April forecasting the rise of a business-to-exchange (B2X) service sector. In the report, Keenan writes: By purchasing financial, shipping, marketing and transaction services from online services, and integrating the services into their sites, Internet exchanges will be able to grow rapidly and service more satisfied members.

CheMatch.com, a marketplace for commodity chemicals, plastics and fuel products, is looking at adding logistics and credit services to its site. The market would earn a referral fee from the providers of those services. The site getPlastic.com currently handles logistics and other aspects of order fulfillment in-house but may outsource those services in the future as other sites become able to handle the work, according to Chris Poirier, the company's president and CEO.

Leah Knight, of Stamford, Conn., consulting firm GartnerGroup, agrees that adding ancillary services will be key to building revenue streams for the Net markets: It's a fairly thin-margin business, but the more value-added services they can build out, the better they can build up those margins.

And the higher the margins, the sooner the Net marketplaces can start generating profits rather than red ink.