e-Commerce
or Bust?
A Primer for Utilities
September 1, 2000
By Soam Goel
The
market says "do or die," but the best move may lie somewhere in
between.
Every day
the press heralds
an Internet offering guaranteed to transform the world as we know it.
Yet as quickly as one new site touts its launch, another fails. Or perhaps
the venture may reposition itself, or become the target of a merger or
acquisition. Whatever the industry, the Internet clearly redefines how
business is conducted. But where to find the opportunities in a given
industry that best unlock value-and how to take advantage-is just now
beginning to be understood. Utilities, of course, are not much different
from other businesses in this respect. They cannot afford to ignore the
opportunities and threats posed by the Internet revolution. They must
enhance their understanding of e-commerce, find solutions that meet their
needs, and act quickly to develop a sound Internet strategy.
E-commerce has emerged in the
utility industry in various ways, many of which may hold significant promise.
Indeed, with its high volume of purchasing activity and large number of
fragmented sellers and buyers, along with deregulation, the industry is
ripe to profit from electronic procurement. Electronic exchanges, or "e-hubs,"
present a myriad of opportunities for utilities to create value through
lower product prices, lower administrative costs, shorter time to fulfill
purchase orders, and lower inventory carrying costs. And although the
benefits of e-hubs may vary in size from utility to utility, these benefits
undeniably are great enough across the board to warrant a thorough evaluation
and a considered strategy.
In the analysis of e-hub business
models, the energy company's strategic options boil down to three general
approaches. One option says to do nothing until possible outcomes are
more certain. A second strategy calls for a big commitment early on, involving
a relatively large up-front investment. A third option-a sort of middle
ground-involves undertaking a staged investment, one step at a time. Given
the uncertainty surrounding the e-hub business models, an evaluation of
the three strategic alternatives quickly reveals the wisdom of staged
investments over a do-nothing or big-investment approach.
This article examines e-commerce
and its profound implications for the energy industry. It discusses the
various business models and evolving trends, shows the energy executive
how to get started, and provides frameworks for evaluating specific opportunities,
including what strategic approach to take, and how to choose the right
e-hub for the specific energy company.
Business Online:
Fad or Revolution?
The genesis of e-commerce can
be traced back to the 1960s and 1970s, when electronic data interchange
(EDI) systems were introduced. EDI systems were designed to transmit large
volumes of electronic information, such as purchase orders and invoices,
between businesses. Although EDI systems allowed businesses to automate
transactions, they were limited because they only allowed for one-to-one
communication between two trading partners. This communication pattern
forced trading partners to pass information along the supply chain in
step-wise fashion, which is inherently slow and prone to error. Furthermore,
EDI systems operate over proprietary dedicated networks that require large
capital investments, thus limiting their use to organizations able to
afford such investments. By comparison, the Internet enjoys significant
advantages over EDI. It is relatively inexpensive to use, and offers businesses
global reach and instantaneous access to information. Trading companies
have been created where all industry participants can interact from a
central location, enabling many-to-many communications. These obvious
benefits allowed the Internet to replace EDI as the e-commerce enabling
technology, and started an explosion of business offerings online for
the exchange of goods and services in digital marketplaces.
Thus, the first wave of Internet
commerce began in the mid-1990s, when a few vendors started to use their
company websites as primary sales channels. In 1995, Amazon.Com pioneered
an e-commerce platform that made it obvious that the technology had arrived.
Amazon offered the average
computer user a digital alternative to the familiar neighborhood bookstore,
and today, shopping for books online has begun to replace the visit to
the local bookstore for purchases. Amazon is still unprofitable, but its
revenues grew to $1.64 billion in 1999; at the peak of summer the company
could boast of a market capitalization of $18.2 billion. Though not to
the same scale, this story has been repeated in industry after industry,
from toys to stamps to prescription drugs. These business-to-consumer
(B2C) vehicles have moved the Internet from a novel application used by
few to a new world embraced by many.
Yet, even with the astounding
growth of the B2C industry, the business-to-business (B2B) market offers
more exciting prospects. The B2B market quickly is gaining size, and already
dwarfs the B2C market. Forrester Research last year predicted that the
B2B e-commerce market in the United States should reach $1.3 trillion
by 2003. This forecast compares to domestic B2C estimates of only $108
billion. It implies a twelvefold increase in four years from the B2B commerce
level of $109 billion in 1999. At this rate, B2B e-commerce will soon
account for over 90 percent of total e-commerce. If the forecasts prove
to be accurate, in 2003 B2B e-commerce will claim approximately 12 percent
of U.S. GDP.
Worldwide, the numbers appear
just as impressive. Some forecast that the global B2B e-commerce market
will reach $2.3 trillion by 2003, while others predict that the global
figures could reach as high as $3.6 trillion in 2003 and $7.3 trillion
in 2004. Currently, the United States accounts for approximately 63 percent
of total worldwide Internet commerce. The Gartner Group expects that percentage
to drop to 53 percent by 2003, with Europe accounting for most of the
non-U.S. growth in the market.
The B2B Segment:
From Site to Hub
In B2B e-commerce, the businesses
that have received much attention recently are the true electronic marketplaces,
or e-hubs. Think of e-hubs as central locations on the Internet where
buyers and sellers aggregate to exchange information and transact. Contrast
that with a more basic model of e-commerce: one-on-one transactions where
a buyer can call up the website of a supplier, access the relevant information,
and place an order. This distinction between models recalls the difference
between a single storefront and an open market in a town square. One-on-one
e-commerce is similar to shopping at one store, while e-hubs simulate
a town square filled with different vendors where a buyer can comparison
shop between stores.
In many ways, in fact, the
one-on-one model of e-commerce denotes nothing more than an automated
version of existing physical processes. By contrast, e-hubs offer the
potential to make industry transactions and entire supply chains more
efficient than what is possible through mere automation. E-hubs can increase
efficiency and add value through means that include aggregating larger
buyer/supplier audiences, enhancing price discovery, increasing price
transparency, eliminating middlemen, expanding the market, and providing
global reach.
Consider an example of a small
manufacturer in China that wants to sell products in the United States.
It faces a series of expensive and logistically difficult options in trying
to bring its product to market, including advertising, direct sales calls,
or selling through a series of distributors. But through B2B e-commerce,
the same manufacturer can reach buyers directly using an affordable desktop
computer. This avenue would lower the manufacturer's transaction costs
substantially, but savings are only part of the value of e-hubs. The manufacturer
now also has access to a global audience. This ability to add value through
creating markets and easing transactions in ways that were almost infeasible
in the physical world is expected to fuel an explosive growth of e-hubs.
In 1999, U.S. e-hubs accounted for only 21 percent of total e-commerce.
By 2003, Forrester Research forecasts, e-hub transaction volume will have
expanded to 53 percent of total B2B e-commerce.
Of course, it is difficult
today to predict which e-hub business model will eventually win out. Even
so, one can readily identify several evolutionary factors already at work.
Economies
of Scale/Scope. Early
on, e-commerce is being conducted largely on a one-on-one basis between
individual companies. But as users become more sophisticated and e-hubs
continue to develop value-added services, a larger percentage of e-commerce
will migrate to e-hubs. That will happen as e-hubs build larger buyer/seller
audiences, and real liquidity is brought to the market.
Demand
for Industry Specialization. As e-hubs mature and become more
sophisticated, the lines will continue to blur between horizontal e-hubs
(those that automate a specific service across a wide variety of industries)
and vertical e-hubs (designed to serve specific industries). Horizontal
e-hubs will face increasing pressure to offer specialized services and
in-depth market knowledge.
One-Stop
Shopping. Vertical e-hubs increasingly will face competition
from horizontal hubs able to use their tremendous economies of scale to
cross industries. One observer1 has suggested that 75 percent
of what a buyer needs in a vertical exchange is industry-specific. Yet,
in order to keep their customers, it appears that vertical exchanges eventually
will have to offer 100 percent of what a customer needs. That will require
added horizontal capacity.
New
Functions. The successful business models increasingly will
be those that create value in an industry by providing a function that
did not previously exist. Accordingly, neutral exchanges that facilitate
price discovery and match supply with demand in the most economically
efficient manner will likely prove to be the most successful business
models.
New
Services. E-hubs will continue to expand their service offerings
and move beyond simply improving the efficiency of market transactions.
Successful sites will continue to add industry-specific information and
content services-including industry trends, news, and analysis-that help
participants manage inventory levels and cash flows. Furthermore, by developing
the abilities themselves or partnering with other e-vendors, sites will
add services that provide access to online credit and financing assistance,
as well as delivery/order fulfillment.
Supply
Chain Management. E-hubs will increasingly create value through
supply chain management services. Going beyond simple market efficiency
services will prove to be a differentiating element of the successful
e-hub. Enhanced supply chain management services not only offer more value
to users, but also diminish the potential of customer switching to other
e-hubs, thereby lending a higher degree of stability and increasing the
growth prospects of an e-hub.
In reality, we have yet to
see an e-hub that is profitable or cash-flow positive, and only a few
have net revenues that exceed $10 million. Yet the market is expecting
big success for several e-hub companies. A quick look at the market capitalization
of some of these gives an idea of what companies Wall Street thinks will
come out on top. The market seems to be favoring the big, horizontal e-hubs
like Ariba ($19 billion market capitalization) and FreeMarkets.Com ($1.9
billion market capitalization). It also is positively disposed to such
large, vertical conglomerate companies as VerticalNet ($3.4 billion market
capitalization) and Ventro ($1.2 billion market capitalization), which
have developed e-hubs in many different industries.
Given the short, volatile histories
of these companies in the stock market, a look at projected transaction
volume paints a picture of promise. Vertical exchange ChemConnect has
an average transaction size of $200,000 and boasts 3,500 members that
post more than 1,300 transaction offers per month. In the neutral catalogue
space, vertical e-hub PlasticNet.Com targets plastic processors and has
30,000 registered members conducting 70,000 user sessions per month. PlasticNet
also has aggregated about 44 suppliers that collectively offer more than
6,500 products on the site. Neutral exchange e-Steel facilitates the negotiation
and purchase of steel products for its 1,700 members, while PaperExchange.Com
has 2,400 members, including eight of the 10 largest paper companies,
using its site.
Energy Plays:
Experience to Date
The Internet revolution, combined
with deregulation, provides a great window of opportunity for the energy
industry. The Internet offers a high-powered, low-cost platform capable
of transforming many utility industry processes. According to Forrester
Research, utilities are the third-largest industry in terms of total online
business trade. Indeed, there already have been several successful applications,
including enhanced trading operations, digitized customer service functions,
and the aggregation of retail customers in deregulated markets. And many
uncharted areas remain where Internet applications can yield substantial
benefits. In the future, one important area of opportunity involves e-procurement
and digital supply chain management.
This section gives a brief
overview of the initiatives already in place in the energy industry, and
then focuses on potential opportunities related to supply chain management.
Retailing. Internet applications first were introduced for commercial
e-commerce activity in the energy industry in the area of customer aggregation
and retail marketing.2 The Internet is particularly adept at
reaching new potential customers and aggregating the demand of small fragmented
buyers. Both independent power marketers and new utility business units
are using the Internet to aggregate customers and increase their leverage
through customer buying pools. One example is ElectricityChoice.Com, which
reportedly aggregates the demand of over 4,000 customers in Pennsylvania
to save 15 percent to 25 percent on the generation portion of their electricity
bills.3
There are several other players
in this market. Like ElectricityChoice.Com, Enermetrix.Com was formed
to provide buyers with lower-cost electricity. It hosts online reverse
auctions for commercial and industrial users who post energy requirements
and let suppliers compete to supply their power.
Another example is Utility.Com,
a virtual utility that acts as an aggregator of retail load. Users can
obtain customized price quotes for their electricity needs and compare
their current rates to Utility.Com rates. Essential.Com is a similar venture
using the group power hub business model.
The recently formed New Power
Co.-a joint venture of Enron, IBM, and AOL-will be the first national
residential and small business provider of electricity and gas in deregulated
markets. Its ultimate intent is to bundle the sale of electricity with
other goods and services.
Deregulation is creating new
customer segments with specific needs that can be fulfilled through the
Internet. For example, Greenmountain.Com, which markets renewable energy
products, is partnering with Yahoo to target electricity customers interested
in environmentally friendly products. Furthermore, they are creating a
brand name for renewable electricity, whereas in the past, electricity
was viewed as a pure commodity good.
Wholesale
Trading. Internet applications were next initiated in the wholesale
energy trading arena. Since its inception about a year ago, wholesale
energy trading has flourished. HoustonStreet.Com was launched in July
1999 as the first fully Internet-based, online wholesale trading floor.
Trading occurs between parties in real-time. EnronOnline was launched
in October to compete with similar features. Recently, Southern Co. announced
that it has joined five other utilities to purchase an equity position
in IntercontinentalExchange, an independent online market for energy and
metals. The size of this market is impressive. As of June 1, EnronOnline
already had surpassed $50 billion in transaction value in 2000. According
to a June press release from Enron, the platform is the world's largest
e-commerce website. Furthermore, a large portion of the $166 billion of
online energy sales expected by 2004 can be attributed to wholesale energy
trading.4
Customer
Care. Customer service was the next area of focus for Internet
application in the utility industry. Using the Internet for basic customer
service functions can yield substantial cost savings for energy firms.
A 1999 article in Utilities IT estimated that a mid-sized utility with
1 million customers could save more than $1 million annually by switching
only 5 percent of its customers from phone to online support. Due to the
enormous cost savings available, Web-based customer service will become
pervasive in the industry. It is estimated that over 50 percent of the
nation's utilities will offer some form of Internet communication with
customers by 2001.5
Bill
Presentment. An Internet application likely to be widespread
in the near future is online bill presentment. It already has been successfully
implemented in other industries, such as telecommunications, and has demonstrated
significant cost saving opportunities as well as enhanced service for
customers. It is projected that utilities will use the Internet for 27
percent of the bills they issue by 2003, providing up to 90 percent cost
savings on bill processing expenses.6 A mid-sized utility with
1 million customers could save $0.8 million per year if it moved 5 percent
of its customers to online bill payment.7
Online bill presentment, combined
with Web-based customer services, significantly can enhance services for
customers. For instance, customers who have direct access to their accounts
online also may be able to view their meter reads, schedule service appointments,
and purchase complementary products and services. The Southern Co. has
announced plans to develop an Internet extension that allows customers
to adjust energy purchases hourly as wholesale prices fluctuate.
Supply
Chain Management. An area receiving much attention is e-procurement
and digital supply chain management, which has significant potential benefits
over traditional processes. These benefits include lower product prices,
lower procurement processing costs, shorter order and fulfillment cycles,
and additional value-added services. In turn, these benefits will allow
for reduced inventory levels and facilitate overall supply chain management.
Though the potential for supply
chain management to benefit from e-commerce is immense, these benefits
depend on the presence of certain factors, such as market size, fragmentation,
technology readiness, and competitive procurement pressures. Fortunately,
e-procurement is especially well-suited to the utility industry for four
reasons. First, it is estimated that the North American utility and energy
supply market represents $130 billion in annual expenditures. Second,
this market consists of a large number of fragmented suppliers and buyers.
Third, the buyers and sellers, while technically sophisticated, are not
advanced in e-commerce applications. Fourth, the industry is being deregulated,
thereby increasing the pressure on competitive procurement.
Consider the volume of purchasing
conducted within the energy industry. It is extremely high. For example,
annual material and supply procurement at a typical utility with 3 million
customers may run as high as $1 billion (excluding fuel purchases). These
expenses differ according to the business unit. (See Table 1.)
E-procurement could provide
large processing and administration cost savings for all transactions.
That is because there are several non-value-added steps along a typical
supply chain that could be made more efficient via an Internet application.
These processing/administrative costs can be reduced dramatically. For
example, technology giant Cisco Systems employed an e-procurement solution
and cut its average cost of processing a purchase order from $130 to $25.8
Not only does e-procurement
allow for lower processing costs, it also enables shorter order and fulfillment
cycles. By automating the non-value-adding activities, such as submitting
the purchase order to the supplier electronically, the time to fulfill
a purchase order can be reduced significantly. For instance, if the time
from order to receipt is seven days via traditional methods, electronic
procurement could reduce that cycle to two days.9 Furthermore,
by shortening this cycle and reducing lead times, utilities could lower
inventory levels without sacrificing reliability. Utilities maintain significant
inventory. The buyers themselves maintain inventory to cover eight to
20 months. Table 2 illustrates the inventory levels at a typical utility
with 3 million electric customers.
Whereas reliability requirements
frequently are stated as the reason for stocking critical parts, in the
deregulated world this proposition can be questioned. Industry participants
agree that inventory levels can be reduced through closer examination
of the components truly required to ensure reliability. Also, inventory
hold upstream is not practiced aggressively in the industry. Under this
practice, end-users enter into agreements with vendors whereby the vendors
must hold the inventory until the utility is ready to use it.
Also, consider what deregulation
means for inventory management. Historically, utility inventory management
has not been strong because inventory was part of the rate base and, as
opposed to being a cost, was a source of revenue. Deregulation is ushering
in several incentive- and performance-based ratemaking mechanisms that
reward a utility for managing costs more effectively. A utility under
a rate cap mechanism can benefit significantly by overhauling its inventory
management practices.
Buyers are not the only ones
to benefit. Utility industry suppliers also can cut costs substantially
by executing their transactions online. In fact, the volume of transactions
in the supply chain preceding the sale to the ultimate buyer far exceeds
the final sale value. A supply chain consists of multiple transactions
executed to fulfill the requirements of the ultimate buyer. It is possible
that some of these savings could be passed along to the ultimate buyer
as well.
Other benefits of digital supply
chain management flow from improved information exchange and data management.
One such benefit is better control of unauthorized buying, because procurement
staff can more easily monitor purchasing activity across the organization.
Purchasing groups also would be able to rationalize their fragmented supplier
base by implementing more strategic sourcing arrangements. Finally, with
better information about vendors and the availability of goods, there
is an opportunity for disintermediation. In other words, procurement could
engage in more direct purchases, bypassing middlemen who are not providing
value-added services.
Digital supply chain management
also enables value enhancements beyond the delivery of goods and services.
Internet applications could be applied to enable electronic payment processing,
reducing internal accounts payable processing costs. Furthermore, as buyers
enter feedback into a database on vendors' performance during transactions,
vendor performance metrics and overall satisfaction levels can be tracked
effectively.
As of May, all but eight U.S.
states had begun some restructuring initiatives. Consequently, utilities
have more incentives than ever to attain lower material and service pricing,
cut administrative costs, minimize inventory levels, and better manage
their working capital.
Preparing
to Launch: Funding and Timing
In the past eight months, several
groups have announced that they will launch Internet exchanges for the
purchase of goods and services in the utility industry. These sites will
differ both in the functions they offer users and how they are developed.
Two key methods are being used
in developing B2B websites for the utility industry: the consortium and
independent approaches.
The consortium approach
involves a group of end-users (utilities) that join to develop the product.
The participants typically are equity investors in the project. They usually
join with a consulting firm to help with project management and implementation,
and a technology partner in charge of product development. To date, two
consortiums have been announced in the United States: Pantellos, and a
consortium led by Ernst & Young.
The independent approach
to site development involves an independent entity that develops and designs
the website, and then recruits participants. The independent developer
usually maintains a majority ownership stake and may partner with other
consulting firms, technology companies, and/or other financial resources.
In the United States, four independent projects have been announced: Selectrica,
EnergyCentric, bex.Com, and Power Co-op. Two other independent efforts
have been announced abroad: one in the UK and the other in Japan.
There are pros and cons inherent
in both methods. Consortiums have the benefit of pooling the interests
and knowledge of all participants. However, they are prone to the problems
of group planning that center around making collective decisions:
- The need for consensus
is likely to retard the development of consortium sites because of delays
in decision-making.
- Compromised decision-making
often is the result, which leads to a solution that works for everyone
instead of the best solution.
- When participants are competitors
and hesitant to divulge information, group planning can be even more
difficult.
In contrast, an independent
website has the benefit of speed and efficiency because decisions are
made by one entity. Independent developers thus are more likely to bring
their product to market earlier than a consortium, which could prove critical
to success in the rapidly evolving e-commerce industry. For utility participants,
independent websites provide access to a product that could add significant
value to their operations without them having to assume the risk of an
equity investment.
This range of options can be
characterized as three simple choices for the sake of discussion: "do-nothing,"
make a "big commitment," or pursue a middle ground solution (the "staged
investment option"). For any given utility, these options may have different
meanings. For a small utility, an investment in a consortium may be a
large commitment, while a large utility would undertake a similarly large
commitment if it were to build its own e-hub. Thus, these three strategic
options are general categories that can be interpreted differently by
each utility depending on its relative size and risk tolerance.
Uncertainty.
Given the flurry of e-procurement announcements in the industry and the
rapid evolution and extreme unpredictability of e-commerce in general,
how does an energy firm decide when and how to develop its e-commerce
strategy? Most would agree that e-commerce will have a lasting and important
effect on utility industry business processes. Yet, at this stage, no
one can predict what business model will prevail, where value will be
created, or how e-commerce could or will benefit a given company. In short,
there is extreme volatility in the range of possible outcomes.
Wait
and See. In the "do nothing" or "wait-and-see" scenario, a
company takes the conservative approach to a changing environment. It
simply moves to the sidelines to wait until the possible outcomes are
more certain. The benefit of this approach is that it involves minimal
downside risk (i.e., no capital is needed). However, because there is
also no upside potential, both good and bad possibilities fade away as
a company chooses to wait. By doing nothing, a business also loses the
opportunity to develop the knowledge and experience gained through participating
in the industry during this dynamic time. Not only will the organization
miss out on a learning opportunity, but it also risks negatively affecting
its culture. For example, as vendors move away from in-person sales and
to the Internet, buyers who do nothing may not be able to obtain the best
price and/or terms and conditions.
Big
Bang. On the other end of the spectrum, a company can jump
in with both feet now through a substantial commitment. This approach
could involve a relatively large up-front investment to start an independent
venture or an equity contribution to a consortium. In this bet-the-farm
approach, a company assumes all of the development costs and potential
downside risk involved with its equity position. If the site proves successful,
the company will be able to realize some of the benefits through its ownership
stake. This option also involves a large downside risk associated with
having to place a bet now in the face of extreme uncertainty.
Step
By Step. A company also can pursue a strategy designed around
a step-by-step or "staged" investment. These options allow for early market
entry while maintaining maximum flexibility. They also allow a company
to enter the game without "betting the farm" by avoiding the problem of
paralysis in the face of uncertainty and by sidestepping the risk involved
with placing a big bet up-front. With this approach, a company decides
only on an initial step that will preserve the option of potential valuable
outcomes.
In today's utility industry,
this option represents a series of small staged investments that allow
a participant to be involved in an e-hub without having to make a relatively
large up-front investment. As it proceeds, the utility can manage its
options by using the time to learn more about the downstream possibilities,
clarify uncertainties, and identify when it is time to commit-if ever-to
the identified opportunities. Staged investments thus allow for high upside
potential with minimal downside risk.
Costs
and Benefits. One way to evaluate the viability of the three
strategic options is to develop a framework for valuing the different
choices. To illustrate the effectiveness of a staged-investment approach,
consider the following example. Suppose that based on assumptions about
market size, transaction volume, and possible product offerings, it is
reasonable to believe that a utility could position itself for a potential
e-commerce earnings stream with a present-value worth of $3 million. Although
this estimate is reasonable, the $3 million is far from certain and could
range from $0 to $6 million. At this point, the utility is faced with
the three options outlined above: do nothing, make a big commitment up
front, or pursue a staged-investment strategy. (See Figure 1.)
If the company decides to do
nothing, it obviously avoids having to make any capital investment, but
it also passes on the possibility of capturing some or all of that $3
million. In addition, it takes on the other, less-quantifiable risks that
involve lost experience and knowledge, and a potential negative impact
on corporate culture. This option is not shown in the figure.
On the other hand, if the utility
decides it is comfortable with the risks involved and wants to gamble
on securing part of that $3 million, it can follow the "big commitment"
strategic option. Here, assume that the up-front commitment will require
an investment of either $2 million or $5 million. Given the possible range
of value in the earnings stream and the required investments, the returns
shown in Figure 1 could vary from -$5 million to +$4 million, producing
an expected net present value of -$500,000. The uncertainty inherent in
the outcomes of this all-or-nothing strategy produces an expected value
that is negative.
The third option is to pursue
staged investment. In this scenario, the utility decides that given the
range of possible outcomes, it would like to delay its investment. Here,
the utility can delay its investment as long as it makes early moves.
Suppose that these early moves involve a more modest investment of $150,000
now, with an additional $50,000 per year over the next two years. After
making initial investments totaling $250,000, the utility faces another
decision: continue and make other required investments, or terminate the
project. Again, the required investment at this point could be either
$2 million or $5 million. But by delaying the necessary investment and
gaining additional time to make a more informed decision, the utility
can know if the outcome is going to be negative. At this point, it can
terminate the project if the expected outcome is negative, and write off
$250,000. By delaying the timing of the big investment decision until
there is less uncertainty over the outcome, the expected value increases
from -$500,000 to +$460,000, even with the extra staged investments.
This example illustrates the
value of staged investment. In an uncertain environment, it clearly benefits
a participant to delay the big commitment and gain more knowledge about
the possible outcomes by taking a series of sequenced steps and building
experience.
Form
and Function
A
Lexicon of E-Commerce
|
|
B2B
e-commerce platforms can be differentiated by the types of markets
they serve, how they create value, and how the transactions between
buyers and sellers occur. Understanding these different business
models is essential to evaluating the opportunities e-hubs present.
Horizontal vs. Vertical
Horizontal e-hubs automate
a specific service across various industries. Whether they are used
to sell excess inventory, provide human resources, or procure office
supplies, horizontal e-hubs serve needs that are common among industries.
The ability to cross industries allows horizontal e-hubs to scale
their particular service offerings and reach huge audiences. Yet,
the strength of the horizontal e-hubs also is their weakness-it
often is difficult for them to fulfill the industry-specific content
needs of customers.
By contrast, vertical
e-hubs serve specific industries with various services. Vertical
e-hubs typically supply the raw materials and components for a product
or process that usually requires specialized logistics and delivery
mechanisms. Players in vertical e-hubs typically have knowledge
of the industry's supply chain and understand relationships between
the key buyers and suppliers. Such hubs can digitize the vertical
supply chain, enhance liquidity throughout the supply chain, and
provide relevant industry news and analysis. The growth of a vertical
e-hub is limited by the size of its chosen industry. Large industries,
such as the utility, airline, and construction industries, are fertile
ground for vertical e-hubs.
Systematic vs. Spot
Buying
Sites that use systematic
sourcing rely on prices determined outside the site. When prices
are pre-negotiated or established, a static site is created where
the positions of both the buyer and seller are fixed. Systematic
sites can aggregate large groups of buyers and/or sellers to increase
the size of the audience and create efficient markets. Systematic
sourcing works best under the following settings:
- Products are specialized
(not commodities).
- Transaction costs
are high relative to the cost of the product.
- Purchasing is conducted
through pre-negotiated contracts.
- A large number of
individual products is offered on the site.
- Products lend themselves
to being listed in a huge catalogue that combines the products
of many sellers.
- The supplier universe
is highly fragmented. Spot sourcing, on the other hand, involves
purchasing commodity-like products on the spot market from anonymous
sellers. Spot sourcing is transaction-oriented and rarely involves
long-term or ongoing relationships between buyers and sellers.
Prices are not set ahead of time and are discovered, or determined,
on the site. By bringing buyers and sellers together in a format
that allows for dynamic negotiation, spot sourcing e-hubs allow
price discovery. Spot sourcing works best under the following
settings:
- Products are commodities
or are like commodities that can be traded without inspection.
- Trading volumes are
high relative to transaction costs.
- Demand and prices
are volatile.
Biased vs. Neutral
Another key distinction
among e-hubs is the nature of their inherent bias. E-hubs can be
either two-sided or neutral, or inherently biased toward either
buyers or sellers. Neutral e-hubs typically are operated by third
parties and favor neither buyers nor sellers. They are the true
market-makers that efficiently and fairly match supply and demand.
At their best, neutral e-hubs bring together large groups of buyers
to interact with large groups of sellers. They can be compared to
market squares that serve as central clearinghouses for "many-to-many"
transactions.
Neutral hubs work best
when both the buyer and seller sides of the market are fragmented.
That provides incentives for both sides to meet in the middle or
come to the market square to gain a larger audience. In this sense,
neutral e-hubs reduce transaction costs through aggregation, and
provide liquidity by improving the matching of supply and demand.
Depending on the underlying industry structure, neutral hubs also
may show some bias toward buyers or sellers. In a case where there
are three large buyers and a few thousand sellers, for example,
clearly the e-hub will have to undertake measures (such as audits)
to ensure neutrality. The long-term viability of such e-hubs may
be a reasonable indicator of neutrality.
One problem with neutral
hubs is that they are more difficult to get started because they
must overcome what is referred to as the "chicken and egg problem."
To work, neutral hubs must convince both buyers and sellers to come
to the market to display or purchase their goods. Buyers are hesitant
to participate until the square has a sufficient number of sellers,
and sellers are hesitant to display their wares until enough buyers
are aggregated. This reluctance must be overcome to achieve the
critical mass necessary for a fully functioning, liquid market.
As opposed to neutral
markets, many e-hubs inherently are biased. Biased hubs work on
the side of either the buyers or sellers to assist in negotiating
better terms for their party or streamlining their procurement process.
Sites that are biased toward sellers function by either building
supplier power in a highly fragmented industry through aggregating
suppliers or by amassing buyers to compete on price in an auction-style
format where there is just one seller. In contrast, sites that favor
buyers are designed to either aggregate a large number of buyers
to collectively increase their bargaining power or to create a reverse
auction where a large number of suppliers compete to supply one
buyer.
Biased e-hubs work best
when one side of the market is fragmented and aggregation can add
significant value. Biased sites also avoid the "chicken and egg"
problem because all that is needed is the aggregation of participants
on one side of the transaction.
Some Useful Examples
Given the vast array
of business models and features, market-making mechanisms, and types
of markets served, it is impossible to capture all e-hubs in the
market today-let alone tomorrow-in one framework. To complicate
their classification further, more sites are becoming hybrids of
one or more business models. Nevertheless, by selecting different
combinations and permutations of the various market-making features
listed above (systematic vs. spot sourcing; neutral vs. biased sites),
it is possible to classify e-hubs into four categories and offer
some examples of each.
1. Catalogue hubs
amass buyers and sellers to source goods and services systematically
in a neutral setting. In catalogue hubs, buyers enter to gain access
to a wide array of suppliers. Pricing is pre-determined, and buyers
can shop from catalogue-style lists of goods and services. Products
typically are specialized, and the buyer usually has some former
or ongoing relationship with the seller. As is true of the other
e-hub models, catalogue hubs can serve either a vertical market
segment where the offerings are industry-specific (PlasticsNet.Com
and Chemdex) or a horizontal market segment where the product offerings
appeal to a number of industries (MRO.Com).
2. Group power hubs
are biased e-hubs designed to aggregate groups of either buyers
or sellers to source goods or services systematically. Like catalogue
hubs, group power hubs operate with established pricing and more
specialized, non-commodity products. The difference is that group
power hubs have an intrinsic bias toward either the buyer or the
seller. They are designed to aggregate participants in a fragmented
market to increase the bargaining power of the group as a whole
beyond what was possible individually. One example of a seller-biased
group power hub in the computer industry is Ingram Micro, which
helps small resellers achieve scale and increase their selling power
by providing collective back-office functions. On the buyer-biased
side of the equation, FOB.Com helps small buyers aggregate to increase
their buying power.
3. Exchanges function
as neutral markets that match buyers and sellers, and enable the
spot sourcing of goods and services. Exchanges are designed to aggregate
buyers and sellers in a neutral market to efficiently match supply
and demand. As opposed to catalogue hubs, pricing in exchanges is
not pre-determined; instead, buyers and sellers interact on the
site to determine pricing. Exchanges are considered to be the most
economically efficient markets because they combine the equitable
benefits of a neutral market with the dynamic pricing abilities
of the spot market. e-Steel is an e-hub that has been very successful
at matching buyers and sellers to negotiate, buy, and sell steel
products. Other examples include ChemConnect, Altra Energy, and
PaperExchange.Com.
4. Auctions are
biased markets that match buyers and sellers, and enable the spot
sourcing of goods and services. Auctions, like exchanges, match
buyers with sellers in a dynamic environment that allows the participants
to determine the pricing of their transaction. The products typically
are commodity-style with easily specified characteristics. Yet,
auctions have an intrinsic bias toward either the buyer or the seller
that separates them from exchanges. Traditional auctions favor the
seller, because groups of buyers are amassed to compete to purchase
an item and the transaction is completed at the price of the highest
bidder. Auctions that benefit the buyer, on the other hand, are
known as reverse auctions. Here, sellers bid to supply an item and
the transaction is completed at the price of the lowest bidder.
Auction sites include TradeOut.Com, which operates traditional auctions
for surplus inventory, and FreeMarkets.Com, a reverse auctioneer
that serves Fortune 500 companies. -S.G.
|
Choosing a
Model: A Framework for Decision
Having narrowed the options
to some form of staged investment in an e-hub, an energy firm can evaluate
staged-investment options by using an additional framework that outlines
key decision-making criteria. Several considerations related to the company's
situation are important in making the choice, including its relative size
in the industry, its plans for mergers or acquisitions, and spin-off plans.
Beyond such concerns, six key factors that differentiate e-hubs can help
to evaluate strategic options:
- Productivity enhancement,
- Credibility,
- Speed of deployment,
- Neutrality,
- Position in the supply
chain, and
- Equity opportunity.
As shown in Figure 2, the framework
can be used to plot the relative merit of each of the factors on a scale
of 1 to 10, which produces the patterns shown by Options A and B. These
options can be evaluated relative to each other and to the preferred option,
which is represented by the outer ring of the chart, and indicates a perfect
score in each category.
Productivity
Enhancement. This is probably the most important criterion
to be considered in evaluating e-hub opportunities. Answering the following
questions will help determine whether a particular e-hub will enhance
productivity for a given utility.
- Does the e-hub enhance
utility productivity through automating/streamlining supply chain processes,
and externally through more efficient sourcing, procurement, and transacting?
- Does the e-hub manage the
supply chain, or simply serve as another access point to the external
market?
- How much will integration
with the existing infrastructure cost, and what benefits will the company
realize in the process?
Credibility.
The survival of any e-hub is closely tied to liquidity and long-term funding.
Liquidity is related to the traffic or transaction volume the hub generates.
The uncertainty surrounding existing e-hubs makes it difficult to predict
future liquidity, but experience from other industries suggests that announced
commitment to transact through a specific hub is short-lived if the hub
doesn't create or add true value. Financial backing can be evaluated using
several metrics, including long-term vs. short-term focus, risk tolerance,
importance to investors, and relationship to other ventures.
Speed
of Deployment. Speed is probably more critical in e-commerce
than in the traditional brick-and-mortar world. The first mover has significant
advantages such as setting industry standards, building traffic more quickly
(and thereby enhancing its ability to grow), and moving faster to value-added
services. Speed is more important in e-commerce than is getting it completely
right the first time. It is much easier to fine-tune an almost correct
solution than to wait for the perfect solution.
Neutrality.
As quickly as traffic builds in a biased hub, it just as quickly
can disappear. Experience from other industries also suggests that a biased
hub will not be able to keep the value it creates because the bargaining
power of either the buyer or seller will lead to the extraction of this
value in its favor. Although a utility may not necessarily seek a neutral
e-hub, it is fallacious to ignore the long-term implications of lack of
neutrality.
Spot
in Supply Chain. E-hubs can create value through the comprehensive
coverage of the supply chain, upstream to downstream. The value creation
is large when a factory in China is able to know when, how much, and what
kind of a component is needed by the end-user, and can coordinate with
a factory in Thailand and an assembly line in the United States. If participation
in the e-hub is limited to the downstream buyer and vendor interface,
the value creation is limited to the tip of the iceberg. The e-hub's real
value creation in the future lies in being able to reach out to the downstream
transactions with increased access and efficiency. It is important to
evaluate the coverage and positioning of the e-hub in the supply chain
in quantifying the value it can add to a utility.
As attractive as investment
in an e-hub sounds, staged investment seems to create the highest value
for the investor. Empty announcements to set up an e-hub are so common
that the approach has been dubbed the "game over" strategy. These announcements
are just the beginning of the game: Investment choices need to be made
carefully until one of the e-hub models starts showing promise.
Soam Goel is senior vice
president at PHB Hagler Bailly Inc. He may be contacted at 917-952-5888
or sgoel@haglerbailly.Com. Soam Goel wishes to acknowledge significant
contributions made by Craig Hart and Gloria Moon supported by Armine Guledjian,
Wynne Cougill, and Gerry Schwinn.
1 David Perry,
of Ventro (Red Herring, 2000).
2 When the
California market was deregulated in 1998, the power exchange and independent
system operator began using the Web for all billing and settlement transactions.
3 Energy
Services & Telecom Report, 2000.
4 Power Markets
Week, 1999.
5 Energy
Services & Telecom Report, 1999.
6 Ibid.
7 Utilities
IT, 1999.
8 Sound View
Technology Group, Feb. 11, 2000.
9 Ariba,
March 23, 2000, E* Offering.
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