Communications of the ACM

Virtual extension

Perspectives of the E-Marketplace By Multiple Stakeholders

By G. Prem Premkumar
Communications of the ACM, December 2003, Vol. 46 No. 12, Pages 279-288
10.1145/953460.953512
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Business-to-business (B2B) e-commerce has been the focus of media hype for the last five years. Like many other technologies in the e-commerce area, it has dropped from a media and Wall Street favorite in 1999 to one that is going through a market shakeout. In both the business-to-consumer (B2C) and B2B marketplaces, existing firms in the physical marketplace (bricks-and-mortar) are responding to threats from new entrants. In the B2C area, the physical stores have created their own online stores as well as an alternative selling channel in what is popularly known as the clicks-and-mortar approach. A similar transformation is occurring in the B2B area. Firms from the physical marketplace, who were customers to the new electronic marketplaces (e-marketplace), have created their own versions of these marketplaces. The big three auto firms have developed their own exchange (Covisint) to link suppliers and buyers, thereby creating serious competition to new start-ups such as Free Markets. While it is relatively easy to create e-marketplaces with packaged software, it is more difficult to create the liquidity in the marketplace by enlisting an adequate number of buyers and sellers to participate in the marketplace.

The current turmoil in the B2B area creates significant uncertainty for procurement and IT managers in the organization. Companies have been undergoing a major transformation in the procurement area in the last five years from various technologies and business practices including EDI, supply chain management (SCM), continuous replenishment schemes, efficient consumer response systems, and collaborative commerce systems. Organizations are interested in knowing if e-marketplaces are the next stage in the evolution of SCM or a passing fad. While these e-marketplaces have much to offer, there is a significant cost for restructuring existing business practices and supplier relationships. Business managers have to address many issues including:

• How do we migrate from traditional SCM to the new marketplaces?
• What are the issues to consider as we formulate strategies to participate in the marketplace?
• How will these e-marketplaces evolve in the future?
• What kind of information systems should we choose to support these initiatives?

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Supply Chain Management

In recent years SCM has been touted as one of the major strategies to improve organizational performance and generate competitive advantage [2]. A variety of changes in the business environment including time-based competition, fast product cycle, just-in-time production, and inter-organizational systems (IOS) have fueled interest in SCM. A supply chain can be considered the value chain for the industry, extending an organization's value chain to include its customers and suppliers [6]. It is a chain of interlinked trading partners that takes a basic raw material at one end, adds value to it while incurring cost, and delivers a finished product to the ultimate customer at the other end. Figure 1a shows the three components—information, physical goods/services, and payment—flowing through the supply chain. To facilitate the movement of these components, the chain requires the service of transportation carriers for the movement of goods, and financial institutions for the movement of payments. Information flow can occur between the entities directly or through a third-party network. The basic thrust in SCM is for tight integration of business process between different players in the supply chain to facilitate the flow of the three components and realize various business objectives, including increased inventory turnover, reduced cycle time, better customer service, and greater flexibility in responding to customer requirements [3].

While from a buyer perspective the supply chain looks like a linear chain as in Figure 1a, from an industry perspective it is a lot more complex, resembling something more like a web. The supply chain for a manufacturing firm, shown in Figure 1b, can have 2–3 tiers of suppliers, creating a complex network. Since they are independent entities, there is no central management of the chain. However, the chain has to operate efficiently to be competitive. A small change in any of the partners' supply chains, or a weak or broken link in the web, can create major reaction in the entire chain.

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E-Marketplace

Marketplaces can be broadly classified into dyadic and electronic marketplaces. While an e-marketplace provides a central location for many buyers and sellers to congregate electronically and complete their transactions, a dyadic market involves direct interaction between a buyer and seller and the formation of long-term relationships. The evolution of communication technologies and inter-organizational systems was a big factor in the creation of e-marketplaces. In the 1980s, EDI technologies enabled the electronic communication of transaction information between trading partners in a dyadic relationship. SCM initiatives such as JIT production and quick response systems also fostered the growth of long-term relationships and exclusive contracts with suppliers. The growth of the Internet led to Internet-based EDI systems, moving away from direct links to use of a public network for communication. It naturally evolved into e-marketplaces in the late 1990s as a technology solution to overcome inefficiency in dyadic interactions.

Figure 2 shows the difference in the context of communication between a dyadic market and an e-marketplace. In a dyadic market there are m x n interaction links between the buyer (m) and supplier (n), with multiple communication messages such as request-for-information (RFI), quote, design documents, purchase orders, and so forth, traveling between these links. In an e-marketplace there is only m + n interactions links. The number of messages flowing is also reduced since a Web-based marketplace can provide richer information and reduce the number of queries.

While from a pure communication perspective the e-marketplace looks advantageous, there are other cost factors that need to be examined [1]. Typically, transaction cost includes coordination cost and a cost associated with transaction risk. The coordination cost includes the search cost of finding the right supplier or buyer, the cost for exchanging information, and the cost of contracting to reduce risk. Contracting cost includes the cost for order negotiation as well as legal and administrative costs incurred in creating an enforceable contract that satisfies both parties. There are other hidden costs associated with transaction risk. Operations risk is the risk that one of the partners misrepresents or withholds information or underperforms. It stems from differences in the objectives of the partners and information asymmetries between the partners. Opportunism risk is the risk of the lack/loss of bargaining power due to relationship-specific investment. It can be considered as the switching costs to switch from an existing relationship to a new one.

Buyers benefit from an e-marketplace since they get the opportunity to evaluate a large number of sellers at a relatively low cost and the competitive marketplace will result in lower prices. The coordination cost in terms of search and information exchange are reduced. However, the operations risk is increased due to lack of knowledge of every supplier in the marketplace. The buyer may incur additional costs in contracting or prequalifying vendors to ensure that the supplier can meet their quality and schedule requirements. Sellers also benefit from an e-marketplaces as they expand their market reach and reduce transaction costs. However, it also creates a more competitive marketplace that increases pricing pressures, commoditizes the product, and reduces the ability to compete on other product/service attributes.

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Categories of E-marketplaces

E-marketplaces can be classified be based on various characteristics including type of procurement, ownership, and industry focus (vertical or horizontal).

Procurement Type. Kaplan and Sawhney [4] classified e-marketplaces based on product type and procurement practice into four categories—exchanges, catalog hubs, yield managers, and MRO hubs.

Most firms have two types of procurement, manufacturing inputs (or direct materials) and operating inputs (or indirect materials), and two types of transactions, spot sourcing and systematic sourcing. MRO hubs are horizontal markets that enable systematic sourcing of mainly indirect materials. Some of the characteristics of this hub are a wide variety of low-value products, large numbers of transactions (high transaction costs), and a large number of suppliers. Distributors (Grainger.com) and infomediaries (MRO.com) provide large product catalogs on the Web and have automated buy-side software customized to a firm's Intranet. These hubs are low-risk initiatives with significant cost benefits for both buyers and sellers, and have been fairly successful.

Figure 3. E-marketplace classifications.

Yield managers use an auction format to buy operating inputs such as advertising (Adauction), capital goods (Imark), and temporary labor (Elance). They are useful for auctioning excess capacity or buying to meet temporary demand fluctuations. Exchanges are typically used for spot sourcing of manufacturing inputs which are either simple in description or can be well described in an industry standard format such as steel, paper, and agricultural commodities. They are used by firms to meet their daily requirements or smoothen sudden supply and demand fluctuations. Catalog hubs are vertical marketplaces that enable suppliers in an industry to market their products in a single e-marketplace. They are used for procurement of manufacturing inputs and are closest to the notions of procurement through traditional supply chain management. The participating firms will most likely have long-term relationships and long-term contracts and use the hubs to reduce their transaction costs.

Ownership. Figure 4 shows four types of marketplaces based on ownership—buyer hosted, seller hosted, neutral, and industry or consortium hosted.

Buyer-hosted marketplaces are normally created by a dominant buyer as a strategy to move away from multiple dyadic supplier interactions to a single e-marketplace interaction with suppliers. One of the initial pioneers in this area was General Electric, which posted their purchasing requirements on the Web and had suppliers bid for them. Auto manufacturers followed suit with General Motors creating Trade Exchange and Ford creating Auto Exchange. While it is convenient for the buyer, it is not convenient for sellers as they have to manually interact with multiple Web sites and run the risk of potential incompatibility problems due to interaction with non-standardized interfaces and data. It seems very similar to the interoperability problems that suppliers faced in the 1980s, interfacing with proprietary interorganizational systems. Standardized EDI mitigated the compatibility problems.

Seller-hosted marketplaces can be hosted by one seller or a host of sellers. These are extended versions of the seller's Web sites with additional functionality including auctions, logistics coordination, financing and payment coordination, and accounting. Sellers are able to displace middlemen by directly linking with the end-users. Most often these are a dominant seller's marketplace, since the seller-host(s) is disinclined to include competitors in their marketplace. If the buyers are powerful, then it evolves over time into an industry-administered or a neutral marketplace.

Broker-hosted marketplaces are the most popular; they were started by many entrepreneurs as a neutral intermediary to provide benefits to both buyers and sellers. These sites normally post offers from multiple buyers and sellers. Modern software from vendors such as Ariba, Commerce One, and Oracle has made it relatively easy to create these e-marketplaces. Vertical Net is an example of a firm that created over 50 marketplaces in different industries in a short time frame. A major constraint for broker-hosted marketplaces is the difficulty in generating the necessary liquidity to attract a sufficient number of buyers and sellers to ensure their survival. Many of the initial pioneers such as Chemdex (Ventro), Vertical net, and Ariba have branched out from hosting e-marketplaces to becoming software providers.

Industry-hosted marketplaces started as a response to the growth in broker-hosted marketplaces. The participants in the physical marketplace (sellers, buyers) realized that these e-marketplaces offered potential opportunities which were being exploited by new firms with limited expertise in their industry. Hence, industry members formed consortiums to create alternate marketplaces using their extensive industry expertise. The presence of major buyers and sellers provides liquidity to these e-marketplaces. Covisint is an example of three major buyers ("Big 3" auto firms) creating a marketplace for both customers and first- and second-tier suppliers to interact. The Grocery Manufacturer's Association created an e-marketplace, Transora, to improve supply chain efficiency in their industry. A significant constraint to the formation of these marketplaces is the willingness and ability of competitors to form a common business entity based on trust and relationships. The ability for buyers to collude and easily compare product/services provides a significant deterrent for sellers to participate in these marketplaces. A major legal issue relates to anti-trust concerns as the participants could create a cartel and reduce competition.

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Different Perspectives of SCM and the E-marketplace

SCM and the e-marketplace address business-to-business interaction from two different angles. While SCM focuses on developing a tightly integrated chain linking a firm to its suppliers, e-marketplace focuses on technology for developing a sophisticated marketplace without examining organizational procurement practices and culture. Buyers, sellers, and IS managers are overwhelmed with the media hype and are unsure on how, if at all, to migrate from their existing business processes to these new options. Below we provide the perspective of three stakeholders—buyers, sellers, and IS managers.

Buyer's Perspective. Procurement managers are concerned about the procurement processes, relationship with trading partners, and costs. Some of the issues that buyers have to address are:

• Where does e-marketplace fit in our SCM strategies?
• Is it compatible with our procurement philosophies and practices?
• How will our existing suppliers and relationships be affected by migration to e-marketplace?
• How will procurement through e-marketplace affect the delivery and quality requirements?

The introduction of JIT production in the manufacturing sector, and efficient consumer response systems in the retailing sector, have brought significant changes to procurement practices. SCM attempts to achieve cycle-time reduction and faster inventory turnover by establishing tight linkages with suppliers and moving from pure transaction orientation to greater coordination and integration of business processes in various functional areas including product design and development, market research, production planning, and so forth. A high level of trust and extensive information-sharing are required for successful implementation of these initiatives [5]. The focus on individual transactions and price reduction by e-marketplaces was not consistent with the procurement philosophies of trust and long-term relationship that have evolved in the last ten years. A firm could jeopardize its relationship with its long-term suppliers by switching to an e-marketplace. Hence, the suitability of e-marketplaces in the current procurement culture needs to be examined. A typical comment from a trading partner is: "Well, you may find the same product at a slightly lower price. But how sure are you of the quality, vendor's credibility, ability to deliver it to our production schedules?"

Since these new initiatives take significant effort and time to implement, a firm has to evaluate if the initiative is in alignment with current SCM strategies. A worst case scenario is the introduction of initiatives that are inconsistent and create confusion among suppliers. Change management, both internal and external, is critical as there are many instances of good systems not producing desired results due to faulty implementation strategies. For example, Nike had major problems in their production/distribution after introduction of an advanced production planning system. It was later found that the problem was not with the software but with the quality of data sent to the system. A major concern of procurement managers is the internal changes in workflow processes and the resultant impact on procurement staff.

Seller's Perspective. Some of the issues that suppliers have to address are:

• How do we choose which marketplaces to, or not to, participate in?
• Do we create our own or join an existing e-marketplace?
• What is its impact on current Web-based online operations—will there be synergies or will one cannibalize the other?
• What will happen to existing long-term relationships and contracts with key customers?
• Will the e-marketplace make their products commodities and create a price-driven market?

A critical business strategy decision is whether to participate in the e-marketplace or continue to develop long-term relationships with key customers or do both. While long-term relationships and contracts provide business stability, they reduce the flexibility of exploring alternative markets and the possibility of growing at a faster pace or making more profits in a niche market. Participating in both markets at the same time can be problematic since the prices could vary and create opportunities for the buyer to break away from exclusive contracts. The supplier also has the option of joining an existing marketplace or creating a proprietary one for order processing and interacting with customers. Capital equipment suppliers may opt for the latter option as the product is unique and a one-time purchase, while other suppliers may find the B2B marketplace provides more benefits.

Another major issue is that e-marketplaces tend to commodotize the offerings and restrict the sellers' ability to compete on other products or service features. The e-marketplace provides standardized order processing, fulfillment, and other related processes, thereby considerably reducing the parameters that a seller can use to create a unique value proposition. If a seller derives competitive advantage from its fulfillment process, the e-marketplace will neutralize its advantage.

IS Managers. Some of the typical issues confronting IS managers are:

• How do we migrate from dyadic EDI platforms to these e-marketplaces?
• How do we integrate our internal ERP or other internal systems with these e-marketplaces?
• What IT infrastructure is required internally and with our suppliers/buyers for successful implementation?
• What are the system and data compatibility issues in interacting with non-standardized systems?

Many firms have internal legacy systems on the sales and procurement side that work with EDI middleware to communicate with their trading partners. EDI provides a standardized data format for two computers to automatically communicate transaction information without any manual intervention, which brings a high level of transaction efficiency in communication. However, they are not very useful for communication of unstructured information as in the initial search, evaluation, and negotiation process. Migration to e-marketplaces may require interacting with different Web interfaces and non-standardized data formats that may create problems with internal systems. For example, getting demand forecast information from multiple customers and incorporating it into internal systems would require individually visiting customers' Web sites, retrieving information, checking their data formats and reentering them in internal systems. This may be a step backward in technology for the seller unless automated interfaces are developed to automatically retrieve the information from the Web site into internal systems.

In the last seven years, many firms have implemented ERP systems to integrate the information flow within the organization. They have proprietary interface requirements for data input and output. While ERP vendors have developed interfaces to EDI, they are still working on developing interfaces to e-marketplaces. New software such as advanced production systems (APS) from I2 or Manguistics and CRM applications have complicated the integration of data across multiple software. e-marketplaces have focused more on improving the marketplace operations and less on interfacing with their customers' systems. There are many new initiatives to address these problems. ERP vendors such as SAP and Oracle are trying to create integrated software that will link their ERP systems with their e-marketplace software.

A single integrated SCM software that links all the participants in the supply and demand chain may be the ultimate solution for an IS manager dealing with incompatibilities in these systems. While communication incompatibilities are relatively easy to overcome through XML and related technologies, data incompatibilities are harder to handle. Unless a significant value proposition exists to move from existing EDI-based systems to an e-marketplace, IT managers will be reluctant to make the migration.

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The Future of SCM and the E-Marketplace

Any new initiative brings change and over time the existing practices and the new initiatives evolve to achieve a fit between the two. The focus on price in early e-marketplaces was more suited for commodities and not consistent with the current philosophy of collaboration in SCM. E-marketplace has to evolve to be consistent with the paradigms of collaborative commerce, where the firm and its trading partners, together as a community, provide greater value to its customers by enhancing the value or reducing the cost in the value chain. The role of the physical marketplace in fostering long-term relationships and trust that enables collaborative commerce cannot be over emphasized. Electronic networks are excellent at creating communities. Software vendors have to develop modules to facilitate collaboration. Recent mergers and partnerships among software vendors indicate recognition of this need.

Collaborative commerce is based on the premise that trading partners will collaborate and freely exchange information to reduce the bullwhip effect that creates significant inventory fluctuations in the chain. The sharing of information is a significant deterrent in all interactions. While database technologies were available in early 1980s, it took more than fifteen years to create integrated information systems in organizations due to various constraints, including an unwillingness of departments to share information for fear of loss of power. The same argument can be made for free flow of information across organizational boundaries. Information asymmetry is critical for participants in the value chain to survive. If we create a super efficient value chain where information flows freely and uncertainty is significantly reduced, the role of many intermediaries in the value chain become insignificant [8]. Hence, these firms have to evolve into other businesses or create barriers to free flow of information to sustain their existence. Therefore, while technology will be available, whether participants will be willing to use it is an important factor that will determine the success of these new initiatives. Sometimes a dominant member in the value chain may have to force its participants to share information.

Future e-marketplaces should provide comprehensive support to a variety of interactions and relationships including spot transactions, short-term contracts, and long-term relationships. An innovative approach to providing these services would be to create private areas within the e-marketplace with limited access where firms that require (or have) long-term relationships can interact. It would provide flexibility for an organization to move all its transactions to a single marketplace, completing long-term relationship-based contracts in private areas, and spot transactions in the public marketplace to take advantage of liquidity and price performance. There are other strategies that e-marketplaces could use to facilitate the creation of relationships. For example, they could use a membership-based model to only admit a select set of buyers and sellers who are referred by an outside agency or by the members of the e-marketplace. This reduces risk and fosters a sense of community.

In a networked age it is inevitable that firms will move to a 100% electronic communication of business transaction information. However, the evolution will be slow and there may be multiple electronic mechanisms to achieve that objective. Currently, many firms use e-marketplaces extensively for procurement of operating inputs since there is a good fit between procurement practices and the services provided in e-marketplaces. The large transaction volume, relatively low-value, inefficient procurement process, and fragmented supplier market provide significant opportunities for an e-marketplace to reengineer the processes. Since it is mostly integrated with a firm's Intranet, it offers significant cost reduction and reduces internal paperwork.

Unless there is a significant value proposition over existing EDI systems, traditional relationship-based methods will dominate the procurement of manufacturing inputs. It is likely that buyers will provide all order information on their secure Web sites for sellers. In the future, software agents will be able to retrieve information automatically from these Web sites to the seller's internal systems.

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