Potentially beneficial to many, Web marketplaces threaten to disintermediate wholesalers.

After years of waiting for an easy way to conduct e-commerce with manufacturers and customers, wholesalers may have gotten their wish: Internet exchanges allow buyers and sellers to trade electronically. This is an extremely powerful concept and potentially beneficial to many wholesalers, but these Web marketplaces threaten to disintermediate wholesalers en masse. This article explains the nature and functions of online exchanges, pro and con, and describes the full impact of disintermediation.

What is an exchange? Industry-specific or vertical exchanges are electronic marketplaces that allow manufacturers, suppliers, wholesalers and sometimes customers to buy and sell online. The goal of exchanges is to eliminate cost from the supply chain by reducing the time and paper it usually takes buyers and sellers to source and complete transactions.

How do exchanges work? Exchanges come in different "flavors":

  • Portals are not exchanges but sites where viewers can find the names and addresses of preregistered sellers of a product category selected from a menu (e.g., plumbing products). Some portals contain hot links to the Web sites of registered sellers. Business is transacted offline via phone, fax or snail mail -- which is true for most other flavors of exchange.

  • Catalog exchanges contain one or more catalogs for each registered seller, and registrants are typically sellers in the industry in question. But sellers can be virtual wholesalers. The catalogs usually contain prices, and buyers transact business offline or via an order form that is e-mailed to the selected seller (who still has to key in the order).

    On some portals and catalog exchanges, sellers are not listed in alphabetical order by company, but according to the amount of "positioning" fee paid to the exchange.

  • In auctions , sellers list items, and bidders bid against each other, usually without knowing anyone else's bid. Auctions are noted for lots of anonymous sellers and buyers.

  • In a reverse auction , buyers list items they want and sellers do the bidding, again usually without knowing anyone else's bid.

  • Collaboration hubs are much more than mere exchanges because they allow invitation-only buyers and sellers to work together on projects, from design through procurement to installation/construction/manufacture. Participation is limited to those with the computer capability to electronically interface with the hub in all aspects of a project. Unlike other kinds of hubs, services as well as products are sold/bought, but the main emphasis is on enabling predefined partners to exchange information.

  • Buy-sell exchanges electronically match lists of items wanted against lists of items for sale, sometimes aggregating on the sell or buy side to lower the selling price. Business is transacted offline.

  • Mixed mode exchanges offer multiple ways of doing business: catalog, auction, reverse auction, etc.

  • A new flavor of exchange is the local exchange , which is designed to enable companies in a geographic region or area to trade electronically, regardless of industry. Such exchanges don't promote disintermediation but make it easier for customers to shop around.

Disintermediation doesn't always mean that wholesalers are put out of business. Sometimes it means additional downward pressure on prices and margins, which in turn can lead to a gradual loss of customers and perhaps voluntary discontinuation of product lines. On the manufacturer side, disintermediation can take the form of less ability to negotiate, and perhaps the involuntary loss of entire product lines as manufacturers sell direct to customers.

Disintermediation can also mean that a distributor's traditional role as a source of product information is reduced, thereby giving customers less reason to interact with and buy from the traditional distributor. The potential for disintermediation is greatest for wholesalers that sell commodities to commercial and industrial accounts that don't need immediate delivery.

I can't be disintermediated; I handle the logistics. Taking a clue from the business-to-consumer exchanges, B2B exchanges have arranged with delivery services and trucking com- panies to handle the shipping and delivery. Some well-established carriers have created special divisions and entered into arrangements with exchanges to handle the delivery of their orders (which tend to be less than a truckload and not so attractive to mainline carriers). Thanks to exchanges and logistics arrangements, distributors no longer have franchised territories; customers, distributors and manufacturers can sell/buy from coast-to-coast and beyond.

Easy to join, but everyone looks the same. Setting up a site (permanently on a catalog exchange or temporarily, as for an auction) on most exchanges is pretty easy, because all the various pages are "forms": A registrant fills in predefined boxes. General terms of doing business (e.g., payment terms, returns policies, etc.) can be defined, and some buy-sell exchanges and collaboration hubs allow terms to be defined for specific trading partners. This information is stored in a database that is part of the exchange. On some exchanges, "dynamic information" such as item availability and pricing is keyed into forms meant for only that information. On other exchanges, registrants insert hot links to their business system, because they contain the dynamic information.

One turn-off on exchanges is that every registrant's site looks pretty much the same as everyone else's. Logos, colors and font sizes can vary, but there are no major differences in look and feel. But that standardization is mandatory in order to have an exchange. Without the ability to visually convey the uniqueness of each distributor's service and business practices, exchanges are trading places where price rules. Even the ability to define partner-specific terms of doing business is not as flexible as the main business systems of many wholesalers, yet that flexibility is needed in a world where "deals" increasingly outnumber official terms.

The razor is cheap, but the blades cost a fortune. The initial cost of joining an exchange is usually less than the cost of creating a site of any significance. But most exchanges charge sellers a transaction fee or percentage of sales, in addition to a modest set-up fee and a nominal monthly maintenance fee. Some exchanges don't charge on the meter.

Simple math shows that it doesn't take too many online sales for fees to reach significant levels. Even if the use of an exchange brings in new business, over time the usage and other fees can be a very expensive method of marketing. But if most sales come from existing customers, a wholesaler would have to get a lot of incremental sales and/or reduce internal expenses substantially to pay for this extra cost -- especially when margins on sales tend to be lower on exchanges, because exchanges tend to be a buyer's marketplace. Over the long term, an exchange could cost considerably more than creating and maintaining a private Web site.

Tying into the main business system. Very few exchanges allow tying into a main business system, which means that dynamic information has to be kept up-to-date by hand -- a time-consuming process. The more dynamic the information involved, and the more it changes, the more effort is required. Inventory availability and customer-specific pricing are just two of many kinds of dynamic information that make a site beneficial to customers, and they increasingly expect to have access to such a site.

There are two kinds of tie-ins that are helpful: the hot link from a site to its owner's main business system and an automatic data transfer from a main business system to the database of an exchange. As mentioned previously, the lack of a tie-in means that sales orders must be printed by the wholesaler and the information then keyed into the main business system.

The lack of a tie-in capability makes sense for those who operate the exchanges. Providing a tie-in to numerous different computer systems, some of which are heavily modified, would be a monumental undertaking. Some exchanges do provide links for tying into a few high-end software packages, used primarily by very large companies, but these are not of any help to most wholesalers.

A tie-in that can tie you out. A few exchanges are trying to create a fully automated electronic information exchange between the computers of predefined buyers and sellers, such as wholesalers and their manufacturers. Data automatically transferred from a distributor's computer to an exchange is in turn transmitted to the computer of a predefined trading partner, which acts on it. For example, sales information transmitted to a manufacturer would allow the manufacturer to determine when to ship goods. This may seem like a great idea, but when it is applied to manufacturers and end users such as contractors, we now have fully automated electronic disintermediation.

Thanks a lot for the competition. Most exchanges do not preclude competing wholesalers from joining. In fact, they are recruiting all wholesalers in the industry addressed by that exchange. This means that public information can be viewed by anyone accessing the site, even non-registrants. Information that is restricted to registrants or specific registrants (such as trading partners) might still be viewed by competitors, or viewed by "friends" and made available to competitors.

As troublesome as overly widespread information can be, there is an even more immediate problem for wholesalers: Customers can easily identify competitors, including new ones they never knew existed (virtual wholesalers, brokers, etc.).

Quality. In exchanges that allow registrants to remain anonymous, buyers don't know the reputation of the seller and so don't know about the quality of the merchandise. If items turn out to be damaged, who pays for return freight, even if a refund of the purchase cost is guaranteed by the exchange?

Viability. Most industries can support two or more exchanges; some industries, only one. So sooner or later, a number of exchanges will fail, and given the free-fall flight from dot.com common stocks, it may be sooner. One of the reasons for failure is that some exchanges will burn through their irrationally provided "vulture" capital before beginning to generate sufficient operating cash flow. Wholesalers who invest a lot of money when sponsoring or joining an exchange that fails will lose money and time.

Another reason for upcoming failures is that many manufacturers are finally creating their own Web sites. So are many of the larger wholesalers. Their use of affordable and easy-to-use Web-building software and outside services should hasten the decline of some exchanges.

Experience? Some exchanges are headed by people great at raising money, marketing and technology, but not well-versed in distribution. They know very little about distributor-customer and distributor-manu- facturer relationships and daily business practices. The result can be an exchange that is not very practical to use.

Fight or join? Although many if not most of the current exchanges will not survive, exchanges are here to stay. Some have already recognized that they need to be more than an online trading pit, and offer registrants special services, such as financing of large orders. But considering the cons of exchanges, wholesalers may not want to rely on them as their only, or primary, method of e-commerce; yet they should certainly investigate them ASAP. On the other hand, wholesalers who don't have true e-commerce Web sites should now more than ever get them -- even if they join or use exchanges.