Survival of the fittest

What will the online MRO exchanges look like when today's dot-com shakeout is over and done with?

By Bridget McCrea, Contributing Editor -- Industrial Distribution, 1/1/2001

Though some industrial distributors embrace them, online exchanges still have a long way to go before becoming what they long to be: the mainstream avenues for getting products to market.

Call it a shakeout, call it an upset or call it inevitable. By whatever name, the facts are clear: consolidation and change are in the air for the online MRO exchanges that came on strong in late-1999 and early 2000, promising to streamline operations and save money by matching up buyers and sellers via the Internet.

These exchanges, typically backed by oodles of venture capital or other private investments, go by names like Vertical Net, PurchasingCenter.com (now known as Excara), MRO.com and Buildpoint.com. So far-at least in the eyes of the independent industrial distributor-few have actually delivered on their promises. And those that have are now either changing their models, changing their names, consolidating or partnering with other exchanges, or altering their transaction fee structures to entice more participation.

It's no surprise really. A close cousin to the dot-com e-tailers who took a dive back in April 2000 and have yet to surface, the online MRO exchange is a brand new concept that needs time to grow and evolve. But that doesn't mean there isn't a place right now for the online MRO exchange with deep industry experience, a reasonable timeline in which to grow and a raison d'etre that goes beyond just making money off of a transaction that probably would have been completed offline just as seamlessly.

"Six months ago, everyone was in and people were investing heavily, and markets were springing up every day," says Wayne Stein, managing director of KPMG Consulting, LLC in Detroit, Mich. "Now many of those companies are struggling to find their real value proposition in the market. Over the course of time, many of these companies will merge and bring their services together, and some will just go out of business altogether."

Using an online exchange

Despite the confusing transformations that online exchanges are going through, some industrial distributors are already using them successfully. Take Applied Industrial Technologies, for example. This Cleveland-based distributor of bearings, power transmission and fluid power systems has tapped into a portfolio of five different online exchanges (or the software providers that power them), including Ariba, Commerce One, ICGC, Datastream and most recently, MRO.com.

"We've partnered with Datastream longer than any other," notes Jim Hopper, Applied's vice president and CIO. "Most of our volume comes through them, but we also work in tandem with the others to not only supply the right kind of information, but also interact with their systems to make the buying experience a seamless process for purchasing agents."

Through Datastream, Applied has opened up its entire catalog to online customers-totaling two million different part numbers. "That works best for us because the nature of our business is to have the full catalog available for the user," says Hopper, adding that the catalog is only accessible to existing customers with established accounts, mainly because some products can pose a hazard if improperly used.

The real challenge of the online marketplace, says Hopper, is that large customers typically need only a few parts a year from such a vast catalog. "We're in a break-fix business," he notes. "Customers come to us to buy a part when a motor, belt, sprocket or other part breaks on their machines," he explains. "As a result, we don't get a lot of repeatability and we need a very broad product offering."

But storing those two million parts poses a challenge to the marketplaces themselves, says Hopper. Especially when it comes to storing the data and keeping it up to date. "It also poses a problem for us because we don't want to have to keep seven versions of our two million-item catalog up to date," he adds. "That's hard enough to do in-house."

One online exchange that's attracting its share of distributor participation is BuildPoint Corp. of Redwood City, Calif. According to BuildPoint's founder Peter Daley, his online marketplace that serves the construction industry can benefit industrial distributors in several ways. For starters, distributors can use the company's e-commerce functionality at a low cost to streamline their business processes and provide customer service through already-established capabilities. All this can happen, says Daley, without incurring the significant upfront and ongoing costs of developing and maintaining an advanced e-commerce Web site.

Unconvinced of value

However, Dave Crannell, president and CEO of Safety Equipment Co. in Tampa, Fla., is one distributor who isn't convinced of the true value of the online exchange to the distributor. As a small, independent distributor, he says his own foray into the online exchange world has been time consuming and tedious at best. "We're currently getting one set up, but it has been a very complicated process," he explains. "The process is moving along, but it's still very complex and the going is slow."

When it comes to assessing the usefulness of online MRO exchanges, Crannell says the "hype is definitely way ahead of the reality."

"I don't think there is actually that much business occurring through them," says Crannell. "The exchanges themselves have to work on the end user to adopt their methods, then somewhat simplify what they are trying to do. The whole thing is very confusing at this point, and the benefits of it all are still not as clear as they need to be."

Battle over transaction fees

Along with the confusion brewing over the exchanges themselves, there exist several other issues on which industrial distributors remain focused. The most thorny of them is transaction fees and how to handle them.

KPMG Consulting's Stein calls transaction fees "a major battleground," and adds that early exchanges came out of the block ready to charge three to five percent across the board. "When you looked at very high capital expenditures, that percentage was even higher," he explains. "Today, because of the increased competition, fees have fallen to between one and 1.5 percent, sometimes even lower, based on a total distribution."

To succeed in the future, Dan Raisovich, president of Remote Inventory Systems Co. in Irvine, Calif., an inventory control service for distribution companies and marketplaces, says exchanges will have to go a step further and move away from those transaction-based models. The solution, he says, may lie in subscription-based models. In other words, sellers would pay a flat monthly fee to use the exchange, rather than paying out a cut of each transaction.

Brian Fihn, e-business development manager for Fastenal Co., a distributor in Winona, Minn., says the issue of transaction fees becomes even foggier for distributors when one exchange uses a vastly different revenue model than the next. Some, he says, are seeking an eight to 10 percent margin, while others are strictly transactional.

"Pricing gets difficult for the distributor," says Fihn. For example, on the Ariba network Fihn says Fastenal's products will actually be distributed through a half-dozen different companies-all of which have a different revenue model.

"The real questions for the distributor are 'do I protect my interest on my price? And, how do I assure that I am the lowest price if I need to be?" says Fihn. "[Distributors] aren't going to be willing to take a three, five or seven percent hit on a product just because they're going through an exchange."

Wolves in sheep's clothes?

And while those exchanges continue to try and lure distributors with promises of streamlined operations and lower costs of going to market, some compare the intermediaries to wolves in sheep's clothing. That brings up the "D" word-disintermediation-a term most distributors would rather steer clear of.

"We recognize that our average margins as a company are around 50 percent, so we see that as the next area for some of these [exchanges] to attack," says Fihn. "The next thing they'll do is ramp up their values and say 'Well, wait a minute, I am selling this item to 25 different customers in the country, so why don't I go off and buy this from one manufacturer source and sell it at the same price but make more margin on it by cutting into the distributorship's margin and the expense of fulfillment?'"

Crannell doesn't see that happening anytime in the near future, namely because servicing the products is a good portion of a distributor's job. In fact, it's why they exist as intermediaries at all: to help manufacturers get their products to market and keep them there.

"I don't think our manufacturers are inclined to sell direct because they still need the distributor for the sales and marketing effort as well as the after-sale support," says Crannell. "They don't want to alienate their distribution base." In fact, Crannell says he's had conversations with several manufacturers, none of whom have expressed any interest in going direct to consumers. "We're seeing more online exchange activity than they are ... it's really just a lot of hype and not very much reality from our perspective."

Select a moving target

With many of the online exchanges consolidating and closing up shop, the most recent "hot" button involves the selection of the online exchanges. Much like throwing a dart at a moving target, trying to establish relationships with consolidating and constantly changing companies is a bit of a crapshoot.

According to Jim Whitemore, associate director of global e-markets for SeraNova Inc., a global e-business consulting firm in Edison, N.J., the key is to first look in-house at the distributorship itself and see what can be done internally to join the online exchange market. "If the distributor already owns the final end customers, then they should ask themselves what they can do better to streamline their operations," he says.

If an exchange is the ultimate answer, then Whitemore advises distributors to closely examine the choice of partner from a financial perspective. Ask yourself: What is the health of this company? What is its burn rate (i.e., how fast it's "burning" through its funding)? How long will it be in business? Who are its key backers? What kind of transaction volume is it pushing through? What is the technology built on? Is it built on a proprietary platform, a mainstream service like Ariba or Commerce One, or prepackaged software?

Whitemore advises distributors to also look at the exchange's management team. "I'm dubious about some of them," he explains. "Some of them really don't have that much deep industry knowledge-they're just two guys in a garage who came up with a good idea. In this space you really have to know the industry well and be able to adapt and directly address those needs."

No end in sight

The shakeout among online exchanges may continue for some time, while the real growth in online exchanges may come from the distributors themselves, according to Whitemore. He says various distributors are already developing-or planning to develop-their own private marketplaces on both the buy side and the sell side.

"That's where the rubber is going to meet the road for a lot of these companies," says Whitemore. "They'll set them up themselves or via a possible consortium of several distributors coming together. In the end, I believe the third party model is going to be in trouble for a couple of reasons-most especially if they don't have any big names in their particular industries supporting them."

And when it comes right down to it, even the exchanges themselves admit that the shakeout was overdue. Buildpoint's Daley calls it "healthy for everyone involved" and adds that weaker companies with products that did not gain wide appeal will end up exiting the market. "The shakeout will result in less confusion and less risk in adopting a solution," he says. "Those technology companies surviving the shake-out will most likely be able to garner enough customers to survive and thrive for many years to come."