Public and Private Exchanges

If you’ve ever bought anything from Hewlett-Packard Co., you probably haven’t given the company’s logo much thought. But making sure that thin plastic strip gets stamped on every product is always on Corey Billington’s mind.

Last November, the company started buying its logos through a private marketplace that Billington, HP’s vice-president of supply chain services, helped establish between four plastics manufacturers and the 49 contractors that make HP’s products. While the logo is hardly the most critical component, if that supply chain were to break down, Billington figures Chairman and CEO Carly Fiorina would be calling. “It would be an unpleasant conversation,” he says. “[She’d say], ‘You know, we don’t ship products without our logos on them.'”

Billington and his staff spent more than two years building the private network – called GetSupply – and training its manufacturing partners and internal procurement professionals to use it. He estimates the network has trimmed 30 per cent from the cost of the logos – a US$7.5 million savings off an annual US$25 million expense. Now HP is adding its memory suppliers to the exchange. Sharing demand and production data with a finite set of suppliers makes economic sense, says Billington. The private exchange lets HP referee the marketplace, ensuring a steady supply of parts and more efficiently distributing the workload among its suppliers.

Executives in other industries are now deciding whether they should build their own B2B marketplaces or participate in public trading hubs as investors or simply users. As dozens of public exchanges fold and dozens more struggle with profitability, conventional wisdom says smart companies should cement connections with current suppliers and customers, but that wisdom is only partly true. The solution should depend on your business needs.

Looking at a few companies in a single industry such as electronics manufacturing shows CIOs taking diverse approaches to exchanges. When trading proprietary information such as product design or forecasting data with established customers and suppliers, those companies opt for private marketplaces. When buying and selling commodities or finding new trading partners, they turn to a public exchange. And many companies also do business in both environments.

Public exchanges, including established ones such as the steel industry’s e-Steel, hope to boost revenues by hosting private supply networks for their members. At a recent conference, Mohan Sawhney, McCormick Tribune professor of e-commerce and technology at Northwestern University’s Kellogg Graduate School of Management in Evanston, Ill., predicted such hybrid exchanges would become the “markets of the future.”

Whether or not to take advantage of those emerging services is “one of the strategic decisions a CIO needs to make,” says HP’s Billington. “Let’s think about the most private of private exchanges, a one-on-one. When I talk to the Converge people, they say, whatever we pay [for that capability], they’ll do it for 20 per cent less. We’ll have to think carefully about that.” HP was one of 15 companies that helped found Converge Inc., a public exchange for technology and electronics manufacturers. As HP was building its private GetSupply exchange, the company divested itself of another trading network it had built to buy and sell parts at auction. The network, called Trading Hubs, became the on-line auction system used by Converge. HP now pays Converge to procure scarce parts and liquidate excess inventory.

The interlocking decisions of buyers and suppliers will determine which trading environments take hold during the next few years. “The conditions are not unlike what they’ve always been for a company to [decide] whether it’s to their advantage to deploy a technology,” says Joan Harbin, research director of AMR Research Inc.’s B2B marketplaces practice in Boston. “One consideration is what are your competitors doing? Another is what does it cost?”

Private Properties

Lisa Colnett, CIO of Toronto-based electronics manufacturing services provider Celestica Inc., linked her exchange strategy to that of her customers. Six of Celestica’s biggest customers, including HP, have private exchanges through which they trade information with Celestica on product designs, sales forecasts and production capacity. Two others, Cisco Systems Inc. and Sun Microsystems Inc., have famously eschewed public exchanges. “We set up an infrastructure to have secure links with our customers even before [exchanges] came along,” Colnett says.

Two years ago, Celestica set up a portal for its 10,000 suppliers, 1,000 of which now use it to pull production planning information from the company’s supply chain systems. When Celestica gets demand forecast data from Sun, for example, suppliers can view it through the portal and let Celestica know how quickly they can get the right materials into the manufacturing pipeline. “We’ve been able to significantly improve our time to build, and we utilize assets and people better,” says Colnett.

To build the supplier portal, Celestica dedicated servers, deployed certification software to manage access and used middleware to move information between internal systems. For some partners, Celestica deployed design collaboration software. The hardest part of building links with trading partners, Colnett says, is synchronizing each company’s data and business processes.

It wouldn’t be hard to integrate Celestica’s systems with public exchanges, says Colnett, but she has little interest in doing so because their capabilities duplicate what she has built in-house. Besides, owning the infrastructure through which Celestica communicates with its partners gives her company a competitive edge. Colnett doesn’t attribute specific financial results to Celestica’s private exchange participation, but she does think it helps the bottom line. “Because supply chain [management] is such a critical part of what we do,” she says, “there’s a major expectation that we are leaders in using e-business tools to do that.”

Chris Whitmore, an analyst with Deutsche Banc Alex.Brown in San Francisco, thinks private exchanges are attractive because they’re efficient. “When there’s direct communication between suppliers and customers, information flows more naturally,” he says. Public exchanges can add a needless middleman.

However, Colnett isn’t ruling out using a public exchange in the future. “If we felt there was a design tool that was better available through an exchange and our customer agreed, absolutely we would invest in an exchange,” Colnett says. Meanwhile, she has outsourced some of Celestica’s on-line trade. Celestica implements Ariba’s auctioning software when the company needs to buy commodity parts such as memory capacitors. Last fall, Celestica became an investor in PartMiner, a public exchange specializing in electronics components procurement. Celestica uses PartMiner to dispose of surplus parts and made the investment to influence the services it provides. Colnett decided auctioning capability isn’t strategic, so she doesn’t need to maintain it in-house.

Ready To Go Public?

Public exchanges haven’t become a primary procurement venue because they’re not as reliable as contracts with preferred suppliers, says Whitmore. However, HP’s Billington believes there’s untapped value in public exchange auctions. He says using those hubs can change how companies manage supplies by helping buyers account for the risk of surplus and shortage.

Billington imagines public exchanges that let buyers and suppliers trade not physical goods but positions on future supplies, such as safety stock – inventory kept on hand in case supplies run short. “You don’t use safety stock all the time, but you pay for it all the time,” says Billington. Buyers could use exchanges to build portfolios of options on supplies or even time on manufacturing equipment, then take delivery or trade as their needs dictate. A similar concept is already in play on exchanges that trade bandwidth, Billington says. Telecommunications companies such as Arbinet use exchanges to sell minutes of capacity. “Once we get the right unit we transact in, that we can hedge in. We’re creating markets that are transparent or nearly transparent,” he says. “The efficiency gains are huge.”

Bud Mathaisel, CIO of Solectron Corp. – a competitor of Celestica – thinks public exchanges can help him save money by connecting to each of his company’s 8,000 suppliers and 300 customers, as it costs between US$10,000 and US$500,000 to enable each private connection. This expense includes mapping each transaction and the supporting data on both his and his partners’ systems. Add to that the cost of keeping those interfaces up to date and soon it could cost Solectron more than US$80 million to build and support a completely integrated, private, Web-based trading network.

Public exchanges provide standards for describing data and business processes, making the job easier and less expensive. “The idea would be for Solectron to build one bridge between us and the public exchange and for all our trading partners to do the same, and then its done,” says Mathaisel. More than 200 of Solectron’s suppliers transact business with the company electronically. “That’s an expense we’d like to take out of the system, and one way is to have public exchanges reduce individual connection costs.” Companies could use that infrastructure for private business as routinely as they discuss confidential matters on the phone. (Solectron is a founder of both the Converge and E2Open exchanges.)

Mathaisel thinks the current enthusiasm for private exchanges stems from the immature capabilities of public trading hubs and questions about their ability to stay afloat. Public exchanges, whether they’re owned by a consortium of industry members or independent investors, depend on fees collected from users to finance operations. Almost none of them are making money, and most are still building the systems that are supposed to deliver the greatest value to members.

Solectron has been using public exchanges the same way as HP and Celestica. “We’re doing basic trading,” Mathaisel says. “It requires nothing special, other than standard Web connectivity.” Buying components from a public exchange isn’t new. Solectron has long been a customer of the New England Components Exchange, a parts exchange that existed before the Web, and was recently purchased by Converge.

Mark Jenkins, Solectron’s director of e-business, says the company has been working with one customer to conduct its order management through one of the exchanges, collecting information about changes in demand for products and providing the customer with data on Solectron’s inventory (he wouldn’t name the customer or the exchange). It’s a small step, but a definite improvement over the previous process, which involved faxing and e-mailing data, says Jenkins. Now there’s a single on-line record of order quantities and related data accessible to both companies.

Mathaisel acknowledges that some key customers show no sign yet of wanting to use public exchanges. So Solectron, like Celestica, is working with six large customers on private exchanges and has set up a Web site for suppliers to share planning and inventory information with Solectron’s systems. “The major multinationals have invested millions of dollars in developing proprietary supply chain processes,” observes James Hatcher, director of e-business and supply chain Asia Pacific for global manufacturer QAD Inc. “That’s part of their competitive advantage.”

Private, Public or Both?

Your readiness to share data outside your company is one factor that will determine whether you participate in public exchanges or stick to private networks. Even companies with fully integrated internal supply chains may not have business processes to support exchanging data with trading partners. That’s another reason why private hubs are so popular right now.

“Private exchanges are evolving more rapidly because that is taking baby steps instead of giant strides,” says Rakesh Sood, general partner of Sprout Group, a Menlo Park, Calif.-based VC company affiliated with Credit Suisse First Boston Corp. “Communities will evolve,” he says. “At some point you’ll need to connect to other things out there – maybe a logistics hub or a payment processing hub.” First, companies have to determine what it takes to build those connections and the respective ROI. These experiments are more likely to happen in a closed environment.

Lam Truong, senior vice-president and head of Seagate Technology Inc.’s e-business strategy group in Scotts Valley, Calif., says that before his company uses an exchange to collaborate with its contractors and suppliers on product design it has to install a central repository for all the documents created in that process. Right now, there’s no version control for engineering drawings or specifications that would be necessary if Seagate and its contractors need to rely on them without the benefit of explanatory e-mails or meeting minutes. Putting that repository into production will take a year, Truong says.

He wants to set up a private exchange on E2Open, of which Seagate is a founder. In the electronics industry, “70 per cent to 80 per cent of our suppliers are the same,” Truong says. “We would ask [them], do you want to deal with each of us separately or deal with all of us the same way?”

Terms of Exchange

Public and private exchanges have subtle differences, but they both serve important functions.

Still not sure what exchanges are all about? You’re not alone. “The definition is debated in the market by participants and owners and analysts and vendors,” says Joan Harbin, research director with Boston-based AMR Research. She offers a simple way to think about exchanges – Web sites that let you trade information with your customers and suppliers.

Private exchanges are owned and operated by a single company. The owner uses the exchange to trade data exclusively with established suppliers and customers.

Those exchanges let buyers centralize and manage purchasing from preferred suppliers. Companies also use them to trade proprietary data, such as product designs and demand forecasts, to improve planning and reduce inventory costs. The investment required to participate in a private exchange depends on the extent to which trading partners need to integrate their systems to share data. The exchange owner generally chooses the technology for the exchange and sets policies for its operation.

Public exchanges are owned by industry consortia or independent investors and have their own board of directors. Though each exchange sets its own rules, they are generally open, for a fee, to any company that wants to use them. One selling point for public exchanges is that they provide services and a common technology platform. The services offered by many public exchanges include auctions, spot buying and ordering from participants’ catalogues. They may also offer payment services and industrywide demand forecasts for products or supplies.

Public Exchanges: Safe Bet or Risky Business?

Participants agree public exchanges are valid in concept, if not execution.

When Dave Evans was working on the launch of World Wide Retail Exchange (WWRE) a couple of years ago, he and colleagues from other consumer goods retailers believed a public exchange would let them pool their product demands to improve discounts and transaction efficiencies. Evans was the CIO of J.C. Penney Co. Inc. at the time.

A year and a half after it debuted, WWRE now supports auctions, catalogue orders and bid solicitations from suppliers. It’s also testing systems for sharing sales forecasts. However, the promise of a one-stop marketplace where retailers would collaborate to buy T-shirts and shampoo is losing its lustre. “There’s a lot of software needing to be built that doesn’t exist,” says Evans, who retired in February.

In the meantime, retailers and manufacturers such as Target Corp. and The Coca-Cola Co. are hedging their bets by building private exchanges to connect with suppliers and customers, says Julian Chu, director of retailing and consumer goods with consultancy Mainspring Inc., an IBM company in Cambridge, Mass. Coca-Cola also helped found Transora, a public exchange for consumer packaged goods manufacturers, and wants to get bottlers and customers to share real-time sales and promotion data, although strategic functions like these are better suited to a private forum, says Chu. “A public forum doesn’t provide any competitive advantage.”

Evans says both public and private exchanges are in many companies’ futures. J.C. Penney’s suppliers use a private hub to trade sales information, track inventory and exchange orders and invoices. “We all accept that the more visibility there is throughout the supply chain [about data like] how merchandise is performing, the better off we are,” Evans says. He thinks having a way to reach numerous suppliers or customers through a public exchange can help the buyer get better prices and help the supplier lower sales costs. “Maybe we’re still a little bit foggy about what the final form will take,” but the concept, he insists, is still valid.

Senior Editor Elana Varon writes about B2B e-commerce. Share your exchange strategy with her