Volume V, Number I

The possibilities for business-to-business transactions on the Internet seemed boundless just a few years ago. Electronic marketplaces were making headlines-touted as Web-enabled intermediaries that could match suppliers with manufacturers for products as diverse as chemicals and steel, car batteries and circuit boards. According to several analysts, some ten thousand sites would be offering their services over the Internet. But reality never came close to that. As the Wall Street Journal reported, the actual number was more in the neighborhood of fifteen hundred. And many of those start-ups were short lived. What happened, and what's the condition of the genre today? To answer these questions, HBS Leading Research spoke with assistant professor Andrew McAfee, whose research and course development efforts have focused on these issues.

What led to the proliferation of the e-marketplace concept?

Entrepreneurs identified a lot of industries where there were a large and fragmented number of buyers, as well as numerous suppliers-of various sizes and levels of sophistication-eager to reach out and sell them their goods. The traditional way to do that was to establish individual links between each buyer and supplier. A viable alternative seemed to be to create an e-marketplace sitting in the middle of all these parties, ready to become the platform for trade across a particular vertical industry.

A colleague of mine coined a wonderful phrase to describe this model. He called e-marketplaces "fat butterflies"-butterflies because they stretch their wings between buyers and suppliers, fat because they offer a broad range of value-added services such as making technology connections, arranging credit for transactions, and solving logistical problems. The attraction of one convenient link capable of doing all this presented a compelling picture that attracted probably billions of dollars from investors.

In these different kinds of ventures, was there a common initial strategy?

Like many other e-businesses, they built their hopes from the start on what is called the "Get Big Fast" strategy. The idea is to spend a lot of money up front, build a brand, penetrate the awareness of customers, create back-office capabilities, and at first give away most products and services. To bring in customers this way and take advantage of hoped-for network effects is quite expensive. As a result, investors must be willing to fund this initial period of the enterprise and hope for the best going forward. But in time, this strategy for building e-marketplaces fell on hard times.

What went wrong?

First of all, in many industries there were simply too many companies trying to be the e-marketplace of choice. Take the chemicals business, for example. By one count, there were about seventy e-marketplaces announced or founded in that sector. When potential customers are confronted with that many choices clamoring for their attention, they tend to sit on their hands and wait to see which e-marketplace rises to the top. Under those circumstances, of course, no venture does.

In addition, building the physical structures and the complex technology that customers need to run all their transactions through an e-marketplace turns out to be a difficult challenge-one that many ventures couldn't pull off. As one analyst observed, the laws of software development are not, in fact, suspended in the age of the Internet. To think that it was possible to build and deploy a high-functioning system with maximum capabilities in a minimum amount of time was unrealistic. But you wouldn't know it from looking at most of the business plans.

Finally, these companies frequently made assumptions that had to be right on the bull's-eye for them to grow and reach profitability; they allowed themselves no wiggle room whatsoever. The best example of this actually comes from the business-to-consumer sphere. Webvan built 300,000-square-foot automated warehouses whose role was to take palettes full of groceries on one end and turn out customized, bagged orders on the other. These facilities needed to work like clockwork if the company was to succeed. It also had to have plenty of customers and big orders to cover fixed costs. None of these assumptions came true, and the business plan fell apart fairly quickly. To one degree or another, that scenario was repeated over and over again in other e-businesses.

	I think we'll learn lessons from the first generation of B2B failures and move on to build internet-based platforms within industries that do make sense.

Your research also points to another fatal flaw in the e-marketplace blueprint-underestimating the impact of real, live intermediaries.

Exactly. Almost every real-world vertical industry contains a group of "middlemen" who sit between buyers and sellers and perform several important functions that make markets run more efficiently. A lot of them are hedgers who will take a position and then try to make a deal happen by bundling here and repackaging there. Say supplier A wants to sell ten thousand units of something, but manufacturer B wants to buy only three thousand. An intermediary will jump in and buy all the items, sell the three thousand, then recombine the rest to make a variety of other sales. That's a service Web sites can't duplicate very well. They can easily identify matches, but can't easily resolve mismatches. Many existing intermediaries, on the other hand, make their living off of mismatches, and they provide liquidity to the markets in which they function. The importance of this role doesn't go away just because there's a new computer network available.

Not surprisingly, middlemen also saw e-marketplaces as a threat to their livelihood. They were, therefore, reluctant to offer a helping hand to them, but more than willing to leverage their relationships with old customers to try to protect themselves from their latest challenger. So, combine their lack of cooperation with the other factors I've mentioned-too many e-marketplaces coming online at the same time, false assumptions in one business plan after another, and operational glitches galore-and it comes as no surprise that lots of these ventures were doomed from the start.

You've painted a bleak picture of the past. Is there any hope for better things to come?

I'd say so. The Internet and other information technologies are not going away. Nor are industrial markets. I think we'll learn lessons from the first generation of B2B failures and move on to build Internet-based platforms within industries that do make sense. One thing's for sure, however: Progress will be much slower than we thought at first blush, and in the midst of continuous and complex change, the manager's job will be even more challenging.

The fundamental problem we face is using IT to enable business-to-business processes such as electronic purchasing, fulfillment, inventory control, and customer service. We have the technology tool kit we need to accomplish this, including the latest addition, an Internet language known as XML that allows computers to talk to one another directly. With that, we bypass people playing phone tag about an order and rely completely on computers to figure things out in a couple of milliseconds.

To accomplish that, however, each industry has to standardize the way it does things, so there's no confusion or delay when one firm wants to check a price electronically with another or report an item out of stock. This means that corporate representatives have to hammer out lots of details, and it remains to be seen whether every company across an industry will be willing to participate. Big players, for instance, might not want to join in with everybody else, while others might be reluctant to agree to standardized procedures that leave them without their own source of competitive advantage. But the long-term benefits of standardized processes are impressive: Manufacturers and suppliers will be able to collaborate faster and more productively than ever before on planning, forecasting, and replenishment. The computer industry has already moved toward this goal with a consortium called RosettaNet; it remains for other industries to follow in its footsteps.

In the aftermath of the dot-com hysteria, I've heard people say that the era of e-business is over. I disagree. Maybe the era of using e-business as a word is finished, but the actual work is just getting started. Words Winston Churchill uttered almost sixty years ago seem particularly applicable at this point in the history of electronic marketplaces: "This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."

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