Advantages of the RHPH Model for Internet-Based Electronic Procurement


The L-Hub model is positioned favorably in the e-procurement market space,
in large part because of the sheer size of regional economies and the
compelling nature of doing business on a local basis. Regional Hubs offer
unmatched opportunities for purchasing services (as distinct from goods),
sourcing items from minority and protected-class vendors, and reducing
logistics costs. The L-Hub model enjoys certain advantages over both universal
horizontal and vertical Internet marketplaces, though it may be used as
a powerful complement to one or both of them.

Emergence of B2B E-Procurement Business Models

The business-to-business (B2B) e-procurement marketplace represents the
convergence of two trends. One the one hand, it reflects conventions established
in the business-to-consumer (B2C) world, especially single seller/buyer
models. In B2C, most commerce for goods and services is organized around
a single seller (e.g., Land’s End, Amazon.com). Under this model, a consumer
may have to visit multiple marketplaces to compare prices or other terms
and conditions when more than one vendor sells the same product. The single-seller
model adapted easily to the B2B world, examples being Dell and Grainger.

The other trend was the growth of single-buyer electronic procurement
systems. Companies such as Ariba and Commerce One developed the software
that supports this model, whose primary feature is the use of a single,
simple, specialized interface that enables one buyer to compare offerings
and make purchases from multiple sellers.

These single-buyer software pioneers exploited a crucial technological
innovation, the extensible mark-up language data standard, or XML. XML
brings commerce-specific capabilities to the language of the World Wide
Web by allowing business-related information (such as prices, product
numbers, quantities, etc.) to be “tagged” as such using a common, standardized
set of codes. In its several varieties, XML makes it practical for systems
using diverse data formats to exchange transactional information. A buyer’s
e-procurement system can put a requisition out to a seller’s system, even
though the two systems use different data formats.1

These two streams converged into multi-buyer marketplaces, where a group
of unrelated companies use a common interface for buying from multiple
vendors. On the surface, extending the tools of single-buyer electronic
procurement to multiple buyers may not appear to be a great leap forward,
but it represents the difference between a mere business tool and a bona
fide marketplace. For example, with multiple buyers sharing an interface
and generating transaction data that can be aggregated and analyzed, the
market-maker can effectively combine the buying power of multiple small
buyers to give them the leverage of a single large buyer. Indeed, buyer
aggregation is a leading impetus for the development of B2B marketplaces.2
By contrast, in the B2C arena, grouping of buyers is almost unheard of.
Individual consumer demand is not readily aggregated, though Priceline
and others are trying to discover a viable, sustainable model for aggregation.

Different Marketplace Approaches

Just as marketplaces can differ in the number of participants (single
buyer, single seller, multiples of either or both), they can differ markedly
in the range and complexity of services offered. Marketplaces can be anything
from a straightforward online meeting place to an E-hub; they can offer
anything from the simple opportunity to purchase a product, to integration
with back-office supply and delivery functions.

The first Internet marketplaces were simply online meeting places: sites
where buyers could identify sellers and obtain contact information to
facilitate a transaction that would continue, and be completed, offline.
Then other marketplaces in the B2B space started to post online catalogs,
where people could browse through a list of items, add them to their shopping
cart, and eventually purchase online. Standardized goods such as office
supplies lent themselves most readily to this type of sale and procurement,
but as time passed, tools were developed to facilitate trading in less
standardized goods and services. As online marketplaces evolved, one could
begin to see a relationship between the value-added of each new breed
of marketplace and its increased level of complexity.3

Exchanges were the next logical progression to follow catalogs online,
as Web marketplaces evolved, but while this migration added value through
greater flexibility, it also added more complexity. An exchange allows
companies both to buy and sell goods online through three general methods:
forward auctions (seller aggregation, prices rise), reverse auctions (buyer
aggregation, prices fall), and real-time exchange pricing (spot market,
prices rise and fall).4

E-hubs create additional value by offering collaborative services that
build upon the underlying transaction and by allowing the buyer and seller
to interact on more levels than just price. Examples include the following:
interfacing the marketplace with manufacturing and delivery systems, which
can reduce both parties’ inventories; automation of specialized buying
patterns, which can cut transaction costs; and integration with back-office
procurement systems, which can increase overall process efficiency. While
they add complexity to the transaction, collaborative services and process
improvements bring additional value to E-hub market participants that
many believe could be greater than the price savings that are often assumed
to be the primary benefit of electronic exchanges.5

Differences Between the Exchange and the E-Hub

An exchange is analogous to a stock market, where ownership changes hands
with real-time pricing but no goods are actually delivered. Value is created
in the transaction itself, not through allied services. Unlike pure exchanges,
however, E-hubs offer multiple opportunities to “deliver the goods,” so
to speak, through a variety of increasingly sophisticated value-added
services.

Examples of potential value-added services include: order matching, one-to-one
marketing, content aggregation, fulfillment, and back-office collaboration.6
Order matching is simply being able to match the buyer and seller through
the desired pricing mechanism discussed above. One-to-one marketing can
be facilitated by the market-maker’s knowledge of orders matched, which
permits the building of new marketing relationships with previously unfamiliar
buyers or suppliers, or more targeted and helpful advertising. Similarly,
the market-maker’s access to transaction data (which, to protect the privacy
of customers, is not available to users) permits detailed information
on purchasing patterns to be collected, aggregated in a way that eliminates
customer-specific references, and used for the benefit of buyers in negotiating
prices and structuring contracts.

Order fulfillment includes a broad set of processes where the potential
for value-added services is significant. Examples of fulfillment services
include contract administration, financing, insurance, credit review and
provision, and shipping.7 For the E-hub, each additional value-added service
can represent a comparative advantage and an added source of revenue.

Demand and supply chain collaboration is another area in which E-hubs
can add value, particularly where integration involves core process redesign.
An example of such integration is Dell Computer. The business process
has been Web-enabled so the customer has the ability to adapt the product
being purchased to a precise set of needs in real-time, be quoted a price,
and know how long production and delivery will take.

E-Hub Business Models: Tailoring Procurement Advantages to Business
Needs

There are currently four major online marketplace business models, each
of which meets different needs in the market. The needs are driven primarily
by traditional procurement concerns, especially the difference between
manufacturing (direct) inputs and operating (indirect) goods. Direct inputs
are generally production goods, which are largely industry-specific and
are typically targeted by vertical Internet marketplaces. Indirect inputs,
on the other hand, cut across multiple industries and are a good fit for
horizontal marketplaces, which serve multiple (or all) industries.8

The first B2B multi-buyer marketplace form was the independent vertical,
an e-procurement interface for a relatively narrow range of industry-specific
goods, or a vertical slice of the economy. Still the most common form,
these marketplaces were developed independent of the buyers (and sellers).
Examples of independent verticals include Chemdex, PlasticsNet, and SciQuest.

These independent verticals face considerable liquidity challenges. Until
enough purchases are made through the market, its bargaining power to
get lower unit prices is limited. Yet it must demonstrate this power to
attract the necessary critical mass of buyers and sellers.

The second B2B marketplace form, currently in vogue, is the buyer vertical.
As with the independent vertical, the buyer vertical focuses on a relatively
narrow range of industry-specific manufacturing, or direct, inputs. Buyers,
such as automobile manufacturers and petroleum majors, typically develop
these marketplaces.

While the independent vertical must cope with the liquidity problem,
the buyer vertical must cope with two insidious issues. First, buyer verticals
require competitors in the same industry to coordinate and act at Internet
speed. Just how formidable this task is when competing entities are involved
has been underscored by the relatively slow start of buyer verticals in
the automobile and utility industries. As difficult as this neutrality
problem is,9 government antitrust authorities may create a second hurdle,
leading buyer verticals not to coordinate in a number of crucial ways.10

The third and fourth B2B marketplace forms are horizontal, encompassing
all vertical slices of the economy. The universal horizontal intends to
serve any business, whatever its industry, location, or size. AOL and
PurchasePro, in a joint venture, are developing a universal horizontal,
as are others. OnVia.com is another variation, offering to serve any small
business. Extreme breadth is as much a liability as a virtue for universal
horizontals.

The regional horizontal procurement hub, or L-Hub, created by energyLeader.com,
serves a particular geographic region’s businesses and non-profit institutions
of all kinds and sizes, capitalizing on local cohesiveness. A wide variety
of goods (both indirect and direct) and especially services can be procured
through an L-Hub. energyLeader.com is working in partnership with utilities
in several parts of the country to develop an L-Hub in each utility partner’s
region.

Every region has dozens of businesses, hospitals, universities, school
districts, and local governments with enormous unmet e-procurement needs.
Knowing a region’s businesses and institutions, and having the regional
standing to leverage procurement opportunities, are core competencies
required to build L-Hubs.

Significantly, because of the sheer size of regional markets, L-Hubs
can develop liquidity more quickly, continue to grow longer, and achieve
larger steady-state size than competing Internet market models. For example,
many individual states have a regional accessible market (a measure of
the total transaction volume that could go through a Net marketplace)
in the hundreds of billions of dollars – far larger than most vertical
industry groups. Because all Internet marketplaces must grow over time,
regional horizontals may have a sustainable competitive advantage.

Some important characteristics of the four different business models
can be summarized as illustrated in Figure 1.

Figure 1
Internet Marketplace Models

Figure 1

Vertical versus Regional – A Comparison

Whatever its form, a multi-buyer marketplace must aggregate a critical
mass of buyers to attain the necessary bargaining leverage to drive down
unit prices. The buyer vertical and regional horizontal (L-Hub) forms
have a decisive head start, since they launch with the commitment of buyers:
Buyer verticals have committed buyer-owners, whereas regional horizontals
start with “Charter Buyers,” a small group of committed users of the L-Hub,
including local businesses and institutions.

A major hospital, for example, can use one or more independent verticals
(Medibuy, Neoforma, Chemdex, SciQuest), join a buyer vertical, or join
an L-Hub. Each of these alternatives offers specific advantages and certain
drawbacks:

o ?Verticals market their interfaces to buyers by leveraging intra-industry
associations and relationships. L-Hubs create value by leveraging regional
associations and relationships.

o ?Verticals excel in driving down unit prices of specialized goods that
buyers in a narrow industry procure in large quantities no matter where
they are located. Regional horizontals excel in driving down unit prices
of a broad range of goods, and particularly services, that buyers within
a region procure in large quantities. The value proposition is compelling,
particularly for indirect inputs. The transactional cost savings are estimated
to be 3.5 to 5 times greater for indirect inputs than for direct inputs,
reflecting the higher volume and generally smaller value per order of
indirect transactions.11 This underscores the potency of the L-Hubmodel
compared with industry verticals.

Given these opportunities, the hospital might go exclusively with a vertical
or a regional horizontal, but it is increasingly likely that buyers will
use multiple procurement channels in ways that maximize value. For example,
buyers may loosely separate direct procurement from indirect, with the
industry vertical capturing a large portion of highly specialized direct
goods and the L-Hub capturing regional and indirect goods and most services.
The L-Hub will also be the solution of choice for goods and services procured
from minority and protected-class vendors, who tend to be local or regional,
and for items (such as bulky goods and frequently purchased products)
where logistics costs are significant but can be reduced through geographic
propinquity. Over time, various e-procurement interfaces will develop,
allowing the markets to interconnect seamlessly (as users “punch out”
or “round trip” from one to another).

Of course, these phenomena may vary by industry and region, and over
time. Nonetheless, evidence suggests a trend toward both specialization
and coexistence of multiple marketplace forms. Buyers will use both vertical
and regional horizontal markets on a complementary basis. Both kinds of
Internet marketplaces will succeed because each creates value.

An Imperative for Utilities

Utility companies, especially in the energy industry, are currently searching
for both e-procurement solutions and ways to create value through e-business
initiatives. L-Hubs provide a unique opportunity for utilities to accomplish
both ends in one initiative.

First, utility companies can both sponsor and use an L-Hub. As sponsor,
the utility can build its brand and strengthen customer relations. It
can capitalize on its long-standing role as a community and economic leader
– advantages shared by no other regional entity – to attract a sufficient
number of charter buyers. Charter buyers, in turn, allow the L-Hub to
aggregate a substantial amount of the regional buy as rapidly as possible,
building necessary liquidity.

As user of the L-Hub, the utility provides a large, locally oriented
procurement requirement, further building liquidity. They can help define
the goods and services available through the L-Hub, and the procurement
processes followed. The level of influence may not be as high as in a
single-buyer vertical, but in the highly fragmented utility industry,
local utilities will surely have more influence in L-Hubs than industry-specific
buyer verticals. This increases and deepens the utility’s opportunities
for supply chain integration with the L-Hub, enabling a higher level of
cost savings.

Second, as owner of an L-Hub, a utility company has an unparalleled opportunity
to create shareholder value. The utility is the majority, controlling,
and branding owner of a bona fide, profitable e-business enterprise. As
such, it reaps the majority of the financial benefits – including large
upside potential – that accrue to such ventures. Such benefits are significantly
greater than could be conferred by, for example, a small ownership share
in an industry vertical.

These unique and compelling advantages present a strong case for utility
companies to consider building L-Hubs. Those that do so will stand among
the winners.

Footnotes/References

1 XML also has dethroned the EDI data standard, which was used in a primitive
ancestor of e-procurement. EDI requires the buyer and seller to agree
strictly on format details, an impracticality in modern e-procurement.

2 Harvard Business Review, “E-Hubs: The New B2B Marketplaces,” by Steven
Kaplan and Mohanbir Sawhney, May-June 2000, “The Emergence of Reverse
Aggregators.”

3 Exhibit 23, “Evolving from Exchanges to E-Hubs,” graphically depicts
the relationship between increased value and increased complexity of the
marketplace in Morgan Stanley Dean Witter Equity Research, “The B2B Internet
Report: Collaborative Commerce,” Charles Phillips and Mary Meeker, April
2000.

4 www.netmarketmarker.com.

5 Numerous investment bank research reports have indicated a belief that
the short and intermediate-term cost savings are only the beginning and
that the longer-term process improvements can lead to significant additional
cost savings and potentially be revenue enhancing, according to CSFB eCommerce
Research, “The B2B eVolution,” by Christopher E. Vroom, et al., May 2000.

6 Exhibit 26, “E-Hub Layers of Value,” provides a good illustration of
this point. It can be found in Morgan Stanley Dean Witter Equity Research,
“The B2B Internet Report: Collaborative Commerce,” Charles Phillips and
Mary Meeker, April 2000.

7 For a more extensive list of potential value-added services for E-hubs,
see Exhibit 25, E-Hub: Collaborations and Value-Added Services, in Morgan
Stanley Dean Witter Equity Research, “The B2B Internet Report: Collaborative
Commerce,” Charles Phillips and Mary Meeker, April 2000.

8 For more on this distinction, see Harvard Business Review, “E-Hubs:
The New B2B Marketplaces,” by Steven Kaplan and Mohanbir Sawhney, May-June
2000.

9 e Company Now, “Corporations of the World Unite! You Have Nothing to
Lose but Your Supply Chains!” by Erick Schonfeld, June 2000, www.ecompany.com.

10 U.S. Federal Trade Commission and U.S. Department of Justice, “Antitrust
Guidelines for Collaborations Among Competitors,” April 2000, Section
3.31(a), Relevant Agreements that Limit Independent Decision Making or
Combine Control or Financial Interests, “Buying Collaborations.” See also
Business Week, “Commentary: E-Exchanges May Keep Trustbusters Busy,” by
Dan Carney, May 1, 2000.

11 CSFB eCommerce Research, “The B2B eVolution,” by Christopher E. Vroom,
et al., May 2000.