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White Paper

Advantages of the L-Hub Model for Internet-Based Electronic Procurement

WRITTEN BY Glenn R. George, Ph.D. energyLeader.com http://george.UtilitiesProject.com

The Regional Horizontal Procurement Hub (RHPH), or L-Hub, a concept created by energyLeader.com, offers a potent alternative to existing models of Web-based electronic procurement (or “e-procurement”). Current e-procurement models range from single-company systems to multi-company marketplaces, and from simple exchanges to networked, collaborative communities. The L-Hub is distinct from these market models, yet builds on their strengths. It is a horizontal Internet marketplace that creates value for market participants in a particular geographic region. Because of their regional intensity, service ethic, and standing in the local communities, utility companies are uniquely positioned to create and sponsor such Hubs.

Dr. Glenn R. George is senior vice president, design, at energyLeader.com. He is a former principal consultant for PricewaterhouseCoopers. Dr. George specializes in creating new business models in the deregulated utilities industry and has managed the creation of a B2B capability for a major U.S. utility. He earned a bachelor’s degree in Mechanical Engineering and an MBA from Cornell University. Dr. George received his Ph.D. in Regulatory Policy from Harvard University. He can be reached at [email protected]

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 protectedclass 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 power ful 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 singlebuyer electronic procurement systems. Companies such as Ariba and Commerce One developed the software that supports

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this model, whose primary feature is the use of a single, simple, specialized inter face 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 multibuyer marketplaces, where a group of unrelated companies use a common inter face 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 inter face 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 impe-

tus 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 ser vices 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 realtime 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: inter facing 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 backoffice 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 valueadded services. Examples of potential value-added services include: order matching, one-toone 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 cus-

tomer-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 Webenabled 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 ver tical, an e-procurement inter face for a relatively narrow range of industr y-specific goods, or a ver tical 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.

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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. W E B L I N K

Kimberly Teague of MasterCard and Ronald W. Averett of Princeton eCom discuss the commitment of buyers/customers in their white papers. Teague’s paper focuses on the value of recurring payments; Averett’s emphacizes Electronic Bill Payment and Presentment (EBPP) as an effective CRM tool.

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LEADING NET MARKETPLACE MODELS

Speed to market, decisive governance Speed to critical mass and being cash-positive

Independent Vertical

Buyer Vertical

Universal Horizontal

RHPH (L-Hub)

Excellent

Problematic

Fair

Good

Problematic

Good

Problematic

Good

Fair

Fair

Problematic

Excellent

None

Problematic

None

None

Growth potential Anti-competitive issues

Figure 1

Internet Marketplace Models

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 LHub. 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.

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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 (LHub) 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: • Verticals market their inter faces to buyers by leveraging intra-industry associations and relationships. L-Hubs create value by leveraging regional associations and relationships. • 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-Hub model compared with industry verticals.

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

The utility 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. 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

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 char ter 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 ver tical, but in the highly fragmented utility industr y, local utilities will surely have more influence in L-Hubs than industr y-specific buyer ver ticals. 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.

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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 intermediateterm 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: EExchanges 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.

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