How to make money from B2B e-marketplaces

When it was set up in 1998, conditions looked promising for Chemdex, a marketplace for the life sciences industry. By its own estimates the US market was worth $15bn to $20bn. With over 5,000 suppliers and 3,000 buyers of life science equipment registered in the US, it was rich pickings.

Even as Chemdex announced its forthcoming closure last month, the exchange boasted 140 enterprise accounts and 30,000 registered individual scientists. Around 1.7 million products from 2,200 suppliers were on offer. Research company Forrester rated them as the exchange with the fourth highest liquidity worldwide.

An image revamp and functionality overhaul at the hands of Razorfish last autumn came too late. The exchange plans to close at the end of March. Its subsidiary operation, Promedix - a marketplace for specialised medical products - closed last Friday. So where did it all go wrong?

Mark Lane, European vice president of marketing with Ventro, the company behind Chemdex and Promedix, said: "We learned that the cost of building marketplaces is deceptive. It's far more than people imagine."

Chemdex evolved over 18 months at a cost of $50m, with Ventro stumping up 100 per cent of the equity. It spent another $334m buying out Promedix. Losses arising from the closure of the two sites are expected to total about $410m. Lane agrees that the sums don't add up.

"The financial climate in late 1997 was very different. It was imagined that you could live on the transaction fees. Now we know that isn't possible," he told silicon.com.

With its fingers burnt, Ventro now opts for a joint venture approach, holding just 25 per cent of the equity in subsequent marketplaces. Broadlane, a marketplace for the healthcare industry set up in partnership with US healthcare giant Tenet, took just six months and $10m to get off the ground.

Within a year it was transacting more business then the total combined volume of Chemdex and Promedix - both of which had been in business for over two years - with Ventro increasingly taking on the role of service provider.

"We weren't bright enough to see that this is what we should have been doing from the start," admits Lane.

The end result is that Ventro is reinventing itself as an MSP (marketplace service provider). Rather than building and operating vertical marketplaces - and consequently competing with powerful industry consortia exchanges - the company will now position itself as an e-services company for B2B, providing everything from a recruitment service to ASP hosting options.

If its own forecast is to be believed, it's a sure-fire bet. There are approximately 1,500 exchanges worldwide, each predicted to spend between $10m and $25m a year on technology and consultancy services. However, many would argue only a fraction of that figure are actually operational businesses.

And Ventro isn't the only one feeling the pressure of disappointing transaction revenue and increased competition. B2B veteran VerticalNet recently sold one of its most lucrative online marketplaces to a consortium exchange set up by leading electronics companies, with an agreement to supply services to the exchange.

James MacAonghus, research analyst with Jupiter Research, believes this service provider model is the right approach for independent marketplaces feeling the squeeze from big industry rivals.

He says: "An independent marketplace doesn't want technology to be its core competency. When it does it is not making revenues any other way.

Exchanges can choose between off-the-shelf packages from names they can trust that might not be as tailored to the particular market, or customised technology from an independent MSP. But as Ariba and Commerce One are getting better at offering tailored software, there soon won't be a need for independent marketplace technology - and that's why added services are important."

But the threat of powerful industry consortia and poor financial returns are not the only reasons for the gradual evolution of the MSP. The change is more about competing than surviving, according to Nigel Montgomery, analyst with B2B research house AMR.

He says: "Costs for services are three to six times more than the cost of software, so there is a lot of money to be made. Services are a way [for smaller players] to gain dominance in a market. They think, 'Why give away service revenue when we can do it ourselves?' It could be a survival tactic for some, but most just want a bigger slice of the cake."

Montgomery believes the change will be good for many sectors. Market leaders like Ariba and Commerce One will be forced to deliver packaged solutions tailored for vertical industries, and find new channels to market, possibly through partnerships with the MSPs.

In turn, smaller companies that currently find the cost of customising technology prohibitive, can take off-the-shelf solutions designed for their market and have an MSP implement them with significant cost savings.

Recent IDC figures confirm that the market for B2B eservices is set to expand. The market was worth $2.5bn in 1999 by 2004 it will be worth $15bn with more demand coming from individual exchange members rather than the exchanges themselves.

Nobody realises that change more than the MSPs themselves. As Ventro's Lane points out, in 1997 Ventro built online exchanges, it could not have visualised the concept of the MSP, a concept set to become its bread and butter.

But as in the case of Chemdex, there could be other lessons to be learned.