Breathing bustle into e-bazaar

G.B. Prabhat

GIVEN the downturn in the fortunes of online marketplaces and exchanges, it seems almost heresy to argue in their favour. Yet, online marketplaces and exchanges have the potential to transform global trade. But they will do so only when they truly add value to the participants.

In their current forms that we term first generation (1G exchanges) or second generation exchanges (2G exchanges), they will find it difficult to add the value they are ultimately capable of. To realise their full potential, current online marketplaces must evolve to become third generation exchanges or 3G exchanges. (The terms ``exchange'' and ``marketplace'' are being used interchangeably in this article).

The 3G exchange model is an inclusive model. A 3G exchange includes all the functionality of a 2G exchange, which in turn includes all the functionality of a 1G exchange.

The 1G exchange

Most of today's online exchanges are 1G exchanges. They focus on the performance of an online trade transaction. Their principal job is to bring together a buyer and seller. They allow the buyer or the seller to determine the price using the free market model (auctions and reverse auctions) or use the relationship model to help the buyer complete the transaction on pre-negotiated prices (most direct materials or direct service purchases).

A 1G exchange performs essential services of the completion of a transaction such as verifying identities, performing credit checks, providing payment mechanisms and ensuring the security of the transaction. The fundamental function of a 1G exchange is to provide the electronic premises for a marketplace transaction. The exchange is not endowed with a great deal of intelligence. Its direct participation in the transaction is minimal. Consequently it does little to influence the transaction in any meaningful sense.

A 1G exchange also generally trades in well-defined products or services. Examples of 1G exchanges are those that permit purchase of materials (both direct and indirect materials) in industries such as chemicals and auto. 1G exchanges would also include private e-procurement marketplaces that function thus, as these are only specific instances of a 1G exchange.

Consider two examples. The first is a logistics exchange that has multiple, independent, small operators offering logistics services, and multiple purchasers of logistic services. A 1G exchange would bring together a buyer of such services and a seller whose selling conditions are acceptable to the buyer. If the buyer and seller signal their agreement to complete the transaction, the exchange then provides the mechanisms for completing the trade.

A second example is an exchange for purchasing machining services. A 1G exchange would help a buyer locate a seller of, say, the service of drilling a 5mm hole, and help complete the transaction if the conditions of one party are acceptable to the other.

The 2G exchange

A second generation exchange -- the 2G exchange -- is a successor of the 1G exchange. It embraces all the functions of a 1G exchange. A 2G exchange distinguishes itself from a 1G exchange in the following respects:

It permits trading in capabilities and processes, besides products and services.

Consider the case of a buyer of machining services for batch production approaching the machining services exchange. Assume also that the components he requires would require shaping, milling, drilling and grinding operations. With a 1G exchange, he would have to look for suppliers with these individual capabilities, purchase their services and individually route the parts to them.

A 2G exchange on the other hand, would have information on the capabilities and processes of the suppliers and not merely on their products and services. What the buyer may have to tell the exchange is the process by which he would like his component to be manufactured. The exchange then locates spare capacities, sequences operations and provides an integrated service quote.

By having prior knowledge of processes and capabilities, a 2G exchange participates with greater intelligence in the transaction.

It improves the overall efficiency of the supply chain by optimisation.

A 2G exchange improves the efficiency of all the participants. Consider the logistics exchange example. Let's assume that a buyer expresses a demand for five trucks. Assume also that no supplier has a capacity greater than three trucks. In the case of a 1G exchange, a supplier would turn down this request since he cannot individually bid for this demand. The exchange cannot provide any assistance either.

A 2G exchange on the other hand, would locate, a supplier A, who has three trucks capacity, locate another supplier B, who has two trucks capacity, and arrange for A to buy the two trucks capacity from B. In many cases A will buy from B at a price lower than B's market price. B may end up selling the capacity at a lower price as otherwise he may not get a sale for it at all during this period. So he ends up selling, not at a loss, but at perhaps reduced margin. This transaction is therefore beneficial to B because otherwise this capacity may not have been sold.

There are three benefits for A. In the first place A has the opportunity to buy the two trucks capacity without having to bear the fixed cost of owning the two trucks. Second, the opportunity to complete the deal for five trucks, which he may otherwise not have been able to complete, thus making margins on the sale of his three trucks capacity. Third, he has the opportunity to make some margins on the sale of two trucks capacity that he bought from B.

This transaction is beneficial, in at least two ways, to the customer also. First, in a fragmented supply situation, the exchange has arranged an almost seamless transaction for his complete supply. He could enjoy a price benefit too. Since A purchased the two trucks capacity at lower than market prices from B, he can price the five truck capacities at lower than market prices overall, while realising his full margins and passing some to B. However, A has the opportunity to now pass on his overall low cost of operations/low price of supplies to the customer as lower price.

The real culprit in the high prices that consumers pay for has long been identified. It is the waste in the supply chain more than the waste in any one enterprise's processes. The current generation supply chain efforts are performing the counter-intuitive miracle of constantly reducing price for the customer while improving margins for all the supply chain participants, be it the distributor or the OEM manufacturer, his principal suppliers or their suppliers.

While these supply chain efforts incorporate very sophisticated optimisation algorithms, they suffer from one handicap: They have information only about the supply chain they actively use, they do not have information about the latent supply chain of which they are a part. Indeed the latent parts of the supply chain would turn into active parts if only information about them was available. For example, a buyer of bearings in America would perhaps not check out a bearing manufacturer in distant Korea if he did not know about its existence.

A 2G exchange remedies this shortcoming of private supply chain efforts by incorporating optimisation techniques that now act on the supply chain as recognised by the exchange as a whole, not just that of any one enterprise. Such supply chains would be dynamically built on varying product requirements. For example, the supply chain for a new plastic component would be dramatically different from the supply chain requirements for a new steel component, albeit for the same buyer. By optimising the performance of the industry supply chain, a 2G exchange achieves a manifold improvement over the supply chain efforts of private supply chains.

It promotes collaborative product development.

If fragmented planning is an important culprit of poor supply chain performance, fragmented product development is equally guilty. Most supply chain improvement efforts desperately try to remedy the problems created by fragmented product development. They try to ease the supply of a part that is complex to manufacture rather than make the design of the part simpler, which is what collaborative product development attempts to do.

It brings designers, buyers and manufacturing planners across the supply chain to collaborate on a part design and not just worry about improving supply chain performance after regular supply of the part begins.

In summary, a 2G exchange is not a passive participant in a transaction as a 1G exchange is. It contains intelligence for optimisation of the entire supply chain and acts on far more comprehensive information about customers and suppliers than just products, services, bill-of-materials, pricing, quality and delivery. If a 1G exchange invokes the vision of a buyer, then a 2G exchange is the equivalent of a buyer and a manufacturing/operations planner with at once a 30,000 ft and a 100 ft view of the industry supply chain.

The state-of-the-art is rudimentary 2G exchanges. Only sporadically are optimisation capabilities being combined with transaction management. The full potential 2G exchange is yet to appear.

To be continued

The author is Director-Enterprise Business Solutions, Satyam Computer Services Ltd.