A market for monopoly? Are business-to-business exchanges a force for good or evil?

The answer is not as obvious as it seems

Jun 15th 2000 | NEW YORK | from the print edition

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SO MUCH for the perfect market. An explosion of business-to-business (B2B) Internet exchanges has raised the promise of friction-free commerce in industries from cars to steel, bringing unprecedented efficiency gains and a consumer's paradise. But an increasing number of regulators and firms in the industries being transformed are starting to worry that the opposite may happen instead: rather than opening markets to greater competition, B2B exchanges could become powerful monopolistic tools. Judged by the grandeur of the worriers, all is not well on planet B2B. Later this month the Federal Trade Commission (FTC), part of the American government's trust-busting apparatus, will hold a two-day hearing on the antitrust implications of B2B exchanges. It is also looking into at least three of the most prominent exchanges: those being set up by the largest American car companies, airlines and aerospace firms. The Department of Justice (DOJ) has already begun its own investigations. In July the Senate commerce committee, headed by Senator John McCain, plans to hold a hearing on the antitrust implications of the airline exchange. Already the FTC review, as well as various technical hitches, has delayed the launch of the car site, which had been due to go live this month. And a gale of criticism has forced the airline site's management to deny any allegations of monopolistic intent. This is odd. Open, transparent online markets are supposed to make monopolistic behaviour harder, not easier. E-business is supposed to mean more competitive, efficient commerce. Yet the economics of the Internet work in mysterious ways. The powerful network effects that create thriving online marketplaces overnight can just as easily help to create cartels and permit price-fixingjust look at Microsoft and the economics of software. What was once an unambiguously positive story of economic transformation is now clouded with allegations of monopolistic behaviour. The exchanges that are causing so much concern are used mainly by groups of companies to buy supplies (such as car parts) or to sell products (such as airline tickets). The antitrust worriers fear that companies could use them to rig prices to sellers. They also fret that big buyers could gang up on suppliers (creating an oligopsony), either through collective purchasing or simply through the amplified buying power created by an efficient market.

Exchanges themselves could turn into monopolies: buyers and sellers alike will be interested only in using the biggest around. Companies that own such a winning exchange in one market might be able to leverage that power to expand into other markets (a big car maker, for instance, could use its buying power in car parts to dominate related horizontal markets, such as steel or glass). Big buyers or suppliers that own exchanges could have access to information on deals that might give them unfair trading advantages. They might also gain unfair advantages by subsidising their own business with the transaction fees of competitors who use the exchange. All these worries may lie in the future. The most heated real-world controversy centres on the car exchange, now named Covisint. A joint venture between Ford, General Motors, DaimlerChrysler and Renault/Nissan, the exchange aims to become not just the main way that the car makers' suppliers sell their wares to the big three, but eventually the preferred place for suppliers to trade with their own partners. The problem lies in the way Covisint persuades its suppliers to participate. Some people in the industry claim that staff at one of the four car firms have implied that suppliers have no choice: if they want to do business with the car makers (the biggest buyers in the industry), they must do it through the exchangeor not at all. Fair enough, if true: there is no law prohibiting buyers from asking suppliers to work the way they want, be it by fax or web auction. But some critics allege that the demands went further. The exchange, they say, also put pressure on suppliers not to work with other exchanges. Suppliers, understandably, panicked. The terror is so thick in Detroit you can cut it with a knife, says one insider, melodramatically. Why would the big car companies resort to such heavy-handed tactics? After all, if the exchange turns out to be as efficient as is claimed, suppliers should need no armtwisting to use it. One conspiracy theory sees it as an opportunity to reverse a power shift from buyers to suppliers in Detroit. After the restructuring and outsourcing of the 1980s and 1990s, car makers ended up designing, assembling and marketing cars; most components were bought, already assembled, from suppliers. Now, because the car companies no longer make parts such as seats, they do not know what the inputs for such components actually cost. By forcing suppliers to do all their trading on the exchange, the theory goes, these big buyers could somehow see the price that the suppliers paid for their own parts, and use this information to beat their prices down. The fact that the car companies plan to run the exchange as a stand-alone operation, one that analysts have estimated could eventually go public at a valuation of $40 billion (nearly twice the value of GM's car operations), has only added to the suspicions.

Paranoia and perception

This is explosive stuff: no wonder Washington is scrambling to understand the threat. Suppliers have complained to the FTC, prompting an extended inquiry. But the evidence of actual monopolistic abuse is tenuous. Not only are many of the allegations about the car exchange both confused and wrong. In addition, none of the three big industry exchanges under the microscope even exists yet. They will not make their first trades until later this year; indeed, few of the B2B exchanges announced so far have done any business at all.
Although there is some evidence that the car and aerospace giants were indeed heavyhanded in encouraging suppliers to join up, most of the allegations stem from understandable confusion over the car makers' policy. Covisint began as a merger of the different exchange plans of GMand Ford. Both plans will remain under way until the FTC approves the combined entity. In addition, the two car makers still run their own core purchasing departments, which tend to wage constant war with suppliers. Both Covisint and the aerospace exchange now claim they do not require that their suppliers forsake other exchanges or do all trading with their own suppliers on the main exchanges. We hope that the advantages of our exchange will be so compelling that suppliers want to use it for all their trading, says a spokesman for Boeing, one of the aerospace exchange's owners, but we're not forcing anyone to do so. After threatening to go it alone and launch their own exchanges, several top car suppliers, including Delphi and Lear, have in the past week agreed to join Covisint on non-exclusive terms. Even if the big buyers had been able to start their exchanges on grossly one-sided terms, the exchanges would probably have collapsed under their own weight. The same criteria that create an attractive marketplacetransparency, balanced with protection of commercially sensitive information, fair and enforced rules and efficient operationstend also to run counter to monopolistic abuse. Good exchanges tend to be self-regulating. Indeed, Internet technology can make that easier by erecting automated software firewalls to enforce rules and ensure confidentiality, something that Commerce One is building into the Covisint system. Moreover, if a marketplace is grossly biased, towards either buyers or sellers, it is likely to fail; a grey market will arise alongside, sapping the main market of liquidity. As long as suppliers still have human salesmen, there will be a back channel that can whisper a better price than that posted. If the benefits of publicly posting a rock-bottom price are not overwhelming, few companies will give their customers the advantage of such a potentially ruinous benchmark. The airline exchange, called Orbitz, also seems less menacing than critics claim. It plans to use powerful fare-finding software to offer flights cheaper than those available on Travelocity or Expedia, the top web travel sites, or through most travel agents. Its owners, five airlines including American, Northwest, and United, want to bypass the distribution middlemen and would rather help consumers find cheap flights than pay travel-agent commissions on more expensive ones. Because the site is owned by

airlines, with their history of anticompetitive actions, scepticism was natural: would the partners use the exchange to signal secretly to each other on price moves, to offer flights unavailable elsewhere or to lock out competitors? The answer is probably none of the above. Orbitz will get its fare information from the same industry database, known as ATPCo, as its competitors. Its main competitive advantagethe software that it uses to find better faresis licensed from an independent firm, ITASoftware, which is free to license it to anybody else, making it easy to set up rival ticket-distribution exchanges. The remaining concern seems to be over the web specials that airlines offer on their own sites to attract direct sales that avoid travel-agent commissions. As part of its deal with its partners, Orbitz will, for the moment, have exclusive access to these deals. But it is hard to know how much to make of this worry: such deals were not part of the open industry databases to begin with. Many of the more theoretical concerns about B2B exchanges also fade a bit under scrutiny. Since most of the biggest planned marketplaces are run by buyers, rather than sellers, they tend to risk monopsony, not monopoly. The law here is less clearindustry concentration that leads to lower prices for inputs generally tends to result in lower prices for consumers, which is no bad thing. The default regulatory rule for this is that collective buying power that represents less than 20-40% (depending on the market) of an industry's total buying is permissible. Given that no B2B exchange is anywhere near that yet, fears of Microsoft-like domination seem premature. So far, the inquiries of the FTC and the DOJ are more fact-finding exercises than full investigations. However, the potential for overzealous intervention remains. The Clinton administration has beefed up the government's antitrust divisions; and in the wake of the Microsoft case, the FTC and DOJ are waging a bit of a turf war over cyberlaw. Indeed, the risk of premature regulation may be as least as great as that of monopolistic abuse. Whether B2B markets will create more competition may depend partly on the patience of the trustbusters.
from the print edition | Business