B2B's Operational and Risk Implications.

Participants in B2B networks should consider a long list of risk and procedural questions before exposing themselves to potential legal, regulatory and contractual problems.

In recent months, major corporations have taken -- or signaled plans to take -- equity interest in business-to-business (B2B) exchanges or participate in them. Changes in relationships with suppliers and wholesalers, as well as internal changes in procurement and credit, create new challenges, as well as regulatory and legal concerns. Besides the risks from the operator and investor side, risk concerns apply to the individual buyers and sellers.

Compared to business-to-consumer (B2C), B2B transactions and relationships tend to be far more complex and long-term. They're typically expressed in contracts and involve bigger dollars. The size of B2B orders ranges from $50,000 to $250,000, although some individual transactions are much larger. The average B2B transaction is $75,000 - 1,000 times the $75 average for B2C.

Pricing in B2B is determined in negotiated, long-term contracts, auctions and catalog purchases. Value, trust and partnerships or equity interest will drive the selection for the e-market or portal. Availability and fulfillment details are more important. Payment will involve a variety of mechanisms, including letters of credit, procurement cards, escrows and more complex payments systems.

Despite the myriad of opportunities associated with online B2B exchanges, companies sponsoring, participating or investing in them face a wide range of risks and will need approaches to deal with them. Because an exchange may operate as an independent company separated from its original equiment manufacturers (OEM) investors, the risk management function may not transfer easily to the new company.

Consequently, businesses involved in B2B exchanges need to identify and assess risk, and then develop corollary risk prevention, mitigation and financing efforts. It is important to carefully consider the business issues facing the exchange; related decisions will help determine the corresponding risks.

Strategic Business Issues

Let's face it: There is no guarantee that suppliers/buyers will come and that a critical level of transactions will be achieved. Suppliers are concerned about control from OEM-created exchanges and squeezed margins. Established procurement management practices are slow to change, and many managers may adopt a wait-and see-attitude. Consider these strategic questions:

1. How will the online exchange increase efficiencies and/or lower prices?

2. Why will companies choose to do business on the exchange?

3. Will there be problems integrating IT systems between the exchange and the potential suppliers and customers?

4. Will participating companies still maintain relationships with their traditional suppliers and customers?

5. How willing will procurement managers be to change to the new on-line environment, and what are their issues?

6. Will there be financial or technical requirements or qualifications to join the exchange? If there are membership requirements, what process will be in place to credential the members?

7. Will certain large purchasers refuse to do business with any supplier not a member of the exchange?

8. Will the exchange become involved in contracts between buyers and sellers? For example, will the exchange assume any risk for a false bid or for non-delivery or non-payment pursuant to a contract made on the exchange?

9. What will be the standard contract terms and methods of payment?

10. Will the exchange receive payments or process payments for goods or services sold on the exchange?

11. Will the exchange hold funds for any period of time?

12. Will the exchange monitor product delivery to see that contracts are fulfilled?

13. Will the exchange provide a dispute resolution mechanism for buyers and sellers unhappy with what they receive?

14. Will an independent board of directors manage the exchange? If so, how will the board and management be selected?

15. How will larger owners of the exchange assure other participants that they will not use the exchange for their own benefit?

Regulatory Issues

B2B online exchanges can encounter antitrust issues in their formation and operation. Indeed, some of the strategic issues outlined above may have regulatory implications and could give rise to concerns about price-fixing, unlawful tying, refusal to deal, deceptive trade practices, etc. The U.S. and Europe have published guidelines on this subject.

While the FTC has considered antitrust issues related to large B2B exchanges, it is prudent to make sure the exchange in formation plays by the rules. The key areas are:

* Illicit sharing of information: Regulators are watching to see if competitors could learn enough about each other's cost structure to cause collusion in the downstream market.

* Price-fixing and rigging of bids.

* Market exclusions: Regulators are considering whether B2B exchanges have sufficient exclusivity to push some competitors out of the market.

In addition, regulators will be concerned about the possibility that B2B exchanges will hurt suppliers by forcing them to accept ruinously low prices.

Advertising, Content & Intellectual Property Issues

B2B exchanges share similar concerns with individual e-commerce sites in issues surrounding content, advertising, and intellectual property infringement, particularly patents, copyrights and trademarks. Key risk identification issues include:

1. Infringement of business process patents. A process utilized by the exchange may be the subject of a business-process patent given to a competitor. Significant litigation has surrounded such issues.

2. Has there been adequate review of material to prevent infringement of trademark, trade dress, service mark or copyright? Does the review check for plagiarism, possible misappropriation of ideas, "palming off" one's goods or services as those of another, trade libel and product disparagement?

3. Defamation issues, such as libel and slander, may be of particular importance in a community of competitors. Competitors routinely deride one another in private meetings, but defamatory comments in a chat room on the Internet may prompt claims for defamation.

4. Will links to exchange members and to non-members be allowed? Will deep links that bypass a member's home page be permitted?

Contractual Issues

The exchange needs to establish rules expressed in contracts with participant buyers and sellers. These rules should address the following issues:

1. Will bids and offers be displayed to all participants?

2. Will exploratory bids or offers be allowed -- i.e., bids or offers where there is no intention to purchase or deliver goods rather just to test the state of the market?

3. What if a buyer meets an offer on the exchange but later decides to back out of the transaction?

4. What if two bids are placed simultaneously for the same sale item?

5. What if the goods or services sold are not of the quality or quantity agreed to? Will the exchange have any role in settling the dispute?

6. Will the exchange encourage members to standardize products to encourage more price competition?

Privacy Issues

Suppliers are concerned about confidentiality issues surrounding having their pricing put online, creating a significant regulatory issue. Privacy relies on effective information security, as industrial espionage and disclosure can be damaging to the exchange and its members. The exchange's rules of con duct should govern member behavior, and controls should be established to prevent breaches of confidentiality. Some relevant privacy questions are:

1. Will one seller be able to access the prices or cost information of other sellers? Assuming that the answer is no, what happens if such information is disclosed to a competitor?

2. Will the exchange collect confidential information about members? How will this information be used? What will be the consequences of disclosure of such information?

3. Could trade secrets be exposed to others besides the party an exchange member has contracted with?

Data Security and Availability Issues

Unaltered, confidential data is critical to avoid the risk of leaks of confidential data and pricing and possible repudiation of the transaction. The transaction must be unaltered in order to be enforceable in a court of law. Some form of transaction archiving will be needed, along with high-level network security. In addition, suspensions and interruptions in the exchange may result in a loss of member confidence and even may result in litigation. Key questions here include:

1. Computer viruses, logic bombs, Trojan horses and worms: A computer virus can be implanted in an exchange and spread to exchange members. What protections exist to prevent this?

2. What kind of technical testing and control audits have been done to validate the security posture of the exchange Web site, its processes, and ongoing maintenance?

3. What has been done to prevent denial of service attacks, spamming, or simple loss of service due to a capacity management or a programming mistake? Is there an effective business continuity plan in place that will address the necessary recovery time? Has the plan been tested?

4. What redundancies and disaster planning exist for critical vendors on whom the exchange depends, specifically the hosting company? Hardware failure, failures in telecommunications, and power failures can all impact or cause outages.

Authentication & Non-Repudiation Issues

Since buyers and sellers may not have had previous business dealings with each other, exchanges create special concerns surrounding trust and nonrepudiation. If there is a failure in these areas, the transaction itself may be repudiated, resulting in one of the parties suffering unacceptable financial costs. Trust in B2B exchanges depends on having legitimate buyers and sellers with acceptable credit, authenticated parties and good data security.

Transaction participants want to know more about each other as the importance and amount of the purchase grows. Buyers also want to reduce their risk of getting stuck with a back order or out-of-stock notification. Consequently, they need real-time reliability and information availability. Sellers and buyers should be rated for their performance on the exchanges; or at a minimum, feedback on past performance should be provided. If the transaction involves parties outside the United States, concerns about legitimacy and credit can result in additional steps to verify the parties and delay delivery until payment has been received. In some international transactions, currency conversion and political risks may further complicate matters.

Authentication methods are not perfect, and no single technology or protocol has gained market acceptance as a standard. Passwords with 128-bit encryption can be broken and expensive to manage. Public key infra structure (PKI) and digital certificates are much more secure, but create issues in deployment and cost. Smart cards are in widespread use in Europe, but have had little penetration in the United States. New technology in bio metric devices (such as fingerprint recognition) can be used in combination with other methods. Some technologies will overlay on others to provide various levels of security.

Another major authentication issue concerns internal credit approval processes for orders over a certain size. Procurement software will have to automate this approval process to improve efficiency. Software companies are providing links to the buyer's workflow and approval process.

1. What authentication method(s) are appropriate in the exchange? Have they been deployed appropriately?

2. How will credit and legitimacy of the members be established?

3. How will the transaction details be stored and for how long?

Risk Transfer Issues

Most risk transfer mechanisms revolve around contracts and insurance. It is typical for an exchange not to accept liability for transactions or consequential damages, and legal outcomes on B2B exchanges may vary from the intentions of disclaimers and contract limitations.

If your firm is considering joining an exchange with typical contractual provisions, one alternative is to require proof of insurance. The insurance required for exchanges is not composed of the typical coverages available in a traditional property and general liability policy. Insurance will have to address Internet liability, which includes the risks of security, privacy, availability, content, advertising and intellectual property infringement.

A certificate of insurance may not provide enough detail to confirm that the coverage provides adequate protection. One alternative is to get a copy of the policy itself. Note these issues apply both to the exchange and to technology vendors on which it depends (hosting, managed security, etc.). Attempt to understand the indemnification and hold-harmless provisions of the exchange contract and what kind of insurance the exchange and its vendors have purchased -- and for what liability limits?

In summary, corporate officers need to examine exchange formation, investment and participation from a variety of perspectives. Risk management needs to be built into the foundation of the exchange community, not treated as an afterthought. Many of these issues require due diligence on an ongoing basis as technology interacts with new business requirements and processes.

Emily Freeman is the National Practice Leader for e-Business Risk Solutions at Marsh Inc. and is based in San Francisco. She has been a frequent speaker on e-Business risk management and was a key developer of cyber risk insurance programs for Internet and network risks.