In Post-Dot-Com Shakeout, B2B Exchanges Shift Strategy.

The shakeout in the aerospace industry's electronic marketplaces, which began more than a year ago, is expected to continue for the foreseeable future. The B2B exchanges that have survived the post dot-com craze, meanwhile, are rapidly introducing new products and services, in an effort to make themselves more valuable to customers.

Businesses that were created for the sole purpose of facilitating Web-based transactions between companies have found that B2B (business-to-business) electronic marketplaces could not generate enough revenue--through transaction fees--to keep themselves afloat. Many of those start-up exchanges have gone out of business during the past one to two years. Others are barely hanging on.

Those B2B marketplaces that have emerged as strong players in defense and aerospace e-business are those with robust financial backing from traditional manufacturers and suppliers. Exchanges such as Exostar and Cordiem--which are owned by established manufacturers of defense and aerospace products--have changed their business models and have developed new software and services that offer "value-added" to customers, instead of merely providing a Web site to conduct buy-sell transactions.

Many of the aviation-related B2B start-ups that failed, such as AviationX, Skyfish and AeroV, had been founded on the premise that, if the prominent buyers in a specific industry bundled their purchasing power on a single Web site, the sellers would follow. These suppliers, according to that B2B model, would compete in online auctions, underbidding one another. Start-up exchanges soon found that, in industries that are highly regulated such as defense and aerospace, suppliers and manufacturers were reluctant to participate in third-party controlled marketplaces. In other words, the problem with third-party Web exchanges is that they interfere with the relationships between suppliers and customers, said Peter Berghammer, chief executive officer of Copernio, an electronic-commerce technology firm.

"The premise of e-business is to create competition and lower prices," he said. But that is a flawed model, he asserted, because it assumes that price is the only thing that matters.

In the defense and aerospace industries, the B2B exchanges have found that suppliers have not been so eager to engage in bidding wars, because those auctions do not take into account factors other than price, such as quality, safety or reliability.

"It's been difficult to get sellers to participate," he said. "They are afraid to turn over proprietary information and to have prices artificially come down."

Public exchanges, said Berghammer, have yet to address how to protect suppliers' proprietary data, such as price lists and customer names, links into inventory, documentation and certification systems. That is a "big psychological inhibitor," which has resulted in a much lower level of participation in B2B electronic marketplaces than had been anticipated.

One drawback of virtual procurement is that "screening is tough," he said. "There are a lot of bottom feeders who speculate on parts."

In the aviation industry, where Berghammer spent most of his career, "people want a trusted source for their parts. With many exchanges, you have no idea who you are dealing with."

Companies that do military business, he said, "don't trust exchanges, because they themselves are trusted sources. Why should you attach your credibility to some Johnny-come-lately operation?"

Some companies often would rather spend money internally and control their customer's "e-business experience" by developing their own portals.

That appears to be among the reasons why TRW's aerospace division invested $10 million in AeroVantix, an e-business portal designed for the company's commercial customers and suppliers. Rather than focus on generating revenue from the portal, the company wanted to improve "customer service," said Arabella Bijlani, vice president for business improvement at TRW Aeronautical Systems. "We did not do this because we wanted to make money," she said.

"Our goal is not to recoup the $10 million investment through direct savings," she told National Defense. "The real savings will be the customers getting a better service. If the customer satisfaction ratings go up, it will have paid hands down."

Many companies that developed portals, she said, "replicated their current processes. What we tried to do is put the pressure on ourselves to redesign our processes." For example, the portal forced company officials to simplify the procurement system, "Do we really need 15 approval signatures on a procurement?" Bijiani asked rhetorically. "We took out 90 percent of the bureaucracy in the process of developing the portal."

TRW is open to the possibility of having other companies become partners in AeroVantix, said Bijlani. "Having other companies join us would allow us to collaborate with other tier-one companies and put joint bids together."

AeroVantix also provides tools for engineering collaboration, which is a useful service for many companies, she said.

The dot-com B2Bs that have gone our of business, she said, "didn't have engineering collaboration engines, didn't have supply-chain collaboration engines."

The demand for digital engineering tools--that allow companies to collaborate on projects--is growing, particularly in Europe, said Berghammer.

During the dot-com fever in the United States in the late 1990s, he said, "we thought we would define e-business for the rest of the world." That didn't work, he explained, because it was "hype about stuff that didn't exist. We were selling vaporware."

Many of the aerospace and aviation-parts exchanges are like the Wild West, he said. "I don't think the shootout for the lowest price benefits anyone."

Not Just Transactions

"B2Bs are more than just about transactions," said Stan Z. Soloway, president of the Professional Services Council, an information technology industry association. Electronic marketplaces have "real potential," he said, because they represent "a step up in collaborative relationships" between customers and suppliers.

The shift away from a transaction-only B2B model is being experienced at Exostar, the aerospace industry's biggest exchange. Exostar was launched with great fanfare about a year ago. It is owned by the world's largest defense and aerospace firms: Boeing, Lockheed Martin, Raytheon, BAE Systems and Rolls Royce. The five founders, which provided the venture capital, sit on the board of directors and also are customers of Exostar.

Approximately 4,000 companies do business online at Exostar, said Barry Lerner, vice president for government sales. They conduct about 20,000 transactions per week, he said. "We've touched 10 percent of the industry." There are about 40,000 suppliers in the aerospace and defense sector.

Exostar is years away from being profitable, although it does generate revenue from multiple sources, such as on-line auctions and buy-sell transaction fees. "We are building the models for a lot of other industries," he said.

To boost its competitiveness in the industry, Exostar plans to launch new products, such as engineering and design networking software that companies can share when they are collaborating on a weapons development project, for example. "Our revenue model over time will be far more than just transaction based," said Lerner. "We are still working this out. We are coming out with new services, which will be our revenue driver."

Some of the expected new products by Exostar include:

* SupplyPath, a browser-based method for suppliers to receive electronic purchase orders.

* MachineLink, an XML-based link for suppliers and buyers to the exchange (instead of going through a browser).

* Auctioneer, a mechanism for one of the exchange's most popular activities, on-line auctions. Exosrar conducts about five auctions a week.

A purchasing system for government buyers, called ProcurePass, is due out later this year, said Lerner. Another product will be ForumPass, which is Exostar's branded name for the widely-used Windchill ProjectLink engineering collaboration tool.

Users of Exostar pay $1.50 on average per transaction. The exchange hosts $5 million a week in reverse auctions.

While Exostar is emerging as the top exchange for the defense industry, it faces tough competition in the commercial aerospace sector from Cordiem.

Cordiem was formed by the merger of two formerly independent B2B exchanges, MyAircraft and AirnewCo. Its founders include Air France, American Airlines, Goodrich Co., British Airways, Continental Airlines, Delta Air Lines, Honeywell International Inc., Iberia Airlines, SAirGroup, United Airlines, United Parcel Service and United Technologies Corp.

Cordiem is focused on commercial aviation, so it does not necessarily threaten Exostar's defense-oriented market, said Jim Mandracchia, Exostar's chief strategist. "In aerospace and defense, I don't think we have any competition that has that much traction."

The reason for having B2B exchanges, Mandracchia explained, is to simplify a complicated process. "In aerospace and defense, we've done electronic business for many years," he said. "The trouble was that it was done in many different ways. Each of us was trying to impose a unique approach. There was additional cost and complexity."

For the suppliers, it is easier to deal with one procurement system than to have to learn the systems of each of the five major companies that own Exostar, said Lerner. He predicted that Exostar will connect about 250 procurement systems in 20 countries.

Soloway, president of the Professional Services Council, agreed that exchanges such as Exostar make it easier to deal with large suppliers such as Boeing, which has 20 different procurement systems.

To earn the trust of the industry's suppliers, he noted, exchanges must have a firm set of policies assuring vendors that the buyers are not using online auctions as an intelligence-gathering tool, to get pricing information. "If the suppliers feel they are being compromised, it [the agreement] will fall apart," said Soloway.

Government Business

Exostar also is trying to expand its business with the U.S. Defense Department, said Mandracchia. The challenge in working with the department is that it is not monolithic, but rather a confederation of agencies. "We are working with the Department of Defense to identify a number of pilot projects, across the services," he said. One of those projects is to set up a private exchange for contractors that do business with the Naval Sea Systems Command. Other pilot programs involve the Naval Inventory Control Point, the Defense Logistics Agency and the Air Force Materiel Command. "They have to go through some testing and comfort on their own," said Mandracchia.

This month, Exostar was scheduled to announce a partnership with Parametric Technology Corp., a supplier of enterprise collaboration software. "We are taking one of their products and fine-tuning it for our industry," said Mandracchia. The goal is to develop software that can support the manufacturing of weapon systems, in a digital environment that multiple firms can share.

Boeing and Lockheed Martin, for example, each built its own collaborative engineering system for the Joint Strike Fighter program, to facilitate the participation of subcontractors from around the world. The downside to that, said Lerner, was that each partner had to buy expensive equipment and software in order to participate. Small businesses often cannot afford such technology, he said. Lerner said he hoped that Exostar could provide lower-cost software that small firms can afford.

"Every major Defense Department program often has one of these environments," Lerner said. "We've done the same thing about 100 times."

Many of Exostar's top executives came from the defense industry. Mandracchia formerly worked for Lockheed Martin. Lerner came from Honeywell Corp. Former Exostar chief executive, Andy Plyler, left Exostar in June, after only five months on the job. Unlike many of the firm's executives, Plyler had come to Exostar from a commercial B2B exchange for aviation spare parts, Partsbase.com.

Even though Exostar said his departure was voluntary, to "pursue other business opportunities," industry observers speculated that he did not fit into the company's defense-oriented culture and that Exostar wanted to avoid being associated with the financial problems experienced by Parrsbase.com, which is being sued by investors. Partsbase.com lost mote than $20 million between 1998 and 2000.

How long it will take for Exostar to be profitable is uncertain, said Mandracchia. "A while. ... I don't know the exact answer."

One advantage that Exostar has over start-ups is that it doesn't have to aggressively market itself to unfamiliar industries, he said. During the heady days of the dot-com e-commerce boom, firms would spend millions on television advertising. "We don't have that problem," said Mandracchia. "We are built by the industry, for the industry. We don't have to spend millions of dollars building the market like the dot-coms. We will be profitable much fluster than many of those companies, many of which did not survive."

The shakeout in the industry is expected to continue, said Berghammer. "There have been both spectacular failures and a few slow deaths," such as Skyfish, AviationX, AeroV and B2Baero, he said.

Berghammer said that the exchanges more likely to survive are those that offer specialty services, such as Overhaulsearch.com, which provides information to the aviation industry on the capabilities and prices from about 550 overhaul shops, airlines, vendors, manufacturers, government agencies and leasing companies.

His company, Copernio, recently announced a deal with TradeAir, an aviation industry exchange, to develop a real-time trading forum for selling and buying aircraft parts.

"We were tired of dot.com hype," he said. "That is not what this business is about."

Copernio is trying to drum up military business by selling niche services, such as networks to help logisticians request parts and avoid cumbersome paperwork. "Someone on the flight line with a hand-held computer or a cellular phone can input what items he needs, versus going to the warehouse and filling out forms to request parts," Berghammer said. "We can seamlessly do that without intermediate steps." Another technology the company launched is called AOG alert (aircraft on ground). When critical components are broken, airplanes can't fly. That costs airlines millions of dollars a year, he said. The AOG wireless services sends alerts to the cell phones of selected AOG vendors, notifying them that there is an emergency and that they need to deliver a specific part immediately.

Pentagon E-Commerce Program Shutting Down

A program started by the Clinton administration to help small businesses work with the Defense Department over the Internet is being terminated at the end of this month. There is legislation moving through Capitol Hill, however, to create a similar program to be managed by the Commerce Department.

About $15 million was removed from the fiscal year 2002 Pentagon's budget for the so-called electronic commerce resource centers (ECRC). There are 17 ECRCs nationwide, which provide, free of charge, assistance to government contractors on how to transition from traditional paper-based transactions to electronic commerce and data exchange. The centers are managed by the Defense Logistics Agency, but the operation of each center is out-sourced to two contractors; Cleveland Applied Manufacturing and Concurrent Technologies Corp.

The ECRCs resulted from a 1993 directive by President Clinton, asking for the Defense Department and other federal agencies to help small businesses do business electronically.

The $15 million that would have been spent on the ECRCs were shifted to other Pentagon projects. The ECRCs had become the target of cutbacks in recent years, because officials in the Office of the Secretary of Defense questioned the effectiveness of the program, and whether the private sector should pick up a share of the cost of maintaining the ECRCs.

The ECRC funding provided by the Defense Department had declined from about $50 million in 1998 to $25 million in fiscal 2001.

Among the OSD officials who favored the phase-out of the centers was former deputy undersecretary of defense for acquisition, technology and logistics, David R. Oliver. The ECRC program, he said, has outlived its usefulness. "The ECRC was a great idea when conceived-- with the goal of teaching small business how to use computers and the internet to do business with the government," Oliver told National Defense.

Over time, however, "my impression was that the commercial [sector's] need to be involved in e-business technology outran the government's good intentions, and small business who wanted to do business with Defense or who were doing business with Defense, got very good, very fast, in using the Internet and e-commerce.

"In fact, the small businesses got so good, that it became obvious the industry's need for basic instruction in how to use computers and the Internet was not as great as the need for other, newer, more difficult concepts, such as the need for assisting small business to learn how they could tap and work in the new markets involved in supply chain management," said Oliver.

A House bill approved last February--and currently being considered by the Senate--requests that the Commerce Department's National Institute of Standards and Technology start a program to assist small and medium-sized manufacturers in the use of electronic commerce technologies and business practices.

"In the United States, business-to-business transactions between small and medium-sized manufacturers and other such businesses and their suppliers is rapidly growing," said the legislation, called H.R. 524, "Small and medium-sized manufacturers and other such businesses play a critical role in the U.S. economy."

The centers were notified in May that they would have to start closing in late August, said Billie Bryant, manager of the Dallas ECRC, which has a $1.4 million budget.

Most of the work recently has involved teaching small businesses how to do paperless contracting with Defense Department, she said. Many of these firms will not be able to get that training without the ECRCs, said Bryant. "Small businesses need to be brought along. ... We haven't seen that they can get through that process by themselves. They need nurturing along."

She said she obviously was disappointed by the Pentagon's decision to close the centers and is hoping that the work they have been doing can be continued, somehow. "As a taxpayer, I see that the Defense Department has been tremendously visionary to have the ECRC. It's unfortunate that they spent the money to build the infrastructure and for all of these resources to go away. It's a terrible waste of taxpayer money."

Sandra I. Erwin