Let's Keep This PrivateLet's Keep This Private

IT budgets are under the microscope like never before, and high-profile electronic marketplaces are closing left and right. But a growing number of businesses are spending millions of dollars to build or extend private online exchanges. They're opening the corporate wallet based not just on promises but on proof that private exchanges add to the bottom line.

Electronics giant Siemens AG, which last week reported a $617 million loss for the third quarter, is eager to improve its financial profile. While its earnings outlook is still grim-Siemens expects continued weakness in the economy will cause this year's profits to dip below last year's-the $78 billion Munich, Germany, company hopes to save $900 million annually within two years by routing all procurement through a private exchange, an exclusive electronic system that links only Siemens and its chosen suppliers.

Siemens, which spends $30 billion on parts and materials each year, has just upgraded the exchange, already used to buy nonstrategic items such as tools, to support procurement of strategic goods, including raw materials and highly engineered parts. Last week, three of its operating companies-including one of the largest, Siemens Westinghouse Power Corp.-began using the exchange's newest procurement features, which will be available by summer's end to all 30-plus Siemens divisions. The exchange lets them reap savings by consolidating purchases, negotiating companywide contracts, and reducing the time and cost of collaborating on designs and selecting suppliers. Previously, each division negotiated its own contracts, even when several shared the same supplier.

Adding strategic procurement to the company's private exchange will advance Siemens' goal of getting a more-accurate picture of its spending. "We get asked what is the purchasing volume of Siemens in the United States, and we have to estimate $6 billion to $10 billion, which is quite a spread," says Markus Frank, controller for Siemens Procurement and Logistics Services LLC, which runs the private exchange built on software from Commerce One Inc. and SAP. The company, which spends $1.5 billion annually on nonstrategic items, has already realized a 10% reduction in the cost of goods and a 75% reduction in administrative costs by using the private exchange to procure these items. The cost per purchase has dropped from an average of $100 to $25.

Private exchanges are gaining momentum because they're able to deliver the capabilities many public E-marketplaces promised but haven't delivered: the ability to centrally manage procurement across many business units, enable real-time design collaboration, integrate with back-end systems, and link production, inventory, warehouse, and order-management systems so companies can give delivery dates to clients. Some businesses also say private exchanges are more secure than public exchanges.

Another advantage: Private exchange operators can limit participants to suppliers they know and trust (see "The Trust Imperative"). That's particularly important for Siemens as it selects suppliers to handle consolidated orders for parts, materials, supplies, and services. Siemens doesn't want those orders, which can be interpreted to reveal production plans, to fall into competitors' hands. "Right now, we've focused on the largest 10% of our suppliers, the ones we've traditionally worked with for the major part of our procurement," Frank says. The deeper relationships Siemens is forming with these suppliers also helps persuade them that the exchange isn't about driving down their prices but about cutting costs and improving profits.

The trend is reflected in the B-to-B software market. Commerce One CEO Mark Hoffman says 80% of revenue this quarter will be from selling software and services to private exchanges and 20% to public exchanges. A year ago, those numbers were reversed. Last week, Commerce One and Intel Online Services began jointly offering private exchanges as a hosted service.

Fifteen percent of the world's largest companies already have private exchanges, according to Jupiter Research. AMR Research says that by 2005, one-third of companies with more than $1 billion in revenue will run them.

Vodafone Group plc joined those ranks last week. The U.K. mobile telecommunications company selected Manugistics Group Inc. to build a private exchange that will let it synchronize inventory, capacity, and distribution with customer demand.

A few dozen of the top operating companies that are part of Royal Dutch/Shell Group in London just finished testing a private exchange for selecting suppliers and procuring strategic materials; these units buy 80% of Shell's petrochemicals and operational materials. It's part of Shell's plan to centralize and consolidate purchasing activity companywide. "Shell spends $22 billion per year on procurement, and it's the goal to do it all online by 2004," says Chris Miller, senior VP of group procurement.

Shell is a major investor in Trade-Ranger, the energy and petrochemical public exchange it founded with BP Amoco, Conoco, Dow Chemical, and other partners last year. But the company decided a public exchange couldn't provide the infrastructure to integrate its nearly 1,000 operating companies. "One of the most important parts of our E-procurement plans is to consolidate orders from divisions all over the world and leverage our buying power as a global corporation," Miller says.

It makes sense for companies to integrate their private exchanges with public ones to take advantage of features such as logistics and financial settlement services, analysts say. Shell will use its private exchange, set to go live in September, to do the critical work of negotiating prices with suppliers and checking catalogs; it will execute orders on Trade-Ranger.

Other companies eschewed public marketplaces from the start. "We examined what it would cost to accomplish our goal using outside providers vs. what it would cost to do it internally," says Siemens' Frank. "We decided we could do it more efficiently ourselves."

Frank declined to specify how much the company has invested in its private exchange, but Siemens decided last October to spend nearly $1 billion to finance a companywide E-business overhaul. Industry observers estimate that the cost of building a private exchange ranges from $10 million to $150 million.

That may be a reasonable investment for companies that spend billions of dollars each year on parts. Volkswagen AG in Wolfsburg, Germany, could have joined other automakers by participating in Covisint, the auto industry's public exchange, but it would still be waiting for some of the capabilities it needs and the savings it wants. During the past 15 months, Volkswagen has bought $5.2 billion in goods on its private exchange-slashing procurement costs by 40% to 50%. It has cut contract negotiations from three months to as little as a day, reducing costs by cutting weeks out of project cycles, says Meike-Uta Hansen, director of business-to-business online negotiations.

The exchange, built for an undisclosed amount on procurement collaboration, supply-chain, and demand-planning apps from Ariba, EDS, and i2 Technologies, has revolutionized the process of selecting suppliers, collaborating on design, and procuring strategic materials, Hansen says. "We now negotiate online for all parts for new car models and for parts for vehicles already in production to optimize pricing for long-term contracts," she says. Volkswagen's cost-cutting is paying off. Last week, it reported a 16% increase in first-half earnings and a 10% gain in sales.

Companies are beginning to deploy customer-facing B-to-B exchanges. This kind of system can be the most complex to implement because it must link to the exchange operator's production and inventory-management systems to enable it to collaborate with customers.

But the payoff can be considerable. Since Panasonic Consumer Electronics launched its real-time system a year ago, the Secaucus, N.J., company has been able to ensure that its top retailers always have its most popular products on their shelves without having to keep a lot of inventory in stock. Panasonic, which wouldn't provide details on the costs of the TradeMatrix-based exchange, says it now meets weekly with 24 large customers online, one-on-one, to share data about product demand, instead of exchanging monthly faxes and phone calls. Panasonic can gauge demand for its products week-to-week and adjust production accordingly. "If we were looking at how our products were moving on a monthly basis, we wouldn't be able to react as quickly as we need to," says Rich Burgstresser, general manager of Panasonic's supply-chain management group.

As more companies build private exchanges, suppliers and customers must cope with doing business on a growing number of sites. XML standards body RosettaNet has worked with 10 private exchanges to implement its interoperability standards, which let suppliers and customers use XML technology with existing back-office apps to directly communicate with trading partners over private exchanges.

"XML technology-that's the vision," says Roger Mowen, CIO at Kingsport, Tenn., chemicals manufacturer Eastman Chemical Co., which did $400 million in business on its exchange in the past year. He says 30% of Eastman's $5.3 billion in sales will be done on its 18-month-old SAP-based exchange by year's end, using direct XML computer-to-computer transactions or manually via its Web site.

At plastics and elastomer manufacturer PolyOne Corp., the percentage is even higher in some instances. PolyOne's private exchange links the $3.5 billion Cleveland company to its largest suppliers in real time using SAP apps. VP of IT Ken Smith says 72% of its vinyl compound raw-material purchases are completed using XML. The exchange has reduced the cost of each of PolyOne's 17,000 monthly transactions from $110 to $75, a savings of $595,000 per month. Both Eastman and PolyOne worked with webMethods Inc., which supports the RosettaNet specs, to implement XML.

Are public exchanges on the way out? Almost certainly not. But as it becomes easier and more cost-effective for suppliers to connect to private exchanges, they'll be key links in the supply chain of the future.