The Strong-Arm Tactics of Exchanges

A version of this article first appeared in eB-21, published 10 times a year in Europe by TBC Research.Based in London and San Francisco, TBC Research helps senior business professionals make more informed technology decisions through its magazine, research, and events portfolio

With exchanges mushrooming every day, and online negotiations becoming mere afternoons of bidding, the Internet trading environment is constantly changing. The pace of change has been so fast, in fact, that regulatory bodies are struggling to keep up. But the situation is set to get worse. If this year's predicted consolidation takes place, it is not difficult to imagine monopolies and cartels becoming the new order of the day.

Already last year, two much publicized B2B exchanges were on the rack: myaircraft.com, a supplier of aircraft parts and Covisint, the automotive exchange set up by GM, Ford and later joined by Daimler Chrysler and Renault.
The European Commission eventually passed myaircraft.com, after stating its belief that due to the increasing number of exchanges there would be competitors coming into the market to prevent a monopoly. Likewise, Covisint was approved by the US Federal Trade Commission (FTC) and by Germany's Bundeskartellamt in September 2000.

But in the FTC's report, "Competition Policy in the world of b2b electronic marketplaces", the regulatory body said: "Because Covisint is in the early stages of its development and has not yet adopted bylaws, operating rules, or terms for participant access, because it is not yet operational, and in particular because it represents such a large share of the automobile market, we cannot say that implementation of the Covisint venture will not cause competitive concerns."

Legal Challenge

Having spent months trawling through the respective exchanges, both the EU and the FTC also passed up the chance to change any existing legislation. Both stated their belief that what was already in place was suitable for today's environment. But there is clearly dissatisfaction and confusion surrounding the guidelines among observers, even in the vendor community. Ariba, for example, is said to be considering lobbying the EU for clearer competition guidelines. Mark Lane, VP of marketing at marketplace service provider Ventro, says: "The whole area of B2B is moving faster than the law. The current law has broad regulations and it is playing catch up. Work needs to be done now rather than later."
The authorities claim they are doing their best to monitor the general situation and will change their monitoring system if it proves necessary. But one official from a UK regulatory body, who did not want to be named, worryingly states that the appropriate bodies rely on whistle-blowing from a third party before they can pursue a complaint on an exchange. Observers also point out it is impossible to monitor exchanges without some kind of software monitoring system. Reactive not proactive seems to be the attitude.

The number of potentially anti-competitive practices which could blow an exchange out of the water are many, with exclusion, information sharing and price fixing at the top of the list. Problems of exclusion can begin before a buyer has even entered an exchange as technical barriers could stop them taking part. Financial constraints can be another dividing factor, particularly for SMEs that do not have the capital to buy the necessary technology to become a member. Also, if the exchange uses incentives to get business, such as rules imposing minimum volume or minimum percentage requirements or the promise of rebates or revenue-sharing, more problems arise.

Once inside the league, marketplaces must prove that members of the board have no access to confidential information and data does not flow from the exchange to the parent company. The marketplace operator should make publicly available details of equity structures, exclusivity arrangements, pricing policies and so on. These policies need to be consistent and universally applied. Non-members should also be welcomed and given generic information.
However, this does not always happen. Chris White, a solicitor at out-law.com, a new technology advice service from law firm Masons, says: "If you are going to exclude people then you need to have an objectively justifiable reason to put that barrier in place."

The information-sharing issues become far worse when members share competitively sensitive information among themselves that could lead to tacit collusion, particularly if future pricing or strategic planning information is shared. On top of this, transactional information, previously unavailable offline, relating to all the transactions that have been conducted on a marketplace, particularly with regard to prices, needs to be handled with care.
Predatory pricing, where a dominant company drops its costs making smaller companies unable to compete before putting its prices back up again, is also frowned upon. White says: "Price fixing and collusion is a classic form of cartel activity and it is at the forefront of regulators' minds that this could be abused."

FreeMarkets, a marketplace vendor, has managed to overcome potential charges of collusion through ensuring its operations are completely transparent. David Sobie, director of market making at FreeMarkets, says: "Suppliers who cheat can be placed in a penalty box and banned from bidding in other contracts. But they bid onscreen, giving price transparency so they can see what others are bidding without knowing who is putting forward the bid. It
doesn't prevent collusion but it's easier to spot."

When Consortia Backfire

While the threat of anti-competitive practices remains, the problem of buyer consortia is rearing its ugly head. Monopsonies, an economic term for buyer-controlled markets, are discussed at length in the FTC report. A consortium may be attractive to buyers, particularly SMEs, as they can combine their buying power and streamline their business processes. But if they only use an existing, agreed supplier base and work within a closed group forcing prices down, they could be deemed anti-competitive. White says: "A buyers' consortium is equally subject to competition law as any other marketplace if there is the suspicion of distortion of competition." Such arrangements could even backfire because if the consortium agrees to standardise on prices then they will not individually be able to compete for a lower price from a particular supplier.

The Office of Fair Trading has done research into this area for its "E-commerce and its implications for competition" report. The paper cites "tippy" markets as a possible problem, where a market tips one way after a critical mass joins an exchange. The exchange would then become too strong a pricing control in the market and possibly exclude new memberships.

The move towards buyer consortia is changing the dynamics of trading relationships with buyers and suppliers. Traditional business has seen a buyer forced to go to one supplier for a particular part but B2B exchanges are reversing the trend and one supplier is convinced his profitable UK business will suffer online because the company is not known internationally and will not be able to compete on a global scale.

Chemdex, an exchange which closed down late last year, found that in some areas there were too many suppliers competing in the same product space, culminating in a buyer driven environment. Lane says: "Many buyers have myopic vision and see a marketplace solely as an opportunity to squeeze their suppliers with bully boy tactics. Getting cheaper prices is only a short term vision, a deeper supply chain relationship is the key."

Rise of the Neutramediary

However, it is not all bad news. If a marketplace shows it has various safeguards, such as firewalls, segmented catalogues and objective criteria, in place, it stands a far greater chance of not being trodden upon by regulatory bodies and being successful. In addition, a new entity springing up may be able to help.

Neutramediaries are independent third parties which help companies monitor their marketplaces. They can also prepare contracts and regulate the marketplace on a day-by-day basis. Neutramediaries should be able to provide third party assurances that players aren't bending the rules.

But companies should check out the global regulations too. Is it acceptable, for example, to have a server in Asia but conduct business in another country? There are various regulatory bodies, including the FTC, the European Commission, the UK government and other bodies in each European country all with particular restrictions and balancing the different requirements is currently an area of concern for bodies like the Cabinet Office's Better Regulation Taskforce (see sidebar).

White concludes: "The existing legislation seems to be working in that it seems to be picking up on the exchanges. But there haven't been enough reviewed yet to make a comment on and maybe there are some that the regulatory powers haven't yet latched onto. It's also a double edged sword in that these things are global and they may be able to hide in one country's regulations but will get picked up another."