Merrill Lynch The B2B Market Maker Book

In-depth Report
United States
3 February 2000
Henry Blodget First Vice President (1) 212 449-0773 henry_blodget@ml.com Edward McCabe Vice President (1) 212 449-8862 edward_mccabe@ml.com
The B2B Market Maker Book

Theyre All Business
Reason for Report: Industry Overview
Merrill Lynch & Co. Global Securities Research & Economics Group Global Fundamental Equity Research Department
#5078
RC#60203410
The B2B Market Maker Book 3 February 2000
Executive Summary
A new species of company is exploding onto the scene the B2B market maker. We believe that over the next five years, B2B market makers will cause profound change in the world economy and, possibly, create more than $1 trillion in stock market value. B2B market makers act as infomediaries and transaction engines within large, established, often stagnant industrial industries. Capturing just a small portion of the enormous value of goods and services transacted within these industries should translate into significant revenue and (hopefully) profit for the B2B market makers. An estimated $400-$500 billion gross revenue opportunity. We estimate worldwide B2B electronic commerce will grow from $158 billion in 1999 to $2.5 trillion by 2003. Importantly, in our view the overwhelming majority of this commerce will occur on seller sites, like those of Grainger, Intel, and FedEx. However, we estimate that 15-20% of B2B electronic commerce will likely be transacted through third-party marketplaces, generating revenue of $400-$500 billion by 2003. A revenue multiple of 2X-3X suggests that B2B market makers could generate market capitalization of $800 billion to $1.5 trillion by 2003, with a present value between $340 billion and $620 billion. Network effect should create high barriers to entry and ROIC for market leaders translating into 1) high valuations for the leader, 2) dismal valuations for No. 3-No.5. Even more than B2C, B2B e-commerce should evolve into a winner-take-most game (sellers will always gravitate to the marketplace with the most potential buyers; buyers to the marketplace with the greatest selection and price competition). The cost of ensuring market leadership will initially be high we dont look for profits anytime soon. Once leadership is won, however, the leader should find itself in the enviable position of being the operating system for the industry, the interactive platform around which the whole industry standardizes. Operating system businesses command high multiples. Not surprisingly, the B2B market maker opportunity has not gone unnoticed: investors are already paying through the nose for the promise of B2B. The current valuations of most public B2B companies, as well as the private valuations of many others, are dizzying (the 10-12 public B2B market maker stocks are valued at $85 billion on run-rate revenue of $3-$4 billion or 20-30X). We expect to see a plethora of B2B market makers go public this year some great, some okay, some poor. As supply and demand move closer to equilibrium, we recommend that investors take care to own only the stocks of the best companies. In fact, there could be as much as 100% downside for low-quality B2B stocks of which, in our opinion, there will be many.
We recommend that investors develop a B2B investment strategy, whether direct or indirect, offensive or defensive. For diversified growth investors, this would include allocating a small percentage of the portfolio to a basket of high quality B2B stocks. The leading B2C internet stocks have outperformed the major indexes for 5 straight years. Assuming B2B follows a similar trajectory, the risk associated with the sectors extreme valuations, volatility, and fundamental uncertainty will, for some investors, be offset by the potentially greater risk of not being involved. Put another way, we continue to believe that for investors the greatest risk in hyper-growth equity investing (which this is) is not losing money, but missing big upside.
Key Points
Huge market opportunity should create major market capitalization. We believe worldwide B2B electronic commerce could approach $2.5 trillion by 2003. Of this, we estimate that $400-$500 billion will be generated by B2B market makers. At 2X-3X these estimates, we believe B2B market makers could generate total market capitalization between $800 billion and $1.5 trillion by 2003 (with a present value between approximately $340 billion and $620 billion). Powerful business models (network effect, customer lockin, low capital intensity (at maturity), and operating system qualities) should create high barriers to entry and high ROIC. As a result of the network effect, leading market makers should enjoy exponential revenue growth once a critical mass of market participants and liquidity is achieved. Expenses, meanwhile, should grow linearly, creating high operating leverage. Once established as the leader in an industry, a market maker should enjoy declining participant acquisition costs, high barriers to entry, high switching costs, and recurring revenue. Start-up costs and near-term losses will likely concern some investors, but, in our opinion, for the best market makers, these investments can be viewed as analogous to CAPEX spending for physical networks (which is capitalized and therefore doesnt negatively affect the P&L). In our view, the good stocks are dizzyingly expensive, but we would rather pay up for them than look for cheap stocks of poorer companies. It is hard to generate firstrate returns by owning second-rate companies, and in this industry, you usually get what you pay for. Although the current crop of market makers will likely generate significant fundamental value over time, the current valuations are driven largely by an imbalance of supply and demand. Assuming markets remain robust, we expect to see a plethora of market makers go public in the next few years. As the supply of stocks moves closer to equilibrium with demand, quality will likely become more important (we believe there is close to 100% downside for low-quality stocks). Long-term, there are likely be many more losers than winners.
Each industry sector is different, so each market maker must be carefully analyzed (ie, a large industry does not necessarily translate into a valuable market maker). There are, however, some common characteristics for success: Plenty of buyers and sellers. If you want to make a market, you need both. Ideally, you will have more than your competitors do (or a plan to get them). Liquidity. The value of a market maker is a multiple of the value of transactions that flow through it. In the early going, the market maker should have, or be focused on generating, industry-leading liquidity. Fragmentation. Middlemen add the most value in markets that are highly fragmented on both the supply and demand sides. Inefficiency. Market makers must add value to both sides of the trade. They can often do so by making the buying and selling process more efficient.
Management with domain expertise. Senior level industry relationships and credibility ease concern and facilitate industry buy in. Early mover advantage. EBay only had a year head start in the C2C auctions business, but this was enough. Partnerships for distribution and logistics. UPS doesnt transport lumber, resin, or hydrochloric acid. Neutrality (but not at the expense of liquidity). Few companies opt to do business with their competitors or with subsidiaries of competitors. Public currency. With a billion dollar market cap, if you dont yet have a real business, you can buy one.
Table 1: Valuation Table Selected Public B2B Market Makers

Company Ariba Chemdex CommerceOne FreeMarkets Internet Capital Group Neoforma pcOrder PurchasePro.com RoweCom SciQuest
(4) (5) (2) (2) (6) (1) (2) (1) (3)
Ticker ARBA CMDX CMRC FMKT ICGE NEOF PCOR PPRO ROWE SQST VERT
02-Feb-00 97.50 172.25 229.00 119.00 50.31 46.38 82.88 35.38 56.63 238.25
52 Week Range High Low 143.00 331.00 212.00 60.94 94.00 175.00 53.56 91.63 289.56 15.13 8.83 7.00 39.88 26.75 14.66 13.13 25.94 17.38
Market Cap ($ millions) $12,203 3,208 12,402 8,107 32,868 3,270 723 2,325 357 1,556 8,386 $85,405 $49,267
2000E Rev. Market Cap ($ millions) To 2000E Sales $145 132 130 43 NA NA 68 18 598 68 77 $1,278 84x 24x 95x 190x NA NA 11x 126x 1x 23x 110x 39x
2001E Rev. Market Cap ($ millions) To 2001E Sales $278 271 260 86 NA NA 104 42 1,028 275 149 $2,491 44x 12x 48x 94x NA NA 7x 55x 0x 6x 56x 20x
$162.63 $211.00 $30.50
370.00 163.88
VerticalNet Total Total (ex ICGE & NEOF)
(1) Revenue predominantly licenses, services, and maintenance fees (2) Revenue predominantly gross product sales (3) Revenue predominantly fixed monthly fees (4) Revenue predominantly subscription, content, and services fees (5) Revenue predominantly subscription fees (6) Revenue predominantly advertising fees
Source: Merrill Lynch Internet Research; FactSet; Investext
Note: At this early point, due to differences of what and how they sell, market makers are recognizing revenue differently. However, almost without exception, the long-term goal for all market makers is to generate more transaction-based revenue.
CONTENTS
n Section Executive Summary Introduction: Asking The Right 1. B2B Questions Overview: An Industry Snapshot 2. A Brief History of B2B 3. Electronic Commerce B2B Market Overview 4. Market Maker Models 5. Horizontal & Vertical Markets 6. Why We Like B2B 7. Market Makers Market Maker Beneficiaries 8. and Liquidity Market Maker Success 9. Key Industry Criteria Market Maker Success 10. Key Company Criteria B2B Market Maker 11. Valuation Framework B2B Market Maker 12. Investment Philosophy Company Profiles 13. B2B Market Maker Master List Page 2 5
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1. Introduction: Asking The Right B2B Questions.

This report focuses on what we believe to be the internets next frontier B2B (business-to-business) electronic commerce. Unlike companies that focus on consumer-oriented commerce such as Amazon and EBay, B2B market makers are third-party intermediaries whose primary purpose, in most cases, is to match corporate buyers and sellers. They typically take a fee, make a spread or receive commissions for their services. Furthermore, the highly targeted audiences many of these sites attract also allow some of them to generate significant advertising revenue. B2B electronic commerce is not a new concept. Many large companies have been communicating electronically with their trading partners for over twenty years via EDI (electronic data interchange). However, the onerous expenses and technological complexity of EDI have limited its growth as well as the appreciation of the stocks related to it such as Harbinger and Sterling Commerce. More recently, companies like FedEx, Dell, Intel, Cisco and Grainger have aggressively adopted the internet as a commerce platform. Their web site launches have experienced tremendous success. However, while some component of the market caps of these companies reflect the benefits B2B electronic commerce has brought to their respective businesses, they are certainly not B2B pure plays from an investment standpoint. Domestically, Forrester Research forecasts the value of goods and services transacted between businesses by 2003 at $1.5 trillion approximately 14X their estimate for B2C online commerce. Considering international opportunities, we believe this market could reach $2.5 trillion in the same year. In our view, the overwhelming majority of B2B electronic commerce revenue will continue to be captured by seller sites like those of Intel and Grainger. However, third-party market makers the B2B pure plays have just begun to emerge. These market makers match buyers and sellers more efficiently not only in vertical (industryspecific) markets such as paper, plastics, chemicals, and steel, but also in horizontal markets (functional) markets for products and services used in all industries like MRO, consulting services, media buying, and excess inventory. As indicated by the highly successful IPOs of companies like Internet Capital Group, VerticalNet, Chemdex, SciQuest, FreeMarkets, RoweCom, Ariba, CommerceOne, PurchasePro, etc., over the last year, we believe investors have correctly identified the magnitude of the B2B opportunity and are aggressively seeking for exposure to it. This demand, coupled with the hundreds of private market makers already in existence, should undoubtedly lead to an IPO calendar over the next 12-18 months full of B2B market makers. Merrill Lynchs B2B market maker recommendations currently include Internet Capital Group and Ariba, which are covered by the Internet and Enterprise Software groups, respectively. The major goals of this report are to provide: 1. 2. 3. 4. 5. an overview of B2B electronic commerce and different market maker models; an investment philosophy/framework for B2B market makers; a valuation framework; key industry characteristics likely to foster market-maker adoption; and key company characteristics likely to drive market maker success.
Merrills Top Ten Questions To Ask B2B Market Maker Managements
1.
How large is the industry (gross sales, US and worldwide)? How much of it do you think will be transacted through a B2B market maker? Why? Many market makers just assume that 10%-40% of gross sales will go through market makers. In many cases, though especially in industries with low fragmentation there is little reason to use a market maker. Market makers must 1) solve specific, identifiable problems and 2) add value to both the buy and sell sides of the supply chain or industries will just ignore them. 2. How fragmented are the buy and supply sides of the industry? Industries with a high level of fragmentation on both the buy and sell sides are the best for market maker adoption, because the MM can add value simply as an aggregator. 3. How inefficient are procurement, sales, and distribution in the industry? The promise of the market place is, in part, to cut fat. So it helps if the industry is chubby to begin with. 4. What specific industry problem(s) can a third-party marketplace solve for both the buy and sell sides. The best MMs can identify specific buy and sell-side problems that they solve, as well as future problems that they expect to be able to solve. Remember: using a market maker requires a change in corporate behavior and changing corporate behavior is difficult, no matter how sensible the change seems. As a result, market makers that can ease painimmediately (provide obvious, identifiable, and quantifiable advantages) will likely see faster adoption than those that dont. 5. How much of a change in behavior does using your marketplace require on the part of suppliers and buyers? The less, the better unless you can convince the company to pay millions of dollars for software licenses and installation, in which case it will have to force change in behavior or risk losing its investment. 6. What are your transaction volumes today? How have they ramped? What is the strategy for generating industry-leading liquidity (transaction volume through the marketplace). The slickest, most highly functional marketplace in the world is worthless if buyers and sellers congregate to do business somewhere else. 7. What portion of your management team is from the industry you address? Do senior people have strong relationships at the most senior management levels of industry players? Even in the internet industry, people like to do business with people they know and like. This is especially true in the case of market makers, which initially might seem to be less friend than foe. 8. How do you intend to induce the participation of suppliers, particularly large ones? What has been the reaction, particularly among large suppliers, to your entrance into the industry? Have they agreed or at least indicated an intention to work with you? Are they considering it? Are they dead-set against it? Big suppliers are usually critical to gaining liquidity (who wants to shop at a market that doesnt carry most of the products?). They are also the least likely industry participants to need a third-party market maker, especially early on. Having clear strategies for signing them up, therefore, are critical to success. 9. Are there other B2B market makers addressing the industry? Are you ahead or behind them in terms of transactions and revenue as well as buyer and supplier relationships? Why? This will likely be a winner-takemost game. The aim is to identify the market leader as quickly as possible and put your eggs in its basket. 10. Do middlemen in the industry add significant value? If so, how do you plan to work with them? Have you partnered with the key distribution and logistics providers? You can buy and sell all day long, but when youre done transacting, you still have to ship the stuff. Depending on the industry, some middlemen will continue to add value in a market maker world, others wont. The best market makers will partner with middlemen that add value and, slowly but surely, take market share away from the ones that dont.
2. Overview: An Industry Snapshot

A Brief History of B2B Electronic Commerce
The recent hype surrounding B2B e-commerce might lead an observer to believe that it is a new concept. It isnt. Although the emerging market makers are new, B2B electronic commerce has a history that dates back more than twenty-five years. We trace the heritage of internet-based Electronic commerce back to EDI (Electronic Data Interchange), which allows businesses and their trading partners using a variety of systems to exchange information through a standard set of transactions over value-added-networks (VANs). However, EDI deployment and ongoing VAN charges have proven too onerous for all but the largest companies. As a result, it is estimated that only 25% of a typical hubs trading partners (spokes) use EDI. So not only does a large population of businesses not use EDI, but those that do only realize its benefits with a small portion of their supplier base. We believe the major principle of EDI reducing the process costs of intercompany trade will live on. However, we believe as businesses continue to get more comfortable with the security, reliability and performance of the Internet that the use of EDI over expensive, proprietary VANs will give way to Internet-facilitated transactions. Enter, the market makers
B2B Market Overview
We dont quibble with Forrester Researchs U.S. forecast of $1.5 trillion ($1.3 trillion for goods and $200 billion for services) for B2B online trade. We also believe there are significant opportunities for market makers in international markets, particularly because many of the large industrial markets these companies typically address, like steel, automotive, telecommunications, and electronics, are global today. In 2003, we assume 38% of B2B electronic commerce revenue will be generated internationally. As a result, we believe worldwide electronic commerce revenue could total approximately $2.5 trillion by 2003. However, more important than this total sales figure is the likely mix between seller sites, like those of Cisco, Dell, Intel, Boeing, Grainger, Federal Express, etc., and the sites of online market makers the B2B investment opportunities upon which this report is focused. We believe that seller web sites will dominate the overall mix of B2B revenue (ie, to play this growth, investors must buy manufacturers such as Cisco directly or companies that sell ecommerce products and services to the manufacturers, such as Verisign, Scient, or iXL). However, we believe it is a reasonable assumption that third-party market makers could represent 15-20%, or $372-$496 billion of overall online B2B sales by 2003. In addition, we also assume advertisers spend $7-$10 billion with market makers at this point in time. Combined, we believe the total revenue attributable to online market makers by 2003 could range between $400 and $500 billion. (In our conservative case, which we consider less likely, we estimate that only 10% of B2B electronic commerce revenue, or approximately $250 billion, is transacted through market markers.)
Market Maker Models
Internet-based market makers, the latest incarnation of B2B e-commerce, come in different variations. The current market makers usually employ one or more of four basic models catalog, auction, exchange, and community which are outlined below. The critical component for success with all of these models is a clearly identifiable benefit for both buyers and sellers. Those that dont have this will have difficulty attracting the critical mass of buyers and sellers necessary to drive liquidity. Online Catalogs. Online catalogs are optimally suited for markets where the supply and demand sides of a market are highly fragmented. SciQuest and Chemdex in life sciences are examples of vertically focused players in this category. Ariba, CommerceOne, and PurchasePro in MRO (maintenance, repair, and operating supplies) are horizontally focused market makers. Essentially, these market makers take the paper-based catalogs of multiple vendors, digitize the product information and provide buyers with one-stop shopping over the Internet. However, the fact that, in most cases, these market makers embed themselves in
the business processes and IT systems of buyers and suppliers, reduce process and inventory costs, extend supplier reach, and improve customer access to suppliers makes their value much greater than just digitizing catalogs. Online market makers allow buyers to search for products more efficiently. Instead of flipping through a mountain of separate, often out-dated, supplier catalogs, buyers can utilize the powerful search capabilities of the Internet to compare products on many dimensions including price, availability, delivery dates, warranty, service information, etc. The prices of products on these sites are typically fixed. Online catalogs usually derive revenue from the combination of a percentage of gross transaction values, typically in the low single digits to the mid-teens, as well as product listing and advertising fees from suppliers. Auctions. Auctions provide a venue for the purchase and sale of unique items such as surplus inventory, used capital equipment, discontinued goods, perishable items, or refurbished products. Examples, among many, include FreeMarkets, a reverse auction for manufactured inputs, and TradeOut or AsseTrade, auctions for asset procurement and disposition and excess inventory. In addition, vertically focused companies like PaperExchange, which is predominantly (as its name suggests) a market maker in pulp and paper, also generate ancillary revenues from the auction of paper-related capital equipment. Auction pricing is dynamic. In a traditional auction, the competitive bidding process results in upward price movement. The reverse auction, a format in which sellers compete for a buyers offer to purchase, results in downward price movement. Revenue for online auctioneers is usually derived from the combination of transaction fees typically ranging from the high single digits to the low twenties as a percentage of gross merchandise value as well as product listing and supplier advertising fees. Exchanges. Exchanges provide a spot market for commodities often with high price volatility. They provide a venue for the purchase and sale of commodities like natural gas, electricity, and telecommunications bandwidth. Altra and Enermetrix in natural gas and electricity and Arbinet in telecommunications are all prominent examples. These markets are bid/ask and provide real-time pricing. Exchanges allow buyers and sellers to trade anonymously, which is key because identifying buyers and sellers can damage their competitive position and skew pricing. Although market share is important in every market maker category, we believe it is of paramount importance for exchanges. This is because market share means liquidity. Exchanges without significant liquidity are likely to fail due to the relatively small transaction fees they extract. However, exchanges that do attain leading market share should have extremely defensible competitive positions because offering the most liquidity will make trading on a competitive exchange less compelling. Exchange revenue typically comes from the combination of transaction fees as well as membership fees. Transaction fees usually range from a spread of a few basis points to percentage spreads in the low/mid single digits. Community Market Makers. Community market makers bring together potential buyers and sellers, in the form of professionals with common interests, through web sites that feature industry-specific content and community aspects. The content and community aspects these sites typically provide include industryspecific news, editorials, market information, job listings, chat, message boards, etc. As a result, these community market makers attract a targeted audience of potential buyers for suppliers. For the most part, community market makers generate revenue from advertising, sponsorship and membership fees as well as from fees paid by suppliers for lead generation. Although in most cases minimal transaction revenue is actually generated on these sites today, we believe this will change over time as these community market makers either add transaction-oriented market mechanisms onto their sites or generate revenue by driving traffic to the commerce sites of others. With over fifty sites ranging from pollutiononline.com to adhesivesandsealants.com, VerticalNet is the poster boy for community market makers.
In summary, today, many of the aforementioned market models are separate entities even within specific vertical industries. However, over time we would expect to see some convergence where, for instance, the catalog, auction and exchange pricing mechanisms for, say, the chemicals industry, take place on one site. Furthermore, as we are already seeing with VerticalNet, we would expect to see community-based market makers monetize eyeballs through revenue streams beyond advertising, sponsorship and lead generation fees. In other words, transaction-based revenue.
Horizontal & Vertical Markets
Fundamentally, we believe there are two business-to-business markets vertical markets and horizontal markets. Vertical markets are industry-specific. The inefficiencies addressed and the requirements required for success in each of these industries differ significantly. Horizontal market makers facilitate the purchase and sale of goods and services used by a plethora of industries. In the short history of Internet-based B2B e-commerce, hundreds of vertical market makers have already emerged in industries ranging from metals and livestock to printing and chemicals. Similarly, horizontal market makers have emerged that support the purchase and sale of goods and services such as those for maintenance, repair and operations (MRO), benefits administration, media buying and logistics. As business adoption of these new models matures, we expect a B2B quilt to be woven where horizontal market makers become interwoven with vertical ones. We expect market makers to capture a meaningful piece of overall B2B ecommerce. In our view, the overwhelming majority of the estimated $2.5 trillion in B2B e-commerce in 2003 will occur on seller sites, like those of Grainger, Intel, and FedEx. However, we believe that 15-20% of B2B electronic commerce will be transacted through third-party marketplaces, implying a revenue opportunity of approximately $400-$500 billion by 2003. User lock-in, operating system qualities, low capital intensity, and the network effect should lead to high barriers to entry and ROIC for the market leaders. Once leading B2B market makers achieve a critical mass of buyers and suppliers no easy accomplishment and one that few have achieved to date they should benefit from the network effect over time. In other words, leading B2B sites (or networks) should scale significantly as they attract buyers looking for a broad selection of products and suppliers seeking a large audience of potential buyers. This dynamic should allow market makers to enjoy exponential revenue growth once a critical mass of market participants and liquidity is achieved. At the same time, expenses should grow linearly, creating significant operating leverage. Although start-up costs are likely to be high, the pay-off for companies that gain control of their markets should be huge. In fact, we believe the initial start-up and customer acquisition costs can be viewed in the same way that CAPEX spending is viewed for companies building physical communications networks (ie, as an investment rather than operating cost). Because CAPEX spending is capitalized, the early P&L for the owner of a physical network will look better than one for a market maker, where the costs are expensed. Over the long-term, however, the market makers ongoing costs will be relatively fixed, whereas the physical networks costs will grow variably with each additional user, which will lead to much higher returns on invested capital for the successful market maker. Participant acquisition costs, which will start out extremely high, should decline over time and allow for margin expansion. For B2B market markers, the cost of attracting buyers and suppliers, in particular, will be extremely high in the early going. However, as the network effect takes hold and more participants migrate to a market maker, it should take less money and prodding to get suppliers to contribute their products to a growing source of demand and buyers to shop at a growing source of supply. Exponential revenue growth due to the network effect, coupled with declining participant acquisition costs should lead to margin expansion for leading market makers.
Why We Like B2B Market Makers
Critical mass will create high barriers to entry. Once a market maker gathers a critical mass of buyers and suppliers, embeds itself in the business processes and IT infrastructure of both, achieves market liquidity, and secures relationships with key distribution and logistics partners we believe it will be tough for another market maker to overtake the leader. Furthermore, leading vertical (industryspecific) market makers will align themselves with specialized distribution and logistics players to fulfill the orders taken on their site. We believe the B2B market makers that forge these important relationships will have a significant leg up toward securing highly defensible market positions. High switching costs for participants. Aligning with a particular market maker typically includes systems integration between the intermediary and buyers and suppliers as well as the market maker embedding itself in the business processes of both. In all likelihood, these factors will make switching to another network prohibitively expensive and disruptive. Recurring revenue. Once market makers embed themselves in the procurement processes of buyers, the sales and distribution processes of suppliers, and the systems of both they should become venues for highly recurring transactions and revenue.
Market Maker Beneficiaries & Liquidity
We believe the benefits of online intermediaries are more evident for certain participants than for others. As we further explain below, we believe small suppliers benefit the most from online market makers, followed by small buyers and large buyers. We believe gaining the participation of large suppliers will prove the most challenging for market makers. Since, in our view, large suppliers are the single most important factor in providing liquidity, we consider their involvement the linchpin of a market makers success. Below we explain our thought process and rank marketplace participants according to what we believe is the relative value proposition offered to each by market makers. 1. Small Suppliers. We believe small supplier participation in online markets is pretty much a no-brainer. Small usually means limited resources which includes sales and distribution. Small suppliers usually have neither the brand name nor the scale to provide a sizable enough discount to induce large distributors or value-added resellers to push their goods and services. Online markets provide a low-cost distribution channel through which small suppliers can reach small customers formerly too far and expensive to reach and large buyers with whom they could never get an entre. Small Buyers. This is another online market maker participant we throw in the no-brainer category. Online market makers allow small buyers to automate and reduce the expenses related to the manual procurement process as well as reduce inventory and related carrying costs. Also, small buyers now get greatly expanded supplier access. Large Buyers. Large buyers buy in volume and, as a result, are highly sought after by suppliers of all sizes. A great deal of what large buyers purchase comes from large suppliers that can handle the service, quality, and pricing requirements to which big customers are entitled due to their buying power. In addition, commerce between large buyers and large suppliers is often already automated through EDI. Therefore, we dont believe the benefits of online market makers are as compelling for large buyers as they are for their smaller brethren. For the less progressive large buyers, market makers will add value through automation and reduce procurement processing and inventory carrying costs. For large buyers that have automated their procurement processes to a large degree, we believe that there are incremental process and inventory cost savings to be realized. Large Suppliers. We believe supplier affinity for online intermediaries will run inversely to their market share. In other words, the more market share a supplier controls, the more work it will take to get it to distribute through an online market maker for several reasons. For one, large suppliers are large, in part, because they already have broad customer reach and efficient sales
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and distribution channels. Secondly, as leaders in their industries, customers are already required to consider these suppliers when making a purchase. Third, due to their strong competitive position these suppliers will be reticent to serve as one of the big draws for a market maker that carries competitive offerings. As a result, large suppliers like Cisco and Intel are likely to continue to sell directly through their own sites. However, we believe large suppliers will end up participating in third-party hosted Internet markets for several reasons. First and foremost, customers will demand it. With global competition increasing, suppliers differentiate themselves now, more than ever, through customer service. As such, we believe that, long-term, suppliers will respond to buyer demands that they make their products and services available via online market makers. Also, once the most progressive large suppliers in an industry have come on board, laggard suppliers are likely to fall like dominos just to maintain market share. Furthermore, market makers present a channel through which smaller suppliers can nibble away at the market shares of larger players; we dont expect large suppliers to sit idle and watch this happen. Finally, we expect large suppliers will use online market makers to gain access to new customers and revenue streams altogether.
Market Maker Success Key Industry Criteria
We believe there are key characteristics that will make certain industries more fertile ground for online market maker success. We paint some pretty broad strokes here and advise investors to assess specific industry characteristics thoroughly for each market maker opportunity. However, we believe developing some broad framework to assess the likelihood of market maker success, one that will be tweaked as we learn more about B2B, is required to even begin considering the merits of particular B2B investment opportunities. The key characteristics we would assess or be looking for follow. A large market. To oversimplify things, we would be looking for market makers that address very large vertical or horizontal markets. Online market makers are about reducing inefficiency. Even if a large market is relatively efficient, it is likely that, due to its size, inefficiencies within it can support a very significant internet business. The optimal market maker will be one that addresses a very large, inefficient market like paper, steel and plastics. However, be careful. While large, inefficient markets might have the most fat to take out and, therefore, the most profit potential for a market maker long-term, the fact that they have remained inefficient for so long likely indicates that they are extremely resistant to change. As a result, some of the best market maker opportunities might take longest to come to fruition. Buyer and seller fragmentation. Theoretically, the more fragmentation, the better. As we mentioned earlier, we believe small suppliers and small buyers benefit the most from online market makers. Therefore, in our view, an industry full of little guys would be ideally suited for a market maker. However, we also believe gaining liquidity in such a market, the key to a market makers success, may take some time because it will require bringing a large number of entities online. We think industries where most of the commerce is conducted between large buyers and large suppliers might be slowest to adopt market makers. However, we also believe that once a couple of large industry leaders contribute supply that others will have to follow suit. Therefore, once the ball starts rolling, we expect liquidity to follow. Fat. We view fat as the non-value-added links in the value chain. Investors need to be careful here. We would be wary of the prospects of market makers that lead with purely a disintermediation strategy. While there are middlemen in many value chains that add minimal value beyond matching buyers and sellers (brokers in the paper and plastics industries come to mind), many middlemen, such as value-added resellers and many distributors, are important and irreplaceable links in the value chain. Market makers that focus on automating processes that are currently manual so employees can focus more on the value added functions they
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perform will probably find themselves in a solid industry position. Those that trumpet a goal of taking food off somebodys table are likely to feel powerful industry forces come to bear on them. High IT adoption. Generally speaking, we believe industries that have widely adopted information technology will be more receptive to online market makers than those that have not. First of all, we believe the fact that the technology infrastructure is already in place for companies within these industries makes utilization of online market makers an easy transition technology-wise. Second, and probably more importantly, we believe IT adoption serves as a rough proxy for an industrys attitude toward change particularly change that increases efficiency, which is exactly what market makers are about.
Market Maker Success Key Company Criteria
Management with domain expertise. Successful B2B market makers must have management with the industry knowledge, senior level industry relationships, and credibility to address industry concerns, particularly among suppliers, and articulate the benefits of migrating to this new market maker paradigm in order to gain industry buy in. (Near flawless) early mover advantage. Market makers that move first without major mistakes are likely to build the critical mass of buyers and suppliers that will make them the default online location for conducting trade in their particular industry. However, more important than moving early, is executing well once youre moving. One high-profile incident of a market maker site going down or a major steel or chemical customers production line grinding to a halt because a market maker facilitated a delivery that was late or off-spec is likely to prompt a chorus of I told you sos from industry. Strong partnerships for distribution and logistics. Unlike books, CDs, and stereos, UPS doesnt transport lumber, resin, or hydrochloric acid. This takes specialized distribution and logistics players. In many industries, leading market makers will need to forge relationships with the key distribution and logistics providers in their industry. Neutrality and liquidity. Market makers need to ensure that all market participants are playing by the same set of rules and being treated equitably in the marketplace. However, we do believe there are ways (ie, performance-based warrants or small equity stakes for large suppliers) for market makers to jump start liquidity while remaining neutral enough to enlist broad participation. To participate in the huge potential upside of a B2B investment, investors cant wait for liquidity to be achieved in order to invest the horse will be way out of the barn by then. So investors need to look for the characteristics that are likely to lead to liquidity management with industry knowledge and expertise, earlymover advantage, a critical mass of potential buyers to attract suppliers, a handful of supplier relationships, key distribution and logistics relationships, and relative neutrality. Public currency. This is not to fan the flames of what may be characterized as a scorching B2B IPO market, but assuming that a market maker is confident that it can execute against the key metrics investors are looking for, we contend that going public is a major competitive advantage. Aside from the fact that the cost of capital may never be cheaper, the IPO significantly increases the visibility of these companies vs. their private competition and also provides them with highly valued currency to quickly grow their businesses through acquisition.
B2B Valuation Framework
At this early stage, sizing the B2B market and the shareholder value it might create is tough. Frankly, over the next couple of years, valuations are likely to be driven as much by the grandiose promises of B2B, a scarcity of investment choices, strong sequential revenue growth (on diminutive numbers), press, hype, sentiment etc. as by the potential long-term fundamentals of market makers. If history has taught us one thing, it is that many investors are insensitive to valuation when the fundamentals for Internet companies are improving. Given that the sector is so nascent, we expect to see improving fundamentals and increasing
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market caps for B2B companies for the foreseeable future. Nonetheless, we believe it is necessary to set up a framework to at least put valuation in some fundamental perspective. Based on our methodology, we believe it is likely that B2B market makers could generate total market capitalization between $800 billion and $1.5 trillion by 2003. We estimate the present value of this total market capitalization to be between approximately $340 billion and $620 billion. (Note: Currently, there are only a handful of publicly traded market markers. Therefore, most of the potential market capitalization to be created resides in private companies. As a result, we believe that the extraordinary valuations of some public market makers reflect more than their long-term fundamentals namely, the general excitement surrounding this seemingly huge opportunity and the scarcity of public ways to play it.) Our methodology is fairly straightforward. We estimate 1) the total market for B2B electronic commerce, 2) the percentage of revenue to be captured by market makers, 3) market maker profit margins, 4) a multiple to apply to the implied market maker earnings, and 5) an acceptable discount rate (35%). As mentioned, we believe worldwide electronic commerce revenue could total approximately $2.5 trillion by 2003. Clearly, in order for third-party market makers to create meaningful market capitalization they will have to pick up a greater share of this growing market. The fact that the Ciscos, Intels and FedExs of the world are dominant suppliers in their respective industries has made gaining relatively quick revenue traction over the web easier for them than it has been for market makers. This makes sense to us because market makers need to enlist supplier and buyer participation, which takes time, before generating a meaningful volume of transactions. Furthermore, established companies with seller-centric sites have a number of characteristics that make generating web-based business relatively easy almost immediately their own supply or relationships with major suppliers and existing customers as well as a brand name and marketing resources to attract new customers. In addition, these companies already have relationships with the key distribution and logistics players necessary for fulfilling orders. In other words, these businesses are quick out of the box in regard to generating online sales, while market makers take longer to ramp. Over the coming years, we expect that many market makers will add meaningful numbers of buyers and suppliers and establish the key distribution and logistics relationships. We believe that seller web sites will dominate the overall mix. However, we believe it is a reasonable assumption that third-party market makers could represent 10-20%, or $248-$496 billion of overall online B2B sales by 2003. In addition, we also assume advertisers spend $5-$10 billion with market makers at this point in time. Combined we believe the total commerce passing through online market makers by 2003 could range between approximately $250$500 billion. We believe something in the $400-$500 billion range is likely. Based on the higher end of our 2003 revenue range, we believe market makers could create approximately $800 billion-$1.5 trillion in market capitalization by 2003. Below, we lay out three scenarios.
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Chart 1: B2B Electronic Commerce Valuation Framework ($ billions)

Conservative Case Middle Case Bullish Case
Total B2B Transaction Revenue 2003E
$2,481
$2,481
$2,481
Seller Site Sales Market Maker Sales

Market Maker Transaction Revenue Market MakersAdvertising Revenue TOTAL Market Maker Revenue CAGR (1998-2003E) US International Net Margin Net Income PE Multiple Revenue Mulitple MARKET CAPITALIZATION (2003E) PV (Discount Rate = 35%)
90% 10%
$248 $5 $253 237% 63% 38% 3% $8 50x 1.5x $380 $154
85% 15%
$372 $7 $380 259% 63% 38% 4% $15 55x 2.2x $835 $339
80% 20%
$496 $10 $506 275% 63% 38% 5% $25 60x 3.0x $1,518 $617
Source: Merrill Lynch Internet Research; Forrester Research; Veronis Suhler & Associates
The valuation methodology outlined above is a framework to bring some perspective to where valuations might normalize several years out. Obviously, tweaking any of the inputs overall B2B market size, the percentage of this market captured by third-party market makers, margins or multiples causes the potential market cap created by the B2B opportunity to swing wildly. In addition, over the near-term (probably the next couple of years, rather than months), the revenue multiples applied to leading B2B companies are likely to remain in substantial excess of what we use for our valuation framework. Despite strong near-term growth, for the foreseeable future almost all B2B market makers are likely to continue to appear small relative to the huge market opportunities they typically address. We expect investors to ascribe extremely high price-to-sales multiples to companies for which potential market opportunities look far from saturation, upside to revenue estimates remain likely, the waning of hyper-growth any time soon seems remote, and execution is strong.
Investment Philosophy
As evidenced by the spectacular public market debuts of B2B companies like Internet Capital Group, FreeMarkets, Ariba, CommerceOne, Purchase Pro, Chemdex, SciQuest, RoweCom, and VerticalNet, among others, there is significant investor demand for public B2B investments. Given the size of the opportunity, this is not surprising. However, despite the multi-billion dollar market caps most public B2B companies enjoy, they are all at early stages of development. In many ways, public investors are taking on roles once reserved for venture capitalists. Whether this role should ever be left to public market investors is open to debate, but, in our minds, that debate is academic. We believe B2B will create tremendous value for public market investors. We believe potential investors should be cognizant of some key points when considering B2B investing. B2B market makers will likely have a profound effect on many economic sectors, particularly industrial ones. The steel, paper and plastics industries have been doing business in essentially the same, often inefficient, manner for many years. B2B market makers, with no legacy business or relationships to protect, seek to make businesses out of capturing profit that many large companies for many different reasons, including potential channel conflict, fixed asset investment, delicate partner relationships, vertical integration, a general failure to embrace electronic commerce, or complacency, have foregone. The established,
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often stagnant industrial ecosystems into which these new B2B market maker organisms look to insert themselves are typically huge often hundreds of billions of dollars. Capturing just a small portion of the value transacted within these industries is likely to create what could be valuable B2B Internet investments. Investors are paying up for the promise of B2B. Currently, the public valuations of most B2B companies, as well as the private valuations of many others, look very expensive. Almost every public B2B company sports a market cap of over $1 billion. Most have multi-billion dollar market caps. In addition, it is not uncommon to see premiere private companies with hundreds of millions of dollars of private valuation. Undoubtedly, valuations are driven, in large part, by the fact that many B2B companies address huge opportunities and will become valuable long-term based on fundamentals. However, we believe that the valuations of public B2B stocks and ones likely to come public over the next year are also driven, to varying degrees, by what seems to be indiscriminate investor demand for anything B2B. This can be attributed to numerous factors, including the B2B hype created by Wall Street, venture capitalists, and the media and the fact that many investors are determined to catch, in B2B, the Internet run they may have missed in B2C. Assuming markets remain robust, we expect to see a plethora of B2B market makers come to the public market some great, some okay, some poor. As supply and demand move closer to equilibrium, it is important for investors to understand the quality of what they might own and realize that, over time, there could be as much as 100% downside for lowquality B2B equities. The net result of so many B2B companies coming public is likely to be that there will be many more losers than winners. Generally speaking, successful market makers will create liquidity in the markets they address by enlisting participation from a critical mass of buyers and suppliers. For vertical market makers particularly, it is likely that the No. 1 player in medical equipment, chemicals, or livestock, etc. will dwarf No. 2 in terms of value. Why? Market leaders will enjoy the benefits of the network effect. In other words, suppliers will align themselves with market makers that provide them access to the most buyers and buyers are likely to make purchases through market markers that present them with the largest choice of products and suppliers. As a result, within a specific market, a dominant share of electronic commerce is likely to be transacted through the leading site and allow the No. 1 player to enjoy the leverage associated with significant scale as well as strong returns on invested capital. However, in these winner take most (if not all) markets, it is questionable whether the next tier of players will scale to a size that provides them the leverage to reach profitability. Obviously, we believe investing in No. 1 is optimal, investing in No. 2 could result in good returns but is more risky, and investing in No. 3, No. 4, and No. 5 is likely to be a bad use of capital. Winners are likely to create significant value. The downside for losers could be close to 100%. Therefore, if you have a loser, we would recommend that you cut bait immediately. If you have a winner, dont let valuation scare you into selling. Historically, good internet stocks have looked expensive from the beginning and looked more expensive over time. Bad internet investments have done one of two things they have either started expensive and gotten cheaper or started cheap and gotten cheaper. In our experience, the only time investors focus on the valuation of an internet stock is when fundamentals are deteriorating. Given that B2B is in its infancy, we would not expect to see sector-wide fundamental deterioration for quite some time. However, if fundamentals should truly deteriorating for a particular B2B company, we believe the stock should be sold. However, if fundamentals are improving and upside to estimates is expected to continue, the stock is likely to continue to rise over the long-term.
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We dont expect investors to sell their best internet stocks because they suddenly look expensive (they always look expensive). On the flip side, we would not advise investors to rush to buy what seem to be cheap B2B internet stocks. They are almost always cheap for fundamental reasons. Investor suitability. So market opportunities are large, the companies addressing these opportunities are early-stage, winners are likely to create extraordinary returns, losers could prove to be close to worthless, and picking winners and losers is tough. Isnt this type of investing suitable only for venture capitalists? No, diversified growth investors, sector investors, and speculative investors all need a strategy for B2B whether offensive or defensive, direct or indirect. In a vacuum, almost every B2B market maker is a speculative, high-risk and early-stage investment. B2B investing is arguably the closest thing to venture capital in todays public markets, so, obviously, these investments are not suitable for the risk averse. However, many other investor types of varying risk profiles need to develop a strategy for the sector. Investors that choose to have exposure to the space need to take different approaches. Diversified growth investors. We have always maintained that diversified growth investors allocate a small percentage of capital (ie, 10%) to pure play internet investments. We would suggest that these same investors earmark a percentage of this overall internet allocation to a basket of B2B market maker stocks. Most B2B market makers address huge markets and have great promise, but they also still have much to prove. A basket approach gives investors the best chance to realize excellent returns by having a couple of success stories in a portfolio of investments in which the majority are losers. In addition, we believe diversified growth investors have limited chances of outperforming applicable investment benchmarks, which are likely to have an increasing B2B component embedded in them over time, without B2B exposure. Sector investors. It is hard to tell if market makers will actually create new value or take it from established industry players. They will probably do a bit of both. In the best case, market makers would create value for themselves and others by providing leading industry veterans with new customers and incremental revenue streams, lower cost distribution channels, expanded customer reach, and improved productivity. Either as a way to capture newly created value or as a hedge against value lost by established businesses, we believe portfolio managers with assets in many industries need exposure to these new market maker investments. Speculative investors. As mentioned, B2B market makers investments are high risk/high reward. Under the assumptions that they have more risk capital at their disposal and are emotionally conditioned to endure more risk than most, we believe speculative investors can seek outsized returns by allocating more capital to B2B investments over the near-term. For maximum near-term appreciation, we would seek out companies likely to deliver extraordinary sequential revenue unit growth over the next several quarters.
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3. A Brief History of B2B Electronic Commerce

B2B e-commerce isnt new. EDI dates back over a quarter of a century.
All the recent hype surrounding B2B e-commerce might lead an observer to believe that it is a brand new concept. It is not. While the emerging third-party companies that provide online catalogs, communities, auctions, and exchanges, among other models, are the pure play internet-based B2B investment opportunities investors are excited about, B2B electronic commerce has a history that dates back over twenty-five years. We believe this bodes well for the acceptance of B2B market makers because it indicates that businesses have been adopting B2B e-commerce, although in a different form, for many years. We would also point out that, although to varying degrees among different industries, IT is prevalent and becoming increasingly so, in all businesses. In other words, business is generally wired for B2B market makers. Although one could go back further, we trace the heritage of internet-based electronic commerce back to EDI (Electronic Data Interchange). In fact, EDI, which allows businesses and their trading partners using a variety of systems to exchange information through a standard set of transactions over value-addednetworks (VANs), is over a quarter of a century old. When one thinks of EDI companies like Harbinger and Sterling Commerce come to mind. EDI facilitates transactions such as purchase orders, invoices, shipping notices and a multitude of other documents. EDI can be viewed as a hub and spoke model. The hub is typically a large company and the spokes are its suppliers. Retail, manufacturing, transportation, and healthcare are among the industries that have been major adopters of EDI. Due to the fact that EDI runs over proprietary networks it is typically well regarded in terms of reliability, security and performance. For those companies with the resources to use it, EDI has, to some extent, automated the manual process of trading between buyers and suppliers. However, EDI deployment and ongoing VAN charges have proven too onerous for all but the largest companies. As a result, it is estimated that only 25% of a typical hubs trading partners (spokes) use EDI. So not only does a large population of businesses not use EDI, but those that do only realize its benefits with a small portion of their supplier base. We believe the major principle of EDI reducing the process costs of intercompany trade will live on. However, we believe as businesses continue to get more comfortable about the security, reliability and performance of the internet that the use of EDI over expensive, proprietary VANs will give way to Internet-facilitated transactions.
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Chart 2: Electronic Data Interchange
Supplier A
Supplier D
Supplier B
Buyer
Supplier E
Supplier C
Source: Merrill Lynch Internet Research
Supplier F
Many companies have employed B2B electronic commerce for years. Federal Express
Beyond EDI, many companies have been utilizing the Internet to increase revenue, reduce and avoid expenses, and improve customer service for several years. We highlight some examples of the successful use of the Internet in B2B electronic commerce. Not surprisingly, the companies we highlight are at or near the top of their industries. Federal Express evolution onto the Internet dates back to 1982 when FedEx put terminals on the shipping docks of its major customers. From these terminals, shipping clerks could place pick-up orders directly into FedExs systems, automating paperwork and allowing for the electronic tracking of shipment status. The evolution continued in 1995 when FedEx extended this functionality to personal computers that accessed FedExs systems over modems. This moved customer access beyond the shipping dock and into individual departments. Customers could now track the status of orders, helping them better manage production schedules and, as a result, customer expectations. In 1996, Federal Express moved onto the Internet. Using fedex.com customers can request pickup, find drop-off points, and track deliveries, among other things. FedEx estimates it would have to hire over 20,000 additional couriers, customer service reps and data-entry clerks to handle the tasks that customers now handle themselves. Clearly, forgoing these hires allowed FedEx to avoid significant personnel costs. Furthermore, FedEx estimates that customers track millions of packages per month on its web site. FedEx estimates that over half of these Internet-tracked packages would have generated customer service handled calls. Its really a double-dip for FedEx. Customers are doing work that allows FedEx to avoid and reduce costs and focus on more strategic and revenue-generating activities. Meanwhile, customers are more satisfied performing these tasks themselves anyway.
Cisco
As the leader in networking gear and the major provider of the Internets plumbing, Cisco is certainly eating its own cooking. Beyond serving as an incredibly lucrative sales channel, the Internet also enhances Ciscos ability to optimize customer service and reduce expenses. In 1991, Cisco began offering software downloads, defect tracking and technical assistance over the Internet. With the deployment of Ciscos web site, which commenced in mid-1995, Cisco brought greater efficiency to and improved customer satisfaction with the ordering process. Ordering networking gear is complicated. It is typically configured-toorder by engineers of Ciscos customers. Pre-Internet, these engineers used to
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communicate these complex orders via fax, phone or mail. If mistakes were made in placing or receiving an order, the procurement process would begin again from scratch with the frustrated customer re-configuring the order. Before Cisco deployed its web site, approximately one out of four orders needed to be re-initiated. Obviously, in such cases, the time and money of both Cisco and its customer were wasted and customer satisfaction was presumably damaged. Via online ordering, engineers now configure products online, get immediate feedback as to errors, fix those errors and route the order to procurement. Customer pricing is maintained on Ciscos web site. Therefore, a customers authorized purchaser can easily complete the order. Similar to FedEx, Cisco allows customers to check the status of their orders on its web site. Cisco receives hundreds of thousands of inquires per month. Ciscos primary freight forwarders update Ciscos database, typically via EDI, so Ciscos customers can get current updates on the status of an order. Cisco sells approximately $30 million+ in products over the Internet every day. Thats approximately $12 billion annually. Over 70% of Ciscos customer service requests are handled on the companys web site. Cisco estimates it is saving at least $500 million in operating costs through its Internet-based initiatives. Cisco is a great example of the benefits that B2B e-commerce can bring to a company increased revenue, improved productivity, reduced expenses and improved customer satisfaction.
Dell
Dell is the #1 personal computer company in the world. Dells build-to-order, direct sales model has allowed the company to reduce inventory carrying costs and avoid the mark-ups of value-added resellers, distributors and resellers. As a result, Dell estimates it has a 10-15% price advantage over its major competitors. In short, Dells model has made it the fastest growing major PC provider in the world and revolutionized the industry. Consistent with its leading edge strategy, Dell was quick to embrace the virtues of the Internet and electronic commerce. While the vast majority of Dells sales are to large corporations, its Internet sales are much more weighted toward small businesses and consumers. Therefore, Dells Internet strategy goes beyond B2B and has allowed the company to expand its presence in the consumer market. However, since small businesses are buying over the Internet and large businesses are accessing the website for product information, technical assistance and order status updates as well as increasingly to buy product, we still consider Dells Internet strategy largely B2B. Similar to Cisco, Dell currently generates $35 million in Internet sales per day thats over $12 billion annually, and growing. In the most recent quarter, Internet sales accounted for over 43% of Dells overall revenue. Dell expects over half of its sales to occur online in the next year or so. The Internet allows Dell to reach brand new customers. Beyond increased sales, Dells web site is extremely valuable in terms of reducing service and support costs. Calls for order status updates and software downloads cost Dell $3-$5 each. Phone inquiries for troubleshooting tips run approximately $15. In aggregate, all of these calls run in the hundreds of thousands of dollars. Moving even a small percentage to the Web enhances Dells bottom line. Given the amount of business running through its website, B2B electronic commerce isnt new to Dell.
GE
GE implemented numerous strategies, including use of the Internet, to improve the purchasing process. GE lighting piloted an online procurement solution developed by GE Information Systems in 1996. Using the system, employees from GE Lighting send requisitions to sourcing electronically. The system pulls down the appropriate diagrams and attaches them to the electronic requisition forms. Suppliers are alerted to an incoming RFQ (Request for Quote) within two hours of when the process is initiated. Bids can be awarded within the same day. Putting together a requisition, which used to require retrieving diagrams from a vault, photocopying them and attaching them to a paper requisition form, took at least seven days. As mentioned, the process can now be completed within one day. As a result, sixty percent of the procurement staff has been redeployed and the sourcing department has at least 6-8 additional days per month to focus on
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strategic activities instead of manual processes. Labor costs in procurement have been cut 30%. Due to the fact that sourcing can reach a much larger group of suppliers, material costs have been reduced 5%-20%. The process of identifying suppliers, preparing a request for bid, negotiating price and awarding a contract has been cut from 18-23 days to 9-11. Over the course of 2000, GE expects all of its business units will be purchasing MRO products via the Internet totaling $5 billion. GE thinks it will be able to save $500-$700 million at this time. Clearly, the Internet is playing an important role in improving margins. These are just a handful of examples of companies utilizing the Internet to improve business. Intel in microprocessors, Grainger in MRO and Boeing in aerospace and defense are other industry stalwarts considered leading edge in the adoption of Internet-based business-to-business electronic commerce. This small sample and a continually growing list of companies using the Internet to significantly enhance their businesses indicate that B2B is neither new nor a tough concept to sell.
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4. B2B Market Overview

Huge Opportunity (in case you hadnt heard)
We dont quibble with Forrester Researchs U.S. forecast of $1.5 trillion ($1.3 trillion for goods and $200 billion for services) for B2B online trade. We also believe there are significant opportunities for market makers in international markets, particularly because many of the large industrial markets these companies typically address, like steel, automotive, telecommunications, and electronics, are global today. In 2003, we assume 38% of B2B electronic commerce revenue is generated internationally. As a result, we believe worldwide electronic commerce revenue could total approximately $2.5 trillion by 2003.
Chart 3: US B2B Market Forecast Goods & Services
$1,600
$1,400
$1,200
$1,000 Billions
$800
$600
$400
$200
$0 Total B2B Services Total B2B Goods
1999E $22 $109
2000E $44 $251
2001E $83 $499
2002E $143 $843
2003E $220 $1,331
Source: Forrester Research
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Chart 4: Worldwide B2B Market Forecast
$2,500
$2,000
$1,500 Billions $1,000 $500
$0 Total Intl B2B Total US B2B
1999E $26 $131
2000E $88 $295
2001E $233 $582
2002E $493 $986
2003E $930 $1,551
Source: Merrill Lynch Internet Research; Forrester Research
However, what we view as more important than this total sales figure, is its likely mix between seller sites, like those of Cisco, Dell, Intel, Boeing, Grainger, Federal Express, etc., and the sites of online market makers the B2B investment opportunities upon which this report is focused. We believe that seller web sites will dominate the overall mix. However, we believe it is a reasonable assumption that third-party market makers could represent 15-20%, or $372-$496 billion of overall online B2B sales by 2003. In addition, we also assume advertisers spend $7-$10 billion with market makers at this point in time. Combined we believe the total revenue attributable to online market makers by 2003 could range between approximately $400-$500 billion. (In our conservative case, which we consider less likely, we estimate that only 10% of B2B electronic commerce revenue, or approximately $250 billion, is transacted through market markers.)
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Chart 5: B2B Electronic Commerce Seller Site Sales vs. Market Maker Sales
$2,481
$2,481
$2,481

Market Maker Transaction Revenue Market MakersAdvertising Revenue TOTAL Market Maker Revenue CAGR (1998-2003E) US International
90% 10%
$248 $5 $253 237% 63% 38%
85% 15%
$372 $7 $380 259% 63% 38%
80% 20%
$496 $10 $506 275% 63% 38%
Source: Merrill Lynch Internet Research; Forrester Research; Veronis Suhler & Associates
Buyer and supplier benefits will drive adoption
Essentially, two constituencies will drive the adoption of B2B e-commerce buyers and suppliers. For the buyers, B2B e-commerce will drive savings through lower process costs, reduced inventory carrying costs, improved purchasing policy compliance, and better prices. Furthermore, it will allow buyers to source based on important parameters beyond price including availability, delivery, quality, and service, among others. For suppliers, B2B e-commerce will provide a cheaper channel through which suppliers can sell to existing customers or reach new customers altogether. It will also enable suppliers to reduce their process costs. Adoption on both the supply side and the demand side, which we believe is critical to e-commerce fulfilling its potential, will allow for much more efficient supply and demand chains. Middlemen that add value will use the Internet to automate processes that are currently manual, middlemen that add no value beyond hooking up buyers and sellers better watch out. Below we explain further what we believe to be some of the major values of B2B e-commerce for both buyers and sellers. n Buyer Benefits Reduced procurement process costs. The National Association of Purchasing Managers estimates that the average manual purchase order costs a company $79 to process, $38 of which is related to internal processing. Searching for products through the separate paper-based, outdated catalogs of suppliers, corresponding with these suppliers to clarify product and service specifications, availability, delivery, price, etc. and routing requisitions through the approval process manually is all terribly inefficient. The efficiencies of B2B e-commerce not only reduce costs related to the procurement process but also allow personnel to spend more time on value-added, strategic work. Reduced inventory costs. A slow procurement process coupled with an inefficient supply chain leads to long lead times and bloated inventory. e-commerce helps buyers reduce inventory costs by improving the order process and increasing the speed at which suppliers can fulfill orders. Reduced rogue purchases. Aberdeen Group estimates that 40-45% of corporate purchases of manufactured goods are made from suppliers other than those on a companys preferred vendor list. As a result, businesses are paying much more for goods and services than needs be the case. B2B e-commerce automates the procurement process and helps keep employees within corporate purchasing guidelines. More choices and better pricing. Oftentimes, there are many suppliers from which a customer could be buying goods. However, whether due to a suppliers or its distributors limited geographic coverage or the time and expense related to investigating all possible options, a customer is limited to certain suppliers and distributors. These suppliers and distributors are not always optimal as it regards numerous key sourcing parameters, including quality, service, availability, delivery and price.
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The B2B Market Maker Book 3 February 2000 n Supplier Benefits Suppliers reduce the costs associated with sales. The Internet is a cheap, efficient and ubiquitous sales channel, not to mention that it works 24 X 7 without breaks, sick days, vacations or complaints. The nature of some customers and products will always require sales and distribution through traditional channels. However, there are many products sold and customers reached through existing channels because no better alternatives exist. The inefficiencies of these less-than-optimal channels typically reveal themselves in inflated costs and margin pressure. The Internet provides suppliers with a new alternative for selling products and services that dont necessarily require the high touch and related expenses of traditional channels. Suppliers reach new customers thereby generating new revenue streams altogether. In many markets, demand is extremely fragmented. Traditional sales and distribution channels are not limitless, so there are potential buyers that suppliers never reach. B2B market makers provide a venue in which vendors can peddle their wares to a brand new audience of potential customers. Suppliers reduce the process costs of order management. Due to the fact that suppliers and buyers often communicate by phone, fax and mail, the exchange of information is not only slower than if executed electronically but also more prone to error, which results in costly rework. By automating the exchange of information, B2B e-commerce helps suppliers reduce errors, speed up the orderto-cash cycle, focus employees on value-added functions, and improve customer satisfaction to boot. Obviously, buyers and suppliers dont operate in a vacuum. In other words, to a large degree, a buyers efficiency is limited by the efficiency of its suppliers and vice versa. Clearly, B2B e-commerce allows businesses to utilize the Internet to automate the workflow of many different processes including manufacturing, finance, sales, and purchasing. The Internet can also be used to increase information flow within an enterprise and outside of it creating a virtual enterprise that spans the entire value chain, which includes customers, suppliers, distributors, etc. All in all, the Internet provides businesses with the ability to increase operational efficiency by reducing the time, costs and resources required to transact business, lowering inventory levels and procurement costs, and improving responsiveness to customers and suppliers.
Market maker adoption is inevitable
We believe the adoption of B2B e-commerce is still in its very early stages. In our view, a major shift to Internet-based commerce among businesses is inevitable and not too far off. However, not all industries will move to this new paradigm as quickly as others will. With technology blue chips such as Cisco, Intel and Dell, among others, already doing a tremendous amount of business on the Web, the hitech industry has quickly embraced commerce over the Internet. This is not surprising given that change and innovation is so deeply ingrained in the hi-tech culture, not to mention that these companies provided the Internets plumbing. In addition, industries like hi-tech, where product lifecycles are short and the risks of carrying inventory are high, are likely to migrate to B2B e-commerce fairly quickly. In addition to industries with short product cycles, we expect companies with high waste from inventory (suitable for auction markets), high distribution costs (online catalogs provide a low-cost distribution channel) and commoditypriced products (suited for exchange-oriented market makers) will embrace B2B e-commerce over the next several years. Aerospace and defense, automotive and electricity are among industries likely to come on board sooner than later. Like in any other paradigm shift, the best companies will move quickly and boldly to make an opportunity out of an inevitable change. Less progressive companies will move more slowly and with dire consequences.
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Chart 6: B2B Market Forecast Industry Segmentation
Telecom $1,600 $1,400 $1,200 $1,000 Billions $800 $600 $400 $200 $0 1999E Business Travel Admin & Support Professional Financial Industrial equipment Heavy industries Construction Aerospace & defense Pharmaceutical & medical Consumer goods Food & agriculture Shipping & warehousing Paper & office products Utilities Petrochemicals Motor vehicles Computing & electronics 2000E 2001E 2002E 2003E
Source: Forrester Research
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5. Market Maker Models

Internet-based market makers, the latest incarnation of B2B e-commerce, come in many different variations. However, we believe the different market makers that do exist are a variation of one of, or a hybrid of, four basic models catalog, auction, exchange and community market makers. All of these models bring benefits to both buyers and sellers. Those that dont will have difficulty attracting a critical mass of supply and demand to be effective.
Table I: Market Maker Models
Market Maker Type Description Catalog Aggregates a multitude of products and services from multiple suppliers to provide a one-stop shopping site for buyers and a low-cost distribution channel for suppliers Static; Prices pre-determined; Support individual pricing agreements between specific buyers and sellers Auction Provides a venue for the purchase and sale of unique items such as excess inventory, used capital equipment, discontinued goods, perishable items, etc. Dynamic; Competitive bidding drives pricing up in favor of seller in traditional auctions; Drives prices down in favor of buyer in reverse auctions Easier means by which to find Reduces procurement process unique products and services; costs and inventory costs; Expands potential supplier base; Discounted prices; Broader Easy product comparison based selection; Lower prices through competitive seller bidding in on multiple dimensions (price, quality, service, availability, etc.) reverse auctions Sellers attract more bidders for Lower cost of sales; New sales more competitive bidding and channel and revenue streams; higher selling prices; Cut out Lower process costs; Improved liquidation brokers; Increased customer satisfaction inventory turnover Percentage of gross Percentage of gross transaction value (typically low transaction value (typically high single digits to low single digits to mid-teens) twenties) Product listing fees from suppliers Ad revenue from suppliers Ad revenue from suppliers Supplier listing fees Exchange Community Provide an industry spot market Aggregates a targeted group of for commodity products buyers for sellers by providing industry-specific content and community characteristics of high relevance to industry professionals Dynamic; Bid-Ask market moves Not applicable; Sites generate pricing up and down based on leads for catalogs, auctions and exchanges supply and demand Venue to fill immediate purchase needs Industry-specific destination with highly relevant content characteristics and community tools; Products and services of advertisers highly relevant Industry-specific nature of site provides a highly targeted group of potential customers
Pricing
Buyer Benefits
Seller Benefits
Venue to offload excess capacity at market prices
Revenue Sources
Percentage of gross
Ad revenue from suppliers transaction value (typically a Revenue sharing with few basis points to low single suppliers and other market digit percentages) makers for commerce and lead generation Membership fees Sponsorship Membership fees
Source: Forrester Research, Merrill Lynch Internet Research
Online Catalogs Online catalogs are ideal for fixed-price products and services and fragmented markets
Since their principal function is to aggregate supply from a mass of suppliers and demand from a mass of buyers, online catalogs, for lack of a better word, are optimally suited for markets where the supply and demand sides of a market are highly fragmented. SciQuest and Chemdex in life sciences are examples of vertically focused players in this category. Ariba, CommerceOne, and PurchasePro in MRO are horizontally focused market makers. Essentially, these market makers take the paper-based catalogs of multiple vendors, digitize the product information and provide buyers with one-stop shopping over the Internet. However, the fact that, in most cases, these market makers embed themselves in the business processes and IT systems of buyers and suppliers, lower process and inventory costs, extend supplier reach, and improve customer access to suppliers makes their value much greater than just digitizing catalogs. Online market makers allow buyers to search for products more efficiently. Instead of flipping through a mountain of separate, often out-dated, supplier catalogs, buyers can utilize the powerful search capabilities of the Internet to compare products on many dimensions including price, availability, delivery dates, warranty, service information, etc.
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The prices of products on these sites are typically fixed. However, these market makers need to be capable of customizing the buyers view of the site so that it is consistent with specific buyer-supplier contracted pricing arrangements where necessary. Inability to support different pricing arrangements will make the participation of many large buyers and suppliers highly unlikely. Online catalogs usually derive revenue from the combination of a percentage of gross transaction values, typically in the low single digits to the mid-teens, as well as product listing and advertising fees from suppliers. n Buyer Benefits
Lower process and inventory costs and strategic sourcing are major benefits for buyers
Lower procurement process costs and better allocation of human resources are the principal benefits to buyers. While the potential for buyers to source from lowercost suppliers is important, we do not believe it is chief among the benefits online catalogs provide for buyers. We consider improving the procurement process, reducing inventory costs, and providing buyers with the ability to strategically source based on many parameters aside from price much more important. For many organizations, procurement is extremely inefficient. Time is money and this means that corporations are paying employees a great deal of money to flip through catalogs in order to get information about suppliers and their products. Since the information in these catalogs is not real-time, buyers typically need to phone suppliers to get current information about pricing, availability, delivery and service, among other important information. Furthermore, the data entry and manual paperwork inherent in the procurement process often results in human error and subsequent rework. Improving the process helps buyers speed up the time it takes to order and receive goods, allowing them to reduce the amount of inventory they must carry. In general, online catalogs enable purchasing professionals to spend more time on value-added, strategic work than current manual processes allow. Finally, the Internet shrinks the world providing buyers with access to suppliers that otherwise never would have been possible. n Seller Benefits
New revenue streams, lower costs, and improved customer satisfaction are major benefits for sellers
Brand new revenue streams, lower-cost sales, marketing and distribution, better order management, and improved customer satisfaction are key benefits for sellers. Due to the costs associated with selling, marketing, and distributing a product there is often demand too expensive for a supplier to fulfill. Furthermore, there is often demand that suppliers dont even know about. Online catalogs allow suppliers to utilize the ubiquity of the Internet to reach these customers at a lower cost than traditional channels allow. Furthermore, automating manual processes such as order management also improves efficiency and reduces process costs. The fact that automation allows suppliers to receive and fulfill orders more accurately and quickly also improves customer satisfaction and inventory turns. The self-service nature of online catalogs enables customers to get answers to inquiries that would usually require human intervention, enabling suppliers to reallocate human resources to more strategic, value-added functions. For example, with the time of sales people freed from providing product information easily accessed by customers over the Internet, they can spend less time managing accounts and more time chasing new business.
Auctions Great venue for purchase and sale of unique items

Auctions provide a venue for the purchase and sale of unique items such as surplus inventory, used capital equipment, discontinued goods, perishable items, or refurbished products. Examples, among many, include FreeMarkets, a reverse auction for manufactured inputs and TradeOut or AsseTrade, auctions for asset procurement and disposition and excess inventory. In addition, vertically focused companies like PaperExchange, which is predominantly (as its name suggests) a market maker in pulp and paper, also generates ancillary revenues from the auction of paper-related capital equipment. Unlike with online catalogs, where
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prices are typically fixed, auction pricing is dynamic. Auctions usually last for a pre-determined period of time. In a traditional auction, sellers post an offer to sell and buyers bid. The competitive bidding process results in upward price movement and, for this reason, we believe the lions share of the benefits of traditional auctions accrue to sellers. However, the reverse auction, a format in which sellers compete for a buyers offer to purchase, results in downward price movement. In these auctions, we consider buyers the major beneficiaries. Revenue for online auctioneers is usually derived from the combination of transaction fees ranging from the high single digits to the low twenties as a percentage of gross merchandise value as well as product listing and supplier advertising fees. n Buyer Benefits
Buyers get access to many more products and services than in physical auctions
Buyers get easier access to much more product at somewhat bigger discounts than through physical auctions. The sale of surplus inventory, used capital equipment and the like is extremely inefficient today. Currently, it is typical for a business to unload these types of goods to liquidation brokers at steep discounts who then sell them at auction or resell them to sources of demand only they know about. The number of items for auction is limited to what the broker tracks down and purchases. Conceivably, virtual auctions are able to offer much more for sale. With the middlemans mark-up removed, buyers can purchase goods at steeper discounts than in real-world physical auctions. However, due the Internets reach we would expect virtual auctions to attract more potential buyers. As a result, it is likely that buyer savings related to the removal of middlemen will be offset to some degree by the upward price movement caused by larger bidding populations. Obviously, reverse auctions via the Internet allow buyers to benefit from more competitive pricing because they receive offers to sell from a wider range of suppliers. n Seller Benefits
Sellers realize higher prices by reaching a larger bidding population
As mentioned, we believe sellers benefit more than buyers when it comes to traditional auctions conducted over the Internet. There are primarily two reasons: 1) the reach of the Internet allows the auction to aggregate a critical mass of buyers and, as such, drive more competitive bidding and higher winning bids and 2) online auctions allow sellers (suppliers) to take liquidation brokers, who typically demand fire-sale prices to buy product, out of the process. Not only does the nature of traditional auction pricing favor sellers but the auction market has many other characteristics beneficial to suppliers. Suppliers can use auctions to test pricing on new products, manage inventory levels, promote products, take old products out of the market to make way for new product releases and, of course, liquidate excess inventory, capital equipment, and other items. While we believe buyers are the primary beneficiaries of reverse auctions, suppliers do benefit because they get the opportunity to sell to buyers they may never have reached without the Internet.
Exchanges The new spot markets

Exchanges provide a spot market for commodities often with high price volatility. They provide a venue for the purchase and sale of commodities like natural gas, electricity, and telecommunications bandwidth. Altra and Enermetrix in natural gas and electricity and Arbinet in telecommunications are all prominent examples. These markets are bid/ask and provide real-time pricing. Exchanges allow buyers and sellers to trade anonymously, which is key because not only might identifying buyers and sellers damage their competitive position, but it would likely skew pricing. While market share is important in every market maker category, we believe it is of paramount importance for exchanges. This is because market share means liquidity. Exchanges without significant liquidity are likely to fail due to the relatively small transaction fees they extract. However, those exchanges that do attain leading market share should have extremely
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defensible competitive positions because offering the most liquidity will make trading on a competitive exchange less than compelling. In addition to providing a venue for immediate buying and selling of commodities, exchanges provide a pricing reference for industry players. The primary inefficiency addressed by exchanges is the use of brokers. Almost by definition, commodities are clearly defined and well understood by all market participants. Brokers add little value beyond matching buyers and sellers a service for which they extract a transaction fee. Online exchanges at least minimize and, arguably, eliminate the need for brokers in many industries. Exchange revenue typically comes from the combination of transaction fees as well as membership fees. Transaction fees usually range from a spread of a few basis points to percentage spreads in the low/mid single digits. n Buyer/Seller Benefits
Buyers and sellers benefit equally
Assuming the market is liquid, buyers and sellers benefit equally in exchanges. Initially, we expect exchanges to attract industry players producers, end-users and members of the extended value chain of a particular industry. These players are likely to purchase in spot markets based on near-term needs and sell to unload excess capacity at market prices. In addition, we would expect futures and derivatives markets to emerge so industry players can hedge risks. Finally, we would expect financial traders and speculators to emerge that are likely to drive trading volumes factors larger than the volumes produced by industry participants.
Community Market Makers Community market makers will migrate toward transactions
Community market makers bring together potential buyers and sellers, in the form of professionals with common interests, through web sites that feature industryspecific content and community aspects. The content and community aspects these sites typically provide include industry-specific news, editorials, market information, job listings, chat, message boards, etc. As a result, these community market makers attract a targeted audience of potential buyers for suppliers. For the most part, community market makers generate revenue from advertising, sponsorship and membership fees as well as from fees paid by suppliers for lead generation. Although in most cases minimal transaction revenue is actually generated on these sites today, we believe this will change over time as these community market makers either tack transaction-oriented market mechanisms onto their sites or generate revenue by driving traffic to the commerce sites of others. With over fifty sites ranging from pollutiononline.com to adhesivesandsealants.com, VerticalNet is the poster boy for community market makers. With its recent acquisition of NECX, a market maker in the multi-billion dollar electronics industry, VerticalNet has accelerated its migration to more commerce-oriented revenue. n Buyer Benefits
Buyers get highly relevant content and community aspects
The industry focus of these community web sites gives professionals, who, hopefully for their employers sake, dont have time to aimlessly surf the web all day, a destination with content and community aspects of high relevancy to their professions. Within these communities, professionals, a great number of whom are potential buyers, can access editorial content, chat with colleagues and reach suppliers, among other things.
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n Seller Benefits
Sellers get a highly targeted audience
Suppliers benefit from community market makers by gaining access to a highly targeted audience of potential buyers. Many of the professionals these sites attract are looking to make a purchase making the sites valuable real estate for suppliers to advertise their offerings. Other site visitors may be on the site simply to take advantage of the content and community it offers with no initial intention to buy. However, we believe advertising on these sites is more likely to convert these visitors into customers than more broad, less targeted web advertising strategies. In summary, today, many of the aforementioned market models are separate entities even within specific vertical industries. However, over time we would expect to see some convergence where, for instance the catalog, auction and exchange pricing mechanisms and all the variations thereof, for, lets say the chemicals industry, take place on one site. Furthermore, as we are already seeing with VerticalNet, we would expect to see community-based market makers monetize eyeballs through revenue streams beyond advertising, sponsorship and lead generation fees. In other words, transaction-based revenue.
Models will merge
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6. Horizontal & Vertical Markets

Fundamentally, we believe there are two business-to-business markets vertical markets and horizontal markets. Vertical markets are industry-specific. The inefficiencies market makers address and the requirements required for success in each of these markets differ significantly. Horizontal market makers are functional in nature and facilitate the purchase and sale of goods and services used by a plethora of industries. In the short history of Internet-based B2B ecommerce, hundreds of vertical market makers have already emerged in industries ranging from metals and livestock to printing and chemicals. Similarly, horizontal market makers have emerged that support the purchase and sale of goods and services such as those for maintenance, repair and operations (MRO), benefits administration, media buying, and logistics. As business adoption of these new models matures we expect a B2B quilt to be woven where horizontal market makers become interwoven with vertical ones.
Chart 7: Horizontal & Vertical Markets
MRO
ENERGY MANAGEMENT
PLASTICS
CHEMICALS
PAPER
STEEL
MEDIA BUYING
EXCESS INVENTORY
Vertical (Industry) Markets Vertical market makers are industry-specific

Vertical market makers serve the commerce needs of buyers and suppliers in specific industries. Once successful in aggregating a critical mass of buyers and suppliers and establishing a liquid market, these market makers are likely to generate solid ad revenue and, more importantly, recurring transaction revenue. Furthermore, once embedded in the systems and business processes of buyers and suppliers, high switching costs are bound to make participant defection unlikely. Earlier in this report, we provided a generic description of the four basic market maker models online catalogs, community sites, auctions and exchanges. All of these models exist within vertical markets. However, buyers and suppliers in specific markets will demand much more than a generic understanding of their industries. Transactions are the endgame for market makers. However, the road to transaction revenue is not an easy one. We believe the most prominent competencies market makers must display to generate transaction revenue through broad supplier and buyer participation are deep domain knowledge and strong industry relationships.
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To attract buyers to their sites, vertical market makers feature industry-specific content and community aspects in order to attract buyers. Content often includes industry news, editorials, job listings and the like. This content, coupled with interactive features like message boards and chat, engenders a sense of community among users and keeps them coming back. Without attracting a critical mass of buyers, it is unlikely that suppliers will participate (and, vice versa). Attracting suppliers may require more than just a well-visited site. It will likely require the convincing, understanding and, at times, prodding of market maker executives and senior sales people with strong industry relationships. Selling through an intermediary is typically not a no-brainer for suppliers. In fact, in most cases it is a major strategic decision made at the most senior levels of an organization. In the minds of suppliers, particularly large ones, it often raises concerns about channel conflict, price degradation, partner alienation, reduced customer control, employee morale etc. Gaining the participation of suppliers will require that the market makers know the industry and the players within it. In fact, we consider these relationships supremely important to the success of a market maker.
Domain knowledge and industry relationships are essential for success
Obviously, failure to generate meaningful numbers of both buyers and suppliers will result in meager transaction volumes. Assuming a market maker does attract a critical mass of buyers and sellers, which is much easier said than done, it will need to accommodate the specific needs of these participants in terms of pricing, distribution and logistics, quality, service, etc. Were not talking about books here. The goods and services traded between businesses, especially where vertical market makers are involved, are often mission-critical. Send the wrong tires to an auto manufacturer or send them late and production could grind to a halt. Needless to say, the cost of failure could be enormous. As it is, market makers are being adopted cautiously in many industries. We expect the value of market makers to win out in the end, but widespread adoption may take longer in many industries than some expect. Industries, especially those least receptive to the market maker concept at the outset, are not likely to tolerate mistakes from interlopers trying to improve processes viewed by many industry veterans as plenty efficient. It wont take many mistakes (maybe one) for a market maker to lose the participation of significant numbers of buyers and sellers. So, while early movement is extremely important. Near flawless early movement is more important. The only thing worse than moving late is moving early and disappointing participants. Once disappointed they are unlikely to return. For the reasons mentioned above, and many more, domain knowledge is of paramount importance to a vertical market makers success.
Horizontal (Functional) Markets Horizontal market makers serve multiple industries

Unlike vertical markets, horizontal markets span across multiple industries. This is due to the fact that the audiences they address and the goods and services bought and sold over them are common to many industries. Horizontal market makers provide a venue for transacting goods and services like MRO supplies, logistics services, media buying, outsourced human resources services, temporary workers as well as excess inventory and excess capital equipment. To a great extent the goods and services bought and sold via horizontal market makers are standardized in nature. In many horizontal markets, like MRO, logistics can be outsourced to third-party providers like UPS and FedEx. In fact, it is these factors that allow for horizontal market makers to sell to a multitude of various industries. However, this does not mean a one size fits all approach will work. Similar to their vertical brethren, horizontal market makers will have to support the specific pricing agreements between customers and suppliers. Many of the goods and services transacted via horizontal market makers are fairly well defined and fixed price in nature. Therefore, much of the value horizontal market makers provide is in automating workflow and reducing process costs for both buyers and suppliers. Defined business rules speed the request and approval process removing paper and errors from the process and allowing employees to spend more time performing value-added functions.
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Many horizontal market makers do utilize content and community to attract buyers. However, we believe this could prove challenging over the long haul. This is due to the fact that although some of the buyers who utilize horizontal market makers focus solely on a specific function and identify themselves with it lets say media buying others buy these goods and services in conjunction with industry-specific functions. These employees may associate themselves with the industry rather than the function. Targeting this mixed bag of users with meaningful content and building a sense of community might be tough. The heterogeneity of horizontal market maker users also may make attracting premium-priced advertising revenue equally difficult.
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7. Why We Like B2B Market Makers

Huge Market Opportunity. The market for B2B e-commerce is huge. Estimated by Forrester Research in the U.S. at approximately $43 billion in 1998, B2B ecommerce is projected to grow at a compounded annual rate exceeding 100% and reach over $1.5 trillion by 2003. Including international opportunities, we believe worldwide B2B electronic commerce could approach $2.5 trillion by 2003. In our view, the overwhelming majority of this commerce will occur on seller sites, like those of Grainger, Intel, and FedEx. However, based on our assumption that 1520% of B2B electronic commerce is transacted through third-party marketplaces, we believe market makers could generate revenue of approximately $400-$500 billion by 2003. From buying and transporting raw materials to moving manufactured products to wholesalers, distributors and retailers as well as many other transactions dotted throughout the supply and demand chains, there are multiple opportunities for B2B market makers to improve the flow of goods and services and extract transaction fees for the service. In Chart 8, we depict a hypothetical and extremely simple view of a generic value chain. In our view, by definition the only transactions that dont fall under the domain of B2B are those between retailers and consumers. In fact, in most cases where the end buyer is a business, particularly a large one, B2B market makers will own the final transaction.
Chart 8: B2B Market Makers & The Value Chain
Raw Materials Transportation & Logistics

Manufacturing
Transportation & Logistics
Distribution
Transportation & Logistics
Retail
Consumer
User Relationships and the Network Effect. With seller-hosted sites like those of FedEx, Cisco or Amazon.com, relationships are one-to-one in nature. Business is transacted between the seller and each individual buyer separately and revenues grow linearly. However, B2B market makers are different. They facilitate many-tomany relationships. Each buyer can buy from one or many suppliers and each supplier can sell to one or many buyers with the B2B market maker getting a cut of each transaction. Once B2B market makers achieve a critical mass of buyers and suppliers no easy accomplishment and one that few have achieved to date they should benefit from the network effect over time. In other words, leading B2B sites (or networks) should scale significantly as they attract buyers looking for a broad selection of products and suppliers seeking a large audience of potential buyers. This dynamic should allow market makers to enjoy exponential revenue growth once a critical mass of market participants and liquidity is achieved. EBay is probably the best example of the network effect weve seen to date in electronic commerce. EBay is the clear leader in person-to-person auctions in the C2C (consumer-to-consumer) market. In our view, only through the power of the network effect could a company just over four years old and staffed with approximately 130 employees serve as the transaction platform for gross merchandise estimated at just under $3 billion for 1999 and enjoy profitability.
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Chart 9: Seller-Hosted B2B Sites vs. B2B Market Makers
Seller-Hosted Site
Buyer A Supplier A
Market Maker
Buyer A
Buyer B
Supplier B
Buyer B
Participant Acquisition Costs, Which Will Start Out Extremely High, Should Decline Over Time and Allow for Margin Expansion. For B2B market markers, the cost of attracting buyers and suppliers, in particular, will be extremely expensive relative to the transactions and revenue they will generate in the early going. Sales cycles are typically long because, in most cases, the decision to participate is one made at the highest levels of an organization. B2B market makers need to attract a critical mass of buyers and suppliers before revenue traction will occur. However, as the network effect takes hold and more participants migrate to a market maker, it should take less money and prodding to get suppliers to contribute their products to a growing source of demand and buyers to shop at a growing source of supply. Exponential revenue growth due to the network effect, coupled with declining participant acquisition costs should lead to margin expansion for leading market makers. Barriers to Entry. For market leaders, we believe the barriers to entry for competition will be extremely high. Once a market maker gathers a critical mass of buyers and suppliers, embeds itself in the business processes and IT infrastructure of both, and achieves market liquidity, we believe it will be tough for another market maker to overtake the leader. Furthermore, we believe that leading vertical (industry-specific) market makers will align themselves with specialized distribution and logistics players to fulfill the orders taken on their site. We believe the B2B market makers that forge these important relationships will have a significant leg up toward securing a highly defensible market position. High Switching Costs for Participants. Aligning with a particular market maker typically includes systems integration between the participants and the intermediary. Furthermore, market makers, once aligned with, embed themselves in the business processes of both buyers and suppliers. In all likelihood, both of these factors will make switching to another network prohibitively expensive and disruptive. Recurring Revenue. Once market makers embed themselves in the procurement processes of buyers, the sales and distribution processes of suppliers, and the systems of both they should become venues for highly recurring transactions and revenue.
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8. Market Maker Beneficiaries and Liquidity

Regardless of whether it is an online catalog, auction or exchange the most important, and most challenging, characteristic market makers must attain is liquidity. We believe the benefits of online intermediaries are more evident for certain participants than for others. As we further explain below, we believe small suppliers benefit the most from online market makers, followed by small buyers and large buyers. We believe gaining the participation of large suppliers will prove the most challenging for market makers. Since, in our view, large suppliers are the single most important factor in providing liquidity, we consider their involvement the linchpin of a market makers success. Below we explain our thought process and rank marketplace participants according to what we believe is the relative value proposition offered to each by market makers.
Market maker participation is a no brainer for small suppliers
1.
Small Suppliers. We believe small supplier participation in online markets is pretty much a no brainer. To us, small usually means limited resources this includes sales and distribution. Capacity is not unlimited for distributors and resellers. They usually limit the products they move to those with the widest customer appeal and the best profit margins for them. Even if a small suppliers quality and service is top notch they usually have neither the brand name nor the scale to provide a sizable enough discount to induce large distributors or value-added resellers to push their goods and services. Online markets provide a low-cost distribution channel through which small suppliers can reach small customers formerly too far and expensive to reach and large buyers with whom they could never get an entre. Small Buyers. This is another online market maker participant we throw in the no brainer category. Online market makers allow small buyers to automate and reduce the expenses related to the manual procurement process. In addition, more efficient procurement allows small buyers to reduce inventory and related carrying costs. Finally, small buyers now get greatly expanded supplier access from the remotely located high-quality supplier they never would have connected with without the Internet to the large supplier for whom selling to smaller customers by traditional means was too expensive. Large Buyers. Large buyers buy in volume and, as a result, they are highly sought after by suppliers of all sizes. A great deal of what large buyers purchase comes from large suppliers that can handle the service, quality and pricing requirements to which big customers are entitled due to their buying power. In addition, commerce between large buyers and large suppliers is often already automated through EDI. Therefore, we dont believe the benefits of online market makers are as compelling for large buyers as they are for their smaller brethren. However, market makers can be beneficial to large buyers by introducing them to smaller suppliers to whom they never would have had access otherwise. These smaller suppliers often sell highquality products and offer high-touch service. In addition, they offer large buyers alternatives on occasions when their large suppliers are constrained in terms of product availability or delivery requirements. For large buyers, market makers mean more choices in terms of products, services, and suppliers. Finally, large organizations have automated procurement to varying degrees. For the less progressive large buyers, market makers will add value through automation and reduce procurement processing and inventory carrying costs. For large buyers that have automated their procurement processes to a large degree, we believe there are incremental process and inventory cost savings to be realized. Large Suppliers. We believe supplier affinity for online intermediaries will run inversely to their market share. In other words, the more market share a supplier controls the more work it will take to get it to distribute through an online market maker, and vice versa. We make a few assumptions here: 1) large suppliers are large, in part, because they have relatively broad
and small buyers
2.
Large buyers have nothing to lose
3.
Large suppliers are the toughest nuts to crack
4.
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customer reach and efficient sales and distribution channels, 2) as leaders in their industries, we think customers are essentially required to consider these suppliers when making a purchase, and 3) due to their strong competitive position these suppliers will be reticent to serve as one of the big draws for a market maker that carriers competitive offerings. As a result, large suppliers like Cisco and Intel are likely to continue to sell directly through their own sites. However, although at times begrudgingly, we believe large suppliers will end up participating in third-party hosted Internet markets for several reasons. First and foremost, customers will demand it. With global competition increasing constantly, suppliers differentiate themselves now, more than ever, through customer service. As such, we believe that, long-term, suppliers will respond to buyer demands that they make their products and services available via online market makers. Also, once the most progressive large suppliers in an industry have come on board, laggard suppliers are likely to fall like dominos just to maintain market share. Furthermore, market makers present a channel through which smaller suppliers can nibble away at the market shares of larger players we dont expect large suppliers to sit idle and watch this happen. Finally, large suppliers will use online market makers to gain access to new customers and revenue streams altogether.
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9. Market Maker Success Key Industry Criteria

Undoubtedly, a case can be made that market makers can bring efficiency to almost every conceivable industry. However, we believe there are key characteristics that will make certain industries more fertile ground for online market maker success. The list of industry characteristics we consider important should by no means be considered exhaustive. Furthermore, since most of the B2B companies in existence today are very early stage it is impossible to point to a history of wild market maker success, period never mind varying levels of success from industry to industry. We paint some pretty broad strokes here and advise investors to assess specific industry characteristics thoroughly for each market maker in which they might consider investing. Caveats aside, we believe developing some broad framework, one that will be tweaked as we learn more about B2B, to assess the likelihood of market maker success is required to even begin considering the merits of particular B2B investment opportunities. The key characteristics we would assess or be looking for follow.
The bigger, the better
A Large Market. By and large, we believe most market makers, if they are successful long-term, will drive revenues by taking a cut of the transactions they facilitate. So, to oversimplify things, in general, we would be looking for market makers that address very large vertical or horizontal markets. Online market makers are about reducing inefficiency. Even if a large market is relatively efficient, it is likely that, due to its size, inefficiencies within it can support a very significant Internet business. The optimal market maker will be one that addresses a very large, inefficient market like paper, steel and plastics. However, be careful. While large, inefficient markets might have the most fat to take out and, therefore, the most profit potential for a market maker long-term, the fact that they have remained inefficient for so long likely indicates that they are markets extremely resistant to change. As a result, some of the best market maker opportunities might take longest to come to fruition. Below, using data from the US Census Bureau, we have ranked what we consider major business-to-business industries in terms of commerce. We have excluded data on industries we deem to be almost exclusively retail in nature. The generic category, wholesalers, tops the list. This is not surprising given that these intermediaries are entrenched parts of the supply and distribution chains in so many industries. As one might expect, the list is populated primarily by old, established industries many with complex supply and demand chains.
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Chart 10: Selected Industries Size

Description Establishments 290,260 162,924 240,621 134,534 621,605 13,206 17,240 26,970 13,482 198,124 409,467 30,580 260,252 62,684 1,911,859 2,143 5,298 33,375 16,686 5,925 103,836 42,010 7,108 236,139 31,433 43,054 2,774 17,101 16,404 8,300 17,831 20,694 4,714 15,904 7,539 7,226 1,923 Sales, Receipts, or Shipments ($1,000) 2,189,603,850 1,865,419,373 1,214,386,597 1,122,841,717 608,627,386 577,916,378 431,375,762 425,282,021 417,690,886 391,087,928 340,320,742 271,544,523 262,463,279 245,906,101 196,864,649 178,945,926 173,851,670 172,165,355 158,967,311 150,707,499 141,883,397 133,904,865 112,387,785 108,634,315 102,855,358 98,724,544 96,606,185 88,718,707 88,138,388 87,271,482 67,742,364 65,420,573 60,062,670 52,429,736 50,205,542 31,947,641 24,915,775 Description Establishments 42 2,354 10,029 1,824 6,471 2,232 Sales, Receipts, or Shipments ($1,000) 24,581,559 24,428,670 20,614,225 10,732,905 10,272,024 7,538,105
Business-to-Business Wholesale trade, durable goods Wholesale trade, nondurable goods Merchant wholesalers, durable goods Merchant wholesalers, nondurable goods Professional, scientific, and technical services Transportation equipment manufacturing Computer and electronic product manufacturing Food manufacturing Chemical manufacturing Building, developing, general contracting Special trade contractors Machinery manufacturing Administrative and support services Fabricated metal product manufacturing Agriculture Petroleum and coal products manufacturing Primary Metal Manufacturing Publishing industries Plastics and rubber products manufacturing Paper manufacturing Truck transportation Heavy construction Electrical equipment, appliance, and component manufacturing Repair and maintenance Miscellaneous manufacturing Printing and related support activities Beverage and tobacco manufacturing Wood product manufacturing Nonmetallic mineral product manufacturing Oil and gas extraction Apparel manufacturing Furniture and related product manufacturing Textile mills Information services and data processing services Mining (except oil and gas) Textile product mills Water transportation
Business-to-Business (contd) Monetary authorities-central bank Pipeline transportation Support activities for mining Leather and allied product manufacturing Warehousing and storage Lessors of intangible assets, except copyrighted works Business-to-Business/Business-to-Consumer (Mix) Insurance carriers and related activities Credit intermediation and related activities Hospitals Utilities Broadcasting and telecommunications Ambulatory health care services Securities intermediation and related activities Real estate Religious, grantmaking, civic, professional and similar org Nursing and residential care facilities Rental and leasing services Personal and laundry services Motion picture and sound recording industries Waste management and remediation services Support activities for transportation Couriers and messengers Air transportation Educational services Transit and ground passenger transportation Funds, trusts, and other financial vehicles
172,010 166,835 6,892 15,558 44,007 454,853 58,020 222,540 99,125 57,359 65,099 186,028 22,100 16,336 30,358 10,923 3,611 40,996 16,006 1,262
1,062,365,641 886,819,003 391,786,805 391,243,209 367,841,279 347,752,717 269,342,485 162,824,225 102,965,794 92,833,001 79,156,509 58,813,352 49,214,165 40,294,167 40,267,182 39,676,674 21,437,669 20,934,202 13,919,480 11,383,601
Source: US Census Bureau; Merrill Lynch Internet Research
Theoretically, the more fragmented, the better
Buyer and Seller Fragmentation. Theoretically, the more fragmentation, the better. In the ideal scenario, an industry would not only be large but feature many small buyers purchasing from many small suppliers. As we mentioned earlier, we believe small suppliers and small buyers benefit the most from online market makers. Therefore, in our view, an industry full of little guys would be ideally suited for a market maker. However, we also believe gaining liquidity, the key to a market makers success, in such a market may take some time because it will require bringing a large number of entities online. We think industries where most of the commerce is conducted between large buyers and large suppliers might be slowest to adopt market makers. However, we also believe that once a couple of large industry leaders contribute supply that others will have to follow suit. Therefore, once the ball starts rolling, we expect liquidity to follow. In order to measure industry fragmentation, we have again used US Census data. This time we have sorted the same set of industries used in ranking industry commerce by the number of establishments in each industry. The census counts individual establishments as separate locations. Therefore, multiple establishments may be part of a single company. This may overstate fragmentation of buyers and sellers to some degree. That stated, we believe the number of establishments in an industry probably serves as decent proxy for the fragmentation within it. It is also important to note that, oftentimes, enterprises with a large number of geographically dispersed locations often cant or dont centralize purchasing, in the case of buyers, or sales and distribution, in the case of suppliers.
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Chart 11: Selected Industries Fragmentation

Description Business-to-Business Agriculture Professional, scientific, and technical services Special trade contractors Wholesale trade, durable goods Administrative and support services Merchant wholesalers, durable goods Repair and maintenance Building, developing, general contracting Wholesale trade, nondurable goods Merchant wholesalers, nondurable goods Truck transportation Fabricated metal product manufacturing Printing and related support activities Heavy construction Publishing industries Miscellaneous manufacturing Machinery manufacturing Food manufacturing Furniture and related product manufacturing Apparel manufacturing Computer and electronic product manufacturing Wood product manufacturing Plastics and rubber products manufacturing Nonmetallic mineral product manufacturing Information services and data processing services Chemical manufacturing Transportation equipment manufacturing Support activities for mining Oil and gas extraction Mining (except oil and gas) Textile product mills Electrical equipment, appliance, and component manufacturing Warehousing and storage Paper manufacturing Primary Metal Manufacturing Textile mills Beverage and tobacco manufacturing Establishments 1,911,859 621,605 409,467 290,260 260,252 240,621 236,139 198,124 162,924 134,534 103,836 62,684 43,054 42,010 33,375 31,433 30,580 26,970 20,694 17,831 17,240 17,101 16,686 16,404 15,904 13,482 13,206 10,029 8,300 7,539 7,226 7,108 6,471 5,925 5,298 4,714 2,774 Sales, Receipts, or Shipments ($1,000) 196,864,649 608,627,386 340,320,742 2,189,603,850 262,463,279 1,214,386,597 108,634,315 391,087,928 1,865,419,373 1,122,841,717 141,883,397 245,906,101 98,724,544 133,904,865 172,165,355 102,855,358 271,544,523 425,282,021 65,420,573 67,742,364 431,375,762 88,718,707 158,967,311 88,138,388 52,429,736 417,690,886 577,916,378 20,614,225 87,271,482 50,205,542 31,947,641 112,387,785 10,272,024 150,707,499 173,851,670 60,062,670 96,606,185 Description Business-to-Business Pipeline transportation Lessors of intangible assets, except copyrighted works Petroleum and coal products manufacturing Water transportation Leather and allied product manufacturing Monetary authorities-central bank Establishments 2,354 2,232 2,143 1,923 1,824 42 Sales, Receipts, or Shipments ($1,000) 24,428,670 7,538,105 178,945,926 24,915,775 10,732,905 24,581,559
Business-to-Business/Business-to-Consumer (Mix) Ambulatory health care services Real estate Personal and laundry services Insurance carriers and related activities Credit intermediation and related activities Religious, grantmaking, civic, professional and similar org Rental and leasing services Securities intermediation and related activities Nursing and residential care facilities Broadcasting and telecommunications Educational services Support activities for transportation Motion picture and sound recording industries Waste management and remediation services Transit and ground passenger transportation Utilities Couriers and messengers Hospitals Air transportation Funds, trusts, and other financial vehicles
454,853 222,540 186,028 172,010 166,835 99,125 65,099 58,020 57,359 44,007 40,996 30,358 22,100 16,336 16,006 15,558 10,923 6,892 3,611 1,262
347,752,717 162,824,225 58,813,352 1,062,365,641 886,819,003 102,965,794 79,156,509 269,342,485 92,833,001 367,841,279 20,934,202 40,267,182 49,214,165 40,294,167 13,919,480 391,243,209 39,676,674 391,786,805 21,437,669 11,383,601
Source: US Census Bureau; Merrill Lynch Internet Research
Large Market + Fragmentation = Great Market Maker Opportunity
Market Maker Receptivity. In the table below, we rank industries based on a combination of the two aforementioned key characteristics market size and fragmentation. Nothing scientific here. We multiplied the number rank of an industry in terms of commerce by its number rank in terms of fragmentation. We then ranked these industries by the product of those two numbers. We acknowledge that the methodology here is extremely conceptual. In addition, many industry characteristics beyond market size and fragmentation will play a part in how quickly an online market maker is adopted (if at all) in a particular industry. However, in terms of setting a framework for assessing possible industry receptivity of market makers, this methodology might be a decent starting point.
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Chart 12: Selected Industries Market Maker Receptivity

Market Maker Description Receptivity Business-to-Business Wholesale trade, durable goods 4 Professional, scientific, and technical services 10 15 Agriculture 18 Merchant wholesalers, durable goods 18 Wholesale trade, nondurable goods Special trade contractors 33 Merchant wholesalers, nondurable goods 40 Administrative and support services 65 Building, developing, general contracting 80 144 Food manufacturing 147 Computer and electronic product manufacturing Transportation equipment manufacturing 162 168 Fabricated metal product manufacturing Repair and maintenance 168 204 Machinery manufacturing Truck transportation 231 234 Chemical manufacturing 270 Publishing industries Heavy construction 308 Printing and related support activities 338 400 Miscellaneous manufacturing 437 Plastics and rubber products manufacturing 595 Primary Metal Manufacturing Furniture and related product manufacturing 608 616 Wood product manufacturing 620 Apparel manufacturing 640 Petroleum and coal products manufacturing Paper manufacturing 680 696 Nonmetallic mineral product manufacturing 736 Electrical equipment, appliance, and component manufacturin 850 Information services and data processing services Oil and gas extraction 870 999 Beverage and tobacco manufacturing 1,050 Mining (except oil and gas) Textile product mills 1,116 1,120 Support activities for mining Textile mills 1,188 Description Business-to-Business Warehousing and storage Pipeline transportation Water transportation Monetary authorities-central bank Lessors of intangible assets, except copyrighted works Leather and allied product manufacturing Market Maker Receptivity 1,386 1,482 1,517 1,634 1,677 1,722
Business-to-Business/Business-to-Consumer (Mix) Insurance carriers and related activities Ambulatory health care services Credit intermediation and related activities Real estate Personal and laundry services Broadcasting and telecommunications Hospitals Religious, grantmaking, civic, professional and similar org Securities intermediation and related activities Utilities Rental and leasing services Nursing and residential care facilities Motion picture and sound recording industries Support activities for transportation Waste management and remediation services Educational services Couriers and messengers Transit and ground passenger transportation Air transportation Funds, trusts, and other financial vehicles
4 6 10 16 36 50 54 54 56 64 77 90 169 180 196 198 272 285 323 400
Source: US Census Bureau; Merrill Lynch Internet Research (Market Maker Receptivity is calculated by multiplying an industrys commerce rank by its fragmentation rank. For example, an industry ranked #1 in commerce and #1 in fragmentation would produce a Market Maker Receptivity score of 1, and, theoretically, be most receptive to a market maker.)
Be wary of market makers with purely a disintermediation strategy
Fat. We view fat as the non-value-added links in the value chain. In our view, investors, should be wary of the prospects of market makers that lead with purely a disintermediation strategy. While there are middlemen in many value chains that add minimal value beyond matching buyers and sellers (brokers in the paper and plastics industries come to mind), many middlemen, such as value-added resellers and many distributors, are important and irreplaceable links in the value chain. Market makers that focus on automating processes that are currently manual so employees can focus more on the value added functions they perform will probably find themselves in a solid industry position. Those that trumpet a goal of taking food off somebodys table are likely to feel extremely powerful industry forces come to bear on them. IT Adoption. Generally speaking, we believe industries that have widely adopted information technology will be more receptive to online market makers than those that have not. First of all, we believe the fact that the technology infrastructure is already in place for companies within these industries makes utilization of online market makers an easy transition technology-wise. Second, and probably more importantly, we believe IT adoption serves as a rough proxy for an industrys attitude toward change particularly change that increases efficiency, which is exactly what market makers are about.
Industries that adopted IT will be more receptive to market makers
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10. Market Maker Success Key Company Criteria

In theory, B2B market makers make a great deal of sense. However, in practice there are many challenges to building a successful B2B business. Presently, there are hundreds, if not thousands, of market makers in various stages of development. Potential investors need to thoroughly inspect individual market makers and the industries they address in detail. However, we believe there are some key criteria common to most market makers investors should examine when considering investment. n Merrills B2B Market Maker Checklist Management & Domain Expertise (Near Flawless) Early Movement Strong Partnerships for Distribution & Logistics Neutrality Liquidity Going Public (if ready) Management & Domain Expertise. Management is probably the single most important factor when evaluating any potential investment. It is of the absolute highest importance for B2B companies because not only are most of them at very early stages of development, but most are trying to delicately nudge their way into existing industries, many of which will be less than receptive initially. Particularly in vertical industries like steel, paper, plastics, and chemicals, deciding to distribute product through online market makers is typically made at the boardroom level. Suppliers need to assess the effects of the decision in terms of potential channel conflict, pricing, distributor and customer relationships, brand dilution, employee morale, etc. Successful B2B market makers must have management with the industry knowledge, senior level industry relationships, and credibility to address these concerns and articulate the benefits of migrating to this new market maker paradigm in order to gain industry buy in. (Near Flawless) Early Movement. This is a land grab so, similar to B2C, moving early for B2B market makers is important. Market makers that move first without major mistakes are likely to build the critical mass of buyers and suppliers that will make them the default online location for conducting trade in their particular industry. However, more important than moving first, is executing well once youre moving. If you get your book a day late from Amazon, the world doesnt end and as long as it doesnt happen frequently (which it doesnt), Amazons business is probably not at risk. AOL and EBay, two dominant Internet companies, have experienced system outages during their respective histories. However, we do not expect commercial customers to be as tolerant of miscues from market makers. Many industries are leery about both the role market makers will play and their ability to execute to begin with. One high-profile incident of a market maker site going down or a major steel or chemical customers production line grinding to a halt because a market maker facilitated a delivery that was late or off-spec is likely to prompt a chorus of I told you sos from industry. A market maker that moves first and makes a major mistake might have been better off not moving at all. Therefore, market makers that move early, not necessarily first, and get it right will probably be much more valuable investments than the first movers that make mistakes. Make sure market makers in which you are considering investment have tested their systems and processes sufficiently and that they have run in beta long enough that the likelihood of major mistakes is minimal. In our view market makers that know all the demands of taking an order and (especially) fulfilling it and move second are destined for much more success than the first mover makes a serious mistake. We think the best-positioned companies are clearly those that move first and flawlessly.
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Strong Partnerships For Distribution & Logistics. Unlike books, CDs, and stereos, UPS doesnt transport lumber, resin, or hydrochloric acid. This takes specialized distribution and logistics players. In many industries, leading market makers will need to forge relationships with the key distribution and logistics providers in their industry. Due to the generic nature of what they transport, UPS or FedEx can typically carry many different types of deliveries for numerous suppliers/senders in a single truck or plane. Conceivably, this allows UPS or FedEx to more easily maximize the utilization of their fleets. However, due to the expense of their vehicles (ie, tankers) and the people that man them, and the specialized nature of what they deliver, scaling up for the incremental supplier that may or may not create enough demand to maximize utilization is a risky economic proposition for specialized logistics players. Winning market makers will have locked in agreements with specialized logistics providers and distributors that can support delivery of the products they sell. Neutrality. Neutrality has quickly become the First Commandment of B2B markets. However, neutrality means different things to different people. To us, it means ensuring that business is transacted in an equitable manner and that all market maker participants are playing by the same clearly defined set of rules. However, market makers must balance neutrality with their #1 goal achieving liquidity. In our view, liquidity is the biggest challenge facing every market maker and achieving it is typically contingent upon gaining the participation of large suppliers. Clearly, a market maker featuring content that favors one or several suppliers to the detriment of their competitors is unlikely to gain mass supplier participation. In addition, a market maker that gives a disproportionately large ownership stake to one or several large suppliers is likely to alienate other potential participants. However, on a case by case basis, we do believe there are ways for market makers to induce supplier participation without becoming or appearing biased. For instance, giving major players in a particular industry moderate, but equally sized ownership stakes in a market maker may help jump start liquidity. Performance-based warrants that reward suppliers for putting a certain amount of volume through a market maker may also work. Neutrality is important, and investors should probably avoid market makers that blatantly violate it as this is likely to limit the participation of other industry heavyweights and, as a result, hamper long-term growth. However, investors also must beware of market makers so wedded to such a narrow definition of neutrality that they never gain liquidity. Liquidity. Before market makers achieve liquidity, the holy grail for every market maker, they must build a critical mass of buyers and suppliers. Once a market maker has acquired a critical mass of buyers and suppliers, it will still take some time to achieve liquidity as these participants, particularly suppliers, are likely to move cautiously to the paradigm until they have confidence in it, which wont happen overnight. At the point most makers go public, in general, they have attracted a significant number of potential buyers (typically through industryspecific content), are working on supplier participation (their biggest challenge), and are quite far from achieving transaction liquidity. In our view, to participate in the significant potential upside of a B2B investment, investors cant wait for liquidity to be achieved in order to invest, as the horse will be way out of the barn by then. So, investors need to look for the characteristics that are likely to lead to liquidity management with industry knowledge and expertise that moves early (and close to flawlessly), a critical mass of potential buyers to attract suppliers, at least a handful of supplier relationships and a bunch more in the pipeline, key distribution and logistics relationships, and relative neutrality.
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Going Public First (if ready). This is not to fan the flames of what may be characterized as a scorching B2B IPO market, but assuming that a market maker is confident that it can execute against the key metrics investors are looking for, we contend that going public is a major advantage. Market makers that have limited or essentially no competition, like PaperExchange in paper, enjoy the luxury of going public when it is optimal and they can get the most value for their companies. However, in markets like steel (e-STEEL and MetalSite), chemicals (CheMatch, ChemConnect, and e-Chemicals) and life sciences (Chemdex and SciQuest both are now public; Chemdex came first), where competition is likely to become intense very quickly, moving into the public markets first is an advantage. Aside from the fact that the cost of capital may never be cheaper, the IPO significantly increases the visibility of these companies vs. their private competition and also provides them with highly valued currency to quickly grow their businesses through acquisition. Weve seen it in B2C. Clearly, it was the highly valued stock currencies of Yahoo! and AOL that allowed them to grow and broaden their respective businesses through acquisitions of companies like Broadcast.com and Time Warner, respectively, and put insurmountable distances between themselves and potential competitors. In B2B, weve already seen Chemdex, which solely addressed the $36 billion worldwide life sciences market at the time of its IPO, move into the healthcare supplies market through its acquisition of Promedix. VerticalNet, a company whose business to date has been predominantly based on advertising revenue, intends to generate much more commerce revenue long-term. By recently acquiring NECX, a market maker in the multi-billion dollar electronics industry VerticalNet was able to accelerate its transition toward commerce revenue because of its public currency.
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11. B2B Market Maker Valuation Framework

Valuing B2B market makers is tough at this point
At this early stage, sizing the B2B market and the shareholder value it might create is tough. Frankly, over the next couple of years, valuations are likely to be driven as much by the grandiose promises of B2B, a scarcity of investment choices to meet what we believe is extraordinary investor demand in the sector, rapid revenue growth (on diminutive numbers), press, hype, sentiment etc. as by the potential long-term fundamentals of market makers. If history has taught us one thing, it is that most investors are insensitive to valuation when the fundamentals for Internet companies are improving. Given that the sector is so nascent, in general we expect to see improving fundamentals and increasing market caps for B2B companies for the foreseeable future. Nonetheless, we believe it is necessary to set up a framework to at least put valuation in some fundamental perspective. Based on our methodology, we believe it is likely that B2B market makers could generate total market capitalization between approximately $800 billion and almost $1.5 trillion by 2003. We estimate the present value of this total market capitalization between approximately $340 billion and $620 billion. (Note: Currently, there are only a handful of publicly traded market markers. Therefore, most of the potential market capitalization to be created resides in private companies. As a result, we believe that the extraordinary valuations of some public market makers represent more than their long-term fundamentals namely, the general excitement surrounding this seemingly huge opportunity and the scarcity of public ways to play it.) Our methodology is fairly straightforward. We 1) estimate the total market for B2B electronic commerce, 2) estimate the percentage to be captured by market makers, 3) estimate market maker earnings, 4) estimate a multiple to apply to these earnings, and 5) discount these earnings back at a 35% rate.
In terms of value created, the mix of revenue between sellerhosted sites and third-party market makers is probably more important than the accuracy of the overall forecast Seller sites will always dominate the mix
As mentioned, we believe worldwide electronic commerce revenue could total approximately $2.5 trillion by 2003. However, what we view as more important than this total sales figure, is its likely mix between seller sites, like those of Cisco, Dell, Intel, Boeing, Grainger, Federal Express, etc., and the sites of online market makers the B2B investment opportunities upon which this report is focused. Clearly, in order for third-party market makers to create meaningful market capitalization, they will have to pick up a greater share of this growing market. The Ciscos, Intels and FedExs of the world should be commended for recognizing relatively early (read mid 1990s) the value Internet sales could bring to their businesses. However, the fact that they themselves are dominant suppliers in their respective industries has made gaining relatively quick revenue traction over the web easier for them than it has been for market makers. This makes sense to us because market makers need to enlist supplier and buyer participation, which takes time, before generating a meaningful volume of transactions. Furthermore, established companies with seller-centric sites have a number of characteristics that make generating web-based business relatively easy almost immediately their own supply or relationships with major suppliers and existing customers as well as a brand name and marketing resources to attract new customers. In addition, these companies already have relationships with the key distribution and logistics players necessary for fulfilling orders. In other words, these businesses are quick out of the box in regard to generating online sales, while market makers take longer to ramp.
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but market makers will gain enough share to create tremendous value
Over the coming years, we expect that many market makers will add meaningful numbers of buyers and suppliers and establish the key distribution and logistics relationships. As a result, we expect them to hit their stride and gain ground in terms of the percentage of overall B2B sales they facilitate. We believe that seller web sites will dominate the overall mix. However, we believe it is a reasonable assumption that third-party market makers could represent 10-20%, or $248-$496 billion of overall online B2B sales by 2003. In addition, we also assume advertisers spend $5-$10 billion with market makers at this point in time. Combined we believe the total revenue attributable to online market makers by 2003 could range between approximately $400-$500 billion. (In our conservative case, which we consider less likely, we estimate that only 10% of B2B electronic commerce revenue, or approximately $250 billion, is transacted through market markers.) In our conservative case, which we deem least likely, we assume only 10% of online B2B trading, or $248 billion, is captured by third-party market makers. Throwing in $5 billion for advertising, the total revenue attributable to market makers would be $253 billion. In this conservative case, we assume an overall net margin of 3%, generating net income of $8 billion. We use a 50X multiple on this net income to reflect the fact that, even in 2003, these are likely to remain high-growth and high return on invested capital businesses for years to come and they will be assigned premium PE multiples to reflect it. Our conservative case yields an aggregate B2B market cap of approximately $380 billion, or 1.5X sales. Discounted at 35%, this market capitalization is presently valued at over $150 billion. In our middle case, we assume market makers garner 15%, or $372 billion, of the online B2B market. Including $7 billion for advertising, we attribute $380 billion in aggregate revenue to market makers. We also assume economies of scale resulting from this stronger top-line produce a net margin of 4% and net income of $15 billion. We apply a 55X multiple to these earnings to reflect strong performance and what is likely to be a great outlook. Market cap generated from this case exceeds $830 billion or 2.2X sales. The present value of this market cap, discounted at 35%, is approximately $340 billion. Following the same methodology, in our bullish scenario, we assume that market makers grab 20% of the online B2B market and generate $506 billion in revenue, including $10 billion for advertising revenue. We assume that net margin expands to 5%. The result is $25 billion in net income. We raise our multiple assumption to 60X, which generates market cap of approximately $1.5 trillion and a revenue multiple of 3.0X. Again we discount this market value at 35%. As a result, we arrive at a present value of approximately $620 billion.
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Framework for potential longterm value creation is an interesting exercise
Chart 13: B2B Electronic Commerce Valuation Framework ($ billions)

$2,481
$2,481
$2,481

Market Maker Transaction Revenue Market MakersAdvertising Revenue TOTAL Market Maker Revenue CAGR (1998-2003E) US International Net Margin Net Income PE Multiple Revenue Mulitple MARKET CAPITALIZATION (2003E) PV (Discount Rate = 35%)
90% 10%
$248 $5 $253 237% 63% 38% 3% $8 50x 1.5x $380 $154
85% 15%
$372 $7 $380 259% 63% 38% 4% $15 55x 2.2x $835 $339
80% 20%
$496 $10 $506 275% 63% 38% 5% $25 60x 3.0x $1,518 $617
Source: Merrill Lynch; Forrester Research; Veronis Suhler & Associates
but it is not what will drive these stocks near-term
The valuation methodology outlined above is a framework to bring some perspective to where valuations might normalize several years out. Obviously, tweaking any of the inputs overall B2B market size, the percentage of this market captured by third-party market makers, margins or multiples causes the potential market cap created by the B2B opportunity to swing wildly. In addition, over the near-term (probably the next couple of years, rather than months), the revenue multiples applied to leading B2B companies are likely to remain in substantial excess of what we use for our valuation framework. Despite strong near-term growth, for the foreseeable future almost all B2B market makers are likely to continue to appear small relative to the huge market opportunities they typically address. We expect investors to ascribe extremely high price-to-sales multiples to companies for which potential market opportunities look far from saturation, upside to revenue estimates remain likely, the waning of hyper-growth any time soon seems remote, and execution is strong.
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12. B2B Market Maker Investment Philosophy

As evidenced by the spectacular public market debuts of B2B companies like Internet Capital Group, FreeMarkets, Ariba, CommerceOne, Purchase Pro, Chemdex, SciQuest, RoweCom, and VerticalNet, among several others, there is significant investor demand for public B2B investments. Given the size of the opportunity, this is not surprising. However, despite the multi-billion dollar market caps most public B2B companies enjoy, they are all at extremely early stages of development. In many ways, public investors are taking on roles once reserved for venture capitalists. Whether this role should ever be left to public market investors is open to debate. However, in our minds, that debate is strictly academic. We believe B2B will create significant value for public market investors. We believe potential investors should be cognizant of some key points when considering B2B investing. B2B market makers will have a profound effect on many economic sectors, particularly industrial ones. The steel, paper and plastics industries have been doing business in essentially the same, often inefficient, manner for many years. B2B market makers, with no legacy business or relationships to protect, seek to make businesses out of capturing profit that many large companies for many different reasons, including potential channel conflict, fixed asset investment, delicate partner relationships, vertical integration, a general failure to embrace electronic commerce, or complacency, have foregone. The established, often stagnant industrial ecosystems into which these new B2B market maker organisms look to insert themselves are typically huge often hundreds of billions of dollars. Capturing just a small portion of the value transacted within these industries is likely to create extremely attractive B2B Internet investments. Investors are paying up for the promise of B2B. Currently, the public valuations of most B2B companies, as well as the private valuations of many others, look very expensive. Almost every public B2B company sports a market cap of over $1 billion. Several have multi-billion dollar market caps. In addition, it is not uncommon to see premiere, private companies with hundreds of millions of dollars of private valuation. Undoubtedly, valuations are driven, in large part, by the fact that many B2B companies address huge opportunities and will become valuable long-term based on fundamentals. However, we believe there is no question that the valuations of public B2B stocks and ones likely to come public over the next year are driven, to varying degrees, by what seems to be indiscriminate investor demand for anything B2B. This can be attributed to numerous factors, including the B2B hype created by Wall Street, venture capitalists, and the media and the fact that many investors are determined to catch, in B2B, the Internet run they may have missed in B2C. Assuming markets remain robust, we expect to see a plethora of B2B market makers come to the public market some great, some okay, and some poor. As supply and demand move closer to equilibrium, it is important for investors to understand the quality of what they might own and realize that, over time, there may be nearly 100% downside potential for lowquality B2B equities. The net result of so many B2B companies coming public is likely to be that there will be many more losers than winners. Generally speaking, successful market makers will create liquidity in the markets they address by enlisting participation from a critical mass of buyers and suppliers. For vertical market makers particularly, it is likely that the #1 player in medical equipment, chemicals, or livestock, etc. will dwarf #2 in terms of value. Why? Market leaders will enjoy the benefits of the network effect. In other words, suppliers will align themselves with market makers that provide them access to the most buyers and buyers are likely to make purchases through market markers that present them with the largest choice of products and
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suppliers. As a result, within a specific market, a dominant share of electronic commerce is likely to be transacted through the leading site and allow the #1 player to enjoy the leverage associated with significant scale as well as strong returns on invested capital. However, in these winner take most (if not all) markets, it is questionable whether the next tier of players will scale to a size that provides them the leverage to reach profitability. Obviously, we believe investing in #1 is optimal, investing in #2 could result in good returns, but is more risky, and investing in #3, #4, and #5 is likely to be a bad use of capital. (There is likely to be more than a handful of winners among horizontal market makers because they sell products and services across many industries a huge market. It is unlikely that one player can make a sizable enough early land grab to lock up the market. That said, there will be many more entrants chasing this market, so while there will be many more winners than in individual vertical markets, there will also be many more losers. Beware.) Investment in successful companies should be extremely rewarding. However, the risk in stocks of companies that fail could be significant. Historically, good internet stocks have looked expensive from the beginning and looked more expensive over time. Although past performance is no guarantee of future results, we recommend that investors stick with the good quality companies and not let what appear to be expensive valuations scare them away. Bad Internet investments have done one of two things they have either started expensive and gotten cheaper or started cheap and gotten cheaper. From our experience, the only time investors focus on the valuation of an Internet stock is when fundamentals are deteriorating. Given that B2B is in its infancy, we would not expect to see sector-wide fundamental deterioration for quite some time. If fundamentals are truly deteriorating for a particular B2B company, the stock should probably be sold immediately. However, if fundamentals are improving and upside to estimates is expected to continue, the stock is likely to continue to rise regardless of valuation. We dont expect investors to wake up some day soon, come to work, and sell their best Internet stocks because they suddenly look expensive. They always look expensive. On the flip side, we would not advise investors to go bargain hunting for B2B Internet stocks. They are almost always cheap for fundamental reasons. So market opportunities are large, the companies addressing these opportunities are early-stage, winners are likely to create extraordinary returns, losers could end up close to worthless, and picking winners and losers is tough. Isnt this type of investing suitable only for venture capitalists? No, diversified growth investors, sector investors, and speculative investors all need a strategy for B2B. In a vacuum, almost every B2B market maker is a speculative, high-risk and early-stage investment. B2B investing is arguably the closest thing to venture capital in todays public markets. So, obviously these investments are not suitable for the risk averse. However, many other investor types of varying risk profiles need to develop a strategy for the sector. Investors that choose to have exposure to the space need to take different approaches. Diversified Growth Investors. We have always maintained that diversified growth investors allocate a small percentage of capital (ie, 10%) to pure play Internet investments. We would suggest that these same investors earmark a percentage of this overall Internet allocation to a basket of B2B market maker stocks. Most B2B market makers address huge markets and have great promise. They also still have much to prove. On a macro level, we are confident that B2B will create significant market cap. However, at this early stage, picking the individual winners is tough. A basket approach gives investors the best chance to realize excellent returns with a couple of success stories in a portfolio of investments in which the majority are major disappointments.
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Yes, investors could realistically lose 80% of their money (with a theoretical maximum loss of 100%) in B2B investments gone sour. However, winners are likely to return investors many multiples of their initial investment. In addition, we believe diversified growth investors have limited chances of outperforming applicable investment benchmarks, which are likely to have an increasing B2B component embedded in them over time, without B2B exposure. Sector investors. It is hard to tell if market makers will actually create new value or take it from established industry players. They will probably do a bit of both. Regardless, sector investors need to formulate an investment strategy to account for the potential impact of successful market makers. We believe investors with exposure to steel, chemicals, and paper, etc. also need to consider portfolio exposure to an e-STEEL and a MetalSite, an e-Chemicals, ChemMatch and ChemConnect, and a PaperExchange. In addition, investors with exposure to certain distribution, wholesale, or broker businesses need to consider investment in market makers, many of which will play the role of improving the lives of middlemen that add value and ending the lives of those that do not. Furthermore, investors in companies that publish trade magazines need to consider exposure to market makers that provide industryspecific content that may compete with existing publications for advertising dollars. In the worst case, some market makers will render existing businesses or important components of them devalued or obsolete and, as such, steal market share, margin points, and market capitalization from established players. In the best case, market makers will create value for themselves and others by providing leading industry veterans with new customers and incremental revenue streams, lower cost distribution channels, expanded customer reach, and improved productivity. In all likelihood, different market makers in different industries will produce results on various points of this continuum. Either as a way to capture newly created value or as a hedge against value lost by established businesses, we believe portfolio managers with assets in many industries need to consider exposure to these new market maker investments. Speculative Investors. As mentioned, B2B market makers investments are high risk/high reward. Our strategy for diversified growth investors, due to the lack of clarity with regard to who the winners will be in B2B, is to allocate a small portion of capital to a diverse basket of investments. This diversification strategy, while limiting downside, obviously limits upside. Therefore, we tweak this strategy for speculative investors. Under the assumptions that they have more risk capital at their disposal and can endure more risk than most, we believe speculative investors can seek outsized returns by allocating more capital to B2B investments over the near-term. For maximum near-term appreciation, we would seek out companies likely to deliver extraordinary sequential revenue unit growth over the next several quarters.
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13. Company Profiles

Industry/Market Cross-Industry MRO/Indirect Goods and Services Procurement/CrossIndustry Affiliate Marketing Automotive, Industrial Products, and Electronics (AIE) Inventory Mangement Asset/Inventory Management Asset/Inventory Management Building/Construction Building/Construction Chemicals Chemicals Chemicals Computer Products Cross-Industry Credit & Financing Energy Energy Energy Knowledge Resource Management Life Sciences/Cross-Industry Life Sciences Livestock Metals/Steel Metals/Steel MRO/Indirect Goods and Services Procurement/CrossIndustry Pulp & Paper Reverse Auctions Small Business Small Business Small Business Telecommunications B2B Master List Company Internet Capital Group Ariba LinkShare NetVendor AsseTrade.com TradeOut.com BuildNet BidCom ChemConnect CheMatch e-Chemicals pcOrder.com VerticalNet eCredit.com Altra Energy Technologies Automated Power Exchange Enermetrix.com RoweCom Chemdex SciQuest eMerge Interactive e-STEEL MetalSite CommerceOne PaperExchange FreeMarkets ONVIA.com SmartAge.com works.com Universal Access Headquarters Wayne, PA Mountain View, CA New York, NY Atlanta, GA Moorestown, NJ Ardsley, NY Research Triangle Park, NC San Francisco, CA San Francisco, CA Houston, TX Ann Arbor, MI Austin, TX Horsham, PA Westwood, MA Houston, TX Santa Clara, CA Maynard, MA Cambridge, PA Mountain View, CA Research Triangle Park, NC Sebastian, FL New York, NY Pittsburgh, PA Walnut Creek, PA Boston, MA Pittsburgh, PA Seattle, WA San Francisco, CA Austin, TX Chicago, IL Ownership Public (ICGE, D-2-1-9) Public (ARBA, D-2-1-9) Private Private Private Private Private Private Private Private Private Public (PCOR, Not covered) Pubilc (VERT, Not covered) Private Private Private Private Public (ROWE, Not Covered) Public (CMDX, Not Covered) Public (SQST, Not Covered) Private Private Private Public (CMRC, Not Covered) Private Public (FMKT, Not Covered) Private Private Private Private Page 52 57 62 63 64 64 66 66 68 68 69 70 71 72 73 73 74 75 76 77 78 79 80 81 82 83 84 84 85 86 87
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Henry Blodget First Vice President (1) 212 449-0773 henry_blodget@ml.com Edward McCabe Vice President (1) 212 449-8862 edward_mccabe@ml.com
Internet Capital Group

B2Bs Land Baron
ACCUMULATE
Long Term BUY
Price:
Estimates (Dec)
EPS: P/E: EPS Change (YoY): Q3 EPS (Sep): Cash Flow/Share: Price/Cash Flow: Dividend Rate: Dividend Yield:
$112
1998A
NM NM NM NA NM Nil Nil
Investment Highlights:
1999E
NM NM NM NM NA NM Nil Nil
2000E
NM NM NM NA NM Nil Nil
Opinion & Financial Data

Investment Opinion: Mkt. Value / Shares Outstanding (mn): Book Value/Share (Mar-1999): Price/Book Ratio: D-2-1-9 $30,912 / 276 N/A NM
Stock Data
***3 Week Range: Symbol / Exchange: Options: Institutional Ownership-Spectrum: $14-$64 1/16 ICGE / OTC None NA
ML Industry Weightings & Ratings**

Strategy; Weighting Rel. to Mkt.: Income: Growth: Income & Growth: Capital Appreciation: Market Analysis; Technical Rating: Underweight Overweight Overweight In Line (07-Mar-1995) (07-Mar-1995) (07-Mar-1995) (28-Jan-1999)
Below Average (21-May-1998)
**The views expressed are those of the macro department and do not necessarily coincide with those of the Fundamental analyst. ***Since IPO, 4 August 1999. For full investment opinion definitions, see footnotes.
ICG is a holding company with ownership positions in 50 partner companies, most of which are focused on Business-to-Business (B2B) e-commerce. In the land grab that is B2B, ICG is quickly establishing itself as the leading land baron. ICG allocates capital to promising B2B opportunities, then provides partner companies with strategic and operational guidance with the aim of building market leaders. ICG facilitates strategic relationships and shares best practices, advantages not enjoyed by stand-alone B2B start-ups. For three reasons, we believe ICG represents an exceptional long-term investment opportunity: 1) it is focused on B2B, which we believe will be the next big Internet wave, 2) it offers a built-in basket approach, allowing investors to diversify risk, and 3) it effectively allows public-market investors to invest at private-market prices. In the last five years, the total market capitalization of pure play B2C companies has risen from about $1 billion to $1 trillion. We think B2B could ultimately generate even greater market value. We believe ICGE is positioned to capture a meaningful percentage of this value.
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Summary
As a holding company with ownership positions in 50 business-to-business partner companies, we believe Internet Capital Group presents investors with a great opportunity to play what we believe is the next big Internet wave B2B ecommerce. According to Forrester Research, domestic B2B e-commerce is projected to grow from $43 billion in 1998 to $1.5 trillion in 2003, approximately 14X the 2003 B2C e-commerce estimate of $108 billion. Generally speaking, ICG has interests in two types of companies market makers and infrastructure service providers. Market makers bring together corporate buyers and sellers of goods, services, and information in a virtual marketplace. Infrastructure service providers sell the software, hardware, and services required for businesses to participate in e-commerce. ICG is a fairly complex company with many moving parts. However, from 50,000 feet the company and its strategy look fairly simple. ICG: identifies or creates companies it believes have the potential to become market leaders; acquires significant ownership interests (ideally, 40%-80%) in these companies and integrates them into its collaborative network; provides strategic guidance and operational support to its partner companies; and promotes collaboration.
ICGs intention is to own its partner companies long-term and actively provide these companies with strategic guidance and operational support. This long-term operating focus clearly differentiates ICG from venture capital firms, which typically fund and advise a diverse portfolio of businesses with eyes keenly focused on a relatively near-term exit strategy. We advocate that aggressive investors allocate a small percentage of capital (ie, 10%) to a basket of high-quality Internet stocks. We would add Internet Capital Group to this group of premiere Internet names, and we believe it has several characteristics that make it an especially compelling investment. ICG is focused on B2B a much more nascent (read strong growth ahead) and larger Internet market long-term, in our view, than B2C, access, content or services. ICG, in and of itself, is a basket of investments. All but four of ICGs 50 B2B partner companies are private. Obviously, there is a large amount of risk in private-market investing. However, that risk is offset by diversity and by what we believe is the potential for a great deal of upside. Not all of ICGs companies will be outstanding success stories. In fact, it is likely that some wont grow at all and thats okay. A few homeruns would likely offset dozens of strikeouts. ICGs most significant stake in a publicly held partner company is its interest in VerticalNet, in which it has invested a total of $14 million. A year after the initial investment, ICGs stake is currently valued at close to $3 billion. By no means should this type of return be considered typical, but it represents the potential value residing in some of ICGs partner companies. ICGs management and Advisory Board are strong. We believe strong management is a prerequisite for investing in early-stage companies. The members of ICGs management team and Advisory Board run the gamut from former entrepreneurs venture executives, and former and current senior executives at blue chip companies. All in all, it is an impressive group.
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Market Opportunity
The business-to-business opportunity is large and in its infancy. The value of U.S. online intercompany trade in 1998 was estimated at $43 billion. In 2003, the total is estimated to grow to $1.5 trillion. That is a compounded annual growth rate exceeding 100%. We think measuring the B2B market vs. the B2C market helps put things in some perspective. In 1998, the B2C market was estimated at $8 billion. It is expected to grow at a compounded annual growth rate of close to 70% to $108 billion by 2003. Thats nothing to sneeze atexcept when you compare it to B2B. As mentioned, in 1998 the B2B e-commerce market was estimated at $43 billion over 5X the $8 billion B2C market. If forecasts are accurate (forecasting markets this big is not an exact science; they could be larger or smaller but it is safe to say they will be big), at $1.5 trillion, the U.S. B2B market will be over 14X the size of B2C. We believe there are several fundamental drivers that will drive B2B e-commerce growth over the coming years. Expanded Access to New and Existing Customers and Suppliers. The sales forces of suppliers and the purchasing departments of customers have traditionally developed and maintained their relationships with each other. We think B2B ecommerce brings important benefits to these relationships for both customers and suppliers: B2B reduces the time and cost required to exchange current information regarding requirements, prices and product availability. Customers get realtime, accurate information whenever they want it and their personnel spend more time on more value-added functions than phoning, faxing and mailing suppliers. Also, in addition to suppliers receiving better marks for customer satisfaction, their sales forces spend more time chasing new business as opposed to dealing with account maintenance issues. Suppliers get access to new customers altogether. In many markets, demand is fragmented. As such, there is often a base of potential customers too expensive to reach by traditional means. The Internet represents a new channel through which to reach new customers. In many cases, suppliers can limit the involvement of middlemen in the selling and distribution process and reduce their costs. Buyers get more choices and better pricing. Oftentimes, there are many suppliers from which a customer could be buying products. However, whether due to a suppliers or its distributors limited geographic coverage or the time and expense constraints that limit a customers ability to investigate all possible options, a customer is limited to certain suppliers and distributors not always the best ones in terms of quality, service and price. Increased Efficiency and Reduced Cost. Traditional businesses can utilize the Internet to automate internal business processes including manufacturing, finance, sales, and purchasing functions. The Internet can also be used to increase information flow within an enterprise and outside of it creating a virtual enterprise that spans the entire value chain, which includes customers, suppliers, distributors, etc. All in all, the Internet provides businesses with the ability to increase operational efficiency by reducing the time, costs, and resources required to transact business, lowering inventory levels and procurement costs, and improving responsiveness to customers and suppliers.
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Internet Capital Group & Its Strategy

ICG has been operating in the B2B space for over three years. By Internet standards, particularly B2B, that makes ICG an industry veteran. This relatively long focus on B2B has provided ICG with the opportunity to observe a multitude of successes and failures in the space. By no means should this be construed to mean that managements investment, strategy and, operating decisions going forward will be perfect, but, presumably, this experience should help ICG better sort through the potential winners and losers in B2B. In addition, this focus should serve as a competitive advantage vs. venture capital firms. Venture capital firms typically have a more general focus and, as such, cannot pitch the benefits of a collaborative network or operational support. ICGs strategy is straightforward identify and acquire market leaders; integrate them into the ICG partner company network; improve their strategic direction; provide them with business services in critical areas such as sales and marketing, recruiting, IT, finance and business development; and share best practices throughout its network of partner companies. ICGs management is actively involved in all phases of this strategy. In addition, ICGs Advisory Board provides additional strategic and operational advice. Many members of ICGs management team and Advisory Board are relatively new. However, we believe they bring a wealth of applicable and valuable experience to ICG.
Risks
Internet stocks in general, VerticalNet in particular, and the health of the Internet IPO market. If any of these were to break down, ICG would likely lose significant value. If all three deteriorated simultaneously, which is more likely than not, the downside could be significant. Competition. ICG competes with venture capital firms as well as some emerging and existing holding companies focusing more on B2B to acquire ownership in partner companies. We believe ICGs ability to offer potential partner companies operational support, strategic guidance and a collaborative network should serve as a significant competitive advantage vs. existing and emerging competition. Potentially, some of ICGs partner companies could compete with each other. However, we believe that as both steward and significant owner of its partner companies ICG is well positioned to cultivate mutually beneficial partnerships where, in other cases, competition might have been the only resolution.
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ICG Valuation Model

Public C om panies VerticalNet Breakaway Solutions U S Interactive Ariba O ther Public Holdings C om pany Type Market Maker Infr. Svc. Provider Infr. Svc. Provider Market Maker Price 02/03/2000 $236.00 $82.50 $56.75 $174.25 Total ICG Shares 12.5 7.0 0.5 0.7 ICG % O w nership 35.0% 30.0% 2.0% M arket Value of Public H oldings $2,958 576 28 125 152 $3,715
Total Public H oldings
(a)
1 2 3 4 5 6 7 8 9 10
IPO C andidates C om m erX (PlasticsNet.com ) C om puterJobs.com D eja.com eMerge Interactive MetalSite O NVIA.com PaperExchange U niversal Access Benchm arking Partners C om m erceQuest
C om pany Type Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Infr. Svc. Provider Infr. Svc. Provider
ICG % O w nership 37.0% 34.0% 27.0% 28.0% 35.0% 16.0% 27.0% 25.0% 9.0% 23.0% Total IPO Candidate H oldings
Discounted Value of IPO C andidate Holdings
$828
(b)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Em erging Com pany H oldings AgProducer Network Anim ated Im ages Arbinet AsseTrade AutoVia BidCom BuyMedia.com C ollabria C ourtlink e-Chem icals eMarket W orld Em ployeeLife.com Internet Com m erce System s iParts.com JusticeLink logistics.com N etVendor System s PlanSponsor Exchange Purchasing Solutions R esidential Delivery Services Starcite! Solutions U sgift.com Blackboard C learC om m erce C ontext Integration Entegrity Solutions LinkShare PrivaSeek SageMaker ServiceSoft Technologies Sky Alland Marketing Syncra Software traffic.com U nited Messaging Vitaltone Vivant!
C om pany Type Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Market Maker Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider Infr. Svc. Provider
ICG % O w nership 61.0% 35.0% 7.0% 26.0% 14.0% 20.0% 32.0% 10.0% 33.0% 34.0% 35.0% 40.0% 38.0% 84.0% 37.0% 0.0% 26.0% 40.0% 60.0% 34.0% 36.0% 35.0% 25.0% 13.0% 14.0% 11.0% 29.0% 13.0% 25.0% 5.0% 26.0% 29.0% 20.0% 33.0% 21.0% 18.0% Total Value of Other H oldings Cash (est.) Subordinated Convertible Note Total Valuation Shares O utstanding Asset Value Price-to-NAV
$263 $1,269 $548 $5,527 276.2 $20.01
(d) (d)
5.8x
(a) Public holdings marked to market; (b) IPO candidate value assumes a 35% discount rate and 20% post-IPO dilution; All IPO candidates expected to go public within one year; (c) Emerging Company holdings valued at cost or last round of financing; (d) Pro-forma for equity and convertible subordinated notes; Ownership stakes presented on a fully diluted basis Source: Company Reports and Merrill Lynch Internet Research estimates.
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Christopher C. Shilakes First Vice President 415-676-3520 Peter Goldmacher Assistant Vice President 415-676-3522
Ariba Incorporated
Foundation Technologies for Net Exchanges
ACCUMULATE
Long Term BUY
Reason for Report: Company Update
Price:
Estimates (Sep)
EPS: P/E: EPS Change (YoY): Consensus EPS: (First Call: 01-Dec-1999) Q1 EPS (Dec): Cash Flow/Share: Price/Cash Flow: Dividend Rate: Dividend Yield:
$172 5/16
1999A
d$0.84 NM
Fundamental Highlights:
2001E
d$0.54 NM NM d$0.50
2000E
d$0.93 NM NM d$0.88 d$0.23 d$0.24 NM Nil Nil
d$0.14 d$0.20 NM Nil Nil
$0.00 NM Nil Nil
Opinion & Financial Data

Investment Opinion: Mkt. Value / Shares Outstanding (mn): Book Value/Share (Sep-1999): Price/Book Ratio: ROE 2000E Average: LT Liability % of Capital: Est. 5 Year EPS Growth: D-2-1-9 $12, 923 / 75 $2.62 76.5x NA 0.0% 80.0%
Stock Data
52-Week Range: Symbol / Exchange: Options: Institutional Ownership-Spectrum: Brokers Covering (First Call): $240 5/8-$61 ARBA / OTC None 2.4% 12
Aribas ORMS, ORMX and IBX product lines and the Ariba Network position Ariba to take full advantage of the explosive growth in both the automated procurement and net market maker vertical exchange markets. The acquisition of Trading Dynamics for $400 million in stock enhances Aribas net market maker offerings by including auction, reverse auction and bid/ask functionality. We expect Ariba to grow revenues from $45.4 million in FY99 to $91.8 million in FY00 (102% YoY): operating margins should drop from -37% in FY99 to -42% in FY00 as the company invests heavily in infrastructure. Key drivers for the next six months include the development of industry leading partnerships and the buildup of the Network Effect as more and more customers and suppliers sign on to the Ariba Network.
ML Industry Weightings & Ratings**

Strategy; Weighting Rel. to Mkt.: Income: Growth: Income & Growth: Capital Appreciation: Market Analysis; Technical Rating: Underweight Overweight Overweight Overweight (07-Mar-1995) (07-Mar-1995) (07-Mar-1995) (28-May-1993)
Stock Performance
220 200 180 160 140 120 100 80 60 1996 0.15 0.14 0.13 0.12 0.11 0.10 0.09 0.08 0.07 0.06 0.05 1997 Ariba Incorporated Rel to S&P Composite Index (500) (Right Scale) 1998 1999
Above Average (30-Aug-1999)
*Intermediate term opinion last changed on 19-Jul-1999. **The views expressed are those of the macro department and do not necessarily coincide with those of the Fundamental analyst. For full investment opinion definitions, see footnotes.
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Investment Thesis
Ariba has developed one of the first true B2B e-commerce applications to fully leverage the Internet. Aribas first application, Operating Resource Management System (ORMS), automates procurement of operating resources. Operating resources consume 33% of a typical corporations revenue base, and are the last bastion of inefficiency in the enterprise, untouched by the huge ERP tide which swept industry for the last five years. We estimate Aribas current customer base, which includes Chevron, Cisco, Fed Ex, HP, Merck, Nestle, Philips, US West, Motorola, Charles Schwab and Visa, has well over $180 billion in purchasing power for operating resources. This attracts suppliers that want to join the Ariba Supplier Link to provide electronic catalogs and conduct commerce via the Internet using Ariba technology. Already the company has signed over 40 suppliers since December 1998 to join ASL, including Office Depot, MicroAge, HP, Boise Cascade Office Products, Beyond.com, and Cort Furniture Rental. Investment highlights include: 1. 2. Ariba is positioned to become the platform of choice for optimizing operating resource demand and supply chains. Aribas leadership in leveraging core e-commerce technologies (cutting-edge Java deployment, cXML champion, The Ariba Network commerce portal) presents unparalleled competitive advantage. Aribas business model combines a proven, profitable enterprise software sale to blue-chip customer base and an expanded revenue opportunity via the ecommerce network effect. The Ariba Network leverages the network effect to lock-in supplier relationships and lockout competitors. Financial history speaks to solid execution and powerful top line growth trends. Ariba employees are smart, aggressive, and loyal team players and senior management had worked together prior to founding Ariba.
3.
4. 5.
We believe that over the intermediate term, investors should expect a highly volatile trading pattern in ARBA, given the premium valuation. As with most ecommerce investments, significant new customer wins, partnerships and revenue upside surprises will be the primary catalysts behind further gains in ARBA.
Ariba ORMS
Aribas Operating Resource Management System (ORMS) attacks the last bastion of inefficiency in corporations worldwide: ERP deployments ignored the operating resource burden pressuring corporate margins. Paper clogged and process-heavy procurement of goods and services supported armies of administrators. ORMS combines a powerful optimization engine and ubiquitous linkages between corporate consumers and suppliers with a zero learning curve interface. Result: Hard dollar savings for efficiently purchased resources and reduced soft dollar costs involving vendor benchmarking and management as well as processing, fulfillment and delivery for both consumer and supplier.
New Products
Ariba ORMX is Aribas Application Service Provider (ASP) version of its market leading ORMS product. This plays exceptionally well in the middle markets where companies typically dont have the money to fund a full IT staff and
58
ongoing product implementation. Ariba ORMX contains all the functionality of the ORMS product thereby bestowing all of the same benefits associated with centralized purchasing to the middle markets. The Ariba Internet Business Exchange (IBX) service is geared towards those smaller companies that want to leverage the Ariba Network platform without utilizing the automated workflow associated with the front-end ORMS application. This new adaptation of the Ariba Network is ideally suited for vertically oriented purchasing communities where Ariba can broker the purchasing of resources from an exchange where a multitude of users can add industry specific content. These vertical hubs allow users to create an exchange around a specific industry.
New Technologies
Aribas punch-out technology is a critical part of its added value in the purchasing world. Rather than simply displaying a static version of a supplier catalog, Aribas punch out technology lets buyers link to a suppliers web site via cXML to take full advantage of all the functionality the supplier offers while still remaining on the Ariba Network. For example, if a company wants to buy a laptop from Dell, using punch-out technology it can go directly to Dells web site to configure a PC exactly as desired. When the configuration is completed, because the purchaser is still on the Ariba web site, it merely submits the order for approval.
The Ariba Network

While ORMS, ORMX and IBX present what appears to be a compelling investment opportunity, Ariba is moving to secure a singular, central role in operating resource procurement with its Ariba Network. The continued rollout of Ariba Network will fully leverage the network effect. By using over $140 billion in purchasing power aggregated by Ariba customers, Ariba Network will connect suppliers with these major customers via a procurement portal.
Acquisitions
In November of 1999, Ariba announced its intent to acquire TradingDynamics, Inc. for $400 million in stock in a deal expected to close in January of 2000. With this acquisition, Ariba will enhance its product offerings to include value-added services like auctions, reverse auctions and a bid/ask exchange for Net Market Makers. This acquisition enables Ariba to begin to follow through on its strategy of building out its product offerings to become the dominant vendor in the business to business on line purchasing market. In December, Ariba announced the signing of a definitive agreement to acquire net market maker platform vendor TRADEX technologies for $1.86 billion in stock. Aribas acquisition of TRADEX complements the Ariba Network strategy by adding similar services and functionality to the emerging net market maker segment of the market. Whereas Aribas initial network focus was on the Fortune 500 buy side B2B market, TRADEX specializes in platform software for net markets including both horizontal and vertically oriented digital marketplaces. TRADEX customers in the horizontal space include American Express, NTT and EDS. Vertically oriented marketplaces include MetalSite and Chemdex. Aribas acquisition of TRADEX and the subsequent creation of the net markets business unit is in line with Aribas stated intent of creating a best of breed global B2B e-commerce platform. By buying TRADEX, Ariba is getting a jump-start in the net market maker space which is expected to grow to over 7,500 Net Market Makers (NMM) by the year 2003. Also, by getting a foothold in the space early through acquisition, Ariba will be able to keep its focus and continue to capitalize on its first to market lead.
59
Partnerships
In December of 1999, Ariba announced a partnership with American Management Systems (AMS) that will serve as a solid introduction for Ariba to the newly coined G2B (government to business) marketplace. AMS is a $1.3 billion systems integrator that generates over 90% of their business through government contracts. By controlling roughly 50 of the top 80 government agencies, AMS will introduce Ariba to approximately half of the $200 billion the federal government is expected to spend on goods and services next year. In January of 2000, Ariba announced a definitive agreement with EDS subsidiary CoNext to provide the software to run managed consortia based B2B net markets. CoNext, a newly formed EDS subsidiary, was created to provide its customers with actively managed joint purchasing, strategic sourcing, auctions and e-procurement. Calling its new service Leveraged Sourcing Networks (LSN), CoNext has targeted 12 net markets, approximately $160 billion in managed spending and has already signed customers including Bethlehem Steel, Clorox, Kellogg and Prudential. More simply, CoNext is creating 12 net markets and has created a partnership with Ariba to resell its e-procurement software and the Ariba Network.
1Q 2000 Highlights
Aribas 1Q 2000 (December) results accelerated further from the strong fiscal year-end close in September. License revenues were well above our projections, at $15.8 million (+227%) and total revenues grew 243% to $23.5 million. License and transaction related revenues grew 61% sequentially off of the strong September quarter close. These numbers were well above our projected $10.4 million in license revenue and $18.7 million in total revenue. It appears that transaction related revenue is ramping much faster than we anticipated, and was 60% of license revenue in the quarter. The aggregation of buying power on the Ariba Network continued to increase dramatically, up 227% to over $200 billion in operating resource spending alone. Subscription revenues from the Ariba Network increased by 450% to $3.3 million. Six to eight customer went live in the quarter, bringing the total number to better than 35. Margins benefited from the revenue upside. Gross margins were 700 basis points better than our model, at 85%. Operating loss narrowed to $7.6 million, versus our forecast $9.2 million operating loss. Ariba has continued to move towards profitability ahead of our model. The balance sheet showed signs of strength as well. The company reported its second consecutive quarter of positive operating cash flow, cash balances grew $8 million sequentially to $107 million; deferred revenues grew 52% sequentially to $ 46.7 million; and A/R days sales outstanding were 34 days, well below our expectations of a move into a 50 to 70 DSO range. Over time, we still expect A/R DSOs to increase to a more traditional level, especially as Aribaa non-US business increases.
Outlook
Despite a stair-step increase in our model assumptions from a revenue and expense standpoint (as TRADEX and Trading Dynamics come on line), we still believe our forecasts for Ariba to be conservative. We believe the potential catalysts from Net Market Makers and new system integrator partnerships with EDS and AMS and hosting providers like USinternetworking have not yet registered in the model. Channel partner contribution is still uncertain and Ariba is treating it as such, with the current model largely driven by direct sales. The companys confidence in turning the corner towards profitability by the end of FY 01 has increased further, and it appears that investors may see black ink before 4Q FY 2001.
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Ariba Earnings Model (in thousands)

1999 (A) Full Year 26,768 59% 6,520 14% 12,084 27% 45,372 8,813 19% 36,559 81% 33,859 75% 11,620 26% 7,917 17% 14,584 53,396 (16,837) -37% 2219 (14,618) -32% 98 0 (14,716) -32% (0.42) 35,032 343% NM 420% 443% 473% 436% 228% 158% 207% 207% N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M Dec 1Q (A) 15,784 67% 3,274 14% 4,421 19% 23,479 3,442 15% 20,037 85% 19,774 84.22% 4,443 18.92% 3,421 14.57% 4,719 27,638 (7,601) -32% 2059 (5,542) -24% 73 0 (5,615) -24% (0.07) 77,990 227% 452% 209% 243% 260% 240% 350% 169% 185% 281% N/M N/M N/M 61% 22% (5% ) 37% (5% ) 48% 55% 3% 21% 39% N/M N/M N/M M ar 2Q (E) 18,154 63% 3,910 14% 6,525 23% 28,588 6,289 22% 22,299 78% 25,610 89.58% 8,436 29.51% 5,014 17.54% 3,602 39,061 (16,762) -59% 2080 (14,682) -51% 77 0 (14,759) -52% (0.17) 85,000 220% 225% 150% 201% 249% 190% 271% 283% 235% 268% N/M N/M N/M 15% 19% 48% 22% 83% 11% 30% 90% 47% 41% N/M N/M N/M June 3Q (E) 20,605 61% 5,530 16% 7,493 22% 33,628 7,398 22% 26,230 78% 30,265 90.00% 9,278 27.59% 5,031 14.96% 2,530 44,573 (18,344) -55% 2100 (16,243) -48% 80 0 (16,324) -49% (0.15) 106,000 220% 170% 120% 183% 203% 178% 209% 168% 110% 185% N/M N/M N/M 14% 41% 15% 18% 18% 18% 18% 10% 0% 14% N/M N/M N/M Sept 00 4Q (E) 23,393 59% 6,690 17% 9,272 24% 39,355 8,658 22% 30,697 78% 33,816 85.93% 9,910 25.18% 5,647 14.35% 2,505 49,373 (18,676) -47% 2121 (16,555) -42% 85 0 (16,639) -42% (0.15) 110,000 138% 150% 100% 130% 140% 127% 165% 130% 100% 148% N/M N/M N/M 14% 21% 24% 17% 17% 17% 12% 7% 12% 11% N/M N/M N/M 2000 (E) Full Year 77,935 62% 19,403 16% 27,711 22% 125,050 25,788 21% 99,262 79% 109,465 87.54% 32,067 25.64% 19,114 15.28% 13,356 160,645 (61,383) -49% 8360 (53,022) -42% 315 0 (53,337) -43% (0.56) 94,748 191% 198% 129% 176% 193% 172% 223% 176% 141% 201% N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M Dec 1Q (E) 33,146 68% 6,548 13% 8,842 18% 48,536 10,678 22% 37,858 78% 37,965 78.22% 11,018 22.70% 6,567 13.53% 2,360 55,550 (17,692) -36% 2143 (15,549) -32% 89 0 (15,638) -32% (0.14) 112,000 110% 100% 100% 107% 210% 89% 92% 148% 92% 101% N/M N/M N/M 42% (2% ) (5% ) 23% 23% 23% 12% 11% 16% 13% N/M N/M N/M Mar 2Q (E) 32,676 63% 7,429 14% 12,071 23% 52,176 11,479 22% 40,697 78% 38,417 73.63% 10,545 20.21% 6,016 11.53% 1,914 54,978 (14,281) -27% 2164 (12,117) -23% 93 0 (12,210) -23% (0.11) 114,000 80% 90% 85% 83% 83% 83% 50% 25% 20% 41% N/M N/M N/M (1% ) 13% 37% 7% 7% 7% 1% (4% ) (8% ) (1% ) N/M N/M N/M June 3Q (E) 38,531 62% 9,953 16% 13,488 22% 61,972 13,634 22% 48,338 78% 40,858 65.93% 10,672 17.22% 5,788 9.34% 1,381 57,318 (8,980) -14% 2186 (6,794) -11% 98 0 (6,892) -11% (0.06) 116,000 87% 80% 80% 84% 84% 84% 35% 15% 15% 29% N/M N/M N/M 18% 34% 12% 19% 19% 19% 6% 1% (4% ) 4% N/M N/M N/M Sept 01 4Q (E) 45,616 61% 12,042 16% 16,690 22% 74,348 16,357 22% 57,991 78% 43,962 59.13% 10,208 13.73% 6,498 8.74% 1,365 60,668 (2,677) -4% 2208 (469) -1% (159) 0 (310) 0% (0.00) 118,000 95% 80% 80% 89% 89% 89% 30% 3% 15% 23% N/M N/M N/M 18% 21% 24% 20% 20% 20% 8% (4% ) 12% 6% N/M N/M N/M 2001 (E) Full Year 149,970 63% 35,972 15% 51,091 22% 237,033 52,147 22% 184,885 78% 161,203 68.01% 42,442 17.91% 24,869 10.49% 7,020 228,514 (43,628) -18% 8700 (34,929) -15% 120 0 (35,049) -15% (0.31) 115,000 92% 85% 84% 90% 102% 86% 47% 32% 30% 42% N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M N/M
Licenses % of Revenues Network Revenue % of Revenues M aintenance & Services % of Revenues Total Revenue Cost of Revenues % of Revenues Gross Profit Gross Margin Sales & Marketing % of Revenues R&D % of Revenues General & Administrative % of Revenues Am ort. of Stock Bsd Comp Total Operating Exp Operating Income (Loss) Operating M argin Other Incom e (Expense) Pretax Income Pretax Margin Income Taxes Tax Rate Net Income Net Margin Operating EPS (Basic) Basic Shares Outstanding YoY Licenses Network Revenue M aintenance & Services Total Revenue Cost of Revenues Gross Profit Sales & Marketing R&D General & Administrative Total Operating Expense Operating Income (Loss) Pretax Income Net Income Sequential Licenses Network Revenue M aintenance & Services Total Revenue Cost of Revenues Gross Profit Sales & Marketing R&D General & Administrative Total Operating Expense Operating Income (Loss) Pretax Income Net Income
Source: Merrill Lynch
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LinkShare (Privately held) Affiliate Marketing

Formed in 1996, LinkShare is a leading provider of affiliate marketing programs that help e-commerce companies sell and market their goods and services through affiliated web sites. LinkShare launched the first affiliate network, an online marketplace where merchants and affiliates can forge sales and marketing partnerships in 1997. The companys network includes hundreds of thousands of affiliate sites and over 400 leading merchants. LinkShare allows merchants to create performance-based marketing partnerships between merchants and affiliate web sites. LinkShare is a third-party provider of software and services to create, track, and manage online marketing partnerships between online merchants and partnering web sites. Through The LinkShare Network, merchants get access to hundreds of thousands of affiliates, a list that is growing by thousands a week. Merchants post offers to the network. LinkShare allows merchants to compensate affiliates in any manner they wish including CPM, impression, click-through, flat fee, percentageof-sales, monthly minimums, and other structures. Merchants can target affiliates by site category, geography and other criteria. Merchants can customize their marketing efforts by making special offers to specific affiliate groups. Merchants are charged a fee for use of LinkShare. LinkShare offers affiliates the opportunity to earn revenue from the traffic their sites generate. Affiliates log-on to The LinkShare Network, assess merchant offers, and decide whether they want to participate in particular programs. Merchants pay affiliates based on the specifics of each particular program. An affiliate might be paid a percentage of a merchant sale that originated from its site, just for driving traffic to a merchant, or simply for putting a merchant link up on its site. LinkShare tracks the activity each affiliate site generates for merchants so affiliates can check on how much merchants owe them. LinkShare is free for affiliates.
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NetVendor (Privately held) Automotive, Industrial Products, and Electronics (AIE) Inventory Management
Through SurplusBIN.com for surplus inventory and E.MBACE, which allows suppliers to establish private-labeled trading networks with their distribution partners, NetVendor provides solutions for customers in the automotive parts, industrial products, and electronics industries. It is typical for suppliers in the AIE market to have numerous surplus inventory items (often in excess of 10,000). There is a lack of infrastructure in these industries to facilitate efficient distribution of surplus inventory. As a result, companies often negotiate the sale of excess inventory through brokers, who typically require deep discounts to take items. Inefficiencies of this system include the geographic limitations of brokers as well as the limits of their buyer contacts. SurplusBIN.com allows participants to communicate, advertise, and post product offerings electronically, participate in online auctions, and arrange for private inventory purchase transactions. Currently, NetVendor offers surplus trading communities for specific vertical markets called PlasticsBIN.com, AutopartsBIN.com, and ElectronicsBIN.com. The industry-specific nature of this vertical market strategy allows suppliers to reach a highly relevant audience of potential buyers, which expands their reach beyond that currently provided by brokers. Currently, most transactions between companies and their trading partners are conducted via printed catalogs, telephone, and fax. The internet enables companies to automate these manual, paper-intensive, time-consuming, and expensive processes. The fragmentation of buyers and sellers, importance of information exchange, numerous product offerings, large transaction volumes, among other characteristics, makes the AIE market well suited for E.MBRACE.com. E.MBRACE.com is NetVendors software-service platform that allows suppliers to establish their own private-labeled trading marketplace to sell and distribute inventory to their established trading partners. NetVendor intends to cross-market SurplusBIN.com and E.MBRACE by leveraging the traffic of SurplusBIN.com to promote E.MBRACE. E.MBRACE facilitates the transfer of product data from a suppliers private trading partner community to the vertical surplus inventory marketplace of SurplusBIN.com. NetVendor generates revenue from transaction fees related to surplus inventory sold through SurplusBIN.com, service and subscription fees from E.MBRACE, and consulting, integration, and customization services.
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AsseTrade.com (Privately held) Asset Management

AsseTrade.com, which was formed in 1998 through a joint venture with Henry Butcher and Michael Fox International, two of the worlds leading asset evaluation, recovery, disposal, and consulting companies, provides a solution for corporate asset recovery teams and procurement groups in large industrial and commercial organizations. AsseTrade provides a complete asset/inventory recovery, disposal, and management solution by leveraging the internet as well as the traditional services provided by Henry Butcher and Michael Fox International. The recurring supply of surplus assets as well business-wide edicts to reduce inventory and improve return on assets creates a market estimated at more than $350 billion. There are numerous ways for companies to dispose of surplus assets. They include selling them directly to other companies, redeploying them within organizations, trade-ins, tax deductible donations, scrap, live auctions, etc. Currently, asset/inventory recovery, disposal and management is disorganized and inefficient whether it is the transfer of assets within an organization or the auction of assets to external buyers through liquidation brokers, among many other related processes. AsseTrade, through the combination of traditional offline services and the internet, hopes to improve the process. The traditional services provided by AsseTrade include offline auctions and global industrial machinery, equipment, inventory and corporate asset recovery, disposal, marketing, and management. However, AsseTrade has integrated these competencies with internet technology. AsseTrade is more than just an online auction. AsseTrades platform allows clients to manage, sell, trade, purchase, exchange as well as auction corporate assets. AsseTrades e-commerce solution is designed to automate ordering, procurement, bid, payment, accounting, shipment, and transaction processing. AsseTrade is customized for individual clients so that they can securely catalog, list, track, and document asset and inventory transactions.
TradeOut.com (Privately held) Asset/Inventory Management

Formed in 1998, TradeOut.com is an online marketplace for businesses to buy and sell surplus assets. Generally, these assets fall into three categories: finished goods, operating assets, and excess capacity and space. There are a multitude or reasons essentially all companies need to regularly dispose of surplus assets. Surplus finished goods may come in the form of manufacturer overruns, retail overstocks, or discontinued and obsolete items, among others. Used machinery or stock, office furniture, and manufacturing components are examples of common surplus operating assets. Production capacity, shipping capacity, and warehouse space are examples of excess capacity and space that businesses often want to dispose of that have value for other companies. The recurring supply of surplus assets as well business-wide edicts to reduce inventory and improve return on assets creates a market estimated at over $350 billion. However, this large market is currently extremely inefficient. There are numerous ways for companies to dispose of surplus assets. They include selling them directly to other companies, redeploying them within organizations, trade-ins, tax deductible donations, scrap, live auctions, etc. However, the most common means of surplus asset disposition is liquidation. Liquidators of excess inventory, called jobbers or closeout dealers, buy large quantities of items and resell them to wholesalers or discount stores. For operating assets, equipment dealers, buy these surplus assets and resell them to other end users. These liquidation brokers, who typically focus on specific industries, know the key players (read buyers) within these vertical markets. They make their money by extracting fire sale prices from sellers and obviously marking up the items for resale.
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TradeOut estimates that there are over 10,000 liquidation brokers. However, these liquidators focus on many different industries. It is neither easy nor a corporate sellers core competency to find a large audience of liquidation brokers in order to stimulate maximum price competition for the surplus assets they are disposing. Assuming a seller does find a reasonably sized audience of potential liquidators, the inefficient exchange of information, predominantly phone and fax, used to negotiate the optimal deal is slow, expensive, and time-consuming. Finally, once a deal is done with a particular liquidation broker, there is always the risk that disposition is not executed the way the seller wants. For instance, a broker might not adhere to a sellers instructions that certain excess inventory be resold internationally to avoid domestic channel conflict. TradeOut.com brings much needed efficiency to the process. TradeOut.com allows sellers to not only achieve better prices, but also speed up and reduce the expense of the overall process of surplus asset disposition. Buyers get access to more supply. In addition, TradeOut speeds up and reduces the cost of the buying process. Obviously, TradeOut significantly improves the exchange of information between buyers and sellers.
65
BuildNet (Privately held) Building/Construction

BuildNet is a business-to-business e-commerce and software company in the home building industry. BuildNet intends to make commerce in building materials more efficient and more profitable. BuildNet ties together the information from the key constituencies of the home building process banks, manufacturers, distributors, builders, and home buyers. During 1999, BuildNet acquired Beacon Systems, Maxwell & Company, The FAST Management Group, and Lloyds. These are market leading construction management software systems in the home building industry. Due to these acquisitions, BuildNet now owns the back-office systems of builders responsible for construction of one out of every three residential homes thats $74 billion in annual construction. Once system integration is completed, BuildNet plans to leverage its strong position within the back-office of builders to offer electronic commerce solutions. Builders using a BuildNet construction management system will be able to connect over the internet to distributors and manufacturers that link their electronic catalogs and inventory systems to BuildNet. Builders will be able to communicate their future material needs up the supply chain electronically instead of using todays time-wasting, inaccurate, and expensive modes of communication phone, fax and mail. Bid requests are sent only to a builders specific distributors. It is estimated that for every $30 million spent on building materials, over 20,000 hours are lost to the inefficiencies of phone, fax and mail communications between builders and distributors. This all results in inflated expenses and delayed project completion. BuildNet will bring automation to this process allowing information to be exchanged more quickly and accurately, while facilitating realtime inventory, delivery and payment tracking information. Automation clearly allows builders to reduce procurement process costs. In addition, it accelerates the time frame in which their material orders are fulfilled expediting the completion of construction projects. Distributors also reduce the costs related to manual order processing. In addition, they are better able to manage inventory because they can manage it based more on real-time demand from builders than on their own internal forecasting methods. With real-time demand information, manufacturers will also better manage their inventory levels. Similar to builders and distributors, automation will reduce costs related to processes that are now largely manual. The BuildNet e-commerce solution will become available in select cities in early 2000. BuildNet will generate revenue from various sources licenses, maintenance, and education fees charged to builders related to construction management systems, fees for hooking suppliers up to the BuildNet network, recurring subscription fees from builders and suppliers for use of the BuildNet network as well as transaction fees. Further out, the company expects to generate revenue from ancillary sources like mortgage loan origination from its installed base of builders for home buyers.
BidCom (Privately held) Building/Construction

Via the internet, BidCom brings some order to the large and complex construction industry. Construction projects typically involve dozens of players including architects, construction companies, sub-contractors, etc. Projects typically last months or even years. From blueprints and contracts to purchase orders, invoices, and permits, documents containing critical information are pervasive throughout any construction project. Time is money in the construction business and improving the speed with which construction project participants can exchange information with each other, which is what BidCom facilitates, goes a long way toward reducing costs. Estimated at $3.2 trillion worldwide, the construction industry is huge. It is the worlds biggest industry and largest employer.
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BidCom provides a suite of business-to-business services that help companies manage risk and complete projects on time and at reduced costs. BidComs services provide an environment for secure communication, collaboration, commerce, business process management as well as relevant industry content. BidComs solution automates the construction industrys standard business practices with Business Process Models (BPMs) that improve the management of the full lifecycle of a construction project from design to completion. BidComs services are sold through a direct sales force on a per-project, per-user basis.
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ChemConnect (Privately held) Chemicals

ChemConnect is a chemical and plastics exchange that provides a venue, the World Chemical Exchange, for manufactures, buyers, and intermediaries to buy and sell all types of chemicals and plastics products including petrochemicals, polymers, pharmaceuticals, agrochemicals, and research chemicals. Overall, the chemical market is estimated at $1.6 trillion its huge. The company was founded in 1995. It started as an online supplier directory. In 1997, the evolution of ChemConnect continued with the company adding online transactions. Also in 1997, the company added ChemConnect Classifieds, an online bulletin board where users placed ads to buy and sell chemicals. In August of 1999, ChemConnect launched the World Chemical Exchange. The Worldwide Exchange has over 3,000 member companies and allows buyers and sellers to conduct business on the floor of the exchange or in Private Trading Rooms. Trading on the World Chemical Exchange is anonymous for both buyers and sellers. Membership is truly global, with only 40% coming from North America. ChemConnect validates and polices membership. In fact, approximately 20% of membership applications are rejected. The exchange offers four different ways to trade. Buyers can search product offers and place a bid to buy or create a product request and receive offers to sell. Sellers can search product requests and place offers to sell or create product offers and receive bids to buy. Access to the World Chemical Exchange is free for buyers and sellers. Buyers and sellers equally split a transaction fee that ranges from 0.2% to 3% based on the dollar value of each transaction.
CheMatch (Privately held) Chemicals

CheMatch operates an online exchange that allows buyers and sellers of high volume, bulk commodity petrochemicals to trade anonymously. More than 80 users around the world are able view real-time information and conduct transactions on CheMatchs trading system 24 hours a day and seven days a week. Since its inception in February of 1998, CheMatch has moved more than $100 million in products. Some of CheMatchs products include benzene, mixed xylenes, paraxylene and orthoxylene, toluene, methanol, MTBE, and styrene monomer. Overall, the chemical market is estimated at $1.6 trillion its huge. The market CheMatch currently targets, which is made up of the Top 25 petrochemicals as well as polymers and plastics, is approximately $400 billion. Not only is the market large, but it is extremely inefficient as it exists today. Once a decision to buy or sell bulk chemicals is made, the buyer or seller contacts a multitude of traders, brokers, customers and producers, negotiates with a couple of potential counterparties, finalizes terms and confirms the transaction. With the trade agreed upon, the buyer and seller need to take the steps necessary to settle the trade submit documentation, arrange for providers of transportation and surveying and testing services, confirm shipping, monitor shipping, and receive physical delivery. CheMatch bring great efficiencies to this process. Trades are executed on the CheMatch exchange, transportation, surveying and testing is arranged via CheMatch and shipment is monitored via the Web. CheMatch ensures user anonymity, which is extremely important because it creates market efficiency. Only when a deal is completed are the two parties revealed to one another. Anonymity will be of even greater importance in the future when the spot market matures and industry and financial participants begin to play in the forwards market that is likely to develop.
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PetroChemNet, a leading online information resource and communications network for the chemical industry, which launched in March of 1997, acquired CheMatch (and kept the name) in June. The combination marries PetroChemNets 170+ information products from respected sources within the petroleum and petrochemical industries with CheMatchs trading platform. From one desktop, participants will be able monitor pricing real-time, execute trades, monitor breaking news news that could effect spot market prices and communicate with peers online.
e-Chemicals (Privately held) Chemicals

Based in Ann Arbor, Michigan and established in 1998, e-Chemicals provides an online solution for the procurement of industrial chemicals in a market estimated at $250 billion. e-Chemicals allows users to select a product, get a price, order, and track order status on line. e-Chemicals has partnered with Yellow Freight for logistics and SunTrust Bank for credit and collections services. e-Chemicals takes orders 24 x 7 x 365 Like in many other industries, the costs associated with buying industrial chemicals are of significant expense. Phoning, faxing, and associated paperwork result in procurement costs that are estimated to range from $75 to $175 per transaction. EDI has been adopted over the last decade to help streamline the demand and supply chains of the industry. However, due to the onerous expenses associated with EDI, Gartner Group estimates that only 15-20% of a typical chemical suppliers trading partners uses it. e-Chemicals hopes to fill the void EDI has left, particularly among smaller companies. Beyond reducing procurement cost for buyers and distribution costs for suppliers, e-Chemicals allows chemical buyers to customize their view of the product and supplier universe so that purchasing policies are better adhered to. e-Chemicals allows buyers to search for products by name (ie, sodium nitrate), manufacturer (ie, DuPont), industry or application (ie, Coatings), product category (ie, acids), or a combination of the aforementioned (ie, DuPont and acids). Users search to find a product, enter the quantity desired, obtain price quotes, and order.
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pcOrder.com (PCOR, $46 , Not Rated) Computer Products

pcOrder.com is a third-party provider of business-to-business solutions that improve distribution in the computer industry. pcOrders e-commerce solution includes sales, marketing, and distribution applications based on technology from Trilogy, a software applications company. pcOrders database of over 700,000 SKUs from over 3,000 manufacturers with detailed product categorization, compatibility, pricing and, availability information make it a robust source of product information. International Data Corporation estimates that the North American computer products market, which includes PCs, servers, workstations, data communications equipment, and peripheral products was $129 billion in 1997. IDC expects this market to grow to almost $180 billion by 2002. Participants in the computer product supply chain include manufacturers, channel participants including distributors, resellers, and systems integrators and retailers, as well as corporate and consumer end-users. In addition, as a result of the internet, Web-based shopping service companies that assist end-users in making more informed purchase decisions have emerged. Moving computer products from manufacturers to end-users can be as simple as the buyer-direct model pioneered and perfected by Dell or, as is often the case, be fairly complex with products touching the hands of a combination of distributors, integrators, corporate resellers, and retailers before reaching end-users. pcOrders solution, eStation, is designed to meet the needs of the major constituents of the computer product supply chain including manufacturers, channel participants, media companies, internet shopping services, and both corporate and consumer end-users. eStation applications include retail kiosks; etail sites for manufacturers, retailers, and resellers; extranets for large corporate customers; small and medium business portals that automate relationships between retailers, resellers, and manufacturers and small and medium-sized businesses; request for quote (RFQ) technology to facilitate reverse auctions; custom Web storefronts; automated configuration and ordering for sales reps, and call center integration. In addition, pcOrder also offers modules for running product promotions, cataloging, finance, custom pricing, and configuration. pcOrders goal is to make its platform an industry standard. pcOrders customer base includes manufacturers such as AST, Compaq, Dell, HP, IBM, Kingston Technology, Nortel Networks, Quantum, SGI; channel participants such as b2bstores.com, beyond.com, CompuCom, CompUSA, EDS, ENTEX, GE Capital IT Solutions, Ingram Micro, MicroAge, Onsale, and Tech Data; media companies such as CMP Media and InfoWorld; and internet shopping services that include Active Research, Inktomi, and mySimon. pcOrder generates the majority of its revenue from subscription fees and occasionally from software license fees. The company also charges services fees for providing integration, customization, training and web-hosting services.
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VerticalNet (VERT, $237, Not Rated) Cross-Industry

VerticalNet started out simply as Water Online and since 1995 has expanded to over 50 industry-specific vertical trade communities. These trade communities span ten industrial categories that include advanced technologies, communications, environmental, food and packaging, food service/hospitality, healthcare, science, manufacturing and metals, process, and service. VerticalNets communities provide industry-specific content, community aspects, and venues for generating commerce. Content within each of VerticalNets trade communities includes professional editorials, white papers, software, news, product information, directories, classifieds, job listings, etc. In addition, VerticalNets trade communities provide a forum where professionals can congregate to keep abreast of industry news and events, learn of job opportunities, and exchange ideas. Finally, because these communities attract thousands of visitors who oftentimes are looking to buy or sell some product or service, they foster an environment for buyers and sellers to conduct business. Currently, advertising is VerticalNets principal revenue stream. However, it has always been VerticalNets plan to generate more electronic commerce revenue longer-term. To this end, VerticalNet offers books, software and other goods from third-party web sites and auction sites with goods posted by inventory liquidators. VerticalNets recent acquisition of NECX Exchange, which closed in December, is its most significant move to date in terms of migrating toward a more transaction-oriented model. NECX is an exchange that allows original equipment manufacturers, contract equipment manufacturers, and distributors to buy, and sell electronic components. In 1998, NECX had approximately $350 million in gross revenue and $37 million in gross profit. NECX has a database of approximately 3 million products from 18,000 suppliers. Forty-five percent of NECXs users are international, which complements VerticalNets international user base of 40%. VerticalNet will integrate NECX with its Advanced Technology and Communication industrial sector web sites. We expect to see VerticalNet expand into new verticals that leverage its significant presence in the electronic components trading business gained through the NECX acquisition. Furthermore, VerticalNet is likely to extend the online trading technology it is developing around NECX into existing and new communities in areas outside of electronic components where the base technology is applicable.
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Credit & Financing
eCredit.com (Privately held)

eCredit.com provides both electronic commerce and traditional businesses with real-time credit, financing and related services. Whether these businesses offer credit and financing themselves or through third-party providers, eCredit.com helps them improve the speed, quality and risk management of credit and financing decisions. Through the combination of sophisticated technology and a wide range of partners in The Global Financing Network, eCredit.com allows both electronic commerce and traditional companies to make credit and financing decisions on a real-time basis at the point of sale. The internet increases sales and lowers costs by matching buyers and sellers and facilitating the exchange of information much more easily and fluidly than is currently the case. However, credit decisions, which are key to consummating transactions, are, by and large, processed manually and can be a major bottleneck in the overall efficiency facilitated by e-commerce. Once an order or credit application arrives from a customer it is typical for a credit analyst to order a credit bureau report, review a potential customers payment history, do some analysis, and make a decision. The manual nature of this process often makes turnaround slow. Slow credit approval increases the risk that a customer may do business with a competitor that can approve credit requests more quickly. The current credit approval process also leaves data interpretation to the subjectivity of individual credit analysts, limits a companys ability to implement an enterprisewide policy for financial risk management, and makes changing enterprise-wide credit policy extremely difficult. eCredit.com, through The Global Financing Network, connects businesses to financing partners and key information sources worldwide. Increasing the speed at which financing is offered to potential buyers significantly enhances a sellers ability to close business. In addition to increasing sales, eCredit.com lowers operating and information access costs. Counting twenty of the Fortune 500 among its customers, the benefits of eCredit.coms solution has clearly resonated with some of the worlds largest companies. eCredit.coms services include InfoLink, which is a single source for accessing all major credit bureaus and information sources; BusinessVerify, which offers a verification check of customer data with bureau data; DecisionDesktop, which automates credit analysis tasks including information access, scoring, and decisioning; InstantDecision, which automates the entire end-to-end trade credit process including information access, scoring, decisioning, and document generation; FastFinance, which provides automated connection to multiple financing partners and end-to-end process automation, and RapidCollect, a collections management solution that increases collections productivity.
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Altra Energy Technologies (Privately held) Energy

Altra was formed in January of 1996 by combining the back-office management systems of PanEnergy (now Duke Energy) and the electronic trading system of Williams. Altra is the leading provider of transaction management software and electronic commerce solutions for the buying, selling and transportation of energy. Altra operates a real-time, anonymous exchange, called Altrade, where customers trade natural gas, crude oil, natural gas liquids, and power online. In addition, Altra offers software solutions that allow users to better schedule and manage their back-office processes. Altra has over 6,000 users worldwide. During 1999, Altra has made several major acquisitions. In January, Altra acquired QuickTrade, Altrades next biggest competitor, and integrated it into the Altrade electronic trading platform. In March, Altra acquired a leading provider of energy-related commodity trading and risk management software, which resulted in the formation of Altras Risk Management Service Division. In June, Altra acquired TransEnergy Management, a competitor in the market for marketing, transportation, and risk management software. Altras solution not only facilitates a marketplace where energy can be traded, but also the software required for managing transactions. As such, Altra combines electronic trading, application software products, and third-party solutions into one solution. The company has three main product lines: Altra Electronic Trading, Altra Gas Suite, and Altra Power Suite. Altra Electronic Trading links energy buyers and sellers in the wholesale energy market, allowing energy traders to buy and sell natural gas, electricity, and natural gas liquids rapidly over the internet. The marketplace automates a trading process historically executed by phone and fax. In 1998, an estimated $6 billion of energy transactions were executed over Altrade. Altra Gas Suite is specifically designed for the wholesale natural gas and natural gas liquids market. The suite combines Altrade, the electronic trading platform, with software tools that help manage the scheduling and delivery of natural gas and natural gas liquids as well as trading risk. Altra Power Solutions is specifically designed for the wholesale power (electricity) marketing industry. Power marketers act as brokers between utilities that buy and sell power with each other. This fast growing market is currently estimated between $60 and $75 billion. Altra Power Suite combines electronic trading with software tools for managing scheduling and delivery as well as trading risk.
Automated Power Exchange (Privately held) Energy

Automated Power Exchange (APX), founded in November of 1996, provides an ecommerce marketplace where buyers and sellers come together to trade electricity and related products. With deregulation, energy transmission and physical capacity are becoming commoditized. Automated Power Exchange provides a venue where energy-related commodities can be bought and sold. The traditional manual process used to match buyers and sellers in these markets is inefficient. However, APX offers services beyond just matching buyers and sellers, such as credit management and financial settlement. There are numerous APX participants. They include utilities, energy retailers and aggregators, power marketers, generators, and municipalities. Automated Power Exchange already operates in California with APX California Markets, Ohio with APX Ohio Hub, and New York with APX New York Markets.. In addition, APX Green Power Market provides an exchange for the environmentally conscious. Automated Power Exchange intends to open exchanges in Illinois and several other areas by the end of the year. APX takes a flat fee for every megawatt hour traded on its exchange. Deregulated markets give buyers and sellers of electricity more choice in terms of whom they transact business with. APX makes assessing and trading with all of these potential partners much more convenient than doing it manually. The
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conveniences of using Automated Power Exchanges include better price discovery, verification of buyer and seller creditworthiness, delivery arrangement, and single party settlement. Using APX Markets, users can trade 24 hours a day, seven days a week. Trading can take place hours, days and weeks ahead of delivery. With APX Market Window, a graphical user interface, buyers and sellers can view price information, market depth, and submit market or limit orders. Transactions are anonymous, which prevents price manipulation. Through services such as off-peak savings, automatic scheduling, web-based settlements and reporting, and credit management, end-users can lower the process costs related to procuring electricity as well as the prices they actually pay. The guidance of forward prices coupled with a ready market in which to sell energy, provides generators with a more profitable way to sell output. APX Markets reduce the costs related to purchasing and reselling energy for aggregators and resellers. The anonymity and liquidity of APX markets allows energy traders to quickly liquidate positions at better prices.
Enermetrix.com (Privately held) Energy

Through its Enermetrix.com Exchange, Enermetrix.com delivers e-commerce solutions that allow energy consumers, suppliers, and utilities in the $320 billion energy industry to share information, execute competitive energy transactions, and generate reports. The company was incorporated in 1995 to deliver e-Commerce solutions to the deregulating energy industry. Energy costs are usually among the top three to five operating costs for a business. With markets deregulating, energy buyers have choices beyond the incumbent energy provider in their geography. Enermetrix.com provides a marketplace for the purchase and sale of energy. For buyers, a staff of Enermetrix.com energy professionals helps them analyze their energy costs and consumption data and define their energy contract requirements. Energy providers then have the opportunity to compete in auction format to fill a buyers energy needs. Enermetrix.com provides suppliers with a low-cost distribution channel. Market channel partners, which include energy service companies (ESCOS), energy marketers, energy distribution companies, government entities, etc., gain a means to provide commodity services without the expenses or risks related to creating energy trading operations. Energy consumers get more reliable and cheaper energy delivery contracts. Enermetrix.com currently does business with approximately 50 of the nations largest energy suppliers including Enron, Duke, and Reliant. Market channel participants include service companies like DQE and Unitil. When it comes to customers purchasing natural gas and electricity, Enermetrix.coms Exchange retention rate is 99%. Its clients include Fortune 500 manufacturers as well as local businesses looking to take advantage of the choices presented by deregulation. Customer savings typically range from 10%-20% through the combination of reduced procurement costs and prices. Enermetrix.com Exchange has maintained 95% of the energy suppliers that have used the exchange system. The solution enables suppliers to bid on a greater amount of commercial and industrial contracts at a low-cost. The sales agreement is executed between the supplier and customer; the customer pays the supplier directly. Bids are confidential, transactions are real-time, and customers are pre-screened for credit. Enermetrix.com generates revenue in two ways. First, it charges transaction fees for the electricity or natural gas traded in its marketplace. In addition, it generates fees for licensing its technology to market channel partners.
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RoweCom (ROWE, $34 , Not Rated) Knowledge Resource Management

RoweCom is the leading business-to-business provider of e-commerce solutions for purchasing and managing the acquisition of magazines, newspapers, journals, books and other knowledge resources. In addition to benefiting from the strong expansion of the overall B2B e-commerce market, RoweComs growth is being driven by the fact that its knowledge resource solution addresses the management of what is increasingly being recognized in business as among the most critical, but most poorly managed, of assets information. The current market RoweCom addresses can be segmented into three parts: (1) its core market, the market for business magazines, as well as scientific, technical and medical journals, and other professional publishing; (2) newspapers, consumer magazines and information services; and (3) various other knowledge resources. In aggregate the U.S. market segments RoweCom addresses and future markets it targets totaled approximately $12o billion in 1997 according to Veronis Suhler & Associates. RoweComs flagship products, the kStore for businesses and the kLibrary for academic institutions, bring convenience, control and cost savings to knowledge resource procurement. RoweComs kStore is the heart of the RoweCom solution as the companys strategy is to do more corporate business than academic going forward. The kStore is a Web-based company store that can either be set up on a customers corporate intranet or as a customized internet site. RoweCom offers a large and ever-growing catalog of knowledge resources on the internet from over 20,000 publishers, including 240,000 titles from magazines and journals to market reports and newspapers as well 8 million discounted books through a relationship with barnesandnoble.com, as well as various other content. Since June Rowecom has made three acquisitions adding a substantial number of accounts, revenue and content as well as increasing the companys international presence. These acquisitions were Corporate Subscription Services, International Subscription Agencies and Dawson Information Group. RoweCom has a pending acquisition of NewsEdge to provide desktop access to real-time news and information, which should serve as a hook to draw users to the site on a more regular basis. RoweCom intends to link relevant knowledge resources from books and magazines to courses and consultants to news items so users can further explore information about topics of interest.
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Chemdex (CMDX, $86 , Not Rated) Life Sciences/Cross-Industry

Chemdex Corporation is a leading provider of business-to-business e-commerce solutions for the life sciences industry but has already begun its move into other vertical markets, with its recent Promedix.com acquisition as well as joint ventures with Tenet Healthcare and Dupont. Founded in 1997, Chemdexs most mature business, the one in life sciences, brings together enterprises, researchers, and suppliers to efficiently buy and sell products over the internet in the Chemdex Marketplace. Using data from the Laboratory Products Association and Strategic Directions International, the North American market for scientific products is estimated to be approximately $12 billion. Worldwide the market is estimated at approximately $36 billion. Annually, approximately 200,000 laboratories worldwide purchase scientific products through thousands of different suppliers for research and testing activities. The market is fragmented, procurement processes are paperbased, and a great deal of information is exchanged between buyers and sellers. Chemdex helps solve the classic problems of transacting business in highly fragmented markets automating procurement for buyers and improving and increasing sales and distribution for suppliers. Chemdexs internet-based procurement system offers enterprises a whole product solution combining an online marketplace and procurement capabilities customized to the meet the unique requirements of each customer. Chemdexs eCommerce solution gives scientists and researchers access to the Chemdex Marketplace, a one-stop shop that offers hundreds of thousands of products. Features include: contract pricing and customized supplier lists; automated ordering, tracking, shipping, and reordering; summary billing and consolidated reporting; and ERP integration. This e-commerce solution is designed to provide purchasing professionals with the detailed information they find necessary to make purchase decisions, resulting in shorter purchasing cycle times and greater research productivity. In addition, it offers suppliers a cost-effective way to reach more customers (vs. paper catalog distribution) and an opportunity to sell more products. Chemdex generates the lions share of its revenue through e-commerce transactions. The difference between what buyers pay and the discounted amount Chemdex pays suppliers is the companys gross margin. However, Chemdex believes its technology is transferable beyond just the life sciences market. Along these lines, Chemdex acquired Promedix.com and formed a joint venture with Tenet healthcare, extending its presence beyond the life sciences market into the $145 billion worldwide healthcare products market; and formed Industria with DuPont to target the $75 billion worldwide fluids procesing market.
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SciQuest (SQST, $62, Not Rated) Life Sciences

Similar to Chemdex, SciQuest is a marketplace for scientific and laboratory products in the life sciences industry. The typical users of these products include pharmaceutical, clinical, bio-tech, chemical, industrial, and educational organizations. SciQuests solution automates the procurement of laboratory products, a process that is currently manual and extremely inefficient. SciQuest Using data from the Laboratory Products Association and Strategic Directions International, the North American market for scientific products is estimated to be approximately $12 billion. Worldwide the market is estimated at approximately $36 billion. Annually, approximately 200,000 laboratories worldwide purchase scientific products through thousands of different suppliers for research and testing activities. The market is fragmented, procurement processes are paperbased, and a great deal of information is exchanged between buyers and sellers. Three groups scientists, purchasing professionals, and suppliers are the primary beneficiaries of SciQuests marketplace. Scientists, who oftentimes need new and different chemicals, supplies, and equipment for research and testing on a project by project basis now have a central location to search, find compare, purchase, and manage lab items. Purchasing professionals who typically buy on behalf of scientists currently prepare purchase orders and track orders manually. SciQuests internet-based procurement solution significantly reduces the errors and costs associated with manual procurement. It also helps keep scientists in compliance with their organizations purchasing policies. For suppliers, SciQuest provides a channel through which they can reach brand new customers altogether or existing customers at lower costs. SciQuests purchasing service gives buyers access to over 300,000 chemicals, supplies, lab equipment, and other products from over 235 suppliers. Buyers are able to search products across multiple suppliers and compare them on numerous attributes. Buyers can purchase from multiple suppliers on one order form, track order status, receive one invoice, and deal with a single point of contact for customer service. Once an order is submitted, SciQuest purchases the items from suppliers at either a pre-negotiated price or at a discounted price. SciQuest arranges for direct shipment from supplier to buyer and does not take possession of products, but does take title. While SciQuest does generate advertising revenue, the lions share of its revenue will be generated through e-commerce transactions. The difference between what buyers pay and the discounted amount SciQuest pays suppliers is the companys gross margin.
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eMerge Interactive (Privately Held) Livestock

eMerge Interactive provides e-commerce business-to-business solutions for the cattle industry. The companys solution is the combination of an internet-based community, content, and transaction platform and therapeutic and diagnostic products for cattle. eMerges solution provides services for livestock procurement, daily feedlot operations analysis, cattle inventory management tools and products for managing and enhancing the health and quality of livestock. According to the National Cattlemens Beef Association, based on U.S. Department of Agriculture statistics, $36 billion of live cattle were sold in 1997, making cattle the largest segment of the American agriculture economy. Furthermore, the U.S. Beef industry spends approximately $600 million on medication and $6 billion on feed. Retail sales of beef and beef by-products are approximately $54 billion annually. It is also important to note that cattle production worldwide is approximately three times greater than U.S. production. There are three primary segments of the beef production chain: producers, feedlots, and packers. Producers, of which there are approximately one million, are comprised of ranchers and small farmers that breed and raise cattle. Approximately 35 million head of cattle that are eventually harvested for food are marketed each year by producers 27 million of these head are processed through feedlots. Feedlots, of which there are approximately 700 major operations concentrated in the Midwest, typically buy cattle 12-18 months after birth when they weigh between 300 and 900 pounds. Feedlots put the cattle through a feeding regimen focused on increasing their weight and value. When the cattle reach a weight of approximately 900-1,400 pounds they are typically sold to packers for harvesting. There are approximately 64 major beef packing operations in the U.S. Packers usually hold the cattle for no more than a day before they are harvested and prepared for sale and final consumption. The complexity of the production chain in the cattle industry has inefficiencies that result in the degradation of the health and value of cattle. By conducting cattle auctions and sales over the internet, eMerge intends to minimize the transport and handling of the animals and, as a result, reduce transaction costs and improve the health and quality of the cattle. In addition, through eMerges information management solutions, customers can access detailed pricing data, better manage daily operations, access benchmarking data for the cattle industry, and access other online products and services that enhance overall cattle quality. eMerge also offers diagnostic and therapeutic products for livestock such as NutriCharge, a food supplement for cattle. eMerge generates revenue from commissions on the sale of cattle over its site as well as from sales of its therapeutic and diagnostic products. eMerge also charges subscriptions for its various information products.
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e-STEEL (Privately Held) Metals/Steel

e-STEEL, which was founded in 1998, is a market maker in the steel industry. eSTEEL provides a neutral marketplace for buyers and sellers in the $700 billion global steel industry. Although the company does feature content relevant to the steel industry on its site, the endgame for e-STEEL is transaction revenue. Like most market markers, e-STEEL expands the customer reach of suppliers and improves buyer access to suppliers. In addition, by automating what historically has been an extremely manual process, e-STEEL reduces transaction costs for both buyers and sellers. The site already has more then 600 members. eSTEEL.com opened up for transactions in September of 1999. e-STEELs focus has not been one of auction, but rather the ability to process transactions in both the spot and contract market. The company was primarily financed by a group of well-respected venture capital groups led by Bessemer Venture Partners, Greylock and Kleiner Perkins. The company has since included key strategic investors including, MSD Capital (Dell), GE, DuPont, Vulcan (Paul Allen), Mitsui, and Mitsubishi. e-STEEL is continuing to build a solid management team with experts in steel sales as well as add key employees from the technology/internet industry. e-STEEL Exchange allows buyers and sellers of steel products to reach each other more easily and transact business more efficiently. It enables sellers to create product offers and send them to all customers, a specific group of customers, or one customer in particular. The ability to tailor offers for specific customers and block information from other customers as well as competitors is important to attracting suppliers. On the demand side, e-STEEL Exchange allows buyers to create product inquiries and send them to the total universe of e-STEEL suppliers, a subset of them, or one in particular. e-STEEL Exchange enables buyers to search through numerous offers and sellers to search through numerous orders to close transactions more efficiently. e-STEEL ensures the integrity of users by requiring that potential buyers and sellers pass a rigorous qualification process, which includes a credit check and a corporate profile. e-STEEL charges no membership or application fees. Although the company will have several ancillary revenue streams, the meat and potatoes of this story will be transaction fees, which sellers pay. Buyers pay no fees. e-STEEL, while recognizing that the US is a key market, has definitively included the global steel industry in its strategy to become the global portal. Importantly, e-STEEL is focusing on adding value to the transaction through such avenues as: credit, member profile, logistics, and eventually benefits such as currency hedging (important in longer term orders).
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MetalSite (Privately Held) Metals/Steel

Launched in 1998, MetalSite is a marketplace that brings together buyers and sellers in the $700 billion global steel industry. It complements the commerce attributes of its site with community aspects such as industry news and discussion groups as well as other resources. MetalSite, with a view of being first to the market, began as an auction site for the investing steel mills, Weirton, LTV, and Steel Dynamics. Weirton, prior to a recent purchase of a good portion of its stake by ICG, had over 50% ownership, with the others holding about 10%. As well, Bethlehem and Ryerson Tull, two later additions, also hold about a 10% stake in MetalSite. We now estimate Weirtons stake at 20%. MetalSites original sales were for secondary steel and excess inventory. Since its inception the site has evolved into incorporating prime material, with a view towards the global markets, as well. Over time, we expect to see MetalSite expand beyond steel into other metals. On the supply-side, MetalSite allows steel makers to reach new customers, reduce the cost and increase the efficiency of selling, improve inventory turns, and reallocate the time salespeople currently spend on administrative account management activities to more revenue-generating activities. Buyers get one centralized location to view the offerings of multiple suppliers, which eliminates the faxing and phoning required today to get information and purchase metals. Obviously, automation wrings costs out of the procurement process for buyers. To buy on MetalSite buyers review the items for sale by suppliers on the site. Purchases can be made in both a fixed-price and an auction format. Sellers are responsible for fulfillment and payment. MetalSite if free for buyers. Suppliers pay transaction fees. MetalSite also generates revenue by charging development and consulting fees for supplier-specific Market Centers within MetalSite. In addition, MetalSite generates advertising revenue from suppliers.
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CommerceOne (CMRC, $169, Not Rated) MRO/Indirect Goods and Services Procurement/CrossIndustry
CommerceOne provides e-commerce solutions that link buyers and suppliers of indirect goods into internet-based trading communities. CommerceOnes Commerce Chain Solution is designed to automate procurement between multiple buyers and suppliers. The procurement processes of corporations for indirect goods like information technology and telecommunications equipment, office equipment and supplies, travel and entertainment, professional services, among other goods and services are typically very inefficient. Procurement of these non-strategic, yet essential items and services, is typically paper-based and time-consuming, and, therefore, expensive. Various software products designed to automate procurement of indirect goods and services have had limited success due to the fact that they have been too buyer-centric and generally neglected the supplier side of the transaction. The Commerce Chain Solution is comprised of BuySite, MarketSite Open Marketplace Platform, and MarketSite Commerce Services. BuySite is an intranet-based purchasing application that allows buyers to purchase from catalogs of many different suppliers, while eliminating paperwork, automating workflow and the approval process, and ensuring employees remain in compliance with corporate purchasing policies. The MarketSite Open Marketplace Platform is the nexus of the CommerceOne network. It serves as a single point of integration for buyers and suppliers. It allows suppliers to publish their catalog content once and update it easily. Buyers, using BuySite or other third-party procurement applications, connect to supplier content on the MarketSite Platfrom. Using the MarketSite Platform, commerce service providers can maintain marketplaces for specific geographies or industries. CommerceOne has established strategic relationships with British Telecom to host a MarketSite in the U.K., Nippon Telegraph and Telephone to host a MarketSite in Japan, and Singapore Telecommunications to host a MarketSite in Southeast Asia. Among other industry-specific relationships, CommerceOne recently announced a high-profile agreement with GM to create GM MarketSite, where GM, its suppliers, and dealers will be able to buy and sell products and services in fixed price catalog, bid-ask exchange, and auction formats.
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PaperExchange.com (Privately Held) Pulp & Paper

PaperExchange is a market maker in the pulp and paper industry. The pulp, paper, and packaging industry is over $100 billion domestically and over $300 billion worldwide. Through Trading Floor, its online marketplace, PaperExchange enables buyers and sellers to negotiate pricing and transact with each other. PaperExchange facilitates the trade of many product grades including containerboard (liner and medium used to make uncoated corrugated boxes), paperboard (used to make boxes and cartons), newsprint (for newspapers), fine paper (used to make writing, printing, and publishing papers), and tissue (used to make napkins and paper towels). Given some of its characteristics, the pulp and paper industry seems well suited for a market maker like Paper Exchange. First of all, paper is a commodity defined by mathematical metrics so it is clearly understood by buyers and sellers. At $300 billion globally, the market is extremely large. Brokers, who extract a fee for not much more than matching buyers and sellers, are pervasive. Finally, the financial performance of the paper industry, which is extremely capital intensive, has been subpar for quite some time. PaperExchange is completely free for buyers. Sellers are not charged subscription, membership, or listing fees. PaperExchange makes it money by charging sellers a commission for transactions conducted on its site. PaperExchanges Trading Floor is private, secure, and anonymous. PaperExchange also offers value-added services for credit and logistics. In addition, PaperExchange facilitates the purchase and sale of paper industry equipment. The site also features industry-specific content including industry news, events, job listings, and a resource directory. PaperExchanges predecessor company was founded in 1996. The initial site was launched and the company did its first transaction in 1997. In 1999, PaperExchange significantly beefed up management and quadrupled its staff to approximately fifty. Also in 1999, the company revamped its web site with the release of Version 3.0. The company also recently struck a strategic alliance with VerticalNet.
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FreeMarkets Online (FMKT, $229, Not Rated) Reverse Auctions

FreeMarkets Online creates customized business-to-business online auctions for many of the worlds largest buyers of industrial parts, raw materials, commodities, and other goods and services. FreeMarkets runs reverse auctions. Unlike in traditional, seller-centric auctions, reverse auctions are designed to drive prices down. In other words, sellers continue to lower their prices until the auction is closed. FreeMarkets estimates that manufacturers worldwide purchase approximately $5 trillion of direct materials the industrial parts and raw materials incorporated in finished products each year. The companys online auctions in 1998 covered $1 billion worth of purchase orders. Through September of 1999, FreeMarkets created auctions covering $1 billion worth of purchase orders. To oversimplify the process, FreeMarkets helps buyers prepare detailed requests for quotations. Simultaneously, FreeMarkets identifies and screens suppliers and trains these suppliers on the companys proprietary auction technology, BidWare. Once the auction begins, qualified suppliers from around the world, many of who would not have been able to participate without the internet, submit bids to fill the buyers purchase order. Bidders remain anonymous but can see the evolving market price, and thus, can respond with new competitive bids driving prices down. During 1998, FreeMarkets estimates its clients achieved cost savings ranging from approximately 2% for commodity items to over 25% for customized items. Since 1995, the company has conducted online auctions for more than 30 clients in over 50 product categories, including injection molded plastic parts, commercial machinings, metal fabrications, chemicals, printed circuit boards, corrugated packaging, and coal. More than 1,800 suppliers from over 30 countries have participated in the companys auctions. Buy-side clients include United Technologies, FirstEnergy, SmithKline Beecham, and the Commonwealth of Pennsylvania. United Technologies serves as an excellent example of the benefits of FreeMarkets. FreeMarkets has held over 45 auctions for United Technologies since 1996. In one particular auction held in 1997, United Technologies put a three-year contract to purchase injection molded plastic parts used in HVAC equipment out to bid. The winning bid is estimated to have resulted in $1.2 million in annual savings, or $3.6 million over the life of the contract a 12% savings compared to what United Technologies previously paid for the same items. FreeMarkets generates revenue through client service agreements. These service agreements are typically fixed monthly fees. However, many also include incentive payments based on auction volume and savings. In certain instances, the company also generates sales commissions paid by suppliers.
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ONVIA.com (Privately Held) Small Business

ONVIA.com operates a site where small business can buy and sell products and services, exchange information and access productivity tools. ONVIA.com improves the procurement process for small businesses by providing a single destination where buyers can purchase products and services and compare offerings and price. Businesses with fewer than 100 employees and income-generating home offices are estimated to generate roughly half of gross domestic product in the United States according to the US Small Business Association. According to International Data Corporation (IDC), there are approximately 30 million SOHO (small office/home office) businesses in the United States. IDC estimates that these businesses will grow to over 38 million in number by 2002. Furthermore, IDC estimates that small business related e-commerce will reach $107 billion by 2002. Clearly, the market is large and fragmented. ONVIA.coms marketplace includes a small business services trading hub featuring over 6,500 providers across 50 services in a request for quote network in which suppliers respond to buyers RFQs. RFQs are formulated based on electronic questionnaires completed by buyers and routed to qualified suppliers. Through its Buy Now system, ONVIA.com gives its users access to approximately 25,000 products and services in nine categories. The Buy Now system contains interactive tools that help small businesses make more informed selections of services and products. Through the combination of the RFQ and Buy Now systems, ONVIA.com provides services such as payroll, business credit cards, internet access, and telecommunication plans, etc. Products on Buy Now cover categories such as computer hardware and software, office supplies and furniture, phone systems, among others. Information and Business Tools include editorial content specific to small businesses, how-to advice, and business tools designed to help small business owners grow their businesses. ONVIA.com generates revenue through both transaction and advertising fees. Further out, the company intends to monetize the valuable purchasing behavior it accumulates from its users by providing suppliers with chaperoned access to these potential valuable customers.
SmartAge.com (Privately Held) Small Business

SmartAge.com is based in San Francisco and was launched in early 1998. SmartAge is focused on small businesses and offers services that allow these businesses to find and retain customers, sell more, and buy better and cheaper. Businesses with fewer than 100 employees and income-generating home offices are estimated to generate roughly half of gross domestic product in the United States according to the US Small Business Association. According to International Data Corporation (IDC), there are approximately 30 million SOHO (small office/home office) businesses in the United States. IDC estimates that these businesses will grow to over 38 million in number by 2002. Furthermore, IDC estimates that small business related e-commerce will reach $107 billion by 2002. Clearly, the market is large and fragmented. SmartAges strategy is to acquire customers through SmartClicks, an online advertising exchange. For every two banner ads a member agrees to display on its site it gets a credit to show its own ad on another site. SmartClicks provides users with reporting tools for advertising campaign management and its technology, SmartTargeting, targets ads to the sites where they get the best click-through rates.
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Once small businesses join SmartClicks, SmartAge offers them a multitude of services from which it generates revenue. Beyond the free banner ad placement users get for presenting the ads of other affiliated sites for free, users can use SmartAge to purchase advertising space not only on the SmartClicks network, but on other popular ad networks and sites. SmartAges MarketPlace and Resource Center allows small businesses to buy from and sell to SmartAges user base, which totals over one million. SmartAge Site and Store allows small businesses to get online and sell online quickly. SmartAges Corner Office, where SmartAge hosts user data, is a management tool that makes SmartAges offering sticky. In summary, SmartAge helps small businesses start a web site, enable it for commerce, find customers, buy with economies of scale, sell on the web, run an affiliate network, and generally, manage their businesses.
works.com (Privately Held) Small Business

works.com, which was founded in September 1997, is headquartered in Houston, Texas and launched its service in May 1999. works.com is an internet-based procurement solution for small and medium-sized businesses. Businesses with fewer than 100 employees and income-generating home offices are estimated to generate roughly half of gross domestic product in the United States according to the US Small Business Association. According to International Data Corporation (IDC), there are approximately 30 million SOHO (small office/home office) businesses in the United States. IDC estimates that these businesses will grow to over 38 million in number by 2002. Furthermore, IDC estimates that small business related e-commerce will reach $107 billion by 2002. Clearly, the market is large and fragmented. works.com automates the whole procurement process, from selection to receiving shipment, for smaller businesses. In addition to the savings works.com provides through reduced procurement costs, the company also provides its users with wholesale direct prices on 20,000 business products including computer accessories, office supplies, furniture, and janitorial products. The company estimates that these wholesale direct prices allow customers to save an average of 15% on monthly purchases. works.com charges $1.50 per order for its services. works.com automates the whole purchasing process. The service allows users to browse catalogs, request items, and place orders online. The approval process is simplified and spending is controlled because the system enables businesses to establish approval processes that filter and manage purchase requests. Once an order is made, the purchasing information is captured so the order can be tracked through all stages of the purchasing process. Through an online request, works.com automatically processes returns on behalf of customers. Custom cabinets allow businesses to customize the site so it presents only their preferred products. In addition, works.com provides management with reporting capabilities that allow tracking of purchases on a company-wide or individual level for better budget management and insights into purchasing habits and patterns.
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Universal Access Telecommunications

Universal Access serves as an intermediary between service providers who buy network capacity and transport suppliers who sell it. Universal Access facilitates the provisioning, installation, and servicing of dedicated communication links, or circuits. Universal Access aggregates network information, operates facilities where networks can be interconnected, provides dedicated circuit access as well as customer support services. Universal Access is vendor-neutral and, as a result, has been able to aggregate network information from over 35 transport suppliers and over 75,000 physical sites. Universal Information Exchange, or UIX, is the companys web-based offering, which through linked proprietary databases, contains capacity, availability, physical location and pricing information for these transport suppliers and locations. In addition, Universal Access operates UTXs, or Universal Transport Exchanges, where transport suppliers can connect to each others networks. Universal Access also provides services that include network monitoring, maintenance, and restoration. Many factors, particularly deregulation and the emergence of the internet, have resulted in an increasingly competitive, fragmented, and growing market for communications network services. Yankee Group projects the domestic market for internet transport capacity and network infrastructure services at $57 billion in 2002 and growth is likely to remain torrid. This robust market opportunity has attracted many players and, as a result, there are multiple networks serving various geographies. Transport and service providers have limited access to accurate information regarding the pricing, capacity, availability, and location of other suppliers networks. Since transport suppliers compete with each other it is not surprising that they are reluctant to share this information. The current market environment provides significant challenges for both service suppliers like ISPs and ASPs and transport suppliers like IXCs and CLECs. Service providers spend an inordinate amount of time and expense quoting, provisioning, and installing circuits. Furthermore, they often have difficulty determining capacity availability, which can result in a backlog of customer orders and lost revenues. Also, this lack of information makes delivering key customer services such as connection maintenance, monitoring, and restoration extremely challenging. Transport suppliers are faced with challenges that include the inability to fulfill customer demand for dedicated circuits due to the limited reach of their own networks, expenses related to selling excess capacity, and inconsistent service levels over multiple segments of their networks. By providing a single point of contact and central repository of transport supplier information where service suppliers can analyze provisioning, installation, and network management services, Universal Access helps its clients save time and money. Furthermore, Universal Access allows service providers to extend the reach of their network. In addition, for transport suppliers, Universal Access serves as a source of aggregated demand. Universal Access currently generates most of its revenue through 12-60 month contracts for providing dedicated circuit access for its clients. Due to the fact that the companys UTX roll-out is in its early stages, the company currently generates a small portion of revenue from leasing space to transport providers in these facilities. As the company adds more facilities we would expect these revenues to increase as a percentage of the overall mix.
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Chart 14: B to B Market Maker Master List
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[ICGE] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years. [ICGE] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company. Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 Reduce, 5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend. Copyright 2000 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.
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Merrill Lynch The B2B Market Maker Book

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Merrill Lynch The B2B Market Maker Book

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In-depth Report

The B2B Market Maker Book

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

Table 1: Valuation Table Selected Public B2B Market Makers

$162.63 $211.00 $30.50

VerticalNet Total Total (ex ICGE & NEOF)

Source: Merrill Lynch Internet Research; FactSet; Investext

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

1. Introduction: Asking The Right B2B Questions.

The B2B Market Maker Book 3 February 2000

Merrills Top Ten Questions To Ask B2B Market Maker Managements

The B2B Market Maker Book 3 February 2000

2. Overview: An Industry Snapshot

B2B Market Overview

Market Maker Models

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

Horizontal & Vertical Markets

Why We Like B2B Market Makers

The B2B Market Maker Book 3 February 2000

Market Maker Beneficiaries & Liquidity

The B2B Market Maker Book 3 February 2000

Market Maker Success Key Industry Criteria

The B2B Market Maker Book 3 February 2000

Market Maker Success Key Company Criteria

B2B Valuation Framework

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

Chart 1: B2B Electronic Commerce Valuation Framework ($ billions)

Total B2B Transaction Revenue 2003E

Seller Site Sales Market Maker Sales

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

3. A Brief History of B2B Electronic Commerce

The B2B Market Maker Book 3 February 2000

Chart 2: Electronic Data Interchange

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

The B2B Market Maker Book 3 February 2000

4. B2B Market Overview

Chart 3: US B2B Market Forecast Goods & Services

$0 Total B2B Services Total B2B Goods

1999E $22 $109

2000E $44 $251

2001E $83 $499

2002E $143 $843

2003E $220 $1,331

Source: Forrester Research

The B2B Market Maker Book 3 February 2000

Chart 4: Worldwide B2B Market Forecast

$1,500 Billions $1,000 $500

$0 Total Intl B2B Total US B2B

1999E $26 $131

2000E $88 $295

2001E $233 $582

2002E $493 $986

2003E $930 $1,551

Source: Merrill Lynch Internet Research; Forrester Research

The B2B Market Maker Book 3 February 2000