Business-to-business (B2B) electronic marketplaces are brilliant at reducing transaction costs and removing inefficiencies from the supply chain. But unless they become more thoughtful about how they value and charge for their services, the profit from the benefits they provide will flow to everyone but themselves.

How much value do they capture? Much less, it would appear, than they create (see sidebar, "Four roads to value"). To induce major buyers to join before they affiliate with any other marketplace—or, alternatively, before starting a buyer-led one—B2Bs have been charging little or nothing for access and even offering buyers equity stakes. One insurance-claims B2B hub (launched in late 2000) is prepared to give as much as 75 percent of its equity to insurance companies. A recent review of 23 leading B2B companies revealed that only 2 levied substantial charges on buyers.

B2Bs have instead charged suppliers, which are now, understandably, pushing for improved terms or forming their own e-marketplaces. In addition, the equity markets, once so free with capital, currently view B2B players with a jaundiced eye. Pressured by suppliers, beholden to buyers, and with little income of their own,¹ B2B marketplaces are being painfully squeezed. Can they ever build solid, profitable businesses? Yes—if they can grasp the value of what they offer and then use the whole range of ways to charge for it.

How will you charge?

There are probably as many ways to generate B2B revenue as varieties of B2B offerings. In many cases, an aggregator should deploy two or more approaches simultaneously. Choosing the wrong model can be expensive. The strategic objective of an insurance claims-processing aggregator, for example, was to handle all the claims of three of the largest US property and casualty insurers. But its pricing method, a flat usage fee, prompted them to send it only their more complex claims, which were of course also more costly to process. Quite likely, a capped subscription-based fee reflecting each insurer's volume of claims would have realized the aggregator's objective of processing the claims of all three companies, and with no sacrifice of revenue.

We see a number of ways in which aggregators can now charge for their services. Giving services away may not seem to be a pricing structure, but of course it is—and a distressingly common one at that. Many B2B companies are guilty of following this course because they fear that fees will repel reluctant suppliers or buyers, reducing the liquidity, and hence the value, of their sites. A desire to build scale quickly is understandable, but rock-bottom prices often don't make sense.

Setting prices too low or at zero poses two hazards in addition to forgoing much-needed revenue that could be obtained from selling valuable services such as order tracking, capacity planning, and inventory and logistics management. First, low prices establish themselves in customers' minds as "reference prices," which are extremely difficult to change as value modulates. Second, low prices imply that the B2B company itself isn't confident of its offering. One printing-services aggregator priced its order-management software at zero to promote the penetration of its market but found few takers. Once the company started charging for this product—and quite aggressively—customers saw its value and began to demand it. In another instance, a provider of content- and community-management software intended to charge a $5,000 up-front licensing fee but was persuaded to raise it to $200,000. The product was successfully launched at that price.

Charging for services is a good litmus test: if customers won't pay, you are not adding distinctive value.

Transaction fees

B2B pricing most often takes the form of transaction fees (sometimes called "cost-plus" pricing structures), which are charged to the buyer, to the seller, or to both. While there are countless variations on transaction fees, most of them are based on a percentage of the transaction price. This percentage can range from 0.1 to 10 percent—and, most often, from 1 to 5 percent. Rates for transaction fees usually decrease as the volume of purchasing channeled through a site rises.

Currently, most B2B aggregators charge transaction fees to sellers only. ChemConnect and FastParts.com charge both parties, however, while OneMediaPlace charges only buyers. Still other aggregators have begun levying charges based on the service level users elect. MetalSite, for example, charges suppliers that respond to a posted RFQ (request for quote) a flat 2 percent of the revenue they take in, and as much as 5 percent plus $10 if the supplier lists its products on the exchange.

Transaction fees present a number of problems. First, if such fees are applied in a simple, undifferentiated way, customers are likely to think of the B2B company as a mere transaction facilitator and not as the "industry portal" or the "infomediary" that B2Bs wish to become. At a minimum, prices appearing on a schedule should correspond precisely to the incremental value of particular transactions to the transactor, which can decide, on that basis, whether to go forward. Suppliers wishing merely to list their products on-line may not have to pay anything for that service, though they would be required to pay a variable charge for a prominent listing of their excess inventory, for a list of prospective buyers, or even for an assisted search.

The second problem with transaction fees is that sometimes the wrong party is charged. It is fine to charge suppliers a transaction fee if they are more motivated to sell than buyers are to buy. But when products or services are scarce, suppliers will be less motivated than buyers to use the aggregator's services—and to pay for the privilege. If one party, as measured by its actions, is more motivated than the other, prices should reflect this.

Another problem is that transaction fees may well begin to disappear when basic buy-sell coordination becomes a commodity. It is worth noting that the largest, most successful exchange in the world, the New York Stock Exchange, with $7.3 trillion in annual volume, nets a mere $100 million or so in annual income.

In short, a B2B company whose business model lends itself only to simple transaction fee structures probably needs a new business model. Some B2B companies have gone beyond transaction fees by introducing a broader definition of usage. One marketplace has identified 30 activities, or "communications" (including postings, invoicing, and order tracking), that its customers employ. It plans to introduce nontransactional usage fees based on the volume of their monthly communications.

Other B2B companies charge simple posting or listing fees—that is, fees for entering and updating inventory data or for hosting on-line inventories and catalogs. It is easiest to charge for these services in fragmented industries and in industries that have very large numbers of stock-keeping units. Such industries include electronic components, medical supplies, and chemicals. B2B companies in these sectors are setting up and running virtual storefronts (which involve keeping price lists and inventory holdings current) and charging clients for this service. PlasticsNet, for example, charges suppliers $5,000 to $8,000 for storefront hosting, and BuildPoint charges suppliers a $10 listing fee in addition to transaction fees of 2 to 5 percent.

Subscription fees

Instead of collecting fees by serving as a venue for simple transactions, B2B companies want to receive membership or subscription fees, which avoid the difficulty of calculating myriad transaction fees for a given complex solution.

Instead of collecting transaction fees, B2B companies want membership or subscription fees

ApparelBuy.com, for instance, charges fashion buyers an annual subscription fee for access to its exchange site. Similarly, TradeOut charges a $30,000 installation fee coupled with subscription fees to sellers of excess inventory. An aggregator in the hospitality industry bases its subscription fee on the number of hotels that its customers run and the number of users for each. Another aggregator has tied its subscription rate to three metrics: the size of the customer's employee base, the number of employees who use the system, and the number of purchase orders placed. Customers initially pay one of several preset subscription fees based on estimated usage; if actual usage in a given three-month period differs enough from the initial estimate, the customer moves into a different price band.

The greater the volume of transactions at a marketplace—and thus the greater its attractiveness to buyers and sellers—the more likely buyers and sellers will be to embrace such payment provisions.

Other ideas

Some B2B companies, instead of operating marketplaces themselves, are licensing software-intensive solutions to third parties that typically pay an up-front, lump-sum charge or licensing fee. FreeMarkets, to give one example, licenses its BuySite customized software platforms, which handle the procurement of near-commodity items, for $650,000 and then charges separately for its ongoing professional services.

Moreover, as gathering places for sharply defined cohorts of participants in particular industries, e-marketplaces should attract advertising and sponsorships. This hasn't happened yet, perhaps because of a lack of strong content and of the technology needed to identify the natural audience of a product or service. One marketplace, Neoforma.com, names health facilities as best in class and then sells sponsorships to the manufacturers of the equipment they use.

We have also seen two less common charging mechanisms. Rather than merely playing host, a number of B2B marketplaces in highly fragmented industries are taking actual ownership of goods. Onvia.com, for instance, buys large quantities of business and office products and resells them at a markup to its 50,000 small-business customers. PartMiner combs its vast inventory for hard-to-find electronic components and claims for itself any margin between its purchase price and what the buyer is willing to pay.

Some other aggregators have proposed keeping for themselves a piece of the savings that buyers derive from improved supply chain efficiencies or from prices lower than some agreed-upon benchmark. No B2B exchanges have yet introduced gain sharing as a standard pricing model, but an exchange would be most likely to broach the idea with a business that dominated a particular industry and had taken an equity stake in the exchange involved.

Two examples

While all of these pricing structures except gain sharing are now in use, few B2B companies have implemented multitiered structures that tie pricing to value. The exhibit shows a very general framework that can help marketplaces by connecting pricing mechanisms to the different types of companies for which they are likely to be most acceptable. Here we consider the experience of two companies implementing the tiered, flexible pricing structures that promise to generate sustainable revenue streams.

Retail.com

In 1995, Retek, which had marketed proprietary enterprise resource-planning solutions to the retail industry for a decade, launched Retail.com, an on-line community and application provider that is also an e-marketplace for private-label clothing and for surplus inventory.

Since the private-label clothing business is highly cost competitive and fragmented, it was a natural arena for an e-marketplace. Neither buyers nor suppliers have much control over prices, so both are beholden to the Private Label Exchange and are thus equally willing to tender fees, which taper off as the number of participants and transactions rises. Buyers like the efficient way the exchange posts their RFQs, to which both new and familiar suppliers may respond. Although suppliers may be reluctant to risk standing relationships by engaging existing customers in auctions, in which long-term relationships and customer-supplier loyalty would suffer, they are certainly willing to pursue new business in real-time public auctions. Since this sort of balance between seller and bidder doesn't occur on the Surplus Exchange, which disposes of excess inventory of which buyers had previously been unaware, Retail.com simply charges the seller a fee for the posting.

Retail.com also offers World Wide Web–based solutions to help members reduce their total system costs, increase the speed and efficiency of their design and sourcing operations, and access broader pools of design talent.² For these applications, Retail.com charges an annual subscription fee for each "seat," or point of access to the system, as well as additional fees based on each user's level of activity. The company charges apparel buyers $1,000 annually for a seat and then imposes a high minimum annual fee. In the case of Retail.com's WebTracks application, an on-line order-tracking system, the annual charge is as high as $25,000 because any access at all to industry designs, trends, and pricing has great value. Suppliers are charged in a similar way, but their rates are roughly half those of buyers, reflecting Retail.com's belief that buyers benefit more from these services.

Finally, Retek offers "behind-the-firewall" applications that span corporate planning, apparel design, ordering, production, logistics, and industry intelligence. Working with the legacy software of customers, Retek aims to cut their costs by automating internal processes and improving speed and accuracy. Retek imposes a mix of up-front licensing fees and ongoing consulting and maintenance fees that vary according to the size of the task and the degree of customization required; the exact price reflects Retek's estimate of an application's value to the customer.

This combination of transaction, subscription, licensing, and professional-service fees has catapulted revenues from $4 million in 1995 to an expected $80 million in 2000 and $170 million in 2001, when transaction fees and open-platform subscriptions will reach $20 million.

Healthmarkets

In addition to reengineering sales and fulfillment practices, Healthmarkets (not its real name) provides a marketplace for a complex, highly fragmented segment of the consumer health products industry. Major manufacturers and suppliers that engage Healthmarkets to undertake a complicated software installation are charged up-front licensing and installation fees based on their size as well as an annual subscription fee.

Suppliers pay a nominal transaction fee, plus usage fees based on a percent of sales that goes up as revenues increase. The transaction fee, which is less than $5, represents the cost savings that users (according to Healthmarkets) reap for each listing. The usage fee, ranging from nothing to 5 percent of a transaction's value, is tied to incremental sales only. One of Healthmarkets' smaller suppliers, for instance, escapes a usage fee on the first $1 million of sales it makes through the system, because Health-markets believes that it would do that much business with its existing customers anyway. Above $1 million, the percentage of sales earmarked for the usage fee grows, on the theory that larger sales represent either a major increment or a wholesale shift to this new platform, allowing suppliers to reengineer their operations—or both. Healthmarkets thinks it can adopt this system because the suppliers are small and have little market share.

For buyers—mostly small storefronts placing many modest orders daily— the Healthmarkets offering dramatically reduces the substantial costs that are associated with ordering, invoicing, tracking, and payments. Buyers pay a subscription fee based on whatever elements of the Healthmarkets service they use, plus a flat-rate transaction fee. The precise size of the subscription fee reflects the value of direct access to manufacturers, an increased selection among suppliers, and a clearer picture of industry products, pricing, and trends. The flat transaction fee reflects the time and money the Health- markets system saves.

There is no single right way for an e-marketplace to charge for its services, but there are many wrong ways. A full consideration of the possibilities should help companies avoid making expensive errors.