BOOTSTRAPPING

Trading Places: Inside the Barter Economy

Once a dusty corner of the economy, barter is emerging as a hot entrepreneurial niche and a valuable tool for cash-crunched companies.
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Not so long ago the idea of abolishing the dollar enjoyed a certain vogue. Long the preserve of populist agitators, antidollar sentiment veered sharply rightward in the 1980s as adherents of the "competing currencies" school called, "Death to the Federal Reserve!" Private currencies, they argued, would be more solid than government-backed money because issuers' profits would be tied to maintaining their worth.

Fast-forward a dozen years. The national motto is "In Alan Greenspan We Trust," and the U.S. dollar economy is the envy of the world. Yet interest in private currencies is stronger than ever, not, this time, at inside-the-Beltway think tanks but among upstart barter exchanges sprouting from that most propagative of roots: business-to-business e-commerce. At the same time, small companies are turning to barter when they want to conserve cash or jump-start sales. More than 440,000 businesses in North America traded through an exchange in 1998, the latest year for which figures are available, according to the International Reciprocal Trade Association.

A barter exchange -- for those who haven't used one -- combines the functions of classified advertising and a bank. Customers sign up to sell anything from drywall to dentistry, the exchange compiles the listings in a directory, and buyers contact sellers directly or through a broker employed by the exchange. All sales are executed in trade dollars, which customers accumulate by selling their own goods and services or by borrowing from the exchange. An accountant, for example, might earn 500 trade dollars for doing a Web designer's taxes and use the credit to purchase a copier. The exchange collects a commission -- typically 5% -- in "real" money from both parties. Traditionally, exchanges have also charged membership fees of $100 to $700 up front and $10 to $50 a month.

Calling such a system "barter" is technically incorrect, industry veterans agree. "We're not trading," says Chris Haddawy, cofounder of Barter Business Network, which was acquired in 1999 by BarterTrust.com, a San Francisco-based start-up. "This is no more barter than if you barter $5 for a sandwich, and the deli barters that $5 to get its windows cleaned," he says. True barter involves a direct swap, be it as prosaic as baby-sitting for grocery shopping or as fanciful as performances of Noel Coward plays, at the depression-era Barter Theatre, in return for pickles and ham. The opportunity for true barter is limited because each transaction requires what economists call the "double coincidence of wants": unless the buyer has what the seller wants and the seller has what the buyer wants, there can be no trade. By creating trade credit, barter exchanges circumvent the unlikelihood of the double coincidence and enable a much wider range of deals.

Money, of course, does exactly the same thing.

But barter has some advantages over money. Doug Jones, president of Color Inc., a 20-employee graphics-production and printing company in Tempe, Ariz., joined a local barter exchange at the beginning of the year. When business is slow, he reports, "I can call Laurie at the Barter Group and say, 'Open the gate.' They'll put me on their site as an available printer, and they also call potential customers. They hustle the other members to send me jobs."

Others see barter as a low-cost way to acquire goods and services. Businesses with excess capacity can often provide an additional unit of their product at little or no cost. For a dentist the marginal cost of a cleaning may be pennies for toothpaste, leaving the gross margin close to 99%. By earning barter dollars and using them to cover some expenses, the dentist can buy at a comparable discount and conserve cash. "Cash is a four-letter word; don't use it," says Alan Zimmelman, executive director of the National Association of Trade Exchanges (NATE). And although even proponents concede that bartering takes extra time and effort, "it beats paying money," says Bob Weisberg, general manager of Affordable Office Furniture, in Cleveland.

Melissa Laughlin, the owner of Buckeye Web, in Gilmer, Tex., agrees. "I would love to do everything through barter," she says. During the past year Laughlin has acquired a $2,600 laptop and $400 worth of office supplies through an online exchange. Sales of her Web-design and desktop-publishing services covered half the cost, and an interest-free credit line paid for the rest. Most exchanges extend credit to customers, with fees among the new online players running from 0% to the prime rate. At those rates, barter compares favorably with many of the financing options available to growing businesses -- very favorably in the case of credit-card debt. "This turns human capital into bootstrap capital," says Timothy Fong, founder of LassoBucks.com, a Los Angeles exchange. "It's a creative way of doing finance."

Unfortunately, not everything can be acquired readily on trade. Services -- especially media, travel, restaurant dining, accounting, and printing -- account for 60% to 65% of the offerings in the typical exchange. Raw materials and manufactured goods -- products with lower gross margins -- are less common. Consequently, barter is most effective for companies that have some flexibility in their purchase decisions, explains Susan Groenwald, who sold her 3,000-member exchange to BarterTrust in 1999. "You're talking printing, office supplies, car repair, janitorial," she says, categories that typically add up to 5% to 7% of a company's expenses. Few exchanges offer opportunities to cover overhead expenses, such as cost of goods, payroll, and rent.

As a result, many companies whose goods or services are in demand on barter exchanges complain of difficulty using the trade dollars they earn. "I can quickly build up a bank account of 10,000 barter dollars, but I can use very little of that for my business," says Jones. "I can't use it to pay the light bill, I can't pay payroll, I can't buy paper, I can't buy ink." Instead, Jones spends on extras, such as yard maintenance for his home and takeout lunches for his crew. Dan Swing, president and CEO of the Computer Guyz Inc., a two-person information-systems consultancy in Greenville, S.C., has bought boxed cigars for clients, Marriott Hotel certificates, and a weekend bed-and-breakfast getaway. "I probably wouldn't have purchased most of it if I had had to pay real money," he admits. NATE's Zimmelman agrees. "Many people see trade dollars as Monopoly money," he says.

That's not the case at Foster & Co., a Seattle certified public accounting firm that has been bartering for six or seven years. Foster & Co. uses trade dollars to help pay for an end-of-tax-season casino party and an annual charity event. "We would certainly spend cash on those things if we had to," says Parrish Jones, who manages the tax and consulting group at the nine-person company, "but we would probably be a little more selective as to how we spent our dollars." Some vendors are less responsive when they're being paid in trade credit, Jones explains. And barter prices can be inflated. Most exchanges require customers to set the same prices they offer customers paying cash, but enforcement is spotty. When Foster & Co. used trade dollars to order pizza for a staff meeting, the company paid two and a half times the cash price.

Barter has its pitfalls, agrees Randy Truckenbrodt, president of Randall Industries, a $4.5-million lift-equipment company in Elmhurst, Ill. However, 18 years of bartering have made him philosophical about doing business through an exchange. "It's not any more legitimate than the cash market," says Truckenbrodt. "But it's not any more corrupt."


If members think items are overpriced, they'll blame BarterTrust's economy, says CEO Mike Edelhart.


Although exchange customers display some ambivalence about barter, the latest generation of Web-enabled exchange operators is predictably bullish. Traditionally, most exchanges started on a shoestring, serving their local communities; and indeed, most members are still small, service-oriented businesses operating within 20 miles of their home base, says Bob Meyer, editor and publisher of BarterNews. But companies like 18-month-old BarterTrust hope to do for barter what eBay did for the garage sale: erase the boundaries of size and geography. "If a plane doesn't have speed, it doesn't have lift," says president and CEO Mike Edelhart. Similarly, without scale, barter won't take off.

Money and technology are fueling the rise of BarterTrust and competitors such as Bigvine.com, LassoBucks, BarterNet, and Ubarter.com. Edelhart has won funding from such big-name corporate investors as General Motors Investment Management Corp. and GE Equity. Bigvine is backed by Silicon Valley kingpins Sandy Robertson and Kleiner Perkins Caulfield & Byers, as well as American Express. LassoBucks was launched with the help of Zone Ventures, the southern California affiliate of Draper Fisher Jurvetson. BarterNet's supporters include Wand Partners, and Ubarter became a subsidiary of publicly traded Network Commerce Inc. earlier this year. Altogether, at least $105 million has flowed into the industry since 1998.

Although everyone agrees that money is transforming barter, the Internet's role remains a matter of dispute. Bippy Siegal, CEO of Bigvine, which is located in Redwood Shores, Calif., is betting that the Internet pure-play model will prevail. By offering real-time online trading without a broker, 24 hours a day, Bigvine can excise time, paper, people, and cost from the process, Siegal says.

Edelhart started with a similar plan but soon became a clicks-and-mortar convert, snapping up three exchanges in the United States, three in Canada, and one in Mexico in the past year. Customers can search listings on a Web site but must contact one of BarterTrust's 50 brokers, scattered across 17 offices, to execute a trade. That's because consummating transactions is more art than science, Edelhart explains. Brokers play an important role in educating customers about barter and helping them trade.

Ultimately, however, an exchange is more than just a trading floor writ large: it's a parallel economy with a private currency, and it lives or dies by its ability to convince customers that that currency is sound. If trade dollars lose their value, customers stop trading, and the economy grinds to a halt. However, determining the currency's value is never simple. Although a trade dollar is the same as a U.S. dollar in the eyes of the IRS, in practice its value ranges widely across the industry, running anywhere from zero (if an exchange folds) to 10¢ on the dollar to the full 100¢. BarterTrust hopes to maintain true parity between its trade dollars and the dollars issued by the Federal Reserve Bank. If prices at BarterTrust equal those in the cash economy across a large basket of goods, BarterTrust's trade dollars can be considered equal in value to U.S. dollars, Edelhart explains.

In order to reach parity, BarterTrust must ensure that its basket is as broad, deep, and balanced as a subset of the larger economy can be. Consequently, its sales force targets new customers in categories in which brokers see excess demand. More laser printers? Absolutely. More massage therapists? No thanks, not today. Meanwhile, a system of spot checks keeps prices in line. "Say there's a computer listed on the exchange for $2,800," says Edelhart. "The compliance officer will call dealers and find out what that particular unit is selling for in the cash market. If there's a problem, we'll get in touch with the company."

Such interventionism has fallen out of favor across most of the world. But Edelhart believes that the BarterTrust economy needs extra care and handling in order to get off to a strong start. With a trade volume of $120 million in 1999, the exchange not only is a tiny fraction of most national economies but also is an unnatural and unfamiliar microcosm. Edelhart points out that a customer who walks into a store and finds that milk is overpriced is more likely to blame the store owner than the currency or the economy. BarterTrust's economy is less likely to get the benefit of the doubt.

Monitoring prices helps minimize the perception of inflation. But if BarterTrust's efforts stop there, suppressed inflation may show up in other forms, such as unsatisfied demand, cautions Janet Yellen, a company adviser and former member of the Board of Governors of the Federal Reserve. Ultimately, the solution to inflation lies not in price controls but in control of the money supply. Giving money away, through sign-up bonuses and other deals, is the easiest way to put liquidity into the system -- and a temptation to which many exchanges have succumbed. However, soon too many dollars are chasing too few goods, debauching the currency, as John Maynard Keynes once wrote, and eventually the exchange.

Aside from self-control, credit is Edelhart's primary monetary policy tool. Nearly 40% of his customers have credit lines in BarterTrust currency with interest set at the prime rate. By raising and lowering the rate it charges, BarterTrust can influence borrowing and spending, much like the Fed. In the past most exchanges based such decisions on rules of thumb, but Edelhart plans to consult with a high-powered advisory board, a kind of quasi Fed, that includes two past chairs of the Council of Economic Advisers.

Edelhart expects his investment in customer confidence to pay off in several ways. A strong economic track record, he believes, will draw large corporations away from corporate barter and into his exchange. Unlike retail exchanges like BarterTrust, which primarily serve the small-business market, corporate barter companies typically take title to customers' excess inventory as well as broker large-scale company-to-company deals. But barriers between corporate and retail barter are starting to fall as corporate barter companies like Icon International open online exchanges and as giants like Maytag Corp. sign up with BarterTrust.

Then there's the international opportunity. "While it is utterly natural for an American to wake up in the morning and see the government-backed money as a wonderful thing, that's not the case in many parts of the world," Edelhart observes.

Ultimately, Edelhart believes, trade dollars will become as natural a form of business-to-business settlement as letters of credit, credit cards, or cash. And one day soon, he hopes to hear people ask, "Are you going to settle this in cash or by wire transfer, in U.S. dollars or in BarterTrust dollars?"

Mary Kwak is a freelance writer based in Cambridge, Mass.


The Vast Swap of History

Barter is often called the world's oldest profession -- or the second-oldest, with a nudge and a wink. The barter-exchange industry, however, has been with us just 40 years. Bob Meyer, publisher and editor of BarterNews, traces its origins to "Mac" McConnell, president of a Los Angeles savings and loan. McConnell devised the system of debits and credits that allows exchange members to "trade." Business Exchange, the company he founded in 1960, floundered for nearly a decade. But in the 1970s, as proliferating computer power simplified matchmaking and record keeping, barter began to grow. By 1980, 280 exchanges across North America were handling an estimated $200 million in transactions.

Alan Zimmelman, executive director of the National Association of Trade Exchanges, describes the industry's youth as a free-for-all. "There were shysters, con men, everybody who would find this business attractive because you print your own money," he recalls. And fly-by-night exchange operators weren't the only ones with a casual approach to the law. Tax evasion was an important motive for at least a significant minority of customers. Some businesses failed to report trade dollars as income; others misstated the value of trades.

The turning point was the passage of the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, which required exchanges to report all transactions to the IRS. Some exchanges lost large numbers of members in the wake of TEFRA. But the industry as a whole won the legitimacy it needed to grow. By 1998, North American retail barter, the type used by most small companies, had become a $1.6-billion business.


A Fistful of Hours

Start-up barter exchanges hope to make the world their oyster. Organizations that issue local currencies target the community as a pearl of greater price. During the past 20 years many nonprofits have created local currencies -- a spin on barter -- to help support small businesses in their communities. Those currencies promote economic diversity and direct local resources to local pockets rather than to global companies' vaults.

Most local currencies in the United States are modeled after Ithaca Hours Inc., a program launched in upstate New York during the 1991 recession. Ithaca Hours issues notes in several denominations, with one Hour equal to $10. A governing board meets monthly to assess the state of the system and make policy decisions. At the beginning of this year there were $40,000 to $50,000 worth of Ithaca Hours in circulation, and more than 1,000 individuals and businesses regularly accepted payment in Hours, either alone or in combination with cash.

Similar organizations -- some short-lived -- have sprouted up in 60 cities across North America and Europe, sponsoring currencies such as SEED (Mendocino, Calif.) and BREAD (Berkeley, Calif.). Outside the United States, LETS (Local Exchange Trading System) predominates. Unlike Ithaca Hours, LETS has no paper currency and no central-bank equivalent. Any member can create credit simply by agreeing to a sale, and all transactions are reported to a registry, which debits and credits members' accounts.

The LETS model is especially popular in the United Kingdom, where 450 groups claim more than 40,000 members. Currencies' names are colorfully localized: members in Canterbury reckon in tales; in Carmarthen, they tot up merlins; and in Edinburgh, reekies are the virtual coin of the realm.


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Last updated: Oct 1, 2000




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