Internet Commerce

Small suppliers are willing to battle for business from the Fortune 500. But Glen Meakem is letting only the fittest gladiators into the arena

If the march toward selling over the Internet were a parade, then Glen Meakem would be the cloud preparing to rain on it.

It's not that Meakem doubts suppliers can reap great gains from the Web. His company, FreeMarkets OnLine, helps them do just that, although it's not the business's primary reason for being. But the 34-year-old CEO fears that some company owners may be mistaking the hot seat for the catbird seat. To them he offers three expectation-lowering truths. One: The Internet gives far more power to buyers than to sellers. Two: The Internet increases the risk that incumbent suppliers will lose business. Three: The Internet may force everyone to lower prices.

FreeMarkets OnLine is an electronic marketplace, and consistent with Meakem's beliefs, its customers are the corporate-procurement organizations that hold down the heavy end of the commerce seesaw. His selling proposition: FreeMarkets will raise the quality of the products and services you buy while lowering the price you pay for them by 15% to 20%. Sixteen Fortune 500 companies, including Siemens, Caterpillar, and United Technologies, have taken him up on it so far. Last year those customers bought $100 million worth of industrial components through FreeMarkets; this year Meakem expects them to buy $500 million.

At a glance, FreeMarkets resembles a combination of an Internet auction house, like the relatively successful Onsale, and an industrial mall, like the doornail-dead Nets Inc. (The company is even located in Pittsburgh, Nets' home until Jim Manzi spirited it off to cerebral Cambridge, Mass.) But Meakem's business model is more interesting than either of those companies'. Yes, FreeMarkets brings together buyers and sellers. But instead of letting keywords do the matchmaking ("Go forth, little search engine, and find every company listing that contains the words circuit board"), Meakem and his staff of 100 do it themselves. Personally. Off-line.

Meakem's argument is that corporate customers--who, don't forget, have all the power--rarely know enough about vendors to make the best buying decisions. So FreeMarkets works with its customers' procurement organizations in person, over the phone, and over the Internet to create exhaustively specific requests for quotes on things like plastic-injected moldings and custom capacitors. Free-Markets next identifies potential suppliers by asking for recommendations from the customers themselves and by conducting custom research--in catalogs, in its proprietary database, and on the Web. Once a stable of candidates has been assembled, the company contacts each one and describes what's wanted. Interested suppliers fill out 15-page questionnaires with information about their products' quality ratings, machine capabilities, and cycle times. Vendors that appear to meet the buyer's requirements are then subjected to FreeMarkets' vetting process, including reference checks and, occasionally, site visits. Finally, after FreeMarkets has culled the field down to a manageable number (usually somewhere between 3 and 50), it hosts a real-time auction on the Internet, in which the finalists battle for the business.

FreeMarkets collects both service fees from buyers and a 1% to 2.5% sales commission from winning suppliers. That's low compared with what most electronic marketplaces charge, but each deal done through FreeMarkets is worth millions of dollars. In 1997 the company had revenues of $1.8 million; this year it is on target to do $8 million.

Meakem became knowledgeable about electronic markets during a brief stint with General Electric, where he labored on a forebear of that organization's high-profile Trading Process Network, a Web-based sourcing system that was originally limited to GE suppliers. He developed his belief in the power of procurement at the consulting firm McKinsey & Co., his first stop after getting an M.B.A. from Harvard. (He graduated a year late, having skipped out on finals to lead a combat engineering platoon in the Persian Gulf War.) It was at McKinsey that Meakem met his cofounder, Sam Kinney. The two launched FreeMarkets Online in 1995 with $500,000 from their own savings and from family and friends. Angel investors put up the second half-million, and last year the company raised several million more through Saturn Asset Management, in Boston.

Editor Leigh Buchanan recently spoke with Meakem about his unconventional approach to Internet commerce.

Inc. : You can learn a lot about a subject by examining the clichÉs that surround it. And if you look at the clichÉs that have sprung up around Internet commerce--leveling the playing field, David beating Goliath--they all suggest how wonderful it is for small suppliers, that they can win big, new global business they never had a shot at before. What's wrong with that picture?

Meakem: A lot of players in this area--like Nets Inc. before it went out of business--have focused on "How do we help you, Mr. Supplier, get your message across to these large buyers?" But in a world where everybody is now linked together, it's the buyers who gain power. Suppliers lose power.

Electronic networks do two things. First, they allow people who purchase things to get better information and make better decisions. A great example on the consumer side is the automotive arena, where you have all these on-line services giving individuals details about cars. As a result you can go to the dealer fully armed and do much, much better in the negotiation. Companies like mine are doing the same thing, only instead of cars it's plastic-injection molded parts and machined tools. The second thing electronic networks do is allow a buyer to put suppliers into direct competition with one another in on-line auctions. If I'm a buyer, it's a choice between doing manual negotiations with five different suppliers to see whom I'm going to buy from, or qualifying those guys to make sure they're all equivalently good and then making them fight out the price over the course of a couple of hours.

Inc. : What's the choice for suppliers?

Meakem: The choice is between being a high-quality, low-cost producer, in which case the market will reward you, or operating inefficiently, in which case you'll lose. In a world where information is more available and people aren't getting business based on sales schmooze, the best, most efficient companies are going to be in tall cotton. The companies that aren't very efficient had better get into their factories and improve because they are not going to be able to hide behind relationships any longer.

Inc. : It sounds as though FreeMarkets--and the information-saturated electronic marketplace in general--is mostly a threat to incumbent suppliers.

Meakem: It is if you're an incumbent supplier that's living the life of Riley, making big margins without your customers' knowing it. Once they have access to all the available information, you may retain the business, but you're going to take a haircut on pricing. What I tell my buying clients is that if incumbent suppliers squeak, it probably means they're scared, and that probably means they're not very good.

On the other hand, if an incumbent supplier is very good, it has a chance to consolidate business. The buyer uses this very analytical, market-based approach and finds out, "Gee, they really are very good compared with the competition. Instead of giving them just $1 million worth of business, let's consolidate $10 million worth of business with them." We've seen many examples where that's happened--and others where the incumbents have lost the business.

Inc. : What's the benefit to suppliers seeking new business?

Meakem: The benefit to new suppliers obviously is that they have access to new business they wouldn't have had access to before, and their cost of sales is something like 5% to 15% lower. That doesn't change, even when you recognize that the process is driven by buyers.

Inc. : You worked briefly on a precursor of GE's Trading Process Network, which also used a "reverse-auction" scenario, in which sellers do the bidding. What's the difference between FreeMarkets and TPN?

Meakem: I learned two things at McKinsey that I brought with me to GE. First, companies save money by putting a real focus on purchasing decisions. Second, companies make money by having superior information. I drew on both those ideas when we were creating the GE Electronic Marketplace, which later became TPN. We did a series of bids with GE suppliers in late 1994, and I realized, "Hey, the technology is great. You can manage and transmit large amounts of data. You can have real-time interactivity across a network so people can bid back and forth. You can really create a market." The problem was that without the right group of people in that market--without the suppliers capable of delivering--the market fails. And if the buyer hasn't done a good enough job defining the specifications he's bidding out, the market fails. So it seemed to me that the thing you had to do to create a successful on-line market in industrial areas is to provide both the technology and the market-making capabilities.

I wanted to do that within GE, but GE had a technology-only vision. Also, GE is so huge that it's a good place to take what's already successful and grow it, but it's difficult to create real start-ups that are doing completely new things. My idea was a completely different animal.

Inc. : You've said that the electronic-commerce community's focus on the transaction process, rather than on the decision-making process, is misplaced, but isn't automating the transaction piece a proven way to save money?

Meakem: Yes, but you can save more by focusing on decision making. The questions most companies ask when they think about electronic commerce are, How do I get my payments back and forth faster electronically? Can we reduce the cost of processing a purchase order by doing it through electronic data interchange? There's a lot of benefit in that. But if I'm buying $5 million worth of machine parts from a given supplier and I discover by doing a lot of good sourcing work that I'm dealing with a guy who's not the most efficient producer of those parts, then I can switch and work with the people that are the most efficient. And by doing that I save 25% a year. Suddenly, I've put $1.25 million on the bottom line. If I'd focused only on transactions, then I would have put a few hundred dollars on the bottom line.

Inc. : Many people say that Nets Inc. stumbled, in part, because its offerings were too broad. Are there things corporate clients buy that you wouldn't sell?

Meakem: Well, first of all, there were a number of reasons Nets failed. One was that it was too broad. Another was that it tried to be a "supplier-push" on-line marketplace in an industry that is "buyer-pull." As far as MRO [maintenance, repair, and operations] goes, there are a number of companies, ranging from a start-up called Ariba Technologies to IBM, that offer excellent buyer-driven on-line catalogs. MRO supplies is not one of our targets.

We are moving aggressively into vertical commodity markets. Of course, the Holy Grail of the on-line market industry is to be the Web site where all the buyers and sellers in a particular industry come to do business. To me, the victory is when you own 70% of the decisions in a given market. With the possible exception of the SABRE system for airline reservations, no one anywhere on the globe has accomplished that yet.

The good news is that the opportunity is as big as the economy itself. For every industry there's an opportunity to create one of those businesses. The game right now is to identify those markets and then go out there and claim them.

Published on: Sep 15, 1998