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The Overblown B2B Hype

James SurowieckiPosted Monday, Dec. 13, 1999, at 7:10 PM ET

Even by the standards of this hyperactive stock market, Friday's initial public offering for FreeMarkets was staggering. The company had originally planned to go public at a price of $16 to $18 a share, but by the time it came to market, the offering price had tripled to $48 a share. That was still too low (though still impressive). The first trade was at $248 a share, and unlike the way most IPOs trade, FreeMarkets' shares kept rising during the day, closing at $280 a share. (The shares were down $11 today. I'll take a guess and say that was profit-taking.)

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FreeMarkets' performance came as no surprise to anyone. (When investment banks triple the offering price on a stock, it's a good sign that the IPO isn't going to crash and burn.) That's not so much because of the company itself, which essentially runs online business-to-business auctions for corporations like General Motors. Rather, it's because investor appetite for Internet business-to-business (B2B) stocks has suddenly become voracious. B2B is, we're being told, the true wave of the future on the Web, and so companies ranging from professional services firms to infrastructure providers to database managers are now the darlings of the Street. Most--in fact, nearly all--of these companies remain unknown to just about everyone in America. But over the past few months you could have made a huge amount of money in stocks like Akamai, Ariba, Sapient, and Viant.

There are, as usual, a host of studies by various research groups to justify the swing in sentiment toward B2B stocks. There have to be, because many of these companies are currently so tiny that estimating their present value on the basis of their internal numbers alone would be futile. (FreeMarkets, for instance, did $7.8 million in revenue last year but now has a market capitalization of $9.1 billion.) In any case, these studies all show that the B2B market for goods and services on the Web will soon dwarf the B2C (business-to-consumer) market. One recent estimate, cited by FreeMarkets in its prospectus, has the B2B market growing from $109 billion this year to $1.3 trillion in 2003. If you can get even a tiny slice of $1.3 trillion, then you're in great shape.

The idea, then, is that within five years, B2C e-commerce--that is, what all the investors piling into Amazon.com and eToys are hoping to capitalize on--will be only a small part of the overall e-commerce market, perhaps as small as 10 percent. This doesn't necessarily mean that e-tailers like Amazon are doomed (as stocks, that is). But it does suggest that you'd be better off looking at B2B stocks for the next true Internet titan.

But there is one problem with this whole theory, which is that the companies that are going to be doing all of the B2B buying on the Web have to make the money with which they pay for all their purchases somewhere. And it can't just be from selling to other businesses. In other words, at the end of the B2B daisy chain there have to be consumers. On CNBC last week, one analyst hyped B2B by saying (I paraphrase): "Think of all the parts that GM has to buy every day just to keep its business going, and multiply that by all the giant companies out there that have to buy parts." But let's remember this: GM spends less on parts in a year than consumers spend on GM cars. That's by definition. Otherwise, GM would go out of business. In fact, if you add up all the money GM and its suppliers spend on parts and databases and infrastructure, it's less than consumers spend on GM cars, again by definition.

In other words, the hype surrounding B2B has depended on the idea that businesses that sell to other businesses are going to migrate to the Web while businesses that sell to consumers are going to stay offline. But while B2B businesses will probably migrate more quickly, and while obviously there's a lot of business that will always be offline (unless we figure out a way to get a virtual haircut), it's illogical that B2B on the Web will explode while B2C will remain stagnant. Especially when the former ultimately depends on the latter. The real message of the whole B2B craze, in fact, may be that we should take another look at companies like General Motors. How much longer can it be before cars are actually being sold online (instead of through the archaic dealer structure)? And when that happens, imagine how much better GM's business will be.

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James Surowiecki writes the financial column at The New Yorker.

COMMENTS

The readers respond:

Two words: multiplier effect. While the total value of parts going into a GM car must be less than it is sold for, the total value of transactions by suppliers won't necessarily be. Some parts will change hands multiple times before being purchased by GM and sold to the final consumer. In macroeconomics this is known as the multiplier effect (because money keeps changing hands, so annual transactions are a multiple [>1] of the amount of cash in the economy). For B2B, it means that if GM succeeds in getting all its suppliers to make all their transactions on line, the value could easily be more than GM's final sales.

--cw

(To reply, click here.)

Mr. Surowiecki predicates his argument of the success of B2B on people actually buying stuff, certainly a valid point, with consumers having to be somewhere. But Mr. Surowiecki misses one crucial point: B2B can exist without B2C, since consumers can purchase goods in the offline world. The crucial selling point of B2B is that it makes business procurement more efficient and cost-effective.

Furthermore, businesses as entities are far more equipped to handle purchasing goods online than consumers are, having already made the necessary IT investment and for the most part already being online. With consumers, this is less likely to be the case.

If you take at most large industries (and automobiles, to use his example are no exception), businesses purchase a lot of goods, on parity with consumers in some industries (like automobiles), but also in far greater quantities in others (energy, telecommunications, office supply goods, construction goods, etc.). Furthermore, the economies of scale you get by focusing on B2B are enormous: to take the example of the automobile, while a consumer may make a single purchase, amounting to $20K in net revenue, when the City of New York (or Philadelphia, or LA, etc.) makes a purchase for a fleet of cars, its a one time sale amounting to $20K * large number of cars = very large number. As you can see, the effort in making the business sale is probably more cost effective than the effort in making the consumer sale.

Additionally, B2B focuses in on the concentration of suppliers selling to diffuse numbers of individuals goods which might not necessarily be sold in small quantities efficiently over the Web. Take, for instance, the oil industry: marketplaces for petrochemicals can be established on-line between businesses but it would be illogical for a Web company to try and sell gasoline to a single consumer pumping gas.

--Eugene Huang

(To reply, click here.)

(12/14)

Another factor that will make B2B bigger than B2C is that businesses aren't "shoppers" like consumers are. Generally, businesses order products/supplies on a specification basis, they know exactly what they want and don't require the tactile shopping experience to refine their needs. Once a given specification is decided, business tends to streamline their operation around that spec and simply re-order it when they run out.

--Paul Bullock

(To reply, click here.)

(12/22)

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