Going, Going, Gone! The B2B Tool That Really Is Changing The World WEB AUCTIONS ARE REVOLUTIONIZING THE $5 TRILLION MARKET FOR INDUSTRIAL PARTS. IN THE PROCESS THEY'RE WIRING THE RUST BELT FOR GOOD.
(FORTUNE Magazine) – In late 1994 a preppy, apple-cheeked MBA named Glen Meakem presented his proposal for a bold new business to his bosses at General Electric's headquarters in Fairfield, Conn. With a visionary's passion, Meakem told his audience, which included Gary Reiner, now GE's chief information officer and a favorite of CEO Jack Welch, that his venture would cost up to $10 million--but it might just change the world. His project would do no less than reinvent one of the murkiest, most backward, least sexy processes in industry: the purchase of the parts and materials that go into everything from granola to cars.
The idea was as simple as it was radical. Meakem proposed to make suppliers compete for manufacturers' orders in live, open, electronic auctions. No more golf-course schmoozing, no more haggling, no more sealed bids. The market for semifinished goods from circuitboards to packaging materials would become as efficient as the market for stocks, and prices would drop to levels purchasing managers previously could only dream of. Besides generating billions in savings for GE's manufacturing divisions, the startup would blossom into a bustling bazaar for all of corporate America, reaping billions more in fees for his company. Warming to his topic, Meakem proclaimed, "This idea will transform the global economy!"
The GE brass didn't buy it. Reiner thought the idea had promise, but balked at launching a costly, high-risk startup inside GE. He preferred to have Meakem remain under the thumb of GE Information Services, tinkering with a primitive auction system already under way. That night, driving home on the leafy Merritt Parkway in his red Honda Prelude, Meakem realized what he had to do. Two months later, the 30-year-old Meakem quit his $135,000-a-year job, bought a printer at Staples, and made his basement his dream factory.
GE makes few bad calls, but underestimating Meakem was one of them. Five years after Meakem made his presentation, FreeMarkets Inc., the Internet auction company he built for $50 million on the banks of Pittsburgh's rusty Monongahela River, boasts a market cap of $7 billion. Meakem himself is now one of America's new Internet megamillionaires (net worth: $750 million).
More important, though, Meakem's breakthrough is beginning to have a seismic impact on industry in the 21st century. Call it the rise of the Auction Economy. General Motors, United Technologies, Raytheon, Quaker Oats--big, shrewd buyers that thought they were already getting rock-bottom prices--have saved more than 15%, on average, buying parts, materials, and even services at FreeMarkets auctions. Within a few years Emerson Electric may send one-fifth of its procurement budget (or $1 billion) through FreeMarkets, and Kent Brittan, vice president of supply management for United Technologies, waxes almost Meakemesque on the subject. "This FreeMarkets auction idea," says Brittan, "is revolutionizing procurement as we know it."
It was GM, however, that paid Meakem the highest compliment of all: It copied his idea. GM was an early customer of FreeMarkets, buying rubber hoses, sun visors, and lock systems, among other components, and it observed firsthand the power of Internet auctions to cut its costs. Now it's partnering with Ford and DaimlerChrysler to start a vast supply-chain network that will also feature online auctions.
FreeMarkets was not the first Internet firm to help industry cut costs, of course. Commerce One, Ariba, and other providers of electronic catalogs can save a company billions in transaction costs over time by automating orders, payments, and product information and eliminating the blizzards of faxes and invoices that conventional purchases inevitably generate. The problem is, automation attacks only transactions costs. Internet auctions can actually slice the price of the goods and materials purchased. That's a formula for far bigger savings.
To be sure, FreeMarkets isn't the only company holding business auctions on the Internet. Sites like e-Steel, MetalSite, and PlasticsNet.com create lively global spot markets for standard processed materials like steel, chemicals, and plastics. (Auctions for the most basic commodities like wheat and fuel oil existed long before the Internet, of course; they're called the futures exchanges.) On MetalSite, for example, Weirton or LTV can put sheet or rolled steel on the block anytime the market looks hungry. Buyers then enter their bids over two or three days, and the highest price wins. That is called a sellers' auction: Think of it as the business version of the familiar estate sale for rugs or antiques.
Meakem's insight takes the Internet into a much bigger, far more complex kind of corporate purchase. Spot markets are fine for interchangeable, off-the-shelf items like carbon steel or plastic resins. But manufacturers typically spend far more on manufactured components. They are the individually crafted parts--the motors, gears, circuitboards, and plastic casings that producers forge into their finished automobiles, washing machines, and locomotives. They are purchased on contracts that typically run three or four years, and there is nothing standard about them. They are the skin and the guts that make one GE refrigerator, say, a sleeker number than the model across the aisle. (Hey, even a vegetable crisper is a fashion statement!) For manufacturers, no less than 35 cents for every dollar in sales, $5 trillion a year worldwide, goes toward purchasing industrial parts.
Traditionally, parts weren't just the largest cost of goods sold; they were by far the most inefficient to buy. A few months before a contract expires, the manufacturer typically sends out RFQs, or "requests for quotation," to its existing suppliers and a couple of other candidates, with the specifications for the component. Problem is, most RFQs don't spell out a lot of other important terms: the delivery schedule, how much inventory the supplier will hold, whether the seller will provide technicians to restock the bins, and so on. Those things can have an enormous impact on the total cost of acquiring the part. When the bids come in, only the parts are the same; frequently, everything else is different, from the payment terms to who's responsible for upgrading machinery. So it's extremely difficult to pick the best deal. To make matters worse, the bids are sealed, and usually go just one round. The suppliers have no idea what prices their competitors are offering. They're taking a blind guess at how low they must go to win.
In the end, most manufacturers choose the path of least resistance. They know precisely what the current supplier's package is costing them, so why take a chance? If the seller they know is willing to keep the price more or less flat, say, it almost always keeps the business. The process is a lot like congressional elections: The incumbents almost always win.
None of this makes any sense to Meakem. In his view, the blue-chip buyer ought to hold the cards--after all, it's the one whose decisions can fill one small supplier's factory and idle another's. The problem, he says, lies in the hidebound and opaque RFQ tradition. To unshackle the power of the purchaser, his system turns the once secretive RFQ into an open bidding war.
It does that by standardizing absolutely every item in the RFQ. To participate in a FreeMarkets auction, suppliers must offer not only to deliver the same part but also to do it on the same schedule, with the same payment terms, inventory arrangements, and everything else. That way each package is practically the same; plastic refrigerator shelves and automobile bumpers become almost as much a commodity as bushels of wheat. All that remains is to find the lowest price, and the best way to do that is through an auction.
No auction can take place, however, without an enormous amount of preparation. FreeMarkets acts as a consultant, showing new clients how to spell out every possible requirement in their RFQs. (The models here are Japanese manufacturers like Toyota and Matsushita, which post incredibly detailed RFQs.) FreeMarkets is also expert at finding and screening suppliers that the clients don't have the time or the information to track on their own. It e-mails extensive questionnaires to each one, surveying its finances, its ISO or other quality ratings, and the condition of its equipment. Starting with a long list, the buyer winnows down the field to those it wants to invite as bidders. For example, the purchaser may choose to accept bids only from suppliers with more than $40 million in sales, the newest machines, and the coveted ISO 9000 emblem.
The climax is the auction itself--a tense, 20- to 30-minute sweepstakes. The events are called "buyers' " or "reverse" auctions because, unlike the exchanges sponsored by e-Steel, the price starts high and moves downward. Linked over the Internet, the sellers don't have to guess at their competitors' bids as they do with RFQs. They see exactly what the opposition is bidding, in real time--and how low they must go to pocket the order.
A recent auction for plastic car parts captures the drama of a FreeMarkets bidding battle. In the company's darkened control room, the action unfolds on a price and time chart displayed on huge videoscreens; sellers and buyers follow along on their computer screens at their locations. FreeMarkets has divided the bidding into five separate auctions, each for a different category of parts. On one batch, the client sets the most recent price paid, $745,000, as a benchmark, and the bidding begins. Twenty-five suppliers are participating, and each time one of them bids, a "ping" rings out, and a black diamond appears on the screens, representing the price of the bid and the time it was made.
At the opening, the first black diamonds start to appear well below the benchmark; the lowest is $738,000. Then machine-gun bursts of bids send the low bid diving to $612,000 just ten minutes into the action. The diamonds hover around that level for a while. But as usual, the action turns frenzied just before the official 20-minute deadline. With 30 seconds left, the diamond to beat stands at $585,000. Every diamond that comes during the last minute of regulation kicks the auction into a minute of overtime; each overtime bid extends the auction 60 seconds more. In 13 minutes of frantic overtime bidding, the diamonds cascade to $518,000, which gives the buyer a savings of 31%. For the parts it bought at all five auctions, the buyer estimated it would have to pay $6.8 million using the traditional RFQ system. When the dust cleared, it ended up paying just $4.6 million.
The George Washington behind this revolution in the corporate purchasing office is a straight-arrow former Army lieutenant who worships the military and sports crisply pressed khakis and plaid buttondown shirts. Meakem looks like a grownup version of brother Wally in Leave It to Beaver, but he has the persuasive powers of a born salesman, pacing his office, pounding a point home by hurling his Diet Snapple bottle into the trash. "He's planning the next speech while he's still speaking," jokes Tom Danowski, a former co-worker who's now marketing manager at the Seattle Coffee Co. "How does he find time to breathe?"
In his dorm at Harvard, Meakem was a little like Hoover, the well-groomed fastidious fellow in the movie Animal House who fights a losing battle against the slobs. It was Meakem who divided up the phone bill every month on a luggable Compaq the size of a wedding cake. "He was the guy telling us to sweep the pistachio nutshells off the floor and hide the Playboy," recalls Chris Buchanan, a Harvard roommate who's now a Hollywood film producer.
Meakem wears his squareness like a combat medal. While an undergraduate in the mid-1980s, he joined the ROTC; in his crew cut and starched uniform, he could not have stood out more in the liberal groves of Cambridge academe had he come to class in a grass skirt with a bone through his nose. By summer 1990, when Iraq invaded Kuwait, Meakem was at Harvard Business School, pursuing his MBA and serving an eight-year stint in the U.S. Army Reserve. Gary Lapidus, a classmate and close friend who's now an analyst at Goldman Sachs, recalls Meakem's zeal: "We're jogging by the Charles River, and Glen says he's disappointed that his reserve unit won't get activated. And I'm thinking, 'This guy is crazy!'"
Unable to bear missing the action, Meakem volunteered for service in the Gulf war, and in the middle of second-year exams, he was called up. Over the next six months, Lieutenant Meakem headed a platoon of dump trucks and soldiers that built airstrips, plowed roads, erected POW camps, and dug berms for Patriot missiles. In his spare time he started a PX, searching dusty Saudi towns for batteries or candy and literally sleeping with the cash box. The PX, in fact, earned a $7,000 profit, which Meakem returned to the Army. Admiring Meakem's desert entrepreneurship was his deputy commanding officer, Colonel Tom Charlson. Five years later, Meakem told Charlson he was starting a new company; Charlson insisted on investing. "I didn't understand much about the concept," drawls Charlson. "I invested mainly on faith, because of Meakem." Today Charlson's $25,000 stake is worth millions.
When GE offered Meakem a job in 1994, he requested a role that only the most unorthodox of MBAs would prize--a position in purchasing. On his second day in Fairfield, Meakem joined a conference call that would change his life. A manager at GE's transportation division was describing an exotic, GE-sponsored event at a Marriott in Pittsburgh. In one ballroom, dozens of suppliers surveyed samples and drawings for machined metal components that GE wanted to order. In another ballroom, GE managers manned a line of flip charts. Suppliers who'd viewed the equipment in one ballroom bustled around the corner to scribble down bids. As they received new low bids, the GE scribes crossed through the former low bid on the flip chart and wrote the new "best price" below it. Prices tumbled to levels that amazed GE. But the scene was a madhouse: Suppliers hated everything from the cattle-market atmosphere to the lines at the pay phones.
Listening to the description, a bulb lit in Meakem's brain. If GE could hold these auctions electronically, without the shoving, confrontation, and travel expense suppliers despised, it could build the world's first "commodity" market for industrial supplies. The idea was on the edge. The Internet was then in its infancy; the first browser wouldn't arrive until a year later. But GEIS, GE's electronic-supply management arm, had a sophisticated private network connecting GE with its suppliers. Meakem's vision: Hold auctions like the one in the Marriott, this time summoning suppliers over GEIS.
The concept intrigued Meakem's boss, Gary Reiner. He assigned Meakem to run a skunkworks, a tiny laboratory that would hold experimental auctions and refine the process through trial and error. A few of the events went beautifully. In mid-1994, GE nailed a new deal for circuitboards, with a new supplier in India, that saved no less than 45% over the former contract. But other auctions were duds. Some GE businesses didn't make suppliers specify all the terms in their bids, so the prices offered were impossible to compare. Most of all, Meakem lacked the staff to unearth promising new suppliers. "This was strictly the bucket brigade," he recalls.
Meakem left when GE declined to expand the skunkworks into a full-blown business, but by then he had learned what it took to make auctions succeed: not just technology, but lots of standardization, consulting, and handholding. His first move as an entrepreneur was to summon a former colleague, Sam Kinney, then working for McKinsey in Pittsburgh. On the surface they form an unlikely twosome. With well-tousled reddish hair, clad in baggy green pants and Birkenstocks, a $25 Swatch on his wrist, Kinney looks like a beefier, more rustic version of Bill Gates. "He has an innate resentment of all authority," says Meakem.
But Kinney boasts just the skills his spit-polished partner lacks. He's a formidable numbers man, a behind-the-scenes player who relishes the grunt work of building the strong systems a tech startup relies on. At FreeMarkets, he has done everything from helping to design the auction software to developing the accounting system. Today Kinney--now worth about $500 million--acts as de facto czar of strategic planning. As Meakem puts it, "Sam trolls for new ideas."
Kinney quickly persuaded Meakem to establish FreeMarkets in Pittsburgh. A headquarters in the onetime capital of smokestack America brands FreeMarkets not as just another Silicon Valley clone but as an expert in gritty industrial processes. Meakem and Kinney put in a total of $125,000 and raised another $375,000 from friends and family. The Steel City venue didn't impress Silicon Valley venture capitalists, however. One VC insulted the partners by, as Kinney recalls, "puking all over our business plan" and offering a pittance for half the shares. Then, in the piece de resistance, he bragged about being expelled from a military school for slugging an officer. Meakem barely resisted an urge to throw the guy out on his dot-com.
Ironically, United Technologies Corp., the quintessential old-economy warrior, had no trou-ble seeing how Internet auctions could change its world. In 1997, UTC set out to pare $600 million, or about 4%, from the $14 billion it spends on supplies and services every year. Since UTC figured that the costs of some commodities might rise, it strove to cut the prices of many components by far more than 4%. "We had to do things dramatically differently," says Brittan of UTC.
Hungry for quick results, he hired FreeMarkets. A deal in 1998 for printed circuitboards (to be placed in elevators, air conditioners and other products) showed with particular clarity how smart a move that was. At the time, UTC was buying circuitboards from eight suppliers in the U.S. and Europe. When it was time to renew the contracts, its practice was to collect bids from the incumbents and several other suppliers. Based on going prices in 1998, UTC expected to pay $74 million.
The FreeMarkets auction landed UTC the contracts for $42 million, a savings of 43%. "The price dropped like a rock," marvels Brittan. FreeMarkets got bids from 29 suppliers, including new candidates from the U.S., Europe, and Asia. The winners of the auction were a classic mix of efficient upstarts and incumbents that found ways to make the components at far lower cost.
The FreeMarkets model is also rattling the stodgy, $600-billion-a-year market for public procurement. Last year Pennsylvania cut 10% or so off its expenditures for aluminum for license plates and coal for heating state buildings. But all that was a warm-up for a recent auction of computer office furniture in Harrisburg's giant Keystone Building. Under existing contracts, the workstation tables and keypad drawers would have cost $12.9 million; the low bidder, Steelcase, is providing the wares for $8.85 million, a savings of 31%. New York, Texas, and federal agencies are now weighing whether to sign on.
Though FreeMarkets is still not profitable--it is an Internet company, after all--its revenues are exploding. Sales have been rising 25% to 50% each quarter, hitting $9 million in the last three months of 1999. Last year FreeMarkets handled $2.7 billion of the $3 billion sold at industrial auctions hosted by purchasers. With the multilingual staff, supplier databases, and industry experts needed to run a thriving marketplace, it will be hard for another Internet upstart to challenge FreeMarkets, at least for now. Indeed, in the last three months of last year, FreeMarkets almost doubled its customer list to 34 big clients, adding names like Raytheon, Cinergy, and Navistar.
That's crucial, because the company still needs to invest heavily in call centers, auction technology, and foreign operations. All of FreeMarkets' revenue flows from buyers. To encourage suppliers to play, FreeMarkets gives them a totally free ride. Big clients pay a fixed subscription fee that can come to $3 million or $4 million a year, plus, in some cases, a share of the savings. (Unlike some dot-coms, FreeMarkets counts only these cash fees as revenues.) So every time a new client signs on, revenues jump. As the client list grows, the cost line will level off even as revenues accelerate. Eventually profits should start pouring in.
That is, they should as long as FreeMarkets' clients don't all start auction services of their own. FreeMarkets' experience with GM was sobering. Starting in 1997, the giant automaker was FreeMarkets' second-biggest customer (after UTC), pocketing $120 million in savings, according to Meakem. The warning signals started last fall when GM took a stake in B2B software provider Commerce One. In January, GM announced it was leaving FreeMarkets to start a vast electronic marketplace called GM TradeXchange in partnership with Commerce One. The network, which will connect GM with its 30,000 suppliers, is intended to help the automaker manage its supply chain from end to end, to plan production, manage inventories, and order office supplies. But it will also host auctions in direct competition with FreeMarkets. GM isn't dawdling. It held the first event in February, procuring $148 million in rubber parts.
The threat intensified in late February, when GM decided to merge TradeXchange into a far bigger network with Ford (which had plans to launch an auction site of its own with Oracle) and DaimlerChrysler. In late February, Sears and French retailer Carrefour followed the automakers' lead by announcing a purchasing network that would also include auctions.
GM's sudden switch from client to competitor is an extremely sore point with Meakem, not least because the departure knocked 18% off the stock in a single day. "GM's decision doesn't make sense," he insists. "They're outsourcing everything else. Why would they take the time and money to set up their own marketplace?" Meakem also fumes that suppliers wouldn't trust GM or any other big company to run a fair, neutral auction because the buyer will also own the marketplace. "It's a case of the fox running the henhouse!" he says.
Ironically, GM seems to have taken the gamble that Meakem's bosses at GE wouldn't--and it's paying off just as Meakem promised. First, GM is reaping billions from its investment in Commerce One. (And why not? GM is supplying much of the business that's driving up its partner's stock price.) Second, TradeXchange could thrive as an auction site. Suppliers are no more likely to distrust GM because it co-owns the exchange than to shun FreeMarkets because it represents the buyers.
The Big Three and Sears notwithstanding, the threat of many other customers' becoming competitors seems remote. Only a few behemoths will have the resources to launch auction exchanges that compete directly with FreeMarkets. For most manufacturers, Meakem's site will be the place to go for the foreseeable future.
Of that, Meakem evinces little doubt, only a near-religious sense of mission. Indeed, in his pantheon of business heroes Bill Gates stands behind the Old Testament hero Joseph, who stored up Pharaoh's grain during the boom times and sold it (dear, one presumes) during a famine. "Joseph pursued a plan others didn't understand, and still got his people to follow him!" marvels Meakem. Sounds a lot like the prophet of purchasing.