By Bill Mann (TMF Otter)
May 3, 2000

Paul's argument, and the argument of everyone bullish about B2B companies, rests upon three premises:

1. The total market is going to be huge.
   
2. Even if the company in question takes a small portion of the overall market, its revenues will still be large.
   
3. Current valuation is defensible given the potential for future growth.

Let's cut to the chase and stipulate the first two. No one knows how big B2B revenues are going to be, but the technological benefit of Internet marketplaces to customers is obvious. I do dislike some of the numbers, as they seem to come more from the Elaine Garzarelli school of prognostication, making huge proclamations with the hope that the publicity of the audacity will pay off if it is correct. In this case it seems to have worked thus far, as every screed I've read on the subject quotes some breathless prediction of $1 trillion-plus revenues in the next few years.

As I said, I'm going to stipulate that the first two points are going to be true. But, as the FASB (Financial Accounting Standards Board) looks at the way Internet companies derive revenues, the notional value of goods and services traded in the market does not necessarily equate to revenues for the business. For example, VerticalNet's 10-K shows "Exchange Sales Transactions" in 1999 of $16 million, and "Cost of Exchange Transactions" at $14 million, which means that their revenue on these transactions is $2 million. That's not a gross profit number, that's VerticalNet's revenue based on the notional value of the total sales. Using these numbers, if the notional value of all goods and services traded in 2003 is $1.5 trillion, and if we just extrapolate these numbers as a rule of thumb, the total market available to B2B enablers is down to $200 billion. Still pretty huge, right?

Yes, but remember, the customers in this realm are much more powerful than your average consumer, and are more than willing to a) try to internalize as much of the above market as possible, and b) shop on price. Single-source providers mean nothing to an institutional customer shopping for a commodity. It wants the lowest price for each commodity, period. And, since the barrier to entry for these vertical markets is not high, and as we have discovered, VC firms are rushing B2B companies out into the market, those huge margins and 3% cuts Paul assigns ICG partner companies are in serious danger of being whittled way down. The combination of low barrier to entry, powerful customers who can also compete, and commodity markets is not a high-margin recipe.

This is the sole basis for my questioning of item number three. The simple fact in the modern economy is that marketshare does not necessarily beget profits. ICG's partner companies are going to have to be able to compete on price for their commodity markets plus provide customer solutions valuable enough to differentiate themselves. This eventuality is not guaranteed in markets where customers are large enough to either dictate the terms of the sale or set up their own exchanges.

To date I have seen absolutely nothing convincing on the ability of B2B e-commerce exchanges to derive suitable profits from their chosen markets, and I expect this trend to continue as many of the e-commerce playing fields become more crowded, which even a cursory glance at the roster of upcoming IPOs will tell you is coming sooner rather than later.

In light of these threats, I can easily see how ICG's partner companies can garner huge markets. What I don't see is a clear path to profitability.

Fool on!

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