FreeMarkets and Online Auctions

Before last year’s dot-com meltdown, oneof the most hyped areas was largeindustry-based business-to-business(B2B) marketplaces. Most of these haveeither failed or are struggling. Instead, thegrowth today is in less ambitious onlineauctions where individual firms,increasingly having to focus on costs, seeksuppliers of the products or services theyneed. FreeMarkets, growing fast thoughstill unprofitable, is the leader in thisgrowing field. This case discusses theproblems and potential not only forFreeMarkets itself but also for the buyingand selling companies which use it.

Since last year’s dot-com meltdown, the number ofpure play business-to business (B2B) e-commerce start-ups has declined dramatically amidst industryuncertainty, unsustainable business models, and theevaporation of venture capital funding. Organisationssuch as Forrester and the Gartner Group estimate thatfewer than half of the B2B e-marketplaces in existencein late 1999 will survive beyond 2001. Industry-basedmega-exchanges, such as the automotive industry’swidely-publicized Covisint, are only stumbling along:complex issues relating to regulation and lack of co-

Case Study

FreeMarkets and OnlineAuctionsJamie Anderson and Mark Frohlich

ordination amongst participants have slowedimplementation. The corporate world has graduallyrealised that integrated e-procurement and thedevelopment of industry exchanges might be a muchlonger and more difficult road to bottom-line savingsthan originally anticipated.

In this broad environment of uncertainty on the futureof B2B, some companies have chosen to develop theirown e-marketplaces: Walmart, for example, with itsRetailLink. Another approach is the B2B onlineauction. Public and private sector use of onlineauctions is growing exponentially, with buyers andsellers using systems from vendors like FreeMarkets,Ariba and CommerceOne.

This article discusses the growth of FreeMarkets, theworld’s largest B2B online auction provider andarguably the most successful B2B online marketplace.It explores the company’s business model, and theways in which online auctions can affect B2Bprocurement. In particular, it draws on theFreeMarkets experience to provide lessons for vendorsof online B2B e-commerce services, and buyers andsellers participating in online auction events.

The Emergence of FreeMarketsSince 1995, FreeMarkets has created over 11,500online auctions for over US$16.6bn worth of purchaseorders. FreeMarkets estimates that its clients savebetween 2% and 25% on their purchases, with averagesavings across all categories of 15% in 2000. Total clientsavings since 1995 are estimated to be more than $3.2bn.

Business Strategy Review, 2001, Volume 12 Issue 2, pp 59-68

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FreeMarkets has more than 110 clients (buyers),including United Technologies, General Motors,Alcoa, Royal Bank of Scotland, Emerson, Nestlé andVisteon. In many cases, FreeMarkets works toconsolidate purchases across several divisions withinthe organisation to provide maximum leverage. Morethan 11,000 suppliers from over 55 countries haveparticipated in FreeMarkets’ auctions.

local support to its customers in various regions andto help buyers and suppliers who wish to trade inthese markets.

The Buying ProcessFreeMarkets’ online auction process follows a seriesof steps. The company first works with the client toidentify products and services that might be purchasedthrough its B2B e-marketplace. Once an appropriatepurchase has been identified, FreeMarkets begins themarket-making process. The company helps the buyerprepare and distribute a detailed Request forQuotation (RFQ), identifies qualified global suppliers,and prepares suppliers to bid. Finally, FreeMarketsconducts a real-time, online auction through its B2Be-marketplace.

FreeMarkets’ e-sourcing solutions are customised tomeet the goals of each e-market. Over 160 millionpossible combinations of bidding formats, displayformats and other parameters are available. Thefollowing lists some of the possible formats:

Downward: allows bids in decreasing increments

Upward: allows bids in increasing increments

Index: allows bidding above/below a published index

Multicurrency: converts bids in different currenciesto a single currency

Net present value: converts different multi-year bidsinto one current value

Rank order: allows bidders to see their ranks only,not all bids

Transformational: converts different types of bids intoone format

Although suppliers can see the bid prices on bid day,all supplier identities are kept confidential. The biddingevent has a scheduled opening and closing time. Aslong as suppliers continue to place bids in a lot, thelot stays open. The lot closes when no new market-leading bids are submitted. An online auction bidhistory graph is shown at Figure 1.

Because price is not the only factor, clients do notnormally make award decisions on bid day. In the daysand weeks that follow the bidding event, buyersexamine bid results, review supplier information (suchas supplier capability, quality certifications, and

Example: Corrugated paper packagingTo consolidate business among the mostcompetitive, high-quality, service-orientedsuppliers, a large global corporation placed itsrequirements for corrugated paper packagingup for bid through the FreeMarkets B2B e-marketplace. Purchases were aggregated acrossfive facilities to create a more attractive biddingopportunity for suppliers.

Supply category: corrugated paper packaging

Historic cost: $3.9m

Buyer: five US locations of a global corporation

Suppliers: 14 US suppliers

Pricing format: downward auction

e-Sourcing solution: FreeMarkets FullSourceTM

Number of Bids: 115

Benefits● Grouped request for quotations (RFQ) from

five facilities

● Introduced new qualified suppliers

● Achieved 12% savings ($468,000) in asupply market operating at near capacity

The company’s B2B e-marketplace handles directmaterials (incorporated into end-products), indirectmaterials (used to support operations) and services inover 175 product and service categories. Examplesinclude injection-moulded plastic parts, metalfabrications, chemicals, printed circuit boards,corrugated packaging, coal, capital equipment, andconstruction services.

FreeMarkets believes that a fair and efficientmarketplace must cross borders. The company hasestablished operations on four continents to provide

60 Jamie Anderson and Mark Frohlich

Summer 2001

manufacturing processes), and sometimes conduct abuyer audit before making a final decision. The clientdoes not have to select the lowest bidder, and may wellstay with an existing supplier who is price competitivebut may not have submitted the lowest price.

Recently, FreeMarkets has started to license use of itssoftware for auctions hosted by the purchasingdepartments, business units or divisions of individualcompanies. Under a three-year agreement announcedin February 2001, United Technologies Corporation(UTC), a global provider of high technology productsand support services to the building systems andaerospace industries, became the first company tolicense FreeMarket’s QuicksourceTM auction software.UTC will not use FreeMarket’s consultancy or market-making services, but will run its own auctions usingQuicksourceTM. Buyer-driven marketplaces operatefrom the buyer’s desktop, branded with the clientorganisation’s look and feel, and are able to support arange of sourcing needs. The service givesorganisations the ability to create their own e-markets,hosted and supported by FreeMarkets.

Another service provided by FreeMarkets is assetrecovery for surplus assets through its online AssetExchange. This represents only a small share of totalrevenue.

FreeMarkets at a GlanceJune 2001

● Founded 1995

● $16.6bn traded volume

● $3.2bn savings generated

● 15% average saving for customers

● Over 9,300 online markets hosted

● Over 150,000 suppliers

● 100 clients (buying companies)

● Over 165 categories

● Nearly 1,000 employees

● Over 30 languages

● Initial Public Offering: December 10, 1999

● IPO Price per Share: $48

● Price Per Share June 2001: $16

Figure 1FreeMarkets Bid History Graph: Microprocessor Auction

FreeMarkets and Online Auctions 61


The FreeMarkets Value PropositionFreeMarkets believes that its B2B e-Marketplacedelivers the following:

Independence: FreeMarkets argues that only anindependent e-marketplace can provide a truly levelplaying field. The FreeMarkets B2B e-marketplace isfully independent and neutral. FreeMarkets does notpromote the interest of any buying or sellingorganisation.

Market efficiency: The company also asserts that anefficient market will bring the right buyers and sellerstogether, facilitate transactions, and create a win-winprocess that encourages even greater participation.

Volume: FreeMarkets sees volume as an importantmetric for any marketplace. Volume is seen to driveboth performance and efficiency.

Integration: The company believes that an e-marketsolution has to be flexible enough to integrate withother technology solutions but powerful enough tostand alone. FreeMarkets has designed its sourcingsoftware to work as seamlessly as possible with a rangeof e-commerce solutions.

Measurable ROI: FreeMarkets aims to deliver fast,measurable results in the form of procurementsavings, reductions in project cycle times andadministration costs.

Figure 2Savings and fees(a) A US based diversified manufacturer


(b) Consumer electronics manufacturer: savings by product

$45,000,0000

$35,000,0000

$25,000,0000

$15,000,0000

$5,000,0000

$(5,000,0000)

Jan

Apr Jul

Oct Jan

Apr Jul

Identified Savings

Fees & Expenses

Cumulative Identified Savings & Fees

Commodity Savings %

16.6%

17.8%

15.9%

21.2%

21.5%

24.0%

27.8%

28.4%

9.0%

Forging

Machining

Injection Moulding (Plastic)

Printed Circuit Bare Boards

Stamping

Blow Moulding (Plastic)

Component Manufacturing (Electrical)

Compression Moulding (Plastic)

Thermoforming (Plastic)

General Freight 0.0%

Summer 2001

savings for a consumer electronics manufacturer.

To participate in a FreeMarkets’ online market,suppliers must provide a detailed capability profile,review the RFQ, prepare a bidding strategy, andcomplete FreeMarkets’ BidWare training.

Revenue ModelFreeMarkets generates revenue from its serviceagreements with clients (buyers). These typicallyprovide for fixed monthly fees (eg $75,000 – $100,000per month for the two-three months of a project lifecycle) performance incentive payments based onvolume, savings or both, and sales commissions. Thecompany expects incentive payments to become itsmain revenue source in the long term.

Monthly fees received by the company are for the useof technologies, supplier and supply marketinformation, market making and market operationsstaff, and facilities. Negotiated monthly fees vary byclient, and reflect both the anticipated auction volumeand the staffing, expertise and technology thatFreeMarkets expects to commit to provide the servicesrequested.

Revenue from the licensing and support of theQuicksourceTM auction software is expected to growsubstantially in the medium to long-term, as othercompanies follow United Technologies.

FreeMarkets’ agreements can provide for salescommissions to be paid by suppliers. But this approachhas been strongly resisted by the company’s supplierbase. Most of the service agreements signed byFreeMarkets since early 1999 have not included

Example: Printed Circuit BoardsA global diversified manufacturing firm facedthe difficult challenge of consolidating millionsof dollars of printed circuit board (PCB)purchases across 14 global divisions. Thecompany wanted to consolidate its supply baseand standardise data to understand futurebuying patterns.

Supply category: printed circuit boards

Historic cost: $36.1m

Buyer: global diversified manufacturer

Suppliers: 43 ISO9000 certified suppliers

Pricing format: downward auction

Sourcing solution: FreeMarkets’ FullSourceTM

Number of bids: 755

Benefits● Obtained buy-in from 14 divisions to

participate in a corporate-wide event.Standardised data on over 1,000 PCBdesigns across 19 divisions

● Introduced several qualified suppliers fromAsian countries

● Consolidated supply base from 58 to 9

● Ultimate saving around $10m

Global reach: Finally, the company believes that anefficient marketplace has to be global. Buyers andsuppliers from over 55 countries have participated inthe FreeMarkets B2B e-marketplace, supported byFreeMarkets’ 19 offices in 13 countries across Asia,Europe and the Americas.

In addition, Freemarkets argues that its clients benefitfrom the depth of information it provides about bothauctions and suppliers, and from the competitionintroduced by bringing in new suppliers from aroundthe world. On the supply side, sellers can gain accessto a global scale, as well as from the cost savingsgenerated by free registration and participation,detailed standardised RFQs, and a much fasterbidding process.

Figure 2 compares the cumulative savings and feesfor a diversified manufacturer and the commodity

Calendar years, $m

2000 1999 1998 1997 1996

Revenue 83.3 20.9 7.8 1.7 0.4

Direct costs (48.9) (12.2) (4.3) (1.1) (0.5)

34.4 8.7 3.5 0.6 (0.1)

Indirect costs (101.1) (31.4) (3.5) (1.7) (1.3)

Operating loss* (66.7) (22.7) 0 (1.1) (1.4)

*Excluding goodwill amortization, interest and other income

Table 1FreeMarkets’ Financial Performance, 1996-2000


R


supplier-paid commissions, and the company expectsto eventually abandon this approach altogether.

Financial PerformanceFreeMarkets is still not profitable (Table 1) and itsshare price collapsed along with those of otherdot.coms last year (Figure 3). However, on release ofits first quarter results for 2001, it declared that itexpected to break even by the first quarter of 2002.In the words of FreeMarkets' Chairman and CEO,Glen Meakem:

“We look forward to building on themomentum we have gained to extend our globalleadership position even further in the monthsahead…Although demand for e-sourcingsolutions softened during the quarter due to theweakening economy, our customers continuedto leverage our technologies, marketinformation and services to generate savingsand efficiencies for their organizations…”

Table 2 shows figures for the first quarter of 2001.FreeMarkets Senior Vice President and Chief FinancialOfficer Joan Hooper said:

“We are pleased with our bottom-lineperformance for the first quarter. While ourrevenues fell slightly short of our expectationsdue to longer sales cycles driven by a softeningeconomy, we are very encouraged by the dealswe signed late in the quarter, which shouldenable us to achieve sequential revenue growthof 10% to 15% in the second quarter.”

The FutureIn mid-2001, FreeMarkets is positioning itself toremain the premier global provider of onlinepurchasing and procurement.

Table 2FreeMarkets’ Financial Performance, 1st Qtr 2001

1Q01 Previous qtr 1Q00

Revenue ($m) 33.0 34.5 (-4.3%) 10.8 (+205%)

Volume ($bn) 2.6 3.5 (-43%) 1.3 (+92%)

Gross margin 51% 50% 41%

Net loss ($m)* 9.3 10.4

Net loss per share ($)* 0.24 0.27

*Excluding stock-based expense and non-cash acquisition costs

Figure 3FreeMarkets' Share Price Performance and Trading Volume December 1999 - June 2001 (US cents)


Summer 2001

According to Glen Meakem, Chairman and CEO

“Demand for sourcing solutions that deliverlarge and immediate returns on investment isextremely strong, and FreeMarkets is uniquelypositioned to capitalise on this marketopportunity… Our portfolio of sourcingsolutions provides professional buyers with thetechnology, information and services they needto make better business decisions.”

According to Ed Smith, Director of Group PurchasingOperations at London-based Royal Bank group, anda FreeMarkets client:

“We see a strong future for FreeMarkets. RoyalBank has 99 different integration activities to

complete by the end of 2001, and the FreeMarketsauction process helps us manage our time moreeffectively. True market price is another benefit.Prices are not based on historic data but what themarket will bear, coupled with the element of costbreakdown from bids so we are able to check howrobust bids are before awarding. FreeMarkets alsodoes a lot of work to ensure supplier integrity. Atthe moment we just have a ‘toe in water’, £60 -£70m worth of work through FreeMarkets in thenext 12 months, but our total spend is well over£2bn per year.”

FreeMarkets intends to expand its client base in 2001-2to include additional global corporations, governmentagencies and medium-sized companies from aroundthe world, supported by additional internationaloffices. FreeMarkets also plans to continue toexpand its e-marketplace to include more direct andindirect materials and services, where its onlineauctions and other services can provide significantsavings for clients.

Online Auctions: Lessons for Vendors,Buyers and SellersFreeMarkets believes that its B2B e-marketplacebenefits all participants. It enables buyers to findqualified suppliers, quality goods and services. It alsoenables competitive pricing. Suppliers have betteraccess to new customers. Transactions flow freely ina secure, transparent environment with fair and equalaccess for all. The company’s e-marketplace isindependent and neutral, and does not promote theinterest of any buying or selling organisation. It bringsbuyers and sellers together, and facilitates frictionlesstransactions. Unlike B2B exchanges, it does not involvehuge upfront investment in terms of capital,organisation or time.

Lessons for vendorsFor other vendors of B2B solutions, the FreeMarketsstory provides a number of lessons. First, any online B2Be-commerce offering must obviously provide a clear valueproposition to customers over existing businessprocesses, and provide clear savings and/or efficienciesin project cycle time and total transaction costs.

Technology for the e-marketplace must be easy toimplement, the most attractive solutions for bothcustomers and suppliers being those which minimisethe changes an enterprise must make when it does

Examples: Online Markets for Services● Tax preparation services: A major client

identified savings of close to 50% on acontract for tax preparation services

● Telecommunications services: More than$4m worth of telecoms services – includingfixed and mobile service in Italy, wiring andhardware installation – have been bidthrough the FreeMarkets online auctionmarketplace, saving over 30%.

● Security guard services: FreeMarkets helpeda global 1000 client save more than 14%on a contract for security guard services.

● Transportation: Contracts for more than$31m worth of transportation, includingless-than-truckload transportation andocean freight, have been bid through theFreeMarkets online auction marketplace.

● Relocation services: FreeMarkets has bid outover $93m worth of relocation services andidentified annual savings of more than 20%

● Hotel services: a major client saved morethan 20% off contract hotel-room rates.

● Office furniture and installation: Officefurniture and installation services worthnearly $9m have been purchased throughthe FreeMarkets online auction marketplace.Average savings on these purchasesexceeded 31%.



business online. But technology is not the key here, assoftware solutions for in-house auctions are becomingreadily available. Elements such as the market-makingexpertise surrounding the technology, breadth ofsupplier base, and the ability of vendors to confirmthe integrity of geographically-dispersed suppliers arewhat buyers are willing to pay for. And this is anotherlesson from FreeMarkets – buyers will pay if thebenefits are clear.

Experience has shown that business models based onadvertising revenue or supplier commissions to supportB2B exchanges or industry-specific e-commerce sitesare usually unsustainable. Despite this, a recent reviewof leading B2B online marketplaces revealed that onlytwo out of 23 vendors levied substantial fees on buyers(Kerrigan et al 2001). The FreeMarkets case suggeststhat vendors should develop a fee structure that isclosely linked to the value-added provided to theirclients, and this might certainly mean basing a portionof fees on project outcomes.

Another important metric is critical mass of bothbuyers and suppliers, with transaction fees dependingon the number and scope of auctions hosted. Withmore than 110 buyers and 11,000 suppliers from over55 countries, FreeMarkets has emerged as one of thestrongest e-marketplaces in terms of active members.

FreeMarkets’s experience with its QuickTrade solutionalso shows that vendors can make money by providingproprietary auction software and support to largecustomers.

One aspect that FreeMarkets and other online auctionproviders need to address should they wish to providea full spectrum of procurement services is relationshipmanagement. Vendors in the e-marketplace need todevelop non-auction or tailored auction offerings tofacilitate transactions where established buyer-supplierrelationships are important in negotiating long-termcontracts, volume pricing agreements or collaborativeproduct development.

While FreeMarkets is not yet profitable, it is likely tobe one of the few B2B e-marketplace start-ups (thatdoes not have a major industry sponsor) to survivethe current round of online marketplaceconsolidation. In mid-2001, FreeMarkets is stillrecruiting amidst significant downsizing by othertechnology companies.

FreeMarkets’ future success will depend upon itsability to continue to build its global customer andsupplier base and to provide sustained value-added.The company’s combination of transaction, licensingand professional service fees provides an attractiveexample for B2B marketplaces struggling to devisesustainable revenue models.

Lessons for buyersFreeMarkets and other online auction providers claimthat the primary benefit for buyers is the cost and timesavings they realise by creating a frictionless andtransparent market. This benefit is coupled withsecondary benefits of access to a global suppliernetwork and extensive market data includinginformation on suppliers' manufacturing processes,quality assurance practice, market focus, and facilities.But, while online auctions such as FreeMarkets offermany benefits for buyers, there are also constraints.

While the auction approach may certainly work forcommodity products such as paper, office products ormicrochips, there might be dangers if buyers expectto be able to apply this model to more critical orcomplex direct inputs.

Even if an online auction company provides extensivevetting and pre-qualification of suppliers, do buyersreally benefit by changing suppliers for every productrun or project? Indeed, the internet-based auctionmodel seems to go against the strategic partnershipapproach that many companies have adopted as theyhave outsourced extensive parts of their value chains.

FreeMarkets and other online auction providers havediscovered that buyers who move to a lower costbidder often return to existing (and higher cost)suppliers after experiencing realignment challenges.It is notable that leading new economy companies suchas Cisco and Dell have avoided subjecting their suppliersto this kind of competition, being more concerned tomaintain strong and dependable relationships than tosqueeze their suppliers to the line on each transaction.It is in no-one’s best interests to force your suppliersout of business by applying hyper-competition.Important strategic considerations include:

● Can this product/service be readily sourced frommultiple suppliers?

● What are the potential or hidden costs of changingmy existing supplier?


Summer 2001

● Are supplier transfer costs acceptable?

● What are the risks associated with alienating coresuppliers?

Before entering the online auction space, buyers shouldfirst assess whether an e-marketplace is the best optionfor the purchases they expect to make, compared toother methods on or off the Internet.

Lessons for suppliersThere are also lessons for sellers. In situations wheresuppliers are drawn into an auction by an existingcustomer, they should recognise that they often do nothave to provide the lowest price to extend previouscontracts. Price is certainly important, but issuesrelating to dependability, quality and establishedrelationships can often result in an existing supplierwho is competitive but not the cheapest bidder winningthe final tender. As mentioned above, and with thepossible exception of commodity-type products andservices, a buyer is unlikely to change supplier for everyprocurement project.

Although online auctions might be applicable forinterchangeable commodities, this is not always the

case for more complex products and services. Amongthose who will experience far less pressure toparticipate in online auctions are: suppliers withunique or specialised products that do not lendthemselves to direct comparison; those with productsthat are not susceptible to substitution (due to a limitedsupplier base); those with significant patent orcopyright protection; and suppliers with hybridproduct and service offerings.

In situations where there are a limited number ofsuppliers providing highly customised products orservices, sellers should be in a strong position. But inthe absence of a reasoned strategy, costly mistakes arepossible. In one case, a large organisation invited theonly three qualified suppliers of a critical componentto participate in an online auction, making a 28%saving over historic cost. The suppliers to their auctionhave now set a much lower price for their products,creating a dangerous precedent for their industry. Awiser strategy would have been for all of the suppliersto refuse to participate – not through collusion butthrough a shared desire to retain healthy profits in aunique market where they have a significant amountof bargaining power.

A Page from FreeMarkets' Website



More and more companies are refusing toparticipate in auctions, particularly in fragmentedindustries with multiple buyers who possess arelatively weak bargaining position. Importantstrategic considerations for suppliers include:

● What is the competitive situation in my industry?

● What is the relative bargaining power of buyers/suppliers?

● Which competing sellers are likely to be involvedin the auction?

● Does the auction provide an opportunity forsuppliers to differentiate their products/services?

● How have auctions affected suppliers’ prices in thisindustry to date?

A final lesson for sellers relates to cost and acceptableprofit margin as the auction process provides an easyoutlet for an undisciplined bidder to lose his or hershirt. Sellers should enter an online auction processwith a pre-determined strategy, and a definitewithdrawal point. It is not unknown for emotion toget the better of reason (particularly if the CEO ispresent for the auction event) and for a company tobid itself below break-even. Unscrupulous bidderswho do not intend to pursue a tender might drivedown the bid price early and then withdraw, usingthe auction process as a competitive tool againstother suppliers.

ConclusionOnline auctions will increase over the coming years.They remove much of the friction surrounding thetraditional tendering process, offer the potentialadvantages of wider breadth of suppliers, and canprovide an effective solution for buyers to establish

true market prices for their inputs. For suppliers, e-marketplaces can provide access to previouslyunattainable accounts and unprecedentedparticipation in global markets. And unlike other e-procurement solutions such as industry exchanges andB2B e-commerce portals, online auctions are relativelyquick and easy to implement.

Despite these advantages, both buyers and sellersshould also acknowledge that electronic B2B auctionshave limitations. For buyers, online auctions areprimarily a tactical tool to get the best price forcommodity products and services from non-strategicsuppliers. For sellers, auctions are a necessary evil incompetitive markets involving high levels ofcommoditization and/or consolidation amongstbuyers, but should be approached cautiously inindustries where suppliers are few.

The shakeout in B2B e-marketplaces is likely tocontinue. Those vendors who survive will be thosewho, like FreeMarkets, can deliver a clear valueproposition to clients and can support this valueproposition with a sustainable path to profitability.

Jamie Anderson is a Programme Director andresearcher within the Centre for ManagementDevelopment, and Mark Frohlich is an AssistantProfessor of Operations and TechnologyManagement and the Deloitte Consulting e-Business Fellow, both at London Business School


ReferenceKerrigan, Ryan, Eric V. Roegner, Bennis D. Swinfordand Craig Zawada (2001) B2Basics McKinseyQuarterly, Number 1, 45-53.

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FreeMarkets and Online Auctions