Why This Railroad B2B Needs $8 Million

A B2B marketplace needs to balance its own checkbook before it can save six major freight railroads millions of dollars on their purchasing.
Joseph RadiganJune 12, 2001 has its technology house in order. Its management team is almost in place, and now all Mark Davis, the B2B exchange’s interim CEO, wants is $8 million to ensure the entity’s survival through the end of 2002.

Davis’ day job is head of E-commerce at Union Pacific, one of the seven current shareholders in closely held The others are Burlington Northern Sante Fe, Canadian Pacific, Canadian National, CSX, Norfolk Southern, and General Electric. He expects to return that post full time once the new management team is announced in the next few weeks.

His colleague, Mike Gorman, was the exchange’s interim CFO until the end of May, and he spoke to shortly before he returned to his permanent post as Burlington Northern’s head of E-commerce.

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“The reason we got together was to streamline the rail industry’s buying,” Gorman says. “We’re looking to reduce the total cost of ownership through reduced sourcing costs.”

Getting those cost reductions is by no means guaranteed. Shortly before Gorman left, the E-marketplace announced the final step in setting up its two-tier technology architecture, but that’s only half the battle.

Most of the individual members will use Clarus E-procurement software internally. The center of the exchange will consist of a subscription-based Web-hosting service from General Electric’s Global Exchange Services (GXS) unit.

At least four of the six railroads in the exchange will use the Clarus systems. Canadian National will be one of the exceptions, and run Ariba Buyer.

A Canadian National spokesman said the railroad chose Ariba as part of its individual E-procurement efforts long before it joined the joint effort.

First, the exchange members will start implementing the sourcing and online auction function this quarter, Gorman says. By the third quarter, the exchange hopes to go live with the request for proposal, bidding, and quote process. The back-end settlement function is scheduled to go live in the fourth quarter.

Burlington was able to install its copies of the Clarus applications in eight days a year ago, but will need a considerably longer time. Gorman says the extra time is required partly because the exchange is building its operations from the ground up.

“Procurement is just one piece of the marketplace,” Gorman says. “We’re creating a full marketplace. You’ve got to create all the administrative functions.”

CEO Davis says GE’s involvement as a Web hoster was crucial to getting the exchange off the ground, lowering the start-up capital that would have to be earmarked for technology. GE, as a major manufacturer of locomotives, is by dollar value, the single largest supplier to the freight market.

Davis says last year, when the railroads worked out the original business model, they determined they needed $40 million. Given the slow economy and the weak stock market, external funding has been unavailable. But GXS’ presence as the technology provider allowed the effort to cut its funding request to only $15 million.

Davis acknowledges that the $7 million the exchange currently has on its balance sheet is only half its goal, and he says the new management will be pressed to raise the remainder of the start-up capital.

One funding scenario is to find an investor who will take a major equity position in the company. While Davis says the original business plan is to keep Railmarketplace as a closely held business, if the outside investor is a venture capitalist, that wouldn’t preclude an eventual public offering.

The sale of equity stakes, in blocks of 1 percent or more, will be an additional funding source.

The third source will be the annual access fee each buyer and seller will pay to participate.

Finally, Davis says the business plan includes a variation of transaction fees that individual buyers and sellers will select.

By the end of next year, Gorman expects the exchange to handle total purchasing valued at $3 billion, or roughly 20 percent of the freight industry’s total annual purchases.

Much of the preliminary work done before launching the exchange centered on looking at the supplies that would be bought and sold on it. The railroads ultimately agreed to standard specifications for many of the items covered by the E-marketplace.

“We might buy 47 different types of safety gloves,” Gorman explains. “We might ask GE for customization on locomotives, but we can save a lot of money if we can come to agreement on a single configuration.”

“In general, most of the differences are a matter of taste, the core technology in a locomotive is the system,” Gorman says.

Antitrust was also a major concern in designing the exchange’s business plan. Davis says an antitrust lawyer was hired to consult with the in-house antitrust counsel from each of the railroads.

The exchange members wanted to avoid running afoul of the Justice Department’s safe harbor provisions, which essentially preclude members of a buying consortium with more than 30 percent of the purchasing market from coordinating their buying activity.

Davis explains that the lawyers were able to hammer out an exception, despite the exchange’s clout. Essentially, if the group limits its efforts to standardizing the technology, but keeps individual purchase orders separate, the members won’t break the law.

The exchange’s technology design includes a Web version of a “sealed envelope” that will prevent other exchange members from viewing purchase orders submitted by other members.

Whether can achieve the desired results for its members remains to be seen. The last 15 months have been tough on the B2B sector and produced plenty of second-guessing about the concept.

That said, it seems that’s focus on a few, set technology options could serve to limit its risk and help it achieve a positive return relatively quickly.

Steve Hornyak, Clarus’ chief strategy officer, says the company’s typical sale is worth from $600,000 to $700,000, including the first year’s installment on the maintenance, implementation, integration, and training. The deal with was worth far more, although he would not say by how much.

Otto Kumbar, a vice president with GXS, won’t specify the exact value of the multimillion software and services contract with Railmarketplace. He says the B2B exchange will use GXS’ Marketplace Web- hosted auction and reverse-auction system and some transaction services, such as materials planning and trade acknowledgements.

Kumbar says most clients typically sign on for a minimum of five years, and the cost of the transaction services depends upon the volume they use.

“They went through every possible gyration of how to form the marketplace,” says Clarus’ Hornyak. “I think they learned from a lot of the failures out there. They’re focused on facilitating what they have with their existing supply chain and then extending it to the second tier. That’s pragmatic and realistic.”

Even so, no amount of pragmatism will be enough if the funding doesn’t come through. Davis notes that if the exchange finds itself at the end of 2002 or 2003 short of cash and with no discernible progress toward self-sufficiency, the members may have no alternative but to “shut it down.”

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