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The lowest bid wins on FreeMarkets, Inc., with millions made in one transaction!
by Siu-Yee Ng
The Internet is one of the fastest-growing means of communication, reaching consumers and businesses globally. So it's not surprising to see businesses joining the cyber frenzy. Forrester Research expects business-to-business electronic commerce to grow more rapidly than business-to-consumer electronic commerce over the next several years.
They estimate that business-to-business electronic commerce will grow from US$109 billion in 1999 to US$1.3 trillion in 2003, accounting for 90% of the dollar value of electronic commerce in the United States by 2003. Total electronic commerce worldwide may reach as high as US$3.2 trillion by 2003.
Auctions targeted at consumers are a popular application of Internet technology. Forrester Research projects that the value of goods sold through Internet auctions will increase from US$8.7 billion in 1998 to US$52.6 billion in 2002. The popularity of consumer-oriented auction sites and the opportunity presented by business-to-business electronic commerce have spurred the creation of business-to-business Internet auction sites.
Everything from Beanie Babies to Pokemon cards are sold on sites like Ebay. But there's a market worth approximately US$5 trillion waiting to be tapped where one transaction could make millions of dollars. This industry may not be as glamorous as bidding on a Roosevelt Hotel Menu autographed by Babe Ruth, Lou Gehrig and Roy Campanella where bidding starts at a staggering US$10,000. But it sure supplies you with modern survival necessities such as oil and gas. And FreeMarkets, Inc. (FMKT-NASDAQ) has positioned itself to be a world leader in the customized business-to-business online auctions for the world's largest buyers of industrial parts, raw materials and commodities.
The need for fuel
Due to inefficiencies in the markets that supply direct materials, there are times when buyers pay prices that are too high. Direct materials are often custom-made or adapted to the buyer's specifications. Unlike maintenance, repair and operating supplies, direct materials are often not standardized and therefore cannot be ordered from catalogs at list prices. Without catalogs or list prices, buyers cannot easily obtain comparative price information.
Also, supply markets for direct materials often contain hundreds of potential suppliers. This fragmentation makes it difficult for buyers to understand the entire supply market for the products they are buying, and to evaluate and select potential new suppliers.
This complexity often leads buyers to rely on suppliers with whom they have dealt in the past, making it difficult for new suppliers to compete for business. Because competition among suppliers is limited by these factors, buyers may pay higher prices or obtain lower quality than they would in a more efficient market with better information.
FreeMarkets, Inc. combines their BidWare Internet technology with their knowledge of supply markets to help large industrial buyers obtain lower prices and make better purchasing decisions. In a FreeMarkets online auction, suppliers from around the world can submit bids in a real-time, interactive competition. Their auctions are "downward price" auctions in which suppliers continue to lower their prices until the auction is closed. Before each auction, FreeMarkets work with their client to identify and screen suppliers and assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use as a basis for their competitive bids.
FreeMarkets' BidWare Internet technology facilitates competitive bidding by enabling suppliers to submit bids in real time and to view competing bids within seconds after their submission. Their technology is also flexible. They can easily configure their BidWare software in many different formats to address the characteristics of a particular supply market and to achieve the particular objectives of each of their clients.
They create online auctions for their clients in a wide variety of product categories, ranging from commodities to custom-engineered components. The number of product categories in which they have experience had grown to more than 50 as of July 31, 1999.
Still growing
FreeMarkets was founded in 1995 and did not generate a significant amount of revenues until 1998. They experienced losses for the partial year 1995 and in 1996 and 1997. They achieved a modest profit in 1998, but are incurring losses in 1999 as a result of their efforts to invest in the growth of their business.
FreeMarkets created online auctions covering approximately US$1 billion worth of purchase orders in 1998 and US$630 million worth of purchase orders in the six months ended June 30, 1999.
They estimate that the resulting savings for their clients ranged from approximately 2% to more than 25%. More than 1,800 suppliers from over 30 countries have participated in their auctions. Their current clients include United Technologies Corporation, General Motors Corporation, Quaker Oats, Emerson Electric, Allied Signal Corporation and the Commonwealth of Pennsylvania.
It bothers me to see their dependence on two clients, United Technologies Corporation and General Motors Corporation, for a substantial portion of their revenues. These two clients represented 77% of their revenues in 1998 and 65% of their revenues in the six months ended June 30, 1999. We'll have to keep an eye on this.
They have a subsidiary in Brussels, Belgium, that serves their clients based in Europe and the European operations of their multinational clients based in the United States.
Making money
FreeMarkets sells their services through their direct sales organization. As of July 31, 1999, their direct sales force consisted of 12 sales professionals, organized along buyer industry lines. They plan to expand their direct sales force and the number of buyer industry sectors.
They typically target senior purchasing executives and other senior executives within a buying organization. When a prospective client is interested in working with FreeMarkets, they will analyze which portions of their direct material purchases are best suited to their market making process. Throughout this analysis, FreeMarkets work with the prospective client to negotiate terms of a service agreement.
Revenues are generated from fixed monthly fees, and may also include performance incentive payments, based on volume or savings, and sales commissions. The revenue structure in a particular service agreement may vary, depending upon the needs of their client and the conventional practices in the supply market where their client obtains its direct materials or commodities.
FreeMarkets' efforts are working. Total revenues increased 336%, from US$409,000 in 1996 to US$1.8 million in 1997, and 338% to US$7.8 million in 1998. During 1998, US$1.6 million of their revenues were attributable to a performance incentive bonus.
Revenues increased 221% from US$2.4 million for the six months ended June 30, 1998 to US$7.7 million for the same period in 1999.
Masterminds
The co-founder of FreeMarkets has served as their president, CEO, and chairman of the board and a director since inception. From May 1994 to February 1995, he was employed as a manager in the Corporate Business Development Group of General Electric Co. He was named on Inter@ctiveWeek's annual list of unsung heroes.
Another co-founder has served as FreeMarkets' secretary, treasurer and a director since inception. He has also served as acting CFO since June 1998. Prior to co-founding FreeMarkets, from March 1992 to April 1995, he was employed as a consultant and engagement manager at McKinsey & Company, Inc.
The executive vice president and chief operating officer has served since March 1998. From October 1996 to February 1998, he served as vice president of market making. Prior to joining FreeMarkets, from March 1992 to September 1996, he was employed with Dole Fresh Fruit International, Ltd., where he worked in key financial and management positions at Dole's Latin and South American headquarters and subsidiaries.
The vice president of market making has served since May 1998. Prior to joining FreeMarkets, from June 1996 to May 1998, he was a principal with A.T. Kearney, a management consulting firm.
The list of outside directors is not too impressive. We'll have to see if there are any future additions. FreeMarkets' directors include the co-founder of FORE Systems, Inc., a pioneer in the development of ATM high speed networking equipment, which was acquired by GEC, p.l.c. in June 1999, and a general partner of Stolberg, Meehan & Scano, a private equity investment fund focusing on business-to-business services in the communications, utilities, information technology and electronic commerce industries.
Shares are available through Goldman, Sachs & Co., Morgan Stanley Dean Witter, Donaldson, Lufkin & Jenrette Securities Corporation and Wit Capital Corporation.
Because FreeMarkets, Inc. filed to debut during the week of Oct. 25th the IPO article for the November issue of Taipan has been posted online early.
Siu Yee Ng now writes a weekly IPO column on this site. Check it out for previews of upcoming IPOs, weekly picks, and a Friday afternoon wrap-up.
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