Commerce One: Everything but Profits

Vendor Genesis:

Commerce One began life in 1994 as DistriVision, originally focused on developing CD-ROM sales catalogs. The company took its first steps toward fame and fortune at age two-and-a-half when it grabbed Mark Hoffman, who had been CEO of Sybase, to be its leader. As new CEO, Hoffman quickly raised more than $7 million in venture funding for the infant company, and brought several former Sybase employees along with him. Hoffman said at the time that he supposed the company could reach $100 million within five years.

A few months later the company had a new name and a new product release to go with it. In April 1997 Commerce One released products for building online catalogs, for shopping and for transaction processing. Following upon this release the company entered into its first significant relationship, a partnership with MCI. Under the terms of the partnership MCI provided network infrastructure and 24/7 operations for Commerce One to build its marketplaces. MCI Systemshouse and Ernst&Young Technologies were signed to provide consulting services to suppliers. MCI also became one of Commerce One's flagship customers.

In 1998 Commerce One teamed with Microsoft, PriceWaterhouseCoopers and SAP to offer purchasing services in Europe. Microsoft's presence was due to Commerce One's strategy of basing its products on standard Microsoft software. SAP was to provide ERP software. Also in 1998 the company made a fundamental commitment to XML by purchasing Veo, Inc. Veo specialized in developing XML based products for trading networks. Veo had been spun off from CommerceNet, where it was instrumental in developing CommerceNet's proposed standards.

By March of 1999 Commerce One had released a fully functional online product suite based on XML as a connector that would enable other companies to link with its software. With this software Commerce One's customers could go through Commerce One's marketplace, called MarketSite, to reach such vendors as Office Depot and Grainger. An XML tool, called the XML Commerce Connector, allowed buying companies to link from their own internally maintained catalogs into MarketSite, and also linked MarketSite to supplier catalogs. Overall, Commerce One's position regarding business languages in general and XML in particular has been to support open connectivity.

The same year, 1999, was Commerce One's IPO, which brought the company $69 million. However, soon afterward Commerce One suffered a setback when, as a result of its merger with WorldCom, an Ariba customer, MCI switched to the Ariba Network. But the loss was not fatal (although. Ariba's PR people made the most of it). By the end of the year Commerce One's stock price had shot up twenty fold, giving it a market capitalization of $20 billion, and it had partnerships with companies like British Telcom, Nippon Telegraph and Telephone, PeopleSoft and such financial institutions as Toronto-Dominion Bank of Canada and Banacci of Mexico. It had signed to develop General Motors' GM Marketsite, and had purchased CommerceBid to gain the technology to add auction capabilities to its product line.

Toddling into the year 2000 Commerce One has been moving strongly, especially in the international part of the world. It has developed regional trading hubs in China and South Africa to add to its others in Japan, Australia and Southeast Asia, Europe and North America.

Figure 1 shows the company's revenue history. Through Q3 of 1999 license revenues were growing faster than exponentially and service revenues were growing slower than linearly. This was an excellent position to be in. (Growth in revenues has been so amazing that were it to continue at those rates it would exceed $5 trillion within two years. So, of course a slowdown was to be expected, and must be seen as healthy. Growth in Q4 seems to have slowed in geometric terms, but this should not be of much concern, especially given the dramatic upturn in Q1 of 2000.)

However, licensing is not where the company expects to make its money. Much of its revenue is expected to be in the form of transaction fees for the purchases made on the various networks it manages or has revenue partnerships with. The company also expects to garner revenues from commissions on auctions and from subscriptions to hosted services. There are also revenue sharing agreements with at least 75 portal partners and the company is developing other services.

Overall, to date the only significant revenues have been from license fees. This is in line with all reasonable expectations, but we'd look to see those revenues begin to flow by Q3 of 2000, and Commerce One agrees that the next year or two will be critical in proving their financial viability.

Figure 1

Vendor Strategy and Trajectory:

Commerce One's initial strategy can be contrasted with that of rival Ariba, which went IPO a week earlier. Both companies discussed desktop (buyer-side) software and marketplaces. Commerce One claims that their emphasis from the beginning was always on the marketplace and that Ariba's was focused more on the desktop. It is possible to read the initial documents this way, although both companies left plenty of room to reset their directions after launch. However it is clear that Commerce One has been moving aggressively to build a large global network, and that the development and growth of the marketplace is a keystone of its strategy.

Commerce One identifies three types of marketplaces as being central to its future.

Mid-market: These are marketplaces dedicated to a single midsize company's supply chain or to a vertical niche. The Promus Hotel chain runs a marketplace of the former kind and OmniCell has one of the latter, in the healthcare industry.

Exchange Markets: These are larger markets organized around supply chain optimization. Examples include Commerce One's partnerships with General Motors, Shell and CitiCorp.

Regional Markets: Commerce One has been busy building regional marketplaces though partnerships with such companies as BT in the United Kingdom, Cable and Wireless Optus in Australia and NTT in Japan, to name about a quarter of these partners.

Commerce One ties these three market types together loosely in a Global Trading Web. For example, a pub equipment supplier in Australia might create a marketplace for its supply chain. If the marketplace operator allows, members of the marketplace can be given access to the regional market or even to the Global Trading Web, which would in principle allow them to sell their beer mugs and skittles to companies across the world. There are about twenty core regional participants in the Global Trading Web, with about twenty core verticals in each region.

Besides its marketplaces Commerce One maintains its desktop purchasing application, Commerce One BuySite, which currently supports about fifty enterprise customers. Commerce One's target customer is the large multi-national member of the Global 1000 or Fortune 200 with $500 million in indirect spending and 500 or more employees. The company is also looking for ASP opportunities, which Corio is the first to develop.

Commerce One has the philosophy that partners should share risks and rewards; as one executive puts it, "both sides should put their skin in the game." Thus, the company will take equity positions in small market makers, trading revenue sharing for lowered license costs. On the other hand, some of Commerce One's larger partners have taken equity positions in it.

Commerce One tends to believe that it is on track with both the BuySite application and the marketplaces, and is looking to extend its capabilities and offerings. A prime area here is developing supply chain solutions, which are being pursued through partnerships with Aspect Development (but see below) and with Adexa (see TEC note: What's in a Name for Supply Chain Vendors?)

Another is in the area of auctions; its Commerce One Auction Services product, based on technology acquired with its merger with Commerce Bid, can be sold as a standalone product or integrated with a marketplace solution. The overall direction of the company is to be a provider of enterprise portal solutions that are leveraged thought the Global Trading Web.

ANALYSIS:
Vendor Strengths

Commerce One's hierarchical network structure is an attractive environment for buyers and suppliers.

Commerce One has also built a very strong position in XML and catalog management, the latter through its acquisition of Mergent Systems. It has displayed a willingness to be an open system, much more than has Ariba to date, and this is helpful because it enables partnerships of many kinds. Not the least of these is its willingness to make network membership available through second tier products. Peregrine Systems and RightWorks are two of at least fourteen partner companies that can compete for the smaller companies within Commerce One's range, but which proudly offer access to MarketSite.

It is important to recognize that Commerce One's commitment to XML is far-reaching and represents a real technical strength. In particular, where XML itself is a standard that is technically neutral to the values passed in fields, Commerce One has incorporated data field validation ("strong typing") into its schema language.

Vendor Challenges

For any company in Commerce One's position - high market capitalization, done almost everything right, never shown a profit - the biggest challenge is going to be to keep the music playing. Although losses have been growing steadily, Figure 2 shows that over the last year the loss per dollar of revenue earned decreased significantly, which suggests that the company may be moving in the right direction.

Given that Commerce One's business plan still calls for it to make the majority of its revenues from transaction fees, it is unfortunate that much of the control of whether that happens is passing into the hands of other large companies. We have no reason not to expect that the various regional marketplaces will develop as long as the global economy stays strong, although it is not clear at what rate that will happen. However with the large exchange markets Commerce One is somewhat at the mercy of the relationships between the major partners (such as GM and Shell) and their supply chains. Those are complicated relationships that might not bend easily to the use of an exchange market.

Figure 2

Commerce One will likely be under pressure to match the incredible partnership between Ariba, i2 and IBM (see TEC note: B2Big Deal for IBM, Ariba, and i2)

While it has partnerships with Aspect (which the company says will continue despite Aspect's absorption by i2 (see TEC note: IBM is not Enough: i2 Snatches Aspect and SupplyBase), with Adexa, and with various system integrators, they do not match the magnitude of Ariba's deal.

In sheer numbers a case can be made that the difference isn't huge. For example, PriceWaterhouseCoopers has 500 consultants dedicated to Commerce One and there are similar arrangements with Arthur Andersen. IBM has not stated how many of the 138,000 people in its Global Services Division will be dedicated to the Ariba/i2 partnership, although it has promised to have "thousands" of salespeople working on it.

Regardless of numbers though, Ariba's deal is breathtaking because of the involvement of IBM. Of course Commerce One will continue to develop solution and partnerships that reach through the supply chain, but it is not clear that Commerce One should try to match the enormity of this partnership. The integration aspects of getting the three companies to play together at the technical level have barely been examined. (And Ariba has other integrations on its mind as well). If they prove difficult Commerce One may look stronger continuing as it is going. Whereas if the integration is smooth and easy the worst that will happen to Commerce One is that it will end up being a successful and rich "number 2."

For completeness, we note that Commerce One has been keeping a large cash reserve for more than a quarter, much larger than the management textbooks like. However, we suspect that Commerce One doesn't need our suggestion that those resources can be better used than for stuffing a mattress.

BOTTOM LINE
Vendor Predictions

Commerce One has enough momentum that even a major stumble will keep it moving forward for a considerable time. But the precise direction it takes will depend on small forces that are difficult to discern.

We think that Commerce One is quite committed to building a huge revenue base from fees (transaction, commission, and subscription) in its markets, and that unless everyone is guessing wrong about the digital economy those revenues should be looking healthy within the next 18 months to 2 years. Whether that means profitability for the company as a whole depends on whether Commerce One gets to slow down its expenditures. While absolute expenditures have been increasing, as Figure 3 shows for the key areas of Sales and Marketing and Product Development, Figure 4 shows these areas shrinking as a percentage of revenues.

In short, it seems that if Commerce One keeps doing what it is doing, its future will be rosy. We think that only a major change in its business model would interfere with this happy story. But such a change is likely to be imposed on them by the growth of new models for doing business on the Internet.

To continue its move toward profitability without giving up its technological growth Commerce One may choose to give its stockholders both the satisfaction of success that everyone desires and the thrill of remaining on the roller-coaster car named Internet. It could do this by spinning off a profitable market management business as a separately traded subsidiary, or spinning off a number of operating divisions under a holding company shell, leaving something looking like a B2B version of CMGI.

While the next product directions have not been announced, we expect to see strong use made of the company's depth in the area of XML; an enterprise level content management system of some kind could be a likely candidate. Commerce One has already acquired Mergent Systems for its catalog aggregation and management technology; we're postulating that a more general content management product (such as a corporate portal) might be a logical way to gain value from the XML investment (probability 30%).

Figure 3

Figure 4

Vendor Recommendations

When Commerce One and Ariba started on their historic journeys, their focus was logically on larger enterprises. However, the mid-market is huge and extremely interested in cost reduction. Some of these companies will find their way to verticals, but many are primarily buyers of MRO goods. Commerce One can capture a lot of this market's transactions by continuing to build partnerships with smaller vendors of purchasing software and purveyors of corporate portals.

We can imagine good results from a tasteful marketing campaign about how Commerce One is very interested in this segment. Such a move, we think, would require Commerce One to provide marketing and technical support for its partners. Commerce One could win big in transaction revenues and, incidentally, spread its flavor of XML very widely.

User Recommendations

Companies in Commerce One's target market should have no concerns about selecting Commerce One's BuySite for MRO purchasing. We think that Commerce One will have to work a bit harder to make sales to companies with aspirations of bringing e-commerce to their entire supply chain. We don't doubt that they will have an adequate solution, but the potential of the i2/Ariba partnership and the uncertainly about where Commerce One's cooperation with Aspect will actually lead requires evaluators to ask particularly hard and probing questions.

Potential large market makers will also be comfortable putting Commerce One on their short list, and should give it extra points for its strong international ties.

Smaller companies, those at the low end of Commerce One's target range and below, can also consider Commerce One through license or, as the capability develops, ASP. But they should shop more carefully because the additional capabilities available from portal and self-service vendors may meet their other needs, in addition to purchasing, in the same package.