Online auctions and trading hubs are cutting net costs

'The playing field will be levelled to help benefit smaller firms'

Every time there is a merger between two large companies there is a promise of cost savings. They are going to shut one of the head offices, combine their accounting systems - and save money by using their larger scale to purchase supplies more cheaply.

Every time there is a merger between two large companies there is a promise of cost savings. They are going to shut one of the head offices, combine their accounting systems - and save money by using their larger scale to purchase supplies more cheaply.

So the bigger the company the cheaper it can buy? Up to now, yes. Indeed, one of the effects of the new communications technologies would seem to be that the competitive advantage of scale might be increased. For a start it allows large companies to centralise their procurement, making sure every part of the business pays the lowest price for its supplies.

Examples abound of cost savings. BP reckons it has saved $15m simply by putting a database on its intranet, showing what supplies have been bought at what price. Earlier this year, Ford shook the automobile world by announcing it was joining General Motors and DaimlerChrysler on a joint online purchasing scheme. GE Lighting reckons it has cut the average cost of supplies by 20 per cent by e-mailing for quotes. The simplicity of e-mail allows it to contact a wider range of suppliers and pull in quotes it might not have received.

So does this mean that far from being a democratising technology, electronic procurement strengthens the hand of the powerful against the weak? Initially maybe, but there are developments which suggest that eventually the playing field will be levelled and small companies will be able to purchase on terms similar to large ones.

Theoretically, this is obvious: the internet is the world's biggest shop; it allows transparency of pricing globally; and it cuts the cost of making transactions. So, in theory, it should not only allow small companies to combine their procurement so they can obtain best global prices; it should also make them as a group easier and cheaper to supply, and accordingly a more attractive market. But there has to be the appropriate infrastructure and that is only now being built.

Most progress, unsurprisingly is in the US. But even there the picture is confused: lots of things are being tried and we don't know yet which ideas will prove winners. But as far as it is possible to categorise, the two broad strands of development are auctions and trading hubs.

Auctions were the first generation of internet-based transaction services: companies including eBay in the US, or QXL (founded by ex- Independent journalist Tim Jackson) here. These are becoming more specific. For example, PlanetTest.com brings together buyers and sellers of testing and measurement of scientific equipment, and DEXPO.com brings together suppliers and distributors of dental supplies with 150,000 dentists.

Auctions will grow and become more specialised, but are not suited to every purchase. The hot development is trading hubs, or internet exchanges. A string of such exchanges is being built, grouping buyers and sellers together. Companies can be grouped vertically by industry or horizontally by size.

A good example of a horizontal grouping is Mondus.com, for small and medium-sized businesses to get quotes for supplies. A good example of a vertical hub is VerticalNet, which operates industry-specific hubs in the US and which is joining BT to set up a similar venture here.

There are also hubs controlled by industries or large companies, such as the joint purchasing plan for the US car industry, or the "portals" set up by Barclays and Lloyds where small companies can buy supplies at prices negotiated by the bank.

But the best hope for smaller companies is probably not getting a bigger one (like a clearing bank) to negotiate a good price on their behalf, but to use the independent trading hubs developing to serve their particular industry. How far will this trend go? The main thrust among small firms seems to be in cutting the cost of supplies which are not an integrated part of the production process.

In other words, they are using the new systems to cut the costs of paper and envelopes rather than components for products they make. This would figure. If you want to dip your toe in the water by switching some purchasing to the internet it makes sense to start with peripheral items.

The risks are smaller and the potential gains larger. There is no significant long-term relationship that might be undermined, as there would be with component manufacturers, and you have enough experience to get decent prices on components and you may not do so on office supplies.

But the scale disadvantage of smaller firms will disappear only if they can use the net to lift their purchasing power through the production process: so they are getting big-company pricing at every stage of their business.

That will not happen until the various trading hubs or exchanges develop further. So the giants will go on using the new technologies to scrunch their own costs.

But small companies don't really need more exchanges: they need ones to provide the specific service their industry requires and that may mean fewer. There are some 600 internet exchanges in the US, and the number is expected to fall to less than a third of that in the next two years.

What the internet has taught us, though, is that if there is an economic need for a service, there will be lots of people trying to figure out how to provide it.

One of the overriding lessons of the net is that it enables smaller companies to gain many of the benefits long enjoyed by big ones. In this business, that task will take a while to figure out.