30 May 2000  Research & Ideas

Market Makers Bid for Success

Two CEOs at the forefront of the transformation in the way businesses buy and sell goods—Scott Randall of FairMarket (HBS MBA '87) and Glen Meakem of FreeMarkets (HBS MBA '91—spoke with Professor Bill Sahlman recently about their paths to new business models and what they've learned along the way.

 

In late February, Harvard Business School professor Bill Sahlman spoke with two former MBA students, Scott Randall ('87) and Glen Meakem ('91), to discuss their perspectives on organizing markets in a new and evolving economy and what they have learned along the way. Randall is the founder and CEO of FairMarket, which provides online auction services for a variety of merchant and community sites. Meakem is the founder and CEO of FreeMarkets, which creates business-to-business online auctions for industrial parts and suppliers.

Sahlman: Glen, tell us a bit about your company.

Meakem: The two-minute version is that after I left HBS I worked at McKinsey down in Texas. I learned two major things while I was there. First, the way to make money in commodities markets is to have superior information, to make better trades, and in some cases, to even create new commodities markets. That happened in natural gas in the late 1980s and early 1990s.

And, there's always money to be saved in industrial sourcing. If management really focuses on purchasing and puts effort into it, you can always save money by creating more competition between suppliers and finding better suppliers who are more efficient and higher quality.

After I left McKinsey, I went to GE, where those two ideas came together. I saw the way that GE was doing high stakes face-to-face negotiations for materials, things like metal components, plastic components, and electronic components, and it occurred to me that instead of doing these manual negotiations, why not just use online auctions?

Glen Meakem, MBA '91
Glenn Meakhem
HBS MBA '91
founder and CEO, FreeMarkets

That was a pretty radical notion in June 1994, but it worked. What I learned very quickly was that it wasn't just a question of technology—it was relatively easy to create rudimentary auction technology that would work across the network. What was difficult was getting the right information at the marketplace. It became clear that there needed to be a whole market infrastructure to create these new kinds of commodities exchanges.

I left GE in early 1995 and set out on the epic quest of trying to create that infrastructure and that new kind of commodities marketplace. And that's what we've been doing at FreeMarkets ever since. The anniversary date of the day I left GE was the end of February, five years ago. I probably got home at 7 or 8 p.m., and the next morning at 6 I got to work in my basement on starting FreeMarkets.

The first thing we did was raise some money, and then we built some software. We found some pilot clients and started to develop market-making skills, a supplier database, rules for the market, and a call center that would operate in multiple languages in many countries. We've been building that infrastructure ever since.

Since we started, we've added a lot of technology to the marketplace over time and utilized the World Wide Web. And we've changed the pricing model quite a bit from the beginning.

Sahlman: How so?

Meakem: We figured out that supplier-side pricing didn't work, that you have to charge the party who receives the greatest benefit for the cost of the marketplace. If you try to shove the cost of the market off on to the parties who are being forced to compete, who in essence are not getting the greatest benefit, it will not work, because those parties will fight the market too much.

We've now moved into upward and downward auctions and other kinds of exchange mechanisms for different economic situations. We have an asset marketplace for used assets and excess inventories and procurement marketplaces in direct and indirect materials, which are primarily downward auctions. Although, there are some market situations where you would use an upward auction just to have people bid on certain kinds of pricing.

Basically, we've evolved our business model over time. We've learned that the buyers, who have the power, must pay the cost of the marketplace, not the sellers.

Sahlman: Scott, can you give us the short version of your career?

Randall: After working at Procter & Gamble in brand management and in consumer packaged goods, I got into e-commerce with NECX and then I ran the Internet Shopping Network. I started FairMarket three years ago. My take on where the market was heading three years ago was similar to Glen's: that dynamic pricing was going to be a significant market opportunity where buyers and sellers could come together and basically set a fair market value for the items traded.

Our initial take in our first business model was that of a destination site, FairMarket.com. We would run a site and drive buyers and sellers to it. Our concept was to start on one vertical market segment and then expand to additional verticals. After doing that for about a year and a half, we came upon a couple of conclusions that ultimately made us change our model.

Scott Randall, MBA '87
Scott Randall
HBS MBA '87
founder and CEO, FairMarket

First, we took a good look and said that ultimately it would be hard for us to become experts in multiple verticals. You can do multiple segments, but it's somewhat difficult to scale horizontally. We also decided that while there are lots of companies with expertise in different verticals, our basic concept of using auctions to help buyers and sellers was exactly right and our pricing was right. While our executional format of a destination site was still certainly a viable model, we decided that we'd rather become an infrastructure provider to other companies and marketplaces as opposed to us driving traffic to our own site.

We switched our model almost two years ago in the summer of 1998. As part of that one shift in strategy, we made the call that a critical ingredient for any marketplace was having a large number of buyers and sellers. And while any one marketplace could do pretty well at it, we thought that by leveraging the power of all of our customers, both buyers and sellers, it would provide even more compelling value to all the marketplace participants. So we invented the concept of FairMarket Network, which is basically a distributed selling environment, where we'll run marketplaces and auctions for many companies underneath their own brand. That way they'll drive the traffic; they'll be responsible for all that. But we'll network them, meaning that goods for sale on any one site can be distributed to all the other sites in our network for bidding. So, as a marketplace operator, you get your own marketplace, you get your own brand. But you also get the benefits, whether you buy or sell, of all the other marketplace participants.

We've been executing that strategy for the last two years. We focused initially on the B-to-C market. But we see the dynamic pricing mechanism as having applicability in all markets, including person-to-person, and B-to-B.

Sahlman: Both of you had turning points where your original business models turned out not to be quite right. Was this painful?

Meakem: It was painful, but whether you're running a start-up or an established company, there are turning points where you need to assess critically how you're positioned and ask, "Is the market coming toward us or running away from us?" And thank God we did what we did. And it's hard, because you need to move. Your board and your investors and everybody in the company need to face up to it. We made a big bet and we just ran with it. As CEO, you can't be scared of making bold decisions. It's tough, but you have to be able to do it.

Sahlman: Scott, part of your goal was to be able to mix and match some of the databases of items for sale, which you could do on a hosted version but couldn't do if they were off in disparate places.

Randall: Right. For instance, right now we run auctions for Dell Computer and Microsoft (MSN). We run Dell's on its site, where only their stuff appears. But we also propagate Dell's listings through to MSN auctions, so people can bid on them from within MSN.

Sahlman: My sense is that many of the people who are engaged in e-commerce ventures are not technology people, per se. This is all about business model reengineering, not knowing bits and bytes and programs. Is that true?

Randall: Technology's just a means to an end. In the application business, where you're running marketplaces or external business applications, it's even more true. If you went to the really heavy-duty tools companies, you'd probably see more techno-geeks. But technology's just a tool to use to build your business. It's not an end in and of itself.

Meakem: I agree. It's all about applied technology in an economic context. The people who tend to be leaders in the applications side of e-commerce are market thinkers, technology thinkers, business thinkers. They understand an area of the economy and apply technology to it. These are not people who are deeply, deeply technical. I agree with Scott that when you get into the heavy-duty tools part of the business, you'll probably find leaders who are more technically deep.

But, we have some true geeks, too, because one thing that's happened is that the Web is almost like Back to the Future. I was on the road with my CIO two days ago, and we were talking about the fact that some 20 years ago, when she was involved with mainframe computing, people who were programming had to understand all the communications protocols and the way everything fit together.

There was a time when that became less important in the whole server era, but now it's happening with the Web. In order to get performance out of the Web, you've got to go back to that real elemental level of communications or architecture.

Randall: Right. In fact, I think it's gotten more complicated as people try to sort out how to improve the capability, speed, and capacity of the existing network.

Meakem: Exactly. In our application, that's critical, because we support real-time global bidding over the Web. We believe economically that you've got to have real-time interaction between people to bid out important, B-to-B pieces of business. And so a 5-second delay, a 20-second delay, certainly a 2-minute delay just doesn't cut it, because you don't get an efficient market outcome. We've worked hard to engineer this real-time environment, and that takes a lot of depth, so we have some real geeks. It's just they're not in my chair.

Sahlman: An interesting thing we have observed is that some very successful people have come out of more traditional jobs, such as Procter & Gamble and McKinsey. For example, Scott Cook [HBS MBA '76], the cofounder and chairman of Intuit, is a famous earlier version of the ex-P&G; guy. How does that work?

Randall: The skills that you learn both in business school and certainly in traditional companies like Procter & Gamble are totally transferable. At HBS you really learn how to think, and at a P&Gamp, you learn classical branding and positioning and market attack plans. You get the experience, then you take it to the high-tech world. I think that experience is just a phenomenal jump-start. The same principles of business still apply in the new environment. It's totally helpful.

Meakem: It's funny. Scott's arguing nurture. I guess I'm sort of a 50 percent nurture, 50 percent nature kind of guy when I think about how people operate. If you go back to the late 1980s, the IT revolution was taking hold, but it wasn't such a pervasive part of the economy, and in 1990-91, we had a major recession. Back then I think a lot of people who had a latent desire to be in small businesses or to be entrepreneurial didn't see the entrepreneurial opportunities. They didn't want to go into banking or be involved in something completely separate from an operating business, like a specialized business field, so they went to companies like Procter or McKinsey, because that was where they could develop more business skills while they hung out and waited for their entrepreneurial opportunities to arrive.

Sahlman: There's been a big shift in the past four years. Graduates used to be in traditional jobs, such as at Procter & Gamble, for anywhere from five to ten years before they'd leave to start their own business. Now, students are starting businesses three to four months after graduation. Do you think that's risky?

Randall: At the end of the day, a student who jumps right out will have a different kind of learning experience. They're not going to get the classical training, and they'll get less mentoring. When I worked at Procter, you got a ton of attention, in large part because of the process: teaching and training you was their key priority. But at FairMarket, we really don't teach anyone. You just throw folks in because you don't have the time. Start-ups are great places. You have to desire a start-up—almost from a genetic standpoint. Certainly I fit in that camp. But the downside is you're not going to get the classical training. You get your training by fire, and so you'll have a different set of skills—an ability to move fast and react quickly and anticipate. This is what the real world is like today. There's certainly some disadvantage to students jumping right out. But there's no place to learn like doing it, though.

Meakem: I agree. The benefit of jumping right out is that you don't get cushy; you don't get used to a corporate job with corporate perks and get lulled into submission by staying at a large corporation for too long. You avoid that. You're sort of in this "closer to the flames" world.

If you look at FreeMarkets, we have over 400 people now. We've got 50 people in Europe, 325 people in Pittsburgh, and about 25 people strewn across America and the rest of the world. And today's market cap is over $6 billion. We finished the year with about $21 million in revenue, and we're growing very fast.

What has recently happened in that environment is it has become necessary to hire senior people with real experience. In September, we had the good fortune of hiring a world-class CFO. She had worked at AT&T for 15 years in various financial roles and had been CFO of a $26 billion business-to-business long-distance networking company within AT&T. She is a real pro. And thank goodness we have her, because I don't know what we'd do without her, with Wall Street and everything from SEC filings to analyst relations. But that's what is interesting to me. Classically-trained people have tremendous value in these companies, once they get to be of a certain size. When you're really small, jacks-of-all-trades are very valuable. But as you get larger, people who are the real pros—experts in their areas—become incredibly valuable. And the jacks-of-all-trades who can do it all, but who aren't really great at doing anything, become less valuable.

Randall: Right. I think it's related to the stage of the company. When we started, we had a lot of jacks-of-all-trades. We've been doing the same thing as Glen from an experienced team standpoint. We hired a VP of sales who had 10 years of great experience managing a couple billion dollars in revenue and 1,500 salespeople. Our VP of engineering and our CFO are also like that. It makes a huge difference, because you can't have people going through this the first time—you need the bench strength. Especially now as market caps reflect very high expectations of performance and the margin for error is so small, you really need senior people to take you to the next level.

Sahlman: Where did you guys learn how to pick people?

Meakem: I used to think that I was a really great judge of people, that I could tell a good person from a bad person through interviews and so on. And I think I started out at FreeMarkets with too much confidence in that area. So as a result, my team and I have made some mistakes in hiring.

We have been humbled and realize that, boy, it's not easy. So we've become more rigorous about trying to get down on paper what are we looking for. We're trying to figure out what we want analytically and then interview for that, and making sure we're getting what we need. We've become much more rigorous about that.

But we also recognize that we make mistakes and that you have a culture that allows you to correct your mistakes. And that means firing people who don't work out. And we're pretty good about that, too.

Sahlman: Scott, I take it you haven't had to fire anybody?

Randall: Exactly, I've made perfect hires my entire life!

It's hard, and you make mistakes. But the more you do it, the better you get at it. And as a company grows, the kind of people you look for is a little bit different, too.

Early on, you do what you can to attract as high quality of a person as you can. We had some good jacks-of-all-trades. We attracted our first crop of people in 1997-98, which basically got us to the next level. And then, unfortunately, we outgrew some of those people; some of them I let go. It just wasn't a good fit for either them or us.

In the perfect world, you hire your ideal team right from the start. But the reality is that we'd never have been able to attract our senior management team two years ago or even a year ago. So, as you grow, you try to do everything better. You hire better people, you get better funding, you get better employees. It's a nonstop upgrade process.

But the hardest thing is really determining what you need and what skill set is required. Nailing down the moving pieces, for a young company, is difficult. Should this be one job or two jobs? If it's one, then you need somebody that does a little bit of both A and B pretty well. If there are going to be two jobs, then you need experts in each area, and that's hard from a structuring standpoint.

Meakem: It's interesting how you start out with a team and then you need to upgrade. Our experience is that if it's a choice between deep, deep experience versus the natural athlete, we still go for the natural athlete.

Randall: Us, too. If you know how to think and adapt—if the situation changes—you're still of use, whereas if you're a kind of a single-purpose performer, if you change the play, you're in trouble.

Sahlman: It's an interesting human resources strategy to try to make sure that you don't have people who define your strategy and make it such that you can't change it.

Randall: Yes. The more narrow and deep functional players you have, who see it with their own view and their own experience level—that can trap you. And in this environment, if you're not flexible, you're dead.

Sahlman: Let me turn to the revolution that is now going on. You guys are at the forefront of the revolution. I've used the analogy of the force field that used to protect Jurassic Park. It goes down, and the raptors run loose. You're the raptors, and I'm a raptor trainer. The VCs are a bunch of raptor feeders out there, and they're attacking all the larger dinosaurs that are not moving very quickly.

Meakem: And the larger dinosaurs are getting angry and are trying to attack back.

Randall: And they're bigger.

Sahlman: Well, we've started a war, and the stakes are very, very high. How do you see this from the frontline? How do you see it all playing out? When do the raptors get their comeuppance? What role do the frothy capital markets play in all this? What's it all going to be like in five years?

Meakem: Well, the frothy capital markets have effectively taken away the camouflage. So if all of us had market caps that were an order of magnitude smaller, it would be easier right now to be infiltrating and creating new marketplaces and new Internet services, etc.

What's happened, though, is that the market caps have gotten so astronomical that everybody wants a piece of the action. As a result, the market caps have made this thing a lot more competitive than it would be otherwise. So the positive is you can make a lot more money. The negative is there's going to be a lot more competition. And there's an infinite amount of capital being attracted to all of these B-to-B e-commerce-type opportunities. Where is it going to evolve? There's going to be a lot of winners. There will also be many, many losers. There were a lot of start-ups back in 1995-97 that have already failed. The press never focuses on that, but there are many examples out there of companies that have failed. It's not a question of the big eating the small. It's a question of the fast eating the slow.

Randall: It's scary to see the Internet sophistication of even our established customers. It's just phenomenal. For instance, we just announced that J.C. Penney is going to be a customer of ours.

Now the scary thing for start-ups is that they are being dwarfed by larger businesses, with their branding and customer base. So the key for start-ups is to be nimble, move quickly, continue to think out of the box, because the big companies can't respond. It's almost like they're just taking body punches from us, the start-up companies.

But we're going to need to figure out how to work with them. At FairMarket, we're enabling these large businesses to succeed. (We're targeting Fortune 1000 companies.) That was the key decision we made—not to compete against them. No way do we want to compete against Dell. What we want to do is enable them. So in effect we're making it easier for them, giving them the tools to make them successful, which we think is big business.

Meakem: We're a little bit different than that. I mean we're an enabler, too, but we're enabling people to access the marketplace. It's a full infrastructure. It's like going to the Nasdaq to buy stocks, you go to buy essential parts. So we may end up being in competition with some bigger players.

It doesn't make economic sense for every $10 billion company out there to try to create its own marketplace. It makes a lot of sense for them to come to a multienterprise marketplace. And then, of course, if you're a $100 billion company and you try to create your own marketplace, you certainly have the financial resources to do so, but, in terms of human resources, can you really get the dot.com people you need to work for you? Finally, another subtle issue: Do you really have the ethical nature to run your own marketplace, to be the fox in charge of the hen house?

So, there are a lot of places for third parties to actually create markets, and police market behavior, and put in place market infrastructure, whether it's technology or information. There are many different ways for third parties to play roles between large, existing organizations.

Sahlman: I agree. And I think the one place you don't want to be is to be competing against the big established players, right?

Randall: Well, that's certainly true as a retailer. You don't want to end up competing against a Wal-Mart, for instance, because at some point the traditional brands really have an advantage. You may have a chance if you're the first one in the market. But if you're not doing something demonstrably better, either creating a new paradigm or servicing these companies, I think it's a tough place to be.

Meakem: It depends on your definition of success. Right now, there's a lot of opportunity to be a fast follower: kind of troll the market, see what's successful. Then as soon as you see a successful business model, go copy it. There are entrepreneurs out there right now who are doing that for a living.

But the most distinctive opportunities, the richest opportunities, come from discovering a new market, finding a new need, and meeting that for the first time. That's what Amazon did, that's what eBay did, and I think that's what we've done.

Sahlman: So there are big payoffs, and there are little payoffs, and there are things that depend on frothy capital markets to have payoffs?

Meakem: Absolutely, and the biggest payoffs come when you have created something truly valuable. If you're Amazon or Yahoo!, you have created something valuable. For this class of company, there's a business underlying all the froth and all the hype. So even if the froth and hype go away for a while, it's still a business that's going to be of value.

We just had a rough week. We lost 25 percent of our market cap. I was on the phone with one of my board members discussing that this morning, and he had one piece of advice and one analysis, which is interesting. And this is an HBS grad, too, just for the record. He said, "You know, as a CEO, you've got to be focused on the key issues. There are so many things coming at you. But always have in your mind what are the five or ten key things that have to get done, and update that list constantly. Constantly keep your focus on those, and don't get carried away on the other things." That's a good piece of advice.

Randall: You need to stay focused on the fundamentals. If you just play the game without the fundamentals, you're dead. As soon as anything turns, you're dead.

Meakem: Right. And even with hundreds of millions of dollars in the bank, if you keep your business running at a $15 million a month burn rate or something absurd, you can be dead. I'll never forget that from the last day of Entrepreneurial Finance—don't run out of money. Don't run out of cash.

Sahlman: One last question. What did you learn at HBS that has helped you as you've gone on this amazing journey?

Randall: I learned how to think. In business, there are so many different situations that you need to assess quickly and come to a decision about, and by reading a case in the 10 minutes before the professor walks in, you've got to get to the punch line and try to get the key decision factors, assess them really quickly, and make a call. So I think the rapid fire and the breadth of situations is critical.

And then it's also a confidence thing. You've got to be confident in your own personal ability to make decisions. In a classroom, you're in front of lots of very confident folks every day. By going against the best of the best and expressing your views articulately and forming coherent thoughts, you gain confidence in your ability to stand on what is really a world-class stage. That is critical, because as CEO, if you ever doubt your own ability, then you're doomed. Those are probably the key things I took away with me.

Meakem: I draw on CCMO [Coordination, Control, and the Management of Organizations] every day, just in terms of compensation—our compensation structure and the incentives it creates. In that course I also learned how not to mess up a sales force. So there's a lot of specific learning.

I think there's a flip side to what Scott just said. There's a certain sense of humility that can come out of being at HBS, too, which is healthy. To lead people successfully in today's intellectual capital businesses—which is basically what we're in—you've got to be, on the one hand, incredibly confident. You've got to have vision, and you've got to be confident about that vision. But on the other hand, people don't want to work for some egomaniac who's totally focused on him- or herself. They want to work for someone who's part of the team and who's making them successful. I think that comes from humility. In the new economy of the 21st century, leadership is about this combination of confidence and humility. I think HBS can, in its way, train you in both, because while it can certainly build confidence, it can knock you down a couple of pegs and give you some humility, too.

Coming right out of that is the team thing. One thing I learned at HBS was that to be successful in business you've got to assemble the right team of people, and it's absolutely true.

Randall: I second the humility piece. Not only do you have to be humble, but also you have to admit your mistakes. We messed up for the first year and a half-wrong strategy, wrong everything. People don't want to follow a leader who thinks he's above everything. You need to be able to say, "Hey, you know what? I messed up. Here's what it is. I take the blame for it." I think people respect that.

I make more mistakes than anybody, and that's my goal. If I'm making enough decisions, I'm making more mistakes.

Sahlman: Thank you very much. We're very proud of you both.

FairMarket
Woburn, MA & London
FreeMarkets
Pittsburgh, PA & Brussels
Business Deploys, manages, and
maintains online auctions for customers
Creates business-to-business
online auctions for buyers of
industrial parts, raw materials,
commodities, and services
CEO Scott Randall (HBS MBA '87) Glen Meakem (HBS MBA '91)
Founded 1997 1995
Employees 200+ 400+
IPO March 14, 2000 December 10, 1999
Market Capitalization
(March 24, 2000)
$1.1 billion $6.5 billion

From HBS New Business, Spring 2000.