Monday, June 22, 2009

Are Lead Exchanges Doomed?

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When I entered the lead generation industry a couple of years ago, all I ever heard about was lead exchanges. Lead providers were building them, independent companies were operating them and even mortgage CRM companies like Ellie Mae were starting to offer them. The smart money seemed to be on lead exchanges being a fundamental force of change in the lead industry. An individual as smart as Lew Ranieri, the inventor of mortgage securitization, even had a personal stake in a lead exchange called Root Markets.

Exchanges are appealing. I used to work at Andersen Consulting in the ‘90s and advised companies about their marketplace and exchange strategies. I even left Andersen Consulting to start an exchange in the soft commodity industry myself. So I am certainly not the least bit immune from “exchangitis”. However, the fact is that exchanges rarely work. The first mega-exchanges like Covisint in the auto industry which sucked up billions of dollars, that it appears would have been better spent on building better cars, failed spectacularly. I simply cannot name a successful business-to-business online exchange. I don't think there are any.

I believe that lead exchanges will fail. There are a variety of reasons that I believe this to be so:

1.     The economics of an exchange doesn’t pencil in the lead industry.

An exchange usually makes money by charging money to the buyer, seller or both. What this means is that to justify itself on a cost-basis the lead exchange has to be able to administer the transaction more cheaply than buyer and seller can currently. This can work in an industry with a lot of middle men since you can replace them with an exchange and save money. However, the lead industry doesn’t have too many middle men. Therefore to make a cost efficiency argument a lead exchange needs to be able to take on operational and administrational functions at the lead buying and selling companies far more cheaply than they can do it themselves. Lead generators are not very fat these days so replacing your sales and operational personnel with an exchange is far from easy and very risky. Furthermore, the economies of scale required by an exchange in order to allow them to operate far more efficiently than standalone lead generators are pretty large. To achieve these economies of scale you have to believe that only one or two exchanges will ultimately succeed. However,

2.     The Lead Exchange is not a “winner-take-all” industry

A winner-takes-all industry is one that lends itself to monopoly. In the absence of regulation, industry characteristics that make this occur are a) when a platform exists which has significant costs associated with switching from it even when something better comes along (Microsoft might be a good example) b) when there are huge costs associated with market entry and little incentive to be one of two players (railroads are a good example), c) when huge advantages exist from network effects, in other words as the network becomes larger the value to participants becomes exponentially higher (Facebook would fall into this category). 

A popular argument by those struck by “Exchangitis” is that a network effect is at play in the lead exchange industry. The more buyers and sellers you get the better off everyone is. The only problem with this argument, if you agree that having many more buyers and sellers is a good thing,  is that an exchange rarely succeeds because it possesses just one of the characteristics I mention above; the ones that succeed tend to have 3 or 4 of the factors going their way. If an exchange’s only reason for success is network effects then what I have generally observed happening is that a huge amount of money is consumed trying to get sufficient “traction” i.e. getting enough buyers and sellers to participate at the same time to make the network effects a reality. Sadly I have never seen this strategy work, much to the considerable expense of many reputable venture capital firms.

Given these reasons I am skeptical that a lead exchange will ever be the dominant platform for lead transactions. I do think that certain companies could do some things that would give them a better chance of success but frankly I think the model is ultimately doomed to failure.

2 comments:

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