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Interconnections, private equity, and architectural deficiencies supply the leverage to dominate today’s critical supply chain communications markets. A.D. Wilensky, Analyst, BizQuirk Strategery
Abstract Interconnection dependent markets are very different than product driven markets. The participants in interconnected marketplaces are influenced by so called ‘network effects’ - a phenomenon of accretion whereby interconnections between networks influence the subscribers residing on the networks, thereby creating a composite of a market’s total value for all of the participants.1 There has been a great deal of research on the topic of network effects2. In the area of antitrust and telecommunications law, the courts and regulators3 have struggled to clarify the economic issues pertaining to networked markets, and how the policies of providing or withholding interconnections to one’s lateral competitors influence the market. When negative influences arise, and are magnified, as a result of interconnection abuse and network effects, there should be expedient mechanisms for resolving anti-competitive fallout. In unregulated markets, as in the present case, the courts have found it difficult to rectify damages inflicted upon competitors overcoming overt interconnection denials by the over-sized incumbents within their particular market sector. In this briefing, we focus on the anti-competitive effects arising from (or reinforcing) the abuse of market power by a singular, large EDI transaction network (VAN or Value Added Network). By exploiting a large, influential subscriber population gained via acquisitions, GXS Inc. has come to leverage its inter-network connections (interconnects), making its dominance all but absolute; GXS has passed the point where econometrics or revenues adequately portray the company’s unchallenged ability to bar any competitor from the market, or its potential ability to inflict harm on its existing competitors at a time of its choosing. It is where and how GXS applies these market levers that bear on the current case. Finally, we should acknowledge the positive aspects of network effects; in the present case of Value Added Networks, cooperative interconnection policies built the industry, fostered a diverse market, allowed subscribers freedom to choose among many providers (and the ability to switch providers), and finally, new ventures entering the market were able to innovate and offer creative solutions. All of the attributes of a diverse, open, and healthy market, an EDI market offering the same types of network ubiquity that we as consumers take for granted in our phone and Internet services - is being
consumers, and the network providers themselves.
on Network Effects and Antitrust
hobbled by the interconnection practices of GXS Inc. The short-lived fecund stage of EDI’s renaissance lasted for a brief year or two in the late 1990’s, until GXS’ ascendancy was cemented during the 20052009 years which witnessed the consummation of the key GXS acquisitions; the GXS campaign that led to its hegemony began much earlier, however4. Finally, all of the prized characteristics attractive to risk capital, i.e., end-user agility and the incentives to innovate are being denuded in today’s EDI market due to the interconnection foreclosures by GXS. Any market influenced by a monopoly is inhospitable to seed and mezzanine investors - a state describing the present EDI sector as dominated by GXS5.
Market Overview Markets that derive value from network effects differ immensely from those deriving their value from the sales of goods or services; widget bound markets may become subject to network effects, tying agreements, etc., and may also be affected by interconnected services, such as road, rail, freight, pipeline, and of course, networked communications services. These dynamics have simply become pervasive in our times. In the case at hand, Value Added EDI networks, we have systems predating the Internet proper, that are loosely related to modern email systems, although there are important distinguishing factors that bear on the case. For the purpose of this brief, however, let us agree that EDI networks, called VANs, are simply private email systems used to convey standardized business documents destined for delivery to automated systems, i.e. inventory databases and retail systems, as distinguished from email communications, destined for delivery to people. Value Added Networks (VANs), are private messaging systems used to convey common business process documents in standardized formats: invoices, purchase orders, and various shipping acknowledgements are sent and received via approximately 40 domestic VANs supporting various supply chains of the major retailers, manufacturers, and package /courier/ freight common carriers. VAN services comprise a 1.5 billion dollar global services market - a figure that belies a system that supports the transactions representing more than a trillion dollars of annual domestic and international trade. EDI transactions are conveyed in real time, to and from real companies of all sizes. If any one of the major EDI networks (VANs) were to fail prior to the holiday season, there would be no cheer. EDI communications are therefore not inconsequential, especially for small and medium enterprises forced to comply with strict EDI transactional specifications dictated by the mega retailers and manufacturers they conduct business with. Servicing the likes of Ford, GM, Target, or Sears, forces suppliers to accede to the realities of implementing the guidelines of these influential trading partners, the supply chain buyers.
appendix, “GXS History of Acquisitions”.
only notable B2B sector investments of the post Internet bubble era (2000-2010), are IBM-Sterling, GXS-Inovis, and Liaison Softshare, all private equity, not one VC or Angel / seed in the decade to far. Telling.
The lone market competitor of similar scale to GXS is IBM-Sterling, whose interconnection practices stand in harmony with the EDI industry’s tradition of granting non-settlement interconnections to bona fide network operators. The practice has not compromised Sterling’s ability to generate new business or retain accounts, and comports with IBM’s philosophy of having its acquired business units act as stewards within their market niches. The author will extract a further lesson later in the monograph, regarding the cleavage points distinguishing these two companies.6
VAN politics in an unregulated market space - who may play, who shall decide?
It was previously explained that there is a substantial top down influence emanating from the large trading partners to the subordinate suppliers. The larger partners can, and often do, dictate the means by which suppliers communicate with them, and this might even include not using VANs at all - an increasing option that is illustrative of the colloquially termed, ;VAN Exodus’. But, for better or worse, today’s EDI market is dominated by VANs, which means GXS and IBM-Sterling own the top 70% or more of the large purchaser market. Restated, Retailers and Manufacturers often dictate all sorts of terms to their suppliers, such as which VAN ID to transact with, the technical composition of transactions (transaction set), etc., and, outrageous as it may sound to the ear of free enterprise, and that subordinate trading partners use the same VAN as the purchaser. Though his last requirement is not widespread, it is also not unheard of in the industry. Such requirements by a major retailerdictating ‘same VAN terms’, Resisting EDI requirements essentially results in suppliers forfeiting their trading relationship with major purchasers, making EDI crucially important to the survival of downstream members in the supply chains. One interesting artifact of this lopsided influence arising out of VAN network effects, is that large VANs may avail themselves of impressive and influential hub-buyers; as borne out in practice, such networks may in turn misuse the unwitting cachet of such clients to the disadvantage of other EDI networks catering to the smaller and mid-sized enterprises making up the great majority of suppliers. Influence gained by a ‘weighted’ client type population, is further exacerbated by exploiting a VAN’s routing access (interconnection arbitrage), decoupling the bad actor from typically reliable econometric measurements of simple percentages. For example: 1000 clients on VAN A, a mix of buyers and suppliers, is different in quality than VAN B, composed mostly of influential retailers and manufacturing hubs. And astounding though it is, these key clients are often blissfully unaware of the VAN’s intention to exploit their cachet. Let’s, however, not mince our words here - the only VAN conducting this practice as to court legal and regulatory scrutiny is GXS, as its nearest competitor, IBM-Sterling, has never come close to such shenanigans.7
Alert: Although a larger company by market metrics, GXS generates less profits than Sterling, despite its Stentorian interconnection policies. These ill-conceived views have exposed the company to the present antitrust lawsuit, and a potential regulatory investigation. This cleavage between Sterling and GXS is nothing other than Interconnection policy. More analysis follows under “comparative practices”.
Simply recapitulated, major retailers (or manufacturers) are “must have” EDI message paths, and the suppliers need them to survive. Concomitantly, VAN interconnections to competing networks thereby become an ideal abuse mechanism to achieve the power to foreclose market entry to competitors, new ventures, and most certainly, technological innovators. Market Effects: EDI providers wielding unequal Influence via their unwitting clients In the absence of collegial interconnection policies, the concentration of a large cohort of purchasers on a particular VAN creates the potential for toxic network effects - as these large hubs tip the scales of influence towards a VAN acting with ill intent. Interconnections between VANs and other specialty commerce communications providers are the bulwark against such behaviors, keeping the market honest, prices competitive, and enhancing the climate of innovation and end-user choice. Interconnections are the ultimate market lubricant; they expand the market reach of all participants while preserving the interests of the end-users. There is nothing else quite like interconnected markets. The specific practice of non-settlement peering between the VANs, an established and accepted practice for years, built this very market. The fight to preserve the policies and practices of agnostic, non-settlement interconnection the one concentrated incumbent seeking to convert peers into payers8, is absolutely crucial to the industry’s survival.
Innovators into the Breach- Electronic Commerce Service Providers and the EDI market’s lone Communications Specialist Network embark n hostile territory.
Not much earlier than the 1990’s (some say as late as 2005) it was hopeless for SMEs to engage in EDI automation with trading partners, due to the costs and technical requirements. Accommodating the SME’s became an prevailing trend in the 1990’s, beginning with a handful of innovative IT ventures seeking to take the sting out EDI. These New Age Electronic Commerce Service Providers (ECSPs) sought to democratize the SME’s entry into the automated supply chain model, using the EDI documents mandated by the largest purchasing hubs, the great majority using the dominant VANs for conducting EDI communications.
Interconnects in EDI Networks - Using Routing policy as a Lever
Non-settlement interconnections between collegial networks created today’s EDI market. The history of AT&T’s rise to monopoly power mirrors the travails between Loren Data Corp and GXS, Inc. Though topologies may differ in minor details between telephone, Internet, and EDI networks, the early march
8Peers into payers: VANs have modeled their industry on assessing usage fees from their subscribers, while choosing not to settle accounts
with collegial networks. The reason for this ‘non-settlement’ practice between networks was simple - EDI is a bi-directional transaction, with each interchange between trading partners accounting for approximately equal carriage. By adopting a ‘peered’ model, the industry could grow through its formative stages, adding subscribers, without the needless and time-consuming accounting that would most likely net to nearly zero in a bi-lateral settlements. And, this regime has worked - even GXS must admit that it was built upon the bedrock of nonsettlement peering with its peers.
towards a consolidated market dominated by one actor are a virtual repetition of the history of telecom antitrust case law. The character of the litigants is also somewhat reminiscent of the parties populating landmark antitrust cases often referenced in the post-divestiture era. The issues are similar as well to the landmark MCI v. AT&T case, with Loren Data Corp playing the advocate for liberal interconnection, modernization, and end-user freedom of choice, while GXS Inc. takes the role of consolidator, monopolist, and technological laggard. That technological prowess is quite unnecessary to dominate a communications market, is not a revelation. The present matter of Loren Data Corp v. GXS Inc. is an almost identical case of interconnection and market abuse via such interconnections, the buying of other networks with their clients via private equity of questionable provenance, and then the subsequent arbitraging of the VAN interconnects. The GXS mergers flew past FTC, DOJ, and the foreign UK regulators - all of them perfectly uniform in their misunderstanding of the architectural dynamics of interconnected markets and the particular deficiencies of EDI routing mechanics that are exploitable by a toxic actor, despite best intentions and help volunteered by many eager industry experts.
A familiar history of a rapidly reconstituted monopoly
VANs, or more generically, the EDI communications industry, grew from a few major IT communications specialty providers in the late 1960’s, and provided that one specialty service conveyance of electronic business documents in their early non-standard formats. We can compare EDI messages to the email of today, with a caveat that the recipients are not people, but are rather computers used in processing automated inventory, manufacturing supply chain, retail shelving management, and ever-popular Enterprise Resource Planning software, made ubiquitous by SAP. VANs provided secure communications, connections to trading partners, and a modicum of expertise. The early technologies wedded communications to specialized professional services that came to be known as ‘The Value Add’. Thus, Value Added Networks were indeed private, wire-line facilities, almost indistinguishable from the telegraph, telex, and TWX wire communications services that were well under the regulatory authority of FCC titles and tariffs. However, VANs escaped becoming subject to the regulations befitting a sector that handles the data representing billions in supply chain and durable goods / raw material data, not to mention crucial Federal and Military logistics data in those critical supply chains. Early VANs, amounting to a handful of highly specialized systems operating during the period of 1960-‘80’s, simply did not leave a trace on the regulatory radar. The most popular and compelling value added service of the early EDI era was the ability to connect any two large, influential companies in a supply chain relationship; a corporate purchasing department database, a complex mainframe, would generate and sent orders via a VAN, and their top tier supplier(s), almost always Fortune 500 behemoths as well, would receive and subsequently ingest the transaction, thereby automatically updating their inventory or shipping status automatically. The science of EDI reduced the human effort and errors that were common in high volume ordering and fulfilment systems of the time.
The recipe for concocting a VAN monopoly is quite similar to other markets: 1) enter a market with existing cooperative interconnections, where 2) network operators participate in a fully interconnected communications marketplace, and 3) offer each other non-settlement terms (they do not dun other networks for bi-directional traffic flows), 4) secure private capital, 5) buy the top two or three VANs and software IP assets, and 6) begin the process of interconnection arbitrage and foreclosures. This formula has worked in other interconnected markets, and is often overlooked by regulators. The remedies that are eventually assessed are trivial, or take decades to fully resolve. The AT&T consent decree and subsequent divestiture took almost fifty years to complete, covering four Presidential Administrations, the creation of new agencies, and the participation of one far seeing yet crafty AT&T VP, Kingsbury.
Future Remedies; the suitability of Courts of Law in Resolving Interconnection Disputes In order to remain viable, the competitor must overcome the network access hurdles (placed by incumbents), acting with the utmost alacrity, while navigating a legal processes routinely exploited by incumbents with superior legal resources. The incumbent may often accomplish as a defendant what it could never hope to gain had the industry operated with rational interconnection policies. Lawsuits require remedial explanations and evidence based metrics, both of which are necessary to inform non-specialists, jurist and attorneys alike. However, most cases of interconnection denials are nothing more complex that extant case law and are ill-suited to delivering the rapid corrections needed in an interconnection abuse case9. The industry would much rather see expert panels delivering binding directives. Until that time, the courts are all we have to resolve disputes in the EDI Communications market, a sector that properly belonged in wire-line enforcement, but slipped under the threshold of the Internet’s all consuming grasp. There may be more direct ways of resolving many of the problems associated with interconnections, especially in the unregulated markets. The author will include some thoughts on methods of alternative dispute resolution at the end of this monograph. Appendices Fact Sheets Loren Data Corp Facts: Founded: 1987 Founder: Todd Gould Branded Service Offerings: ECGrid®, ECGridOSSM, FBO Daily, WorldWide EDISM Staff, Full-time + Contract: 5 Key Persons: Todd Gould, President, CTO | Crystal Kuczynski, VP of Network Operations | Kristine Finlay,GM | Shelly Donkin, Network Operations | Alan Wilensky, Product Strategy + Industry Relations
smaller competitors are unlikely to survive a protracted legal process, and the issues are not nearly so complex, as portrayed by the typical incumbents occupying the monopolist's cat-bird seat.
Primary Line of Business: EDI Message Routing Evolution of Lines of Business: Web Services Message Switching, Data and Partner Integration Management Forward Lines of Business: Component Commerce Network as a Service, Current Gross Revenues: ~$1mm Projected Gross Revenues end ‘011: ~1.5mm Infrastructure Type: SAS-70 Collocation in Portland, OR and Los Angeles, CA Architectures: Windows, SQL Server, .NET Framework Web Services, IPSec VPN Featured ECGrid® Clients: SPS Commerce, Trubiquity, CovalentWorks, Energy Services Group, Radley, Activant, Pinnacle Data Services, Incorporated in: California General Offices: Indian Rocks Beach, FL Network Operations: Colorado Springs, CO ECGrid Network: Network ID’s Total Active + Registered Inactive + Test = 19,000 Entries Total Trading ID’s active in last 6 Months = 8-10,000 Transactions Avg. Daily: 30,000 GXS TGMS + Inovis + IBM IE (G Inc.) MegaVAN#1 GXS facts cross-referenced against available analyst coverage
GXS is the combined organizations of the former GE Information Services (GEIS), Inovis, and IBM’s IE VANs, plus the resources of their catalog of software and professional services acquisitions:
GXS Merges with Inovis June 2010 GXS becomes the world’s largest network of integrated business communities. Verified by 3rd Parties Gartner, Forrester, others. GXS Acquires Interchange Services December 2008 Interchange Services, a B2B integration services provider focused on the Brazilian market. GXS Acquires UDEX November 2006 UDEX, was a for profit quasi-industry standards body, like a GS1, providing data cleaning, meta-data, and data quality services for the retail sector in the US and UK. GXS Acquires G International April 2005 Acquired G International, a IBM’s former EDI VAN and Business Exchange Professional Services Group. GXS Acquires HAHT Commerce February 2004 Acquired HAHT Commerce, a provider of Customer Order Management and Product Information Management applications for chemical, high tech, and consumer products industry. GXS Acquires Celarix June 2003 Acquired Celarix, a market leading provider of Logistics Visibility applications offered in a Software-as-a-Service (SaaS) model.
Numbers: Analyst’s Say: GXS has 100,000 trading partners on network GXS says 40,000 before the Inovis buyout Two independent analyst bureau’s have called GXS undeniably the largest VAN 1800 employees 450MM++ annual Big. Alternate Legal Theories The Community of Analysts Complicit in the Perpetuation of a GXS Hegemony The Industry’s Momentum