The TSC Streetside Chat: Mark Hoffman of Commerce One

When it comes to B2B, Pleasanton, Calif.-based Commerce One (CMRC:Nasdaq - news - boards) is second only to archrival Ariba (ARBA:Nasdaq - news - boards). While both firms sell software that allows businesses to buy and sell products over the Internet, Commerce One's $11 billion market cap hasn't reached the stratospheric levels of Ariba's, which stands at around $36 billion.

Mark Hoffman, Commerce One's CEO, would like to change all that. On a Monday morning when Covisint, the Internet exchange for the auto industry, cleared regulatory hurdles, Hoffman talked to TSC about B2B, the competition, the company's recent acquisition of consulting firm AppNet, and its ever-cozier partnership with German software provider SAP (SAP:NYSE ADR - news - boards).

Since that interview, many of the subjects touched upon in the discussion have come to fruition for Commerce One. At the company's recent conference in Las Vegas, analysts were impressed by the momentum that the company has built up both at home and abroad.

The future, though, is still unclear for B2B in general and Commerce One specifically. That's because in order for Commerce One's business model to work, global corporations will have to do something they've never done before: buy trillions of dollars of goods over the Internet, while coordinating and collaborating with their partners in the special exchanges Commerce One is helping set up.

Hoffman, a West Point grad and engineer by training, addressed that future as he laid out a road map on his company's strategy, and B2B, for TheStreet.com.

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TSC: So, let's talk a little bit about B2B. We've all heard the trillion-dollar estimates and people are familiar with some of the savings that B2B is bringing to companies, but what about the sort of the hype that's out there? Why should investors or corporations believe now that B2B will in fact do what it's supposed to?

Mark Hoffman: Well, I guess the main thing is that we're getting proof points up. I mean, we're actually starting to see these market sites get traction and start to transact business. So we have proof points that we didn't have even three to six months ago in this marketplace.

TSC: What are some of the marketplaces that you're referring to?

Mark Hoffman: Well, these are mostly the regionals today because the mega-exchanges still don't have approval, like Covisint. It still doesn't have the Federal Trade Commission approval, but as you heard today, people are expecting it. And I do too, by the way. [Editor's note: Covisint, an Internet exchange for the auto industry, received approval from the Federal Trade Commission an hour after Hoffman left TheStreet.com's offices.]

TSC: So, let's talk a bit about Commerce One's business model. Obviously you guys have gone with the philosophy that software licensing fees aren't the way to make money in the software business forever; you do need some recurring revenue streams and things like profit sharing, transaction fees, network access fees, services. Yet, at the same time, some of your competitors -- most notably Ariba -- have gone the other way and stressed more licensing fees. The story goes that Commerce One has big ambitions and great plans, but in order for those to come to fruition, you guys have got to do something that no one has ever done before.

Mark Hoffman: Right.

TSC: Why should investors believe that you can pull it off?

Mark Hoffman: Well, I think we're getting belief in the marketplaces ... the people that actually have to build the exchanges and sell them. I mean, they're building all of these exchanges with SAP and now we're up around a hundred exchanges total. I think it's 77 on our own, but now we've got the SAP exchanges, too. So, you've got a huge chunk of Fortune 200 companies that have bought into the model and are in fact building their own business models around getting transaction fees, being able to layer on incremental services, charging for those incremental services, all of those things. So I think there's a lot of proof points in that area. Now the transactions themselves are still pretty small. But still, it was about 10% of our business last quarter, which was a big jump up from the quarter before. And I expect you'll see something like that going up this quarter, too.

TSC: Just to stress the business model and address some of the criticisms that have been there, what is Commerce One's mission?

Mark Hoffman: Well, basically our mission is to provide electronic commerce infrastructure on a worldwide basis, so anybody can trade with anyone at any time anywhere around the world. That we're just really going after these mega-exchanges and these big companies and Fortune 200 businesses ... that's just not the case at all. We want to build this infrastructure for a lot of different sized companies, and so that's going to be mega-exchanges, it's going to be net market makers, it's going to be regional players that are plugging in ... regional players like British Telecom (BTY:NYSE ADR - news - boards) and AT&T (T:NYSE - news - boards) and others that are out there.

TSC: Is your vision more difficult to execute?

Mark Hoffman: It's definitely a bigger vision and a more comprehensive way of executing, but your savings over a period of time are going to be huge and it'll do two things for you: It's going to automate your existing business to an extent that nobody else can do it, but it's also going to provide flexibility in your business. So I think if we automate these whole supply chains, we're fundamentally changing the way that people can think about their business. That takes some time; this is not a simple problem, but it's going to allow them to become much more flexible about their business, to be able to change their business quicker, to be much more responsive to their buyers, their customers.

TSC: So, five years from now, where do you see yourself positioned revenue-wise, mega-exchanges, regional, small? What's the mixture?

Mark Hoffman: I think you're going to have one or two regional exchanges ... probably on a per-country basis. You're going to have 50 mega-exchanges, and you're going to have thousands of net market makers.

TSC: What are some of the industries where you see opportunity from mega-exchanges? What are some of the industries where that opportunity is still out there to be won?

Mark Hoffman: There's still the utilities. On a regional basis. So right now we've got a couple of utilities in this area. I think there are going to be multiple exchanges in each area, but on a regional basis. Europe, Asia, wherever.

TSC: What does that mean to you in terms of revenue? What will the breakdown be looking forward?

Mark Hoffman: Well, originally that turns into license revenue, right? It's still the biggest chunk of our business. So right now our revenue is dominated by license revenue. But the goal is to build the services revenue, services being two things: One is the professional services and the second is the transaction-type services. So the question is, How do you get recurring transactions and shared revenue at all of these market sites? And equity?

TSC: And that's a good question, how do you avoid becoming "the Safeway (SWY:NYSE - news - boards)" kind of model where you're getting a penny or two margin on what you sell? How do you build your margins up?

Mark Hoffman: I think you're going to see -- on the basic transaction of buying and selling -- it's going to feel pressure over time. Today there is no pressure in this marketplace because people are just happy to get automated and save so much money. But as more and more of these things come up -- maybe it's a year; maybe it's two years from now -- you're going to start to feel pressure in those marketplaces. And so the basic buying and selling transaction is going to get monetized, so you've got to lay your services on top of that. Like collaboration, e-requisition, or ERP, advertising. Literally hundreds of services are going to get layered on top of these things, so you've got to keep driving new services into the marketplace and be able to get an added value for those services. Because I don't think we yet even understand some of the business ramifications of the exchanges and some of the automation that they're driving.

TSC: So what are the business and economic hurdles involved in this business? What are those hurdles that you see ahead? Tell us what you see the obstacles to be as you go forward.

Mark Hoffman: I don't feel the hurdle on the technology side. There are new things to get built, new services, new features, all of that. But that's not my biggest concern. Execution is probably the biggest one now -- starting to see the transactions close -- being able to execute this marketplace. All of those things are extremely important in making this stuff happen more easily because -- I mean Ariba is now starting to look at this as an end-to-end process, but I've been looking at it as an end-to-end process for a long period of time. So, in some sense, we've got a more complicated vision than Ariba has had in this marketplace, because their original mission was, "Let's just go out and sell." Essentially they're "byte pedalin." That's all their software is doing.

TSC: So, it sounds like you've got more moving parts. Does that make your job more difficult?

Mark Hoffman: It probably does. Now, somebody could do the same thing with us as they do with Ariba, but the customers that have bought it have bought it because of the bigger vision. They understand the power of this bigger vision that we have and they want that. GM (GM:NYSE - news - boards) and Covisint need to get more flexible. They understand. The aerospace companies need to get more flexible, and they understand.

TSC: Some investors have looked at Commerce One's acquisition of consulting firm AppNet and haven't liked it because it's a software company buying a services company. This is very high-turnover business with hard-to-keep people in it, that has lower margins. Some people might say that this was a mistake on Commerce One's part. What do you say to that?

Mark Hoffman: Here's the issue, and I was probably the biggest champion of the company. I wanted a company that was bigger rather than smaller because right now we've got huge demand for professional services people and a business model that gets built out that's more than just being an arms merchant out there -- and you have the responsibility to help that exchange come up and start to transact and get productive -- you've got to have people in there helping to build it, and support it, passing on business dollars to that exchange. Otherwise it's just software. And what's the value that you're contributing to this exchange over the long run? So they have high value. And quite frankly, I am stretched -- although I'm not starting to apply AppNet people -- I was very stretched to get people working on getting these exchanges going.

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"Our mission is to provide electronic commerce infrastructure on a worldwide basis, so anybody can trade with anyone at any time anywhere around the world."

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TSC: Yes, it's hard to get the guys that know how to plug it all in.

Mark Hoffman: And our business was growing at this incredible rate, but it still couldn't grow fast enough to keep up with the demand.

TSC: So, let's talk a bit about SAP then. Why did Commerce One go into this partnership? What does Commerce One get out of it? And what does SAP get out it?

Mark Hoffman: I think there are a couple of things. One is that there is definitely an alignment going on in the marketplace. I mean Oracle (ORCL:Nasdaq - news - boards) is Oracle; they're going to go it alone, right? But then you saw IBM (IBM:NYSE - news - boards), Ariba and I2 [Technologies] (ITWO:Nasdaq - news - boards) align, and so we looked at those alignments and SAP became very important to us. We had worked with SAP before and just felt that they would be the best partner. They have very robust software in this area. They might not have all the right software, or software that's flexible enough, but that's an area that we can help them in. So they can help us with in-depth software, very robust software. We can help them with more flexible software. And so that was the genesis of coming together. They also realized we probably had an 80% market share in exchanges today.

TSC: Of course, this partnership is winning praise on Wall Street. But that has led to further speculation about an even closer relationship between these companies. How do you address speculation that this is a prelude to a merger between the two companies?

Mark Hoffman: Well, when [SAP CEO] Hasso [Plattner] and I first came together, we basically didn't discuss the acquisition side of this thing. Other than to say, "Let's turn this into a unique partnership. Let's share the marketplace so that we can come together as software companies." And really almost nobody else has been able to do this. To partner in this marketplace in a very tightly integrated way, that's what we've accomplished.

TSC: Now that you have accomplished that, are you talking about acquisition possibilities?

Mark Hoffman: Never had that discussion. I'm not saying that it's not ever going to happen. This is a very big marketplace. But today the whole strategy is built around partners and executing together.

TSC: But it would make strategic sense for you to take this one step further.

Mark Hoffman: Here's my position in the market. I think there's a rationale for an independent electronic commerce vendor in the marketplace. Because it's a very heterogeneous market out there, where Oracle had to play with SAP, I mean hook into their stuff, SAP had to work with PeopleSoft (PSFT:Nasdaq - news - boards), PeopleSoft had to plug into others that are out there. So I think there's a rationale in the market to have independent platforms, just as there was in the early 1980s to have an independent database company. The same holds true in this area.

TSC: Are the pressures for consolidation strong out there in the sectors?

Mark Hoffman: Not with this type of growth going on, where lots of the consolidation happening is off in other companies. The auction companies, adding services on there, I think there's tremendous ability to do mergers in that area and break huge strides.

TSC: Will we expect to hear about more of those in the foreseeable future?

Mark Hoffman: Yes. I'm not forecasting anything in the short run, but I will definitely say that our strategy is one of buying where that's appropriate. The timing in the market, expertise, all those things are extremely important, particularly with a good market cap.

TSC: Well, the partnership has been viewed, so far, as an incredible success. You've got two joint wins announced and four more apparently in the pipeline. The word on the street is that two of them, at least, are in the forest and paper products industry and also the regional exchange in Australia called corProcure. What do you think?

Mark Hoffman: I can't talk about it now. But I will say: We are winning. Pretty much consistent with our place and the number of sites in the market. [Editor's note: Ten days after this interview, corProcure picked Commerce One and SAP to power its marketplace.]

TSC: Did you compete on Transora, the food exchange that has reportedly been awarded to Ariba?

Mark Hoffman: We did.

TSC: What happened there?

Mark Hoffman: It was a different business model than we really agreed with. Such as "no partnership, no equity." Very low-margin business. I think maybe they're going to have some problems there.

TSC: What about integration issues in B2B? When you see a problem in B2B, you see it in getting this stuff plugged in and working. How can the industry overcome that hurdle in a way that executives don't throw up their hands and say, "This stuff is too complicated, we can't make it work"?

Mark Hoffman: Well, we've done a couple of things. We're training as many professional services people as we can, Anderson Consulting, Pricewaterhouse Coopers, they have a couple of thousand people now trained around the world, but it's still not enough for everyone. Whereas I'm trying to get AppNet to ramp up; those guys have to ramp up pretty aggressively, too. It means you've got a lot of ramping to do, a lot of growth in that area.

TSC: How about internationally? How do things look in Europe and Asia?

Mark Hoffman: Great. We've built our international business tremendously. We have just killed Ariba, outside the U.S.

TSC: Ariba was talking about being soft in Europe this summer. Have you guys seen any of that?

Mark Hoffman: Our growth continues to do very well. Greater than 50% of our wins in the last quarter were in the international area.

TSC: Was that an expectation?

Mark Hoffman: It was actually better.

TSC: So the markets you're currently targeting?

Mark Hoffman: Asia. We're pushing hard in Europe. We're pushing hard in Japan and Asia.

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"We're the only ones in the market that have the capability to do marketsite-to-marketsite communications. It works today."

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TSC: And that's something that SAP will help you with?

Mark Hoffman: SAP will be phenomenal in Europe. Also, they're very strong in Japan, very strong in Southeast Asia.

TSC: Talking about Europe and European companies, Nestle made a significant investment in SAP for software, about the same size investment that SAP made in Commerce One. However, Nestle, of course, was a huge win, early on, for Ariba. Is Nestle soon going to be a premier customer of Commerce One?

Mark Hoffman: (Chuckle) Again, that's forecasting.

TSC: Always got to ask those questions.

Mark Hoffman: There's no question about it. SAP has brought us into locales we would not have gotten into before. I believe that this partnership is going to have an unbelievably strong effect. This is going to be the premier offering on our side. If you look at what's going on with IBM, I2 or Ariba, you've got this loose coupling of software, and it's kind of IBM-driven. Those guys, I don't believe, will ever cooperate enough to do what we've done with SAP. They [Ariba and i2] both want the same side of the marketplace.

TSC: Does the SAP partnership give you opportunity to realize more licensing fees up front, and therefore calm some of those investor jitters that say, "We like the idea down the road, but we also want to see revenue now."

Mark Hoffman: Certainly we'll allow them to continue driving at a very aggressive rate. We have a good revenue arrangement with SAP.

TSC: Where you get a percentage of the licensing fees they use for their software?

Mark Hoffman: We won't talk about what the exact splits are. We'll make money off of SAP's software, we'll make money off of our software, they'll do the same.

TSC: What about private marketplaces? They've received increased attention lately as companies say, "I want to participate in the exchanges but I also want to have my own shingle on the Internet that I can hang out there and bring my own customers in and we can talk in private." What direction are you going in there?

Mark Hoffman: We'll definitely support customers needs. We don't have a public statement there. We talked about private exchanges and supporting private exchanges. I just know those private exchanges are really a smaller instance of what we're building as bigger exchanges.

TSC: Any significant wins in private exchanges?

Mark Hoffman: We have a couple that we're doing right now. [Editor's note: Commerce One announced a private exchange for telecommunications giant Cable & Wireless shortly after this interview.]

TSC: What about the different values in the marketplace? You at $10 billion while Ariba's got a $32 billion market cap.

Mark Hoffman: Ariba is ahead of us, and we don't like that distance. We don't think it's a justified lead. But at the same time there's nothing wrong with a good $10 or $11 billion evaluation.

TSC: But their revenues are higher than yours, right?

Mark Hoffman: Their revenues are higher. A lot of people say, "Gee, we believe you've got a superior model but you've got to show it." We've got to provide them proof. We're starting to see that. Secondly, I think that we haven't worked the investor's side of our business as well as we should have.

TSC: So that's a problem for you -- getting investors to understand what your model is about?

Mark Hoffman: Right. At Ariba, for example, several people over there really worked aggressively for more than a year on that. I think one of the things that I go back to in this market is the market's evolving into this more complex picture of electronic commerce, which I think has been our picture all along. It's more complex to operate a marketplace itself. I think we've had a more complex model to explain, but I think if the market begins to come into alignment with that vision and that model then everyone is going to start to get it in a simpler, easier fashion.

TSC: How concentrated are you on buying direct goods at this point given that companies in some cases are just getting used to buying pencils and paper online? [Editor's note: Direct goods are the raw materials or components used in the manufacturing process. Indirect goods are the things companies need to run their business on a day-to-day basis, like pencils and paper.]

Mark Hoffman: Every major exchange is definitely focused on the direct goods strategy. That's what helps us win in the most recent exchanges. You go back to all of the eHitex, the aerospace exchange, others, they're saying direct goods are the essential part of their strategy. They need to execute this. I don't think you'll see any of the new exchanges coming to market that are just an indirect solution, they're all going to want direct.

TSC: I think I've exhausted my list of questions. Anything you'd like to add?

Mark Hoffman: One thing that we didn't talk about was the Global Trading Web, which I think is pretty powerful, maybe our strongest point. This whole idea of marketsite-to-marketsite communication. Because it's a different thing to hear [Ariba CEO] Keith [Krach] talk about Cisco (CSCO:Nasdaq - news - boards), whining about Cisco and their marketplace. But they don't really have any way to communicate marketsite-to-marketsite, to do seamless transactions in an electronic commerce infrastructure.

I think we're the only ones in the market that have the capability to do marketsite-to-marketsite communications. It works today. We have Global Trading Web partners that are planning to do marketsite-to-marketsite transactions. They're very excited about it. The capability's there. That's going to have a huge leverage effect on our business at the moment. I think the unique functionality of our marketsites, all of these new services being added, tied into a Global Trading Web, being able to do all these things on a global basis, is a very powerful solution.

TSC: I appreciate your coming in today.

Mark Hoffman: Thank you.

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