Deep Dive: Fixing B2B's third market
Traditional B2B markets focus on the exchange of products and services for cash, but what if there’s a third market for value that is not sold?
I monitor new episodes across a large number of podcasts, few of which have anything to do with B2B innovation. At least not on the surface. I look for ideas and concepts for reshaping how work is done. Now and then, I find an idea that seems incredibly powerful and impossible to implement at the same time. I found one such concept in the 155th episode of Stanford Engineering’s The Future of Everything Podcast. The podcast is about markets that function without the exchange of money. I can’t imagine anything further from the operation of B2B markets. But then again, there is a B2B market—one that is not thought of as a market—that exchanges value without setting a price or directly accepting cash in payment. In this edition, I set off to chase a white whale in the hopes of a breakthrough market concept.
B2B is three markets: two that work and one that doesn’t
In practice, there are three well-established B2B markets. Two are understood as markets, one is not, which creates problems. In the first, the primary value exchange is about providing physical assets (products) for financial remuneration (cash through purchases). The second market is an exchange of the value supplied through services (delivery, maintenance, repairs, and so forth)—again, in exchange for financial remuneration (cash through fees). Manufacturers play mainly in the first market, although some have established service businesses. Logistics companies play primarily in the second market, although many have added light manufacturing and other value chain functions through third-party logistics (3PL) contracts.
The third B2B market—the problematic one—offers value without a price. This market concerns the exchange of knowledge and performance for procurement loyalty, measured by the share of customer spend. It is a vibrant market, but it’s based on a lie. Value is not free. Or better, value is correlated with price. Every time a salesperson provides valued advice for free, the price of that advice is set at zero. In the short run, salespeople may score a victory for a deal on the table, which may carry some momentum for gaining follow-on sales. But in the long run, customers cannot truly factor the salesperson’s valued advice into purchase decisions, because there is no cost paid, and therefore, no metric to measure. Every B2B company knows this, but they are locked in a trap because there is no established way to charge for advice when the advice is truly valuable. Creating a new market may be a solution. More on that below, but let’s dig in first.
While manufacturers and service companies both play (and suffer) in this third B2B market, it is a unique challenge for distributors. Distributors sell products manufactured by suppliers through a “buy, hold, and resell” business model. They take orders and service demand, and they seek to create a competitive advantage by offering added value in the form of customized delivery, inventory management, performance guarantees, application knowledge, and business advice. These offerings are provided without charge as “for free” services. In return, customers offer loyalty reified as repeat purchases across a wide range of product needs.
Conducting business based on the exchange of value-add for customer loyalty creates a colossal problem for distributors because customers expect continually improving value-add and performance, and at the same time, lower prices. Distributors can attempt a workaround by packaging added value as for-fee services, but customers often resist paying for what has always been free. Distributors are caught in a margin trap. Unable to raise prices or demand fees for services, they must continually reduce costs and seek scale. This self-destructive dynamic has existed for decades but is fast reaching a tipping point, precipitated by disruptive threats and the demands of competing in the digital economy. Distributors are under pressure to compete through new value-creating customer experiences, which require significant investments to develop new capabilities.
How to solve the third-market problem
As I listened to Irene Lo’s conversation with Russ Altman on Stanford Engineering’s The Future of Everything podcast, some massive lights turned on. Lo explores the workings of nontraditional markets that are not based on the exchange of assets (or services) for cash. In traditional markets, price plays a critical role in enabling cash payments as purchase prices are paid. More importantly, price facilitates the flow of information between buyers and sellers. Sellers use price as a mechanism to communicate the relative value of features and benefits. Buyers consider price to infer the value they will receive. Think of it this way: When considering a purchase, from the very beginning, customers ask, “How much is that?” The answer they receive speaks volumes about whether the product or service is a viable solution, even if analysis, negotiation, and competitive bids follow. Without price, business cannot be done, and traditional markets cease to function.
So, maybe the problem of the third B2B market is that it doesn’t conform to standard, price-for-product model—and can’t be made to conform. Maybe the exchange of knowledge and performance guarantees for customer loyalty requires an entirely different construct and way of thinking. On the podcast, Lo shares her insights gained by working on the market for school choice. In that market, parents are customers seeking attendance at the public (free!) school that is the best fit for their children. School districts are service providers and seek a fair allocation of available placements across various schools in a given geography. (The public policy that enables this market is termed open enrollment. As an example, Colorado’s policy is here.)
Lo’s work takes a mathematical approach to create, model, and manage a market for enrollments. Very little of it seems precisely applicable to the third B2B market, but some stands out as guiding principles for B2B innovators. As is my standard practice, I list refer to three insights drawn from Lo’s discussion (the bolded words below) and add my thoughts on their application to solving the third market problem:
Trust. Markets cannot exist without trust. Perhaps there is a market rationale for emblazoning U.S. currency with the motto, “In God We Trust.” Prices are set in currency terms. Currency is backed not by gods but governments, making it a trusted mechanism for transferring money. How will trust be created, managed, and guaranteed in a new B2B market that operates without prices or the exchange of money?
Designers and Participants. Renaming providers and customers as designers and participants, respectively, forces a rethink of expectations and roles. B2B companies are not just providers of products and services. They must design the market, meaning the exchange of value and associated mechanisms. Customers are participants, meaning that they must engage in the market in ways beyond simply making a choice and making payments.
Preferences and gaming. Prices create clarity. They help customers solidify their preferences as they realize the amount of money they will spend. Without price as a control mechanism, participants on both sides of the value exchange may try to game the market. Designers must consider how preferences and gaming play out today and how they might be dealt with, eliminated, or perhaps, enhanced in the new non-price market.
Doubtless, I have missed many of Lo’s compelling insights. I will listen to this podcast many times to extract more ideas for B2B innovations, and I encourage you to do the same. Expect updates in future editions.
Ideas for innovating B2B
Undaunted by my admittedly surface-level understanding of Lo’s ideas and the operation of non-financial markets, I have charged ahead and brainstormed three ideas for solving the “third market” problem:
Add price by offering subscriptions. This idea is about giving customers a choice. They can buy as they always have from a B2B company, but they can also pay for added value through a subscription paid independently of product purchases. To make this option work, B2B companies will need to back up the valued advice with data-based proof of value. But that’s just a start. They will need to institutionalize the added value in business processes. Options include annual audits of customer operations followed by work plans and mutual commitments. Careful management of the legacy sales process is needed to make sure that salespeople do not work against its success. The value that can be provided for free must be carefully designed and managed.
Create a B2B market to facilitate cohorts. This market would focus on creating practical solutions and game-changing innovations for customers, but as a service for a community, not individual accounts. In Innovate to Dominate: The 12th Edition in the Facing the Forces of Change® Series, I suggest that the best path to the future for any B2B company is to help customers get to their future. In my view, cohorts are a trendy, but valuable, tool for establishing working groups staffed by B2B company employees and people from customers, vendors, thought leaders, and more. Cohorts are about coming together to create a solution, with every participant providing diverse experiences. The exchange of value is about offering ideas, effort, and time in exchange for a breakthrough solution that is not otherwise achievable
Build a B2B market for creating public goods. In Distribution Leans In: Stories of Resiliency and Innovation During the COVID-19 Pandemic, I found that distributors stepped up to develop solutions to help customers survive the pandemic. They did so without a market to offer their innovations and without any expectation that customers would provide reciprocal value. Distributors did it because it was the right thing to do. By doing so, they created an immense public good measured by the survival of businesses big and small in every sector of our economy. Perhaps distributors can institutionalize an ongoing commitment to developing public goods by creating a market to enable concerned distributors to work with interested communities. Projects and collaborations might replace price and money. (See my earlier edition, Can your company thrive with an integrated approach to business innovation and social responsibility? for another discussion of innovation and public goods.)
Join the journey
I originally titled this post “Thinking Out Loud” because I am far from advocating for a specific B2B innovation or course of action. Irene Lo’s ideas, and the discussion on this The Future of Everything episode, Irene Lo: How Math Makes Markets Fairer are totally out of the box. There is a gap between Lo’s experiences and the needs of B2B markets, but perhaps there is a game-changing and mind-blowing solution if we can close it. I invite you to join the quest. Don’t be a stranger. Share your thoughts in the comments section below. If you prefer, reach out directly at mark.dancer@n4bi.com.