The Net Revolution
from Spring 2000
by Ann Reilly Dowd
Back in 1998, nothing big was happening at General Electric regarding the Internet. Then Jack Welch had an epiphany. Some say it was a dinner with Microsoft CEO Bill Gates. Others credit Welch’s Christmas foray into online shopping and vacation planning. Maybe it was some shaggy, Net-savvy Gen-Xer he stealthily pulled into his office for private surfing lessons. Whatever the trigger, by January 1999, GE’s chairman and CEO had seen the empire-shattering force of the Internet and was instructing his senior executives to figure out fast how it could destroy their businesses—and how to recreate them to survive and prosper. The two-pronged campaign became known as DYB (Destroy Your Business).com and GYB (Grow Your Business).com. Welch told employees, investors, analysts—anyone who’d listen—this was GE’s priority one, two, three, and four.
A year later, the process of creative destruction is already well under way, and investors who saw the stock rise some 60% last year are cheering. GE’s Polymerland division is now selling directly over the Internet, freeing its sales force to concentrate on loyalty-building service and support rather than order taking. Purchasers of giant GE turbines now can inspect them from the comfort of their homes and offices, thanks to a digital camera placed inside and connected by a modem to the Internet. Health care providers can customize GE MRI equipment for their own needs on the Web. Homeowners try out different lighting schemes at GE’s lighting website. Even the GE board is recreating itself with the November appointment of Scott McNealy, CEO of Sun Microsystems, a leading provider of Internet infrastructure. Says Welch: “E-business is changing the way we at GE work and interact with our customers.” Bruce Temkin of Forrester Research Group, an Internet consulting firm, believes in GE’s approach: “Every company should go through what GE did with DYB.com.”
GE is not the only brick-and-mortar giant that is waking up to the king-making—and -breaking—power of the Internet and beginning to fight back. Charles Schwab recognized early the importance of a “click-and-mortar” strategy that integrates its storefronts with an online trading and financial services capability. Now other corporate giants such as Sears, Wal-Mart, and Cisco Systems are following similar online retailing strategies or are using the Net to cut costs and streamline internal processes. And media giant Time Warner shook the very foundations of Corporate America by casting its lot with the golden girl of the dot-coms, America Online. “E-commerce will hit hypergrowth in 2000,” says Temkin. “That means the time for ambivalence is gone. Either you get on board this revolution, or get out of the way.”
Take it from Jack Welch and others who’ve seen the light, the Internet is a revolutionary force that is fundamentally, irretrievably changing the rules of corporate engagement. It offers opportunities—to boost productivity, open up new markets, and uncover new revenue streams—and it poses threats. By giving consumers the power to comparison shop for price and quality with the click of a mouse, the Internet puts the customer in charge. At the same time, by reducing costs of entry, the Net exposes corporate giants to life-threatening attacks from dot-coms, not from their known competitors but from industries outside their own.
What’s a board member to do? First of all, make sure the CEO and executive team has or is developing a Net strategy. (For questions to ask at your next board meeting, see box on page 41.) That takes determined Welch-style leadership from the top as well as a management with the structure and determination to drive change throughout the organization. At GE, for example, DYB/GYB operations in every business unit reported to the head of e-business, who reported directly to the CEO.
Unfortunately, there is no one, silver-bullet Internet solution. Each company needs to chart its own course, beginning with an analysis of its own competitive advantages. What are your most valuable assets? Customer relationships, innovation, manufacturing, distribution? If it’s your brand name and your bond of trust with customers, maybe you don’t need to do your own manufacturing or product development. Instead, you might be better off outsourcing these functions and focusing on building even broader and deeper customer ties through the Net. “The key is getting a full understanding of your business model,” says Kirk Klasson, director of strategic solutions at Cambridge Technology Partners, another leading Internet consultant. “Only then can you begin thinking about what is your most appropriate strategy. Otherwise, you may end up building a boat in a basement.”
A sleek Net-age spaceship more what you had in mind? Here are five steps you can take, from the simplest to the most challenging, to transform your company into a player on the Web:
1. SHOP ONLINE. This is the step you can’t afford not to take. From Hewlett-Packard to Bristol Myers Squibb, Chevron, and Canadian Imperial Bank of Commerce, major corporations are using Internet-based solutions to slash the cost of purchasing everything from paper clips to PCs. With systems developed by companies like Ariba and Commerce One, companies can save millions by requiring employees to buy everything off a corporate website featuring preferred providers. By centralizing purchasing, companies get a handle on what they are spending. And by setting up a network of preferred providers, employers can eliminate maverick buying and leverage their purchasing punch to capture corporate discounts.
The effect can be dramatic. Take Canadian Imperial Bank, which was surprised to learn, after installing a Web-based purchasing system, how much it had been spending on supplies. “People were running down to the local Office Depot and expensing stuff,” explains C.J. Glynn, a marketing executive for Ariba. Jack Miles, CIB’s vice president of purchasing, estimates that the bank will save 5% to 10% of its total spending once the e-commerce system is fully implemented. Likewise, Hewlett-Packard figures it will save more than $225 million, or 5%, on the $4.5 billion it spends on goods and services annually. “These systems are paying for themselves in months,” says Tony Friscia, president of AMR Research, a Boston-based consulting firm. “As Internet strategies go, this is really a no-brainer.”
2. SELL ONLINE. Much has been made about the threat of pure online retailers like Amazon.com, or even manufacturers selling direct to customers online, like Dell Computer Corp. But increasingly, experts say the risk for traditional retailers is not getting “Amazoned” or even “Delled,” but getting “Schwabed.” By that they mean facing a competitor that smartly integrates the dual powers of a brick-and-mortar empire and the Net, as Schwab has with its huge network of storefronts and its leading online brokerage site. “Early on, the big fear was that great manufacturers and pure online retailers would displace brick-and-mortar retailers,” says Kevin Murphy of Internet consultant Gartner Group. “But it turns out this is not necessarily a good play, particularly where services need to be delivered locally.” In a recent survey of 40 established businesses and dot-coms, Gartner found not a single company pursuing a strategy of getting rid of the middle man.
Instead of dumping their distributors, many manufacturers are using the Internet to empower them. Consider Ford Motor Co., which has devised a customer website where buyers can research a car or truck, apply for a loan, and submit an order. The final sale and delivery must be arranged through a dealer on whom the customer will rely for service. “Our approach allows for two-to-one-marketing versus one-to-one,” says Ford’s public affairs manager Kathleen Vokes. “We’re not taking away sales from the dealers. Only the dealers can sell. But we are offering them another way to reach the consumer. It’s a partnership, not a competition.”
Likewise, major brick-and-mortar retailers are experimenting with ways to use the Internet not just to capture otherwise lost online sales, but to create a better customer experience and generate more in-store sales. An early model is REI, the 61-year-old Seattle-based outdoor gear company, which has 55 stores nationwide. REI boasts the Internet’s biggest outdoor gear store with 15,000 product offerings plus expert advice, online clinics, a community bulletin board, and a complete adventure travel service. Inside the stores, customers can surf the REI website, where they can order out-of-stock items, research camp gear specs, and book travel.
Now giants like Sears and Wal-Mart are emulating that model by launching online sites that are chock full of information about their products, and installing Internet kiosks in stores to enable customers to investigate products and services. Though many retailers originally feared a website would draw customers away from the stores, Sears has found the opposite to be true. “After we introduced our Sears Craftsman catalog online, we found that customers bought 27% more in the stores after buying online,” says Sears Online’s public relations spokesperson Ann Woolman. “And when people buy appliances, they are doing their research online, then coming to the stores with printouts in hand. These are some of the easiest sales to close because people have done their research.”
Indeed, over the longer term, brick-and-mortar giants may be in a better relative position than pure online retailers, which have to spend massively on advertising and build costly warehousing, distribution, and service networks. “The Achilles heel of online retailers is advertising and promotion costs,” says Gartner’s Murphy. “Established retailers with sterling brands like Tiffany or Wal-Mart don’t need to promote their names as much and can piggyback advertising for their website on store receipts, bags, or existing ads. Plus, they have a strong service advantage. We believe the empire will strike back.”
3. NETWORK YOUR “VALUE CHAIN.” The reengineering wave of the 1980s and early 1990s was largely about streamlining internal processes. But today’s e-engineering wave uses the Internet to reach out beyond the walls of the corporation to create a network from its “value chain”—suppliers, subcontractors, distributors, and customers. That virtual integration enables companies not only to cut costs but to improve quality and service.
To glimpse the future, visit San Jose-based Cisco Systems, the leading manufacturer of the switches and routers that form the guts of the Internet. At Cisco, e-engineering has produced stunning results: savings of $800 million and productivity gains of 20% annually, five years of rising customer satisfaction ratings, and a stock that more than doubled last year. “Essentially we are using the Web to create operational efficiencies,” says Cisco spokesman Tom Galvin. “We are doing more with less.”
Roughly 80% of Cisco’s sales are generated online, where customers use a program that guides them through the task of ordering complex equipment like servers and routers. Orders are then zipped to Cisco’s plants (all but two of the 37 are contract manufacturers) where managers keep close tabs on production—as well as suppliers and distributors—through Web-based programs. Meanwhile, a customer can check on an order or deal with operation and maintenance problems over the Web, where Cisco has migrated some 80% of its customer service. Likewise, the company does 70% of its recruiting and virtually all of its internal administration, training, and communications via the Web.
An added benefit: Because all financial data is tracked in real time on the Net, Cisco now has a virtual close daily. That enables it to spot and address problems early—production or distribution bottlenecks, for example. Similarly, opportunities, such as a spike in demand or a shift in customer preferences are quickly identified. Cisco’s Web-based accounting system also slashes the time and resources needed to meet financial reporting deadlines. It used to take the company three weeks to generate a quarterly statement required by the Securities and Exchange Commission; now it takes just a day. “Cisco’s virtual accounting system knocks me out,” says shareholder activist Nell Minow. “Can you imagine if you were on an audit committee and could check the numbers on a daily basis? You could spot early problems like Sunbeam’s spiking inventory numbers. You might even eliminate extraordinary charges! One of the greatest short-term benefits of the Net is its capacity to improve financial accounting.”
Recently, GM, Ford, and DaimlerChrysler also announced plans to set up a single electronic bazaar bringing together their suppliers into the world’s largest Internet exchange. The companies are replacing an inefficient, slow-moving system of phone calls and forms with a real-time global information network that everyone along each company’s supply chain can see. Says Ford’s Kathleen Vokes: “It now takes weeks for an order to work its way through the supply chain. But with the auto exchange, suppliers and suppliers’ suppliers will be able to see information that comes into plants from the orders in real time. So it will let the supply base see up front what we may be selling and what trends are developing.” Once launched, the e-market could generate annual revenues from transaction fees, advertising, and services of at least $3 billion. More later on such so-called e-markets.
4. CREATE A VIRTUAL COMMUNITY. In the old world, setting up a forum where suppliers, customers, employees, and even competitors could talk freely and publicly might have gotten you fired. But in the Internet Age, the ability to build such freewheeling communities of interest is an asset, not a liability. AOL founder Steve Case was among the first to grasp that new reality when, in the mid-1980s, he began approaching groups of people with common interests—airline pilots, gardeners, retired people—and offering them a place to “hang out” and “chat” electronically. Today, with more than 20 million members, AOL is a cash cow, able to generate massive advertising revenues and charge partners hefty fees to post content on it. Last year, AOL’s net income—and stock—more than doubled, making it one of the few really profitable Internet pure plays.
Others that have capitalized on community networking include eBay, the leading Internet auction site, which started out as a forum to swap info and trade such collectibles as Pez dispensers and Beanie Babies but now hosts auctions on some 250,000 items a day, from rare coins to fine jewelry and antiques. The key to its success: a bond among eBayers fostered by chat rooms like the eBay Cafe or bulletin boards where people with common interests can share ideas and tales from the collecting trail.
Or consider Tripod, a site started in 1995 by two Williams College grads, Bo Peabody and his economics professor, Dick Sabot, to provide 18- to 35- year-olds with practical “tools for life,” on everything from personal finance to romance. Three years later, having attracted more than a million loyal, upwardly mobile Gen-Xers, Tripod sold out to Lycos for $58 million, or roughly $1 million per employee. “Tripod.com functioned as both a destination and a starting point, not just as a way station in cyberspace,” writes Boston-based consultant Patricia Seybold in her book Customers.com (Times Books, 1998). “Once your site has become a magnet, once it becomes the place customers go first and go back to often, you have achieved stardom in the Internet world. If you can sustain that sense of community and belonging, you have created real value.”
Dot-coms are not the only ones discovering the power of community. Indeed, one of Cisco’s first steps down the road of e-commerce involved allowing customers to answer each other’s technical questions on its website, a community-building move that cut calls to Cisco’s technical staff. “The most cost-effective way to support highly technical and complex products is to let customers act as an adjunct to your own technical support staff,” says Seybold. “Let customers help other customers solve their problems.” Now the constant interaction of Cisco’s community of suppliers, manufacturers, distributors, and customers adds enormous value to the company in terms of quality, efficiency, productivity, and service.
One of the most valuable aspects of online communities may be their information-mining potential. Cisco, Tripod, and others have found that online customers love to tell you what they think about your products and services and how to improve them. And those who don’t tell you show you by where they travel on the site. “Once you understand who your customers really are, what are their interests and habits, you can refine your products and services, send them e-mails with creative offers, and expand your business,” says CyberDialogue President Mark Esiri. “Community building allows you to unlock value out of your most important asset: your customers.”
5. ESTABLISH E-MARKETS. Wondering where the Net could make you some real money? For the most part, it’s not online retailing yet. And the profitable consumer portal business already is dominated by Yahoo! and America Online. But experts see enormous opportunity for established companies in so-called “e-marketplaces” or “corporate exchanges.” These are essentially business-to-business portals, or electronic shopping malls for companies. By 2003, the Gartner Group estimates, 7,500 to 10,000 such e-markets will be in operation. “This is the hot new twist in e-commerce,” says Glynn of Ariba, which develops systems to manage e-markets. “We are being approached by major global 2000 companies on a daily basis. The potential is immense.”
One believer is SAir Group, the parent company of Swissair, which is setting up an e-marketplace of its suppliers where the entire airline industry will be able to buy everything from jet fuel to airplane tires to meal trays. By doing so, SAir cuts its own costs, since it can use its aggregated purchases to negotiate bigger discounts. SAir also can generate revenues from subscriptions paid by users and by taking a cut of the transactions made over the site. The system also should please suppliers by exposing them to a broader range of customers and buyers who get more choice and lower prices.
Still others are going a step farther and creating e-markets that feature rivals’ products alongside their own. Crazy? Not necessarily. Consider Fruit of the Loom, which, despite its overall financial woes, has made striking headway with this strategy. The company developed an e-market that set up distributors with a website from which they can access not only Fruit of the Loom garments but competitors’ lines as well. The program has paid off for Fruit of the Loom, increasing sales by as much as 25% and expanding the company’s market share. Says Gartner’s Murphy: “Fruit of the Loom had an advantage because it built the system and could present its products more favorably. But the big factor was that it was the first online and demonstrated that it understood its customers needs.” Likewise, MetalSite.com, which started out as an auction site for excess inventory set up by Weirton Steel, LTV Steel, and Steel Dynamics, did not take off until all the industry players were included.
In any event, if you don’t create an open e-market, it’s only a matter of time before a competitor or dot-com will. Says Murphy: “A lot of companies look at these e-markets and immediately feel threatened. But they are not necessarily your enemy and may be your friend if you’re an early adapter.”
Not surprisingly, most corporate leaders shrink from the prospect of launching an Internet venture of any kind that would compete directly with—or even destroy—their existing business. Even in the corporate world, it’s unnatural to eat your own. “It’s incredibly difficult to change people’s mindsets when they are busy with their core businesses,” says Esiri. “It’s fine to tell the sales director in Boise that he’s now responsible for online sales. But particularly if his compensation is based on sales in Boise, he’s not going to cannibalize that revenue stream, even if the online venture is good for the overall business.” Moreover, large companies have trouble tapping into entrepreneurial talent that’s drawn by the freedom, fast pace, and stock options of the dot-coms. Notes Esiri: “Most big companies just can’t compete with their existing business channels except as investors.”
But there’s good reason to try. If you are going to lose customers to an online provider, it might as well be your own. What’s more, the venture is likely to lead to new business opportunities. And if you structure it as an independent dot-com stock or tracking stock, you may get enormous financial returns, thanks to the stunningly cheap cost of capital enjoyed by dot-coms.
Consider the saga of Amazon.com and the Barnes & Noble bookstore chain. In its first four years of operation, Amazon lost more than $840 million, yet it recently boasted a market cap of $28 billion. If leading brick-and-mortar competitor Barnes & Noble had lost that much money, the market probably would have forced it into bankruptcy. Why the double standard? Explains Esiri: “The market valued Barnes & Noble on a traditional earnings and cash-flow basis at about 18 times earnings, so every $10 million it spends on marketing reduced its market cap by about $180 million. But every $10 million Amazon spent increased its market cap by about double, because as a dot-com, Amazon is valued on its revenue-generating ability. So the more money it spends to buy customers, the higher its capitalization.”
To access that cheap Internet capital, some large companies are setting up separate subsidiaries, like Bank One’s Wingspan, an online bank. Others are forming partnerships like Office.com, an e-market for small businesses that is jointly owned by Winstar Communications and Cambridge Technology Partners. Still others like Disney with go.com and DLJ with DLJ Direct have chosen to keep their ventures in-house but fund them with tracking stocks, which “track” the subsidiary’s performance. Whatever structure you choose, one thing is clear: the more independent the subsidiary—culturally, managerially, financially— the better.
So where will this revolutionary force called the Internet ultimately land us? No one knows for sure. But it seems clear that the power of the Net will force companies to rethink their competitive advantage. “The Internet will cause an unbundling of traditional business models,” predicts Marc Singer, a principal of McKinsey & Co. “Now they consist of three main things: product and service innovation and commercialization; managing your infrastructure from accounting to payroll to distribution; and sales and customer relationship management. But most companies are really only good at one out of the three. The Internet will enable companies to focus on the piece they do best and outsource the rest.”
Indeed, figuring out what your company does best may be the key to determining your best Internet strategy. If you know that customer relations are your most valued asset, you probably want to build a retail website, perhaps even an e-market, to deepen your relationship with your customers. But if product innovation is really your thing, perhaps you can rent space on an e-market rather than build one and, instead, focus your Internet strategy on supply chain management.
Often the simplest questions are also the toughest—and most important. So before you ask your executive team to define their Internet strategy, ask them to identify their most valued asset. Remember, you want to build a rocket ship—not a boat in a basement.
