Let’s Get Crazier!

Everyone knows why all those dot-coms crashed and burned:
They had a bunch of crazy ideas that would never work. Bzzzzt! Wrong answer. The
truth is, they weren’t crazy enough. Now that the downturn has scraped the
veneer of cool off every e-business from Yahoo! to Amazon.com, it’s apparent
that they are all too normal, borrowing old business models that worked on
television and in the mall. To succeed on the Net we need twisted, cockamamie
notions that just might have a chance in this nutty New World.

Three years ago, almost everyone thought eBay was a crazy
idea: How many people really want to buy cars and boom boxes, let alone used
cribs and diet pills, from someone they’ve never met, halfway across the
country? The skeptics even included future Chief Executive Margaret Whitman,
whose friends doubted her sanity when she took the job in early 1998. Now, eBay
hosts a profitable $5 billion worth of transactions annually, more than any
other dot-com. Its execs and backers recognized that the seemingly kooky idea
worked perfectly on the Net, where people could form a uniquely self-sustaining
global marketplace.

By contrast, most dot-coms have clung to products and
services companies offer in the physical world, often without adding enough
value. Maybe it’s a little easier to order groceries on the Net than drive to
a supermarket, but not so much so that it can charge enough to make a profit.
Yahoo does a great job of aggregating information, but its business model so far
has been selling ads to the masses–hardly an innovative idea.

The problem now is that few investors want to hear any crazy
talk. Maybe you can’t blame them. The line between imagination and lunacy was
mighty thin in the last couple of years. So now, venture capitalists, who are
supposed to take risks, are shying away from funding any e-commerce company that
looks the least bit risky.

Fortunately, some entrepreneurs haven’t checked out of the
asylum yet. Take Karl Jacob, CEO of the online-advice service Keen.com. After a
short stint as an entrepreneur-in-residence at Silicon Valley VC firm Benchmark
Capital–where he admits he didn’t believe in eBay at first–Jacob started
Keen. His aim was to get people to log on to the Web to locate experts on
everything from astrological readings to computer repairs–and then pay to
consult with them over the phone. Weird as it sounds, it’s working so far:
Sales at the privately-held company have jumped from almost zero a year ago to
more than $5 million in the first quarter. Says Jacob: "You can’t create
lasting companies and great value by following everybody else."

Or listen to E-Loan CEO Chris Larsen, who talks about
person-to-person lending over the Web. The online loan broker may eventually
help people invest in real estate loans in their neighborhood or in trusted
members of their Kiwanis Club, bypassing middlemen in between. Sound crazy?
Maybe, but it’s what local savings and loans did before they got greedy and
stupid. And the Web can create much broader communities, matching investors with
loans of appropriate risk and return.

Even Amazon, while rightly cutting costs in hopes of earning
an operating profit by yearend, still hasn’t stopped innovating. It keeps
releasing new features, such as an honor-payment system so customers can
volunteer a few bucks to keep other sites they like in business. A lot of folks
think it’s nonsense, but Amazon gets a cut–and a chance to make its Web
payment service a standard that could bring in big bucks in the future.

I don’t know if any of those ideas ultimately will fly. But
with a disruptive new technology such as the Net, intuition–backed by
intestinal fortitude–often wins out over safe bets. "There’s a lot of
opportunity for more creative ideas on the Internet," says John Hagel III,
author of Net Worth and Net Gain. Entrepreneurs and investors just need to find
that backbone under the shirts they lost.

By Robert D Hof in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc

True grit

But the very strengths of the Net are also its limitations. Just because
communication is ubiquitous doesn’t mean it’s everything. The last five
years have taught us that in industries such as retailing, manufacturing, and
transportation, physical factors overpower the virtual. E-tailing turns out to
be more about which company is best at moving boxes around rather than who has
glitziest web site or the biggest virtual store on earth. Linking supply chains
over the Net cuts costs and improves response times, but ultimately
manufacturers succeed or fail if they develop good products and figure out how
to produce them at low cost and high quality. Online airline reservation systems
can improve customer convenience and boost the revenue yield per passenger, but
they can’t do anything about long delays caused by runaway congestion, too few
loading gates, antiquated air traffic control systems, and mechanical
difficulties on airplanes.

Even in areas where the Internet can play a central role, the big changes are
not going to come overnight, as investors have found to their chagrin. Some of
the information-intensive industries where the Internet could have its biggest
effect are also the ones where institutional and regulatory barriers are the
highest and vested interests are the strongest. In health care and education,
for example, the possible benefits from widespread use of the web are enormous,
but it’s going to happen in baby steps, over time. What’s more, it’s a
difficult, painful, and slow process to restructure companies and markets.

In the end, it turns out that the speed of Internet time has more to do with
the capital markets than with the pace of technology adoption. The enormous
amounts of venture capital available to startups drove companies to grow far
faster in a few short years than the underlying infrastructure or consumer
demand could support. In fact, the eventual benefits of the web should be
measured over a decade. "People had higher expectations for the next couple
of years than are likely to be realized," says Jeffrey Bezos, CEO of
Amazon.com. "And people have much lower expectations for the next couple of
years than are likely to be realized over the next 10 years." That may help
explain the current confusion about the future of the Internet.

Got Web?

That’s why Internet optimists are refusing to retreat. Analyst Mary Meeker
of Morgan Stanley Dean Witter is urging Net leaders such as Amazon, Yahoo, and
AOL Time Warner to band together in a ‘Got Milk?’-style marketing campaign
promoting the idea that the web is alive and well.

Such webfests, however, aren’t likely to change the minds of burned
investors or restore the once-buoyant expectations for the Net. For instance,
Merrill Lynch analyst Henry Blodget recently reduced his expectations for how
much retail sales will go online to only 5% to 10%, down from 10% to 15% he
envisioned just a few months ago. Even Bradford Koenig, head of the technology
banking practice at Goldman, Sachs, which underwrote many of the hottest Net
IPOs, has lost confidence in pure Internet companies: "The notion of an
Internet company is no longer viable."

But that’s too pessimistic. In fact, part of the problem was that much of
the investment flowed into areas where the Internet is incremental rather than
revolutionary. Take retailing. The hyped consumer dot-coms were supposed to blow
away their brick-and-mortar counterparts. But it turns out that the importance
of information and communication in retailing–the Internet’s forte–is much
smaller than the role of logistics. How much smaller? According to a Softbank
spokeperson, it takes between $15 million and $25 million to build a
top-of-the-line web site. Yet it costs at least $150 million to build a
warehouse and distribution system for a consumer web operation.

All across retailing, the Internet is no longer seen as the 800-pound
gorilla. For example, a year ago, the prevailing wisdom was that old-fashioned
auto dealers were going to be passe. But so far, that hasn’t turned out to be
true. "There hasn’t been the massive shift to buying cars online that we
thought there would be 18 months ago," admits Mark Hogan, president of
e-GM, the auto maker’s online consumer unit.

And there’s growing evidence that shoppers on the Net are supersensitive to
price, according to Austan Goolsbee, an economist at the University of Chicago.
The implication is that any profits e-tailers might make could be short-lived as

competition drives prices down on the web.

Perhaps the biggest surprise is the comparatively limited impact that the Net
may have on manufacturing. To be sure, there is no doubt that e-business has
become an essential part of any manufacturer’s toolkit. The use of the Net can
reduce inventories, take costs out of the supply chain, and eliminate
unnecessary transactions. Collaboration can also speed up product development,
e-marketplaces can lower the cost of components and other supplies, and detailed
info on customers can help customize products to snag bigger orders or even help
determine which customers aren’t cost-effective. At Procter & Gamble, a
web-based information-sharing network makes it easier to collect and evaluate
new product ideas from the company’s far-flung workforce of 110,000 people.

Nevertheless, at the end of the day, manufacturers are still in the business
of making things, not simply moving bits and bytes around. Wheels have to be
bolted onto the car, circuit boards have to be installed in the router–and
that has to be done physically.

To know how this limits the impact of the Net in manufacturing, look at the
example of Cisco, the communications equipment giant, universally regarded as
the poster company for using the web. Some 68% of Cisco’s orders are placed
and fulfilled over the web and 70% of its service calls are resolved online.
Cisco is in the process of linking all of its contract manufacturers and key
suppliers into an advanced web supply-chain management system, dubbed eHub
speeding up the rate at which information about demand is distributed to
suppliers.

According to Cisco’s own calculations, its payoff from its use of the
Internet amounts to $1.4 billion per year, or 7% of sales. If the rest of
manufacturing could even do half as well as Cisco in using the Net, that would
cut an impressive $150 billion from annual manufacturing costs. And yet it is
not the radical reduction in costs that would signal a revolution.

Slow as molasses

While supply chains linked over the Net are more responsive than their
predecessors, they have their limits, too. "The flexibility now being
demanded by customers exceeds the physics of what the supply chain can actually
deliver," says Kevin Burns, chief materials officer for contract
manufacturer Solectron, whose big customers include Cisco and IBM. Now that
companies have switched to web-based models, he notes, they expect to be able to
ramp up or halt production of a product within weeks. But it still takes at
least three months to get a specially designed chip made in a Taiwanese foundry
and around 40 weeks to order an LCD screen.

Obstacles don’t disappear, but it’s easier to see the far-reaching
potential of the Net in industries that are primarily about moving information
rather than goods. Take financial services. In many ways, financial products are
ideally suited to the Internet, since they deal only with information. A recent
Goldman Sachs survey reported that 63% of financial companies had sold their
products through an e-marketplace or a web site, the highest of any industry.

The Internet is already well on its way to transforming financial services.
Online brokers such as E*Trade Group have completely changed how the retail
brokerage business worked. And Net services are now offered by nearly every US
bank and credit union. Bank of America says it’s signing up 130,000 online
customers a month, giving it more than 3 million Net customers. Citigroup has
2.2 million, Wells Fargo, more than 2.5 million.

But as in the case of entertainment, technological and institutional barriers
are slowing down the eventual gains. Consider online bill-paying, widely
anticipated to be the "sticky app" that drives traffic. The benefits
of paying bills on the Net, for both consumers and businesses, could be
enormous. But the technology has proven exceptionally complicated, and it has
hit a wall trying to penetrate the banking industry. Among the problems: Banks
and billers have been unable to agree on how bills should actually appear
online. Still, Bank of America plans to launch a big ad campaign later this year
to promote its bill-paying service.

And then there’s health care. Despite the tangible nature of many medical
services, health care has a very large information component that makes it a
natural for Internet applications. Just shifting claims- processing to the web
could save $20 billion a year, according to the Brookings economists. At a
leading provider of prescription drug care in the US, it costs a matter of cents
to handle a prescription order on the Internet, as opposed to more than $1
through other methods.

Broadband’s promise

But there are enormous institutional barriers. For one, privacy
considerations may slow down the full shift of health-care records to the web.
Moreover, health-insurance companies, doctors, and hospitals are unwilling to
give up control of patient records and insurance payments to a third party. This
reluctance helped frustrate WebMD and Healtheon, which expected to lead a
restructuring of health care by moving many claims, payment, and related
processing services to the Net. WebMD’s efforts to provide real-time payment
capabilities were shunned by insurers and HMOs, who prefer the current
cumbersome process that lets them hold onto the money longer.

There’s also the technology factor. In the long run, realizing the promise
of the Net will depend on the widespread introduction of advanced technologies
such as broadband to the home and high-speed wireless. With broadband
connections over telephone or cable-television lines, consumers will be able to
watch TV-quality video clips of the NCAA basketball tournament or download
crystal-clear music files faster than ever before. What’s more, they’re more
likely to use the Net because they’ll always be connected and won’t have to
spend minutes dialing into the Net each time they want to visit a site.

The problem is that getting the new technologies in place may take longer
than expected. Financially stressed telecom companies are slowing down the roll
out of broadband. The failure of small telecom providers means that subscriber
growth may slow down in second- or third-tier markets. And the prices for
high-speed Internet access may rise.

In the end, the Internet seems likely to revolutionize mainly
communications-intensive industries. If that seems too

limited, remember that almost every breakthrough technology over the last 200
years affected some areas of the economy more than others. The automobile
transformed personal transportation and patterns of housing while little
affecting manufacturing. Electricity radically altered manufacturing practices
and any industry that was power-intensive, while not having an enormous effect
on health care. The Net deserves to be put in such august company.

Michael J Mandel and Robert D Hof with inputs from Linda Himelstein in
Silicon Valley, Dean Foust in Atlanta, Joann Muller in Detroit, and bureau
reports–BusinessWeek