Survival of the Fastest
As they analyze an increasingly tangled Web, E-business gurus see trouble -- even extinction -- ahead for entrepreneurs who aren't on their toes
Once upon a time, there was a happy land called the Web -- a great, open, global, and democratic marketplace where opportunity seemed to be as limitless as real estate. Merchants from around the kingdom scurried to erect virtual shops serving customers who were willing to live with sore typing fingers if it would save them a trip to the mall. The future looked especially bright for the "dot-coms," pure Web companies conceived and executed on-line, and thus lacking the baggage of their terrestrial counterparts. As the millennium approached, Internet entrepreneurs watched annual on-line orders climb to 1 billion. They smiled, patted one another's backs, and took early retirement.
Well, like most stories beginning "once upon a time," this one is a little too good to be true. For many Web-based companies, success, at least in terms of profits, remains elusive. And a number of circumstances are making things harder. First there's the noise: every day, hundreds of new Web shops sprout up, hoping to catch the interest of Joe and Jane Consumer. Second, customers are getting spoiled. Visitors will click off, never to return, if a site isn't clever, easy to navigate, and fulfilling. Meanwhile, established brick-and-mortar businesses with big brand names, solid infrastructures, and legions of employees are muscling in. As those brand-name behemoths -- Nike, Gap, L.L. Bean -- move in, consumer business could grow ever harder for the small Internet-based company to attract. Today small and midsize retailers capture only 9% of Web sales, reports Forrester Research, based in Cambridge, Mass. By 2003, with more large companies dominating the Net, that market share will have dropped to 6%, the research outfit predicts.
Moreover, while start-up dot-coms struggle to attract consumers, they may be missing more-lucrative opportunities -- particularly in selling goods and services to other businesses. Forrester predicts that business-to-business sales over the Internet will have grown from $43 billion in 1998 to a staggering $1.3 trillion by 2003.
What does all that mean to the Internet entrepreneur? To find out, Bronwyn Fryer, a contributing writer at Inc. Technology, asked six of the brightest stars in the E-commerce world to describe the current and future state of Web business. The participants in the following roundtable discussion -- conducted entirely by E-mail -- include author Evan Schwartz; MIT professor Thomas Malone; Dell Computer vice-president Richard Owen; John Briggs, director of E-commerce production for the Yahoo Network; Mark Hoffman, CEO of Commerce One; and Greg McLemore, president and CEO of WebMagic. (Profiles of the participants appear below.)
The Ages of the Internet
Inc.: If you were writing a history of Web commerce that identified different epochs, what age would you say we are in now? What are its defining characteristics?
Briggs: If it were to take God seven days to create a mature Web-commerce universe, I'd say that we are only on the third day so far. On the first day, God created the Internet.
On the second day, God created Web-only companies that really understood the Internet and knew how to leverage it. These were mostly low-overhead businesses that could offer commodity products such as books, music, videos, and computers. While those businesses have managed to sell a lot of product, most haven't figured out how to make a profit.
On the third day, God allowed traditional brick-and-mortar and catalog companies to recognize the opportunity of the Internet, and they began selling merchandise on-line. It was easy for the catalog industry, because its infrastructure is well suited to on-line sales and distribution. Brick-and-mortar retailers have had a tougher time. Not only have they had to educate themselves about the Web, but they have also had to develop the distribution, fulfillment, and inventory-automation mechanisms to enable them to conduct business on the Internet.
But many companies, like the Gap, have overcome those obstacles and are beginning to thrive on-line. They do that by passing on their volume pricing to the Internet shopper and leveraging their brick-and-mortar locations.
Schwartz: John, I'm intrigued by your creationist view of the Web universe. I happen to believe that Darwinian evolution is an appropriate metaphor, but I don't want to turn this into a Kansas school-board meeting.
For my part, I think we have already witnessed something like a Cambrian explosion of life. Since Netscape went public, in 1995, we've seen a big bang of new economic species burst forth, producing thousands of enterprises that couldn't have existed previously. All the necessary elements came together rather suddenly. Software for creating and browsing Web sites flooded the market, making the digital landscape hospitable. And the venture capital started flowing like a river, so there was enough food.
But I think we are inevitably going to enter an era of mass extinction in which most of the dot-com enterprises that now exist will be gone or swallowed up. The great Darwinian sorting of winners and losers has already started happening.
McLemore: I agree. In many consumer-goods sectors, there are already more companies than the ecosystem can support. Only large, broad-market players and niche ones will survive. Many middle players will starve to death or be devoured by larger ones. As the Internet evolves, there will be some extinction, but there will also be more growth.
Owen: Michael Dell's philosophy on Internet business models is that, like most embryonic businesses, the initial winners on the Net are often not the real winners. Maybe one or two of the current pack can adapt and win big, but many players may simply not be around in a five-year time frame. First-mover advantage is great if you pick the right model, but the model can change so much that maybe the second mover makes the real money.
Inc.: So what age will we give way to?
Hoffman: The next Internet age will be the era of business-to-business commerce, which represents a huge opportunity. Forrester Research estimates revenues for business-to-business E-commerce of more than a trillion dollars by 2003. Today most of that business is happening on a regional basis: North American buyers buy from North American suppliers, and the same with Europe, Asia, and so on. The next big phase will occur as regional trading communities begin to do business with each other.
Inc.: How are dot-com-company founders today different from those of a couple of years ago?
Owen: Too much capital is chasing too few good ideas. Many dot-com founders are poor businesspeople who are attracted by the potential to get rich rather than to create something that is -- in the words of authors James Collins and Jerry Porras -- "built to last." The mix of quality has changed in the past year as the providers of capital have become less discriminating.
McLemore: I disagree. I've noticed that investors want a lot more management experience in founders because competition has increased. Repeat Internet entrepreneurs such as myself and savvy founders from outside the Internet with extensive management experience are becoming much more common.
Briggs: And more dot-commers now come from traditional retailing backgrounds. They really understand their customers and the value of superior customer service. That is very different from early Web-centric companies, which simply offered a big selection at low prices.
Current (and Future) E-vents
Inc.: Right now, many big dot-com companies are experiencing considerable success. Look at Amazon, with its ever-expanding tentacles. Will small dot-coms get squeezed out?
Schwartz: People misunderstand why Amazon is growing so fast. It's not just the low prices and wide selection; it's the attention to detail in customer service and the wide range of services, like one-click payment, personal recommendations, and a powerful affiliate program. But Amazon won't be like Wal-Mart coming to a small town, wiping out everything else. There will be thousands of other winners in niche categories, especially in business-to-business markets.
McLemore: There is plenty of room and opportunity for well-funded world-class brands as well as small, shallow-pocketed players. Small players just need to focus on a niche where their expertise can provide a value-added experience for the consumer. I just ordered a book on vintage soda machines from a collectors' site because of the expert editorials I saw there.
Owen: You could view this as an argument between big department stores and specialty stores. A lot of people still shop at department stores, and they are not going away, but America has chosen specialty stores. Amazon-style companies will have to compete against the specialty players, who may dominate their own spaces. And price will increasingly disappear as a method of differentiation and will be replaced by content, community, and customer experience.
Inc.: The crossroad at which the dot-com companies intersect with land-based business represents both an opportunity and a challenge to new, shallow-pocketed entrepreneurs. What model offers more likely success -- the pure-play dot-com or the hybrid?
Schwartz: The conventional wisdom is that new dot-com start-ups have an imposing advantage over traditional corporate species because they don't have the brick-and-mortar baggage holding them back. But the companies that are tying the new together with the old -- by tightly integrating digital commerce with physical commerce -- are the ones that are going to survive and thrive. Look at what Dell is doing in the computer business; or what REI, the chain of outdoors superstores, is doing in retail; or what Streamline is doing using the Web to coordinate the in-person delivery of consumer goods to people's homes.
McLemore: But Evan, the conventional wisdom isn't always wrong. Millions of customers all over the Internet are voting with their wallets. Dot-com stores are still a lot more nimble than many land-based retailers caught in their antiquated structures. Many land-based retailers begin to move only when they feel they need to in order to survive.
Briggs: Greg, the traditional players are coming. They see the threat and the opportunity, and they are moving their businesses on-line at a furious pace. These retailers can offer services, such as holding items for same-day pickup or even offering same-day deliveries. Web-only companies cannot compete with that.
Inc.: So what should small companies be doing? Changing their business models? Deepening their brands?
Malone: Certainly, an important part of the rationale for giving high valuations to dot-com companies is that they are establishing brands in the E-commerce-based economy. But I believe that brands themselves will become less important in the future.
Here's why: Right now, brands provide a signal of quality that buyers can use to judge the potential value of a product they are considering buying. That is important in today's "frontier" world of E-commerce, because brands provide one of the few ways to judge the value of products you can't see or touch. For example, most people would assume that a TV from Sony would be of higher quality than one from Joe's Garage Electronics.
But in the not-too-distant future, there will be many Consumer Reportstype rating services on the Web, perhaps including Gomez.com, Deja.com, and Epinions.com. These services will make it very easy for you to get summaries of many buyers' experiences and of expert evaluations of products. In this world, would you rather buy a TV from Joe's Garage Electronics that was rated excellent by numerous buyers and experts or a TV from Sony that everyone thought was terrible?
I think most people would clearly prefer to buy from Joe's -- and therefore brands will become less important in the future. I also think E-commerce investors who are betting primarily on the future value of today's brands will be disappointed.
Schwartz: Tom, I respectfully disagree. All the evidence so far points to the fact that strong brand names are becoming more and more important in a world in which we can't rely on the typical visual clues. People will always need strong brands to cut through confusion and clutter.
And the brands that dominate the Web economy are not the ones we grew up with in TV commercials. There are no new brands of soaps and deodorants, cars and trucks, jeans and sneakers and such that have been made prominent on the Web. The brands that are thriving are what I call "solution brands" -- the ones that help you find the right information and services and complete tasks and transactions in a unique way. I think that Yahoo, E*Trade, eToys, Dell, and many of the emerging business-to-business start-ups are good examples of this.
Malone: I completely agree with you that, so far, strong brand names are becoming more and more important in the world of E-commerce because they are the best way we have of establishing trust. But what's coming next? I just think people are more interested in trust than in brands, as such. When services that aggregate and refine the opinions of real people are widely available, brands will be less important.
Schwartz: Well, Tom, perhaps these new aggregators become solution brands in and of themselves.
Owen: Doesn't the answer to all this depend on what you are selling on the Web? There's a difference between selling your own product and acting as an intermediary. You may have a brand that the manufacturer is selling directly on-line. Fedex.com, for example, has Federal Express behind it, and people want the FedEx customer experience. But if you are an "E-tailer" like BestBuy.com or Buy.com and simply act as a low-cost, on-line intermediary, the brand belongs to the product you are selling. A Sony microdisc player is branded Sony regardless of whom you buy it from. In these markets, some branded intermediaries are already having a tough time, and things will only get worse.
What Can Go Wrong
Inc.: What are the biggest mistakes that the dot-coms are making today?
Briggs: I think the biggest mistake dot-com merchants have made in the past was pricing their items so low. Now they have two problems: They can't cover their own costs, so they are losing money. And they have set consumers' expectations for these low prices, and it's tough to ever go back.
Schwartz: Dot-coms are also spending prodigious amounts of money blitz-marketing their domain name, as if a general awareness of their brands were the only important factor. Just because a brand is well-known doesn't mean it's a strong one. Look at Music Boulevard versus CDnow. Everyone knew the names, but no one knew why one was better than or different from the other. So they merged. Then the merged company couldn't even survive on its own -- it was swallowed up this year by Columbia House.
McLemore: I think the biggest mistake of dot-com companies today is not satisfying the customer. For instance, eToys was famous last holiday season as the poster child of perfect customer service. A few other sites, however, evoked so much rage that their own customers launched special anti-dot-com Web pages in protest.
Also, strange as it may sound, many dot-coms aren't spending enough on technological infrastructure. It isn't always easy: just ask the folks at eBay -- an auction site notorious for its technological hiccups. Sites need enough sophistication to be reliable, quick, and friendly.
Owen: I agree. Many sites are struggling with performance and reliability. Ironically, many of the fundamental challenges with information technology have not gone away. Dot-coms also fail to invest in the quality of physical operations so that supply-chain performance is up to scratch. Many companies have the "nice site, shame about the product" problem, because they focus too much on customer acquisition and not enough on retention. Customer retention through excellent service will be the primary economic differentiator.
Inc.: Which emerging technologies will matter most to the success of Web commerce?
Schwartz: Ten years from now, I don't think there will be any such thing as an Internet company, per se. Every company will be an Internet company, and the technology will be ingrained into everything we do. Just think of all the everyday objects joining the Web and becoming Internet devices -- everything from industrial equipment such as oil rigs or factory machinery, to consumer devices such as refrigerators and children's toys, to cars and trucks. As more and more of these objects get embedded chips that can send and receive information from anyplace in the world, there will be thousands of new applications that we haven't even thought of yet.
McLemore: I foresee a huge boost for E-commerce when people become able to order anything they can imagine from anywhere on earth just by pulling out a PalmPilot.
Briggs: Technologies that save people time and money will have a big impact. The "one-click" payment used by many merchants is a good early example. On-line registries that simplify gift-buying for weddings, holidays, birthdays, baby showers, and housewarming occasions will be big.
I also think that technologies like shopping agents and alerts that notify customers when a product they are looking for is found in their price range could be popular. Those technologies essentially do the shopping for you. And if one on-line wallet standard ever emerges, it will also help simplify the checkout process and save consumers time.
Malone: In a certain sense, however, I think that new technologies will matter less than we think. Sure, all kinds of computational things will get smaller, faster, cheaper, and better. And as new technologies dramatically lower the costs of communication, many new possibilities are becoming economically feasible. But even if we had infinite bandwidth at zero cost in all parts of the world, the question becomes, What do we do with it?
What if, for example, most of us become "E-lance" workers -- independent contractors connected electronically to one temporary project team after another? Or, to take an opposite example, what if today's mergers keep increasing and we end up with 80% of the world's population working for five huge megaconglomerates? Is that something we want? Is there something we haven't even imagined yet that would be even better?
Inc.: Are there any myths or truisms about the Internet that you think have turned out to be surprisingly off base -- even dangerously wrong?
Schwartz: One is the myth of the Internet as a timesaving technology. It saves time for some things but sucks up time for others. Four years ago I didn't foresee people spending hours and hours bidding on obscure items on eBay. But people who collect antiques and such have integrated those pursuits into their lives.
Hoffman: Another common myth is that the Net is all about disintermediation. The Web was supposed to create direct access between buyers and suppliers, so why do you need intermediaries? But almost all our customers want to drive down the number of suppliers they deal with. They want intermediation. There will continue to be a demand for such services.
McLemore: Maybe, maybe not. Certainly, many entrepreneurs -- myself included -- originally thought that the quickest way to build an E-commerce company was to farm out distribution to a third party. The idea was to focus on company growth without the distraction of a land-based-style infrastructure. But without control over distribution, it's tough to control quality. Last holiday season, all the sites that served their customers well did their own distribution.
Inc.: Last question: What lessons have you learned about business on the Internet?
Owen: That the more things change, the more they stay the same. John is right: customer service is still the basis of loyalty. And outstanding execution is still as important as a good strategy. Profits and basic economics win out. Companies that forget those things in the belief that the paradigm has changed for Wall Street do so at their peril.
Briggs: It's all about trust, too. Consumers need to trust the brand they are buying and believe that their on-line purchases will be safe transactions. They need to feel comfortable that personal data will not be sold to others and that they won't get spammed by giving their E-mail address. And they need to know about shipping costs, product availability, and return policies up front.
Schwartz: Ultimately, it's all about people. I think we've learned that people don't do everything for entirely rational reasons. And we need to understand real human behavior better before plunging too far into new business models.
McLemore: One thing is sure -- the Internet waits for no one. In a chaotic world with countless opportunities, fast enough sometimes isn't. If you don't move quickly, your competitors will.
Mark Hoffman is the CEO of Commerce One, a business-to-business software company based in Walnut Creek, Calif., whose products handle electronic procurement from requisitions through payments. Launched in 1997, Hoffman's company made a Wall Street splash: on July 1, the day the company went public, shares of Commerce One nearly tripled in value, soaring from $21 a share to a high of $61 a share.
John Briggs is director of E-commerce production for the Yahoo Network, which entertains 80 million regular visitors. Briggs develops and launches new E-commerce subsites; those produced under his watch include Yahoo Shopping, Yahoo Store, Yahoo Auctions, Yahoo Classifieds, and Yahoo Yellow Pages. More than 2.3 million listings have appeared on Yahoo Classifieds and more than 930,000 auctions have gone gavel to gavel daily on Yahoo Auctions.
Thomas Malone is the Patrick J. McGovern Professor of Information Systems at the MIT Sloan School of Management. As founder and director of the MIT Center for Coordination Science, he studies ways in which technology can help people work together. In a 1987 article, the prescient professor predicted many of the major developments in electronic commerce, including electronic buying and selling and the use of intelligent agents for commerce.
Evan Schwartz, a contributing writer for Wired and an occasional columnist for the New York Times, is the author of the business best-seller Webonomics (Broadway Books, 1998) and a new book, Digital Darwinism (Broadway Books, 1999). In the latter, Schwartz argues that the Web is undergoing a process of natural selection, in which weak ventures are being replaced by strong and adaptable ones.
Greg McLemore is president and CEO of WebMagic Inc., an incubator based in Pasadena, Calif., that dreams up -- and finds funding for -- Internet ventures. McLemore was the force behind Toys.com (which was acquired by eToys Inc. in 1998) and Pets.com, the on-line category leader for pet products, information, and services. McLemore started his first business, in retail computer supplies, when he was just 14 years old.
Richard Owen is vice-president of Dell Online. He oversees the company's fast-growing Web business, which includes running separate sites for different kinds of customers (big businesses, small businesses, and consumers). Of the 30,000 products that Dell sells, Owen says, more than a quarter are sold over the Web, generating more than $14 million in daily revenues and 25 million site visits per quarter.