It’s a Wired, Wired World

Category: MERGERS & ACQUISITIONS THE FLOW OF BUSINESS-TO-BUSINESS TRANSACTIONS ACROSS THE INTERNET WILL SOON BECOME A MIGHTY CASCADE.

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Not long ago, the typical corporate Web site was a low-cost pilot project in search of a mission, a constituency, and a provable return on investment.

Today, many of those early efforts have evolved into mission-critical systems. Cisco Systems Inc., for example, expects to move $1.8 billion worth of its internetworking products via its Web site in 1997. Dell Computer Corp. reports it will ship $500 million worth of PCs ordered via its Web site using a process that costs half what it does by phone. Hewlett-Packard Co. says its intranet will save it $250 million this year. And General Electric Co. executives say they expect to purchase $1 billion worth of goods using the Web this year, and $5 billion by 2000.

Forrester Research Inc., in Cambridge, Massachusetts, predicts Internet commerce will skyrocket from $8 billion this year to $327 billion in 2002 (see chart, page 66). Forrester identifies three company types currently at the center of this growth: manufacturers, chiefly in electronics and airplane parts (Cisco, Boeing Co.); middlemen, computer-related and office supplies (MicroAge Computer Center Inc., Boise Cascade Office Products Corp.); and services and utilities (QuickTrade LLC, Altra Energy Technologies LLC).

On the consumer side, sales are growing, but sometimes profits aren’t. For example, cyberspace bookseller Amazon.com’s sales increased more than 1,000 percent in one year– to $27.9 million in the first quarter of 1997, from $2.2 million in ’96–but losses also skyrocketed, from $767,000 to $6.7 million.

But those that have invested in Web technology for business use are getting dramatic returns on investment. Vendor-supported research should be taken with a grain of salt, as should four-figure ROIs; still, a study by International Data Corp. conducted for Netscape Communications Corp. found typical ROIs on intranets of 1,000 percent or better, and payback times of 6 to 12 weeks. Most of that was from “increased productivity,” but savings also came from reduced paper and labor costs, and from uniting heterogeneous computing environments. Others have found good returns from replacing toll-free phone numbers and operators with Web pages, attracting new customers (particularly from overseas), increasing sales to existing customers, and consolidating purchasing operations.

For many companies, the next task is to bind their intranets with those of their trading partners to form “extranets.” More a concept (and a marketing term) than a technical breakthrough, extranets function like closed user groups, supporting data and applications sharing among members while securing them from outsiders.

“The next logical step for organizations that have built intranets to share information internally is to make that information, or a subset of it, available to external business partners with a private Internet, or extranet,” says Alyse Terhune, a research director with Gartner Group, a Stamford, Connecticut-based consultancy. While most companies are still in the early stages of deployment, Terhune says, “there are some assumed values from extranets–for example, better customer relationships, more-efficient distribution channels, and better supply chain management.”

Manufacturers currently dominate intercompany Internet commerce, says Forrester. One of the most ambitious extranets under construction is the Automotive Network Exchange, which will link the Big Three automakers–General Motors Corp., Ford Motor Co., and Chrysler Corp.– with some 8,000 suppliers. But it won’t take long for wholesale and retail businesses to catch up, according to Forrester; by 2002, that sector should account for half of all business-to-business Internet commerce.

Happier customers, lower costs

Boise Cascade Office Products (www.bcop.com), of Itasca, Illinois, a $2.7 billion­a-year business with 42 distribution centers in the United States plus several others overseas, recently deployed an extranet that is already helping about 600 large corporate customers make purchases. That number is growing by about 100 users per month; by the end of the year, it will be used by 5 percent of Boise Cascade’s accounts.

The extranet, which Boise Cascade calls Internet ’97, is based on Web server products from Actra (a joint venture between Netscape and GE Information Services) and Boise Cascade’s existing Oracle database. Customer satisfaction is a primary goal of the system, but so is reduced cost. “What we are trying to do is move more customers into more sophisticated forms of E-commerce to make them happier,” says Laurie Beeson, vice president of marketing at Boise. “One way we keep them happy on pricing is by continually reducing our operating costs, which allows us to give direct reductions in prices.”

In 1996, Boise Cascade spent $27 million for inbound call service–not including the cost of the operators. “When we take an order via our call center, it costs us about 86 cents a line, but when we take the order electronically it can drop to 41 cents a line,” Beeson says. The electronic systems also allow Boise Cascade to customize price lists and ordering procedures to suit individual accounts, she adds. “Every item is priced differently for every customer.”

Boise Cascade’s approach to helping customers improve their purchasing operations makes sense, says Jim Sha, Actra’s CEO. “If I have a typical 10 percent aftertax margin, I have to increase revenue 50 percent to improve the bottom line by 5 percent–or I can reduce purchasing costs by 5 percent.” Purchasing operations can also be improved by order consolidation. “The National Association of Purchasing Managers says 33 percent of buying is done off-contract, which results in a 17 percent higher price,” Sha says. “And there is a second cost of $75 to $150 per purchase order. If you are doing 100,000 transactions a year at $75 each, you have a huge opportunity to save money through automation.”

Overall, Boise is doing about 20 percent of its business electronically. Most of that 20 percent is still via EDI, which accounts for about 13 percent of total lines, and a CD-ROM catalog called CEO (Complete Electronic Ordering), which can post orders to Boise’s EDI system. But the Internet offers a crucial cost advantage over EDI, points out CFO Carol Moerdyk.

“EDI ordering typically takes longer to implement than setting up an Internet-based ordering system, because EDI can require more unique coding and a special set-up process for each customer,” says Moerdyk. The cost of implementing EDI can run as much as $50,000 per trading partner, while the monthly fees charged by value-added networks (VANs) can be prohibitive for smaller companies. Making orders on the Internet, on the other hand, requires nothing more than a browser and access to the World Wide Web.

Internet payments, however, are another story. While a few of Boise’s EDI customers make payments electronically, payments via the Internet are still a ways off. “We have some security issues that the whole industry has to solve for inbound payment, but it’s a great area for cost reduction in the future,” Beeson says.

Making real payments

As the success of Web sites like Amazon.com shows, consumers are growing comfortable using credit cards to order merchandise via the Internet. But for business-to-business transactions, Internet payments have been slow to take off. That’s reflected not only in the stock prices of companies like CyberCash Inc., but also in typical business practices– everyone still makes payments using something other than the Web.

But some banks are beginning to look at ways to offer payment services to their customers. “We are in the business of moving money for customers, and the heart of our work is offering access into our network to authorize transactions and cut checks,” says Robert Chlebowski, senior vice president of Wells Fargo Bank NA’s electronic commerce group. “We want to become a gateway that lets customers send a file via the Net that we can parse to create a payment.”

Although financial EDI (FEDI) has been around for some time, its acceptance has been limited, says Chlebowski. “The promise of EDI has been limited because it has not been based on the growth of common standards that are widely used,” he says. “EDI will continue because it provides a common language, but there will be a rapid overtaking of the traditional VAN by the Internet.” The reasons why, says Chlebowski, include “enhanced customer service, direct savings in network costs, and savings in no longer having to maintain fat clients at customer sites.”

Other experts say VANs will remain the principal conduits for FEDI, at least for the next two years or so. The Internet is still too risky for moving large payment files, says Philip P. Grannan, vice president of marketing for Bottomline Technologies Inc., a Portsmouth, New Hampshire, provider of payment technologies to companies and financial institutions. Hackers, instruction file mishaps (delayed or damaged during transit across the Internet), and timing problems (when does the payment or payment information arrive?) are all reasons why companies will continue to spend a few dollars more to transfer millions of dollars across VANs.

Grannan adds, however, that the Internet can play a role today in transmitting payment addenda information–confirmation of direct deposit of payroll, expense reimbursements for employees, tax payments, and so on. Bottomline, for one, is taking advantage of the Internet to develop for customers what Grannan calls “poor man’s FEDI.” Instead of requiring payees to spend hundreds of thousands of dollars on FEDI translators, a payer can send a payment file over the ACH (Automated Clearing House) network–a secure transaction involving a local phone call on a point-to-point dial-up network. Meanwhile, the addenda record for the payment can be E-mailed (or faxed) to the payee.

“The beauty of this for the payer is that you’ve created no paper,” comments Grannan. E- mail messages can be encrypted, marked as high priority, and sent with an electronic receipt required–although the payment addenda record isn’t a negotiable instrument, so security isn’t as great a concern.

Transforming an industry

Jay DiNucci, vice president of finance and administration at Marketing Specialists Corp., a 2,800-employee, $180 million food broker in Dallas, sees electronic commerce as a force changing the structure of the industry–not only by transforming customer and supplier relationships, but by enabling consolidation through streamlined back-office operations.

“We have doubled in size every six months through acquisitions, and one of the best things we have had going for us is the ability to expedite consolidation of back-office operations by using EDI and electronic commerce transactions,” DiNucci says. “A primary goal of this merger mania in the food brokerage industry is to provide manufacturers with nationwide coverage at reduced cost while still providing the same level of service. The only way to do that is to consolidate operations like MIS and purchasing, so that what is left is a decentralized sales organization and a centralized administration group.”

Improvements to back-office technology have led to direct cost savings. “We’ve been able to eliminate staff and to avoid adding staff as we have grown,” DiNucci says. “We’ve replaced 150 people who were order-entry processors, and that doesn’t include what we have done for accounting, human resources, and business services.”

On the supply side, Marketing Specialists serves as an extended sales force and information clearinghouse for 1,500 different manufacturers, all of which want to know what is going on in local markets (are the ads running?) and in particular stores (is the product in stock on a desirable shelf?). Getting that information used to involve making phone calls. Today, manufacturers can check the food broker’s extranet (www.mssc.com). “With the extranet, we are able to effectively generate whatever information they want in whatever format they desire,” says DiNucci.

Marketing Specialists is also extending EDI services via the Internet using EDI software from Becton/Schantz Co. and an EDI gateway service from Sterling Commerce Inc. “It’s good for smaller manufacturers without the ability to use EDI formats,” DiNucci says. “We’d like to do more transactions via E-mail and then recompile them and decide who each order needs to go to.”

DiNucci is already seeing just-in-time manufacturing and delivery. “Food producers can now manufacture on receipt of the order, and retailers don’t want to maintain extra inventory,” DiNucci says. “The electronic transfers we have created have helped at both ends of the process.” In the future, he adds, “We will extend our extranet to Kroger’s and Albertson’s. Maybe they’ll want to know where products are en route to them, and so we’ll have to be connected into the trucking companies.”

New media, new business

Giving employees, trading partners, and the public access to back-office information systems via the Web will create new business processes in everything from marketing and ordering to payment and postsales customer service.

Yet new efficiencies in the supply chain won’t always be welcome. For example, manufacturers will need to form new relationships with resellers as they begin to sell direct. As Gartner’s Terhune puts it, “How can Compaq compete with Dell and not upset the retail channel that is responsible for most of its sales?” Perhaps it could look for inspiration to the airlines, which sell both direct and through agents. The whole notion of “supply chain” will need rethinking as “supply webs” create new relationships between producers, consumers, and intermediaries.

And not every approach to E-commerce will survive; with the benefit of hindsight, many will look as silly as 19th-century assertions that opera would be the telephone’s killer app. Casualties are already mounting. Nets.Inc., a high-profile effort led by ex- Lotus CEO Jim Manzi to create the ultimate cybermarket for manufacturers, filed for bankruptcy in May after losing more than $2 million a month.

Still, fundamental changes in communications media always lead to fundamental changes in business operations. While the Internet’s effect on business is often hard to guess, its propensity to devour other media and its ability to create new relationships– regardless of time and location–are now beyond question.

A Tax-Free Zone for the Internet?

The last U.S. President who promised “no new taxes” didn’t face opposition to the idea. Creating a tax-free Internet, however, is going to be a battle.

In June, the Clinton Administration released its Framework for Global Electronic Commerce, which argues that “Governments should refrain from imposing…new taxes and tariffs on commercial activities that take place via the Internet.”

The idea has taken root in Congress, where Sen. Ron Wyden (D­Ore.) and Rep. Chris Cox (R­ Calif.) have proposed the Internet Tax Freedom Act, which would outlaw state and local taxes on Internet transactions. Wyden says the bill would prevent “Cyber Tax Chaos”– the need for everyone doing business on the Net to comply with some 30,000 authorities just in the United States that could potentially impose taxes on Internet transactions.

But local governments and state authorities hate the idea. Texas comptroller of public accounts Wade Anderson has said the Wyden bill would be “devastating,” the National League of Cities has called it “offensive,” and the U.S. Conference of Mayors has demanded a “delay in any federal legislation preempting state and local taxation of electronic transactions.” And while California’s Pete Wilson supports the idea, most other governors see it as a violation of states’ rights, not the latest correct use of the interstate commerce clause.

As for the Clinton Administration, its other ideas about the digital economy go far beyond taxation. For starters, the Framework offers a complete reversal on the issue of content restriction, arguing instead for self- regulation, rating systems, and filtering software. In addition, the Administration says it wants to:

  • increase privacy for online transactions
  • help create an international Uniform Commercial Code for Internet transactions, covering dispute resolution, electronic signatures, liability, and electronic registries
  • extend existing World Intellectual Property Organization treaties, as well as patents, trademarks, and copyrights, to the Internet, and add protection for database publishers
  • lobby foreign governments via the World Trade Organization to forgo taxing Internet transactions.

Unfortunately, the Framework suggests no changes with respect to the technology needed to make most of the goals a reality. Instead, it offers the same failed encryption policies that have done so much to undercut the security of end users and hamstring the U.S. software industry. Given FBI director Louis Freeh’s latest request to restrict even domestic use of encryption, it’s fair to wonder just how effective the Framework’s proposals can be.

Worry, But Don’t Panic

Allowing security fears to prevent Internet use is a bit like giving up air travel because planes crash. “Electronic commerce is just a new medium that creates renewed demand for the age-old need for an independent third-party assurer,” says Karl D. Nagel, a CPA and principal of Karl Nagel & Co., a Los Angeles­ based firm specializing in electronic commerce consulting and assurance services.

But clearly, use of E-commerce technologies is tied to perceptions of risk. Ernst & Young LLP reports that its annual information security survey, conducted with InformationWeek, shows that “concern over security is the largest barrier preventing further use of commercial activities on the Internet.”

Specifically, the survey of more than 1,300 executives found that 20 percent of those with Internet connections have had a break-in the past year. In addition, 83 percent of those planning to use the Internet in the next year said they would expand their plans if security issues were resolved, and 66 percent not currently using the Internet said that if security problems were solved, they would start.

That kind of fear has helped to spawn dozens of new security companies in the past four years. These firms have succeeded (several have gone public recently) because they help address legitimate threats. But it’s also worth remembering that fear boosts their sales, and their efforts to capture attention often fail to address the real management issues that should concern CFOs.

Rather than get hypnotized by technical concerns, CFOs should be more concerned with changes to business practices, especially as E- commerce systems evolve from experimental marketing projects to mission-critical applications. These changes center around risk assessment and audit/control procedures. Risk assessment in a digital environment shares the same fundamentals as in a physical space: identifying important assets, threats, and exposure.

Developing internal controls is a harder problem. “Electronic commerce impacts the very nature of [internal controls]: segregation, access, and personnel,” Nagel says. “Before electronic commerce, you hired clerical staff and had control over what they did, but the point of electronic commerce is to displace those labor costs.”

In the end, it’s trust between trading partners that allows transactions to happen, and engineering trust is partly a matter of perception. “If you’re viewed as insecure,” says Nagel, “your trading partners won’t use your systems.”

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