New Models Take the e-Business Runway

Enterprising business models in the New Economy are numerous. Some work and some don't; but many carry on the basic principles of good business.


[From iSource Business, January 2001] Nowadays there are more models of how to do e-business than there are models on Paris and New York runways. Companies are experimenting with high-flair electronic retailers (or more fashionable "e-tailers"), while their back-end systems reach into a vast array of virtual marketplaces. The business models run the gamut of business-solution fashions, with more than just a few falling flat.

When it comes to the business model, what's working or not in the New Economy? Well, many companies learned, to their dismay, that their B2C dot-coms were far from the major new revenue streams they had hoped for; although several, such as Seattle-based outdoor gear retailer Recreation Equipment Inc., better known as REI, have apparently figured out how to merge old business with new.

As for online B2B strategies, the innovation is so mind-boggling and intense that even in the area of the an organization's purchasing and supply chain management arena, this function, too, has become a veritable profit center; and procurement specialists are the high-flying executives of the moment.

With that said, many B2B online markets "will crash and burn like many B2C ventures before them," says Kirk Klasson, vice president of strategic solutions at Cambridge Technology Partners, a Cambridge, Mass.-based consulting firm. "We've already been through the first rise and fall of the B2C's; now it's the B2B's turn."

Klasson is not talking out of turn. There is a legacy of "telling tales" from e-tailer Kozmo's misguided B2C business plan (virtually guaranteed not to produce a profit) to Toys R Us' Grinch-like online delivery debacle last Christmas.

Such lessons are writ large in corporate boardrooms, compelling companies to tread carefully into the New Economy. No wonder only one percent of the Global 2000 are expected to make the necessary technology, organizational and operational adjustments by year-end 2003 to qualify as true e-businesses, according to research firm Gartner Inc.

Five years after that, however, it's a different story, with 50 percent of the Global 2000 making the grade. "By 2008, the word 'e-business' will disappear from the management agenda, and e-business will be 'business as usual,'" Geri Spieler, a Gartner research director, predicts.

Until then, Spieler says the landscape will be littered with failed new economy companies "dot-com strategies that did not survive the transition," she explains. Although companies must Internet-enable their organizations, making one's way through the thicket of B2C and B2B solutions is challenging, simply because there's no reliable map.

"Somewhere between the hype and hope is a business model that will work, but the same model won't work for everyone," says Spieler. "The notion of 'one business model for all' is flawed. Therefore, the key is to find the model that works for you."

Models, Take the Runway

Fortunately, there are some spectacular success stories (and equally dramatic failures) to guide the way. In the B2C space, for example, companies are finding the Internet is more of a corollary to sales and marketing than a replacement. Spieler is very bullish on the strategy undertaken by REI. "Their entire business model is customer-centric that's all they care about," she says.

"Any way the customer wants to buy from them is their value proposition, whether it's in their stores, over their Web site, via a catalog, an 800 number or through their Web-enabled kiosks."

The store-based kiosks are a singular idea, a way for customers to extend their buying experience. "We use the kiosks to provide a wider range of products than we could possibly carry in our stores, given the physical constraints of a brick and mortar," says Matt Hyde, REI vice president of online sales. "When a customer visits a store and can't find what he or she is looking for, they are directed to the nearby kiosk to buy it."

REI has two separate business models that intertwine. One is its traditional role as a retailer, stocking 58 flagship stores around the country. The other is as an online store, selling an astonishing 78,000 items via 45,000 Internet pages. "We treat the business models as separate from an organizational standpoint in order to optimize each, yet they're integrated in terms of our mission helping customers enjoy the outdoors through products and information," Hyde says.

The integration is evident in the proximity between Hyde and his brick and mortar counterpart. "We sit 30 feet away from each other, talk daily and sit in on the same strategy meetings even though we have separate customer optimization strategies and different reporting structures," he says.

REI's procurement group buys products for both traditional retail and non-store retail, augmented by a separate merchandising department that buys exotic products for the virtual store. For example, Hyde, a veteran rock climber, says he just bought a "replacement trigger bar" online for his climbing gear, "something too technical to sell in our stores."

The non-store retail enterprise is also a breeding ground for new marketing concepts. After receiving solid revenues the past few years from online sales of fly fishing equipment, REI is test-marketing the line in its Denver and Seattle stores. Ditto fitness equipment is another example of products that have sold well over the Internet.

To fulfill orders throughout the United States, the company built a 520,000 square foot warehouse in Sumner, Wash. Although the company has scant presence in Europe, it opened a flagship store in Japan this past April, to which it recently added a kiosk linked to a Japanese language Web site. Orders are fulfilled through a warehouse outside Yokohama.

What separates REI from other brick and clicks is profit two years running for its virtual store and similar expectations this year. Revenues have been brisk roughly $41 million online in 1999, versus store sales of $620 million. Hyde projects a 135 percent increase in online sales this year, representing an ever-larger pierce of overall revenues. "I think we've figured out what B2C is all about," he says.

For every REI, there are two or three Kozmo's, a B2C venture still finding its way. The online delivery service lost more than $26 million last year, on just $3.5 million in sales (it recently announced the layoff of 275 workers).

The problem lies in the company's promise: timely delivery of goods to customers. Kozmo's mission is to deliver a wide range of items from its warehouses to consumers' doors anything and everything, from stereos to grocery items. Making good on its promise and making a profit are turning out to be mutually exclusive, however. "Kozmo has an average delivery cost of $10, and an average order size of $15 to $20," Spieler says. "With a 30 percent margin, you cannot possibly scale this to a profitable business."

As a recent New Yorker profile noted, each time a consumer placed an order with Kozmo, the company lost money. The more consumers, the more money lost. "We just don't believe that online virtual retailer Web sites will be profitable," Spieler says. "They will struggle to compete against traditional stores that leverage their brick and mortar businesses with Internet channels."

Even companies that achieve such leverage have an uphill climb to profitability. There are risks to establishing a brick and click, chief among them reputation. Although the average cost to acquire an online customer is cheap, estimated by Gartner at $300, if that person is irritated by poor customer service or faulty order fulfillment, the cost, says Spieler, is "incalculable."

Order fulfillment was at the bottom of Toys R Us' problems last Christmas. Having suffered the ignominy of children not receiving their presents, the company recently announced it would sell toys online via a partnership with Amazon.com, a company known for its robust order fulfillment strategy.

Similarly, Mattel Inc., an El Segundo, Calif.-based toy manufacturer, acquired The Pleasant Co., an upscale dollmaker, in part for its catalog order fulfillment system. "The Pleasant Co. has been in the catalog business for decades," notes John Pinner, Mattel assistant treasurer.

"They had a fulfillment capacity of more than $1 billion, yet had a volume of only $300 million to $400 million," he explains. In other words, there was room to fill other orders. Mattel uses its subsidiary's fulfillment system to deliver collectible merchandise sold on its Barbie.com and HotWheels.com Web sites.

Many companies find the focus required to manage a B2C dot-com from taking orders to delivering goods begs separate oversight. For example, Barnes and Noble Inc., a New York-based bookseller, sold 40 percent of BarnesandNoble.com to German book publisher Bertelsmann and another 20 percent to the public in an IPO. "The dot-com is run by a separate management team," says Steven Benjamin, corporate risk manager at both Barnes and Noble Inc. and BarnesandNoble.com ironically, the only executive to have a position at both companies.

Other companies like the "separate but equal" route, but prefer full ownership. Pittsfield, Mass.-based K.B. Toys Inc. relocated its K"Bkids.com enterprise to Denver, Colo., replete with a separate management team, different employee compensation schemes and even a different dress code. "B2C dot-coms are in an ever-changing, fast-paced business marked by a unique culture typically younger people who feel creatively impeded by a slower moving brick," explains Mike Wagner, senior vice president and chief operating officer of K"Bkids.com.

Like REI's online store, K"Bkids.com carries a much wider selection of products than it does at its 1,300 retail toy outlets. Its parent company is also studying the use of Web-enabled kiosks linked to the dot-com. "We're experimenting with the idea," Wagner says.

The B2B Model: Seeing is Believing

In the B2B space, several business models are flourishing, from inter-industry exchanges to auction sites (both forward and reverse) to seemingly old-fashioned catalog aggregators. Of course, not all of them will continue to prosper or survive. "The latest prediction is for 10,000 e-marketplaces of different stripes by 2003," says Kevin Costello, a managing partner in accounting firm Arthur Andersen's Atlanta-based digital market solutions division.

"We agree with that, except to add that only 2,000 of them will be left by 2005." He jibes that "you just don't need 15 vertical markets around cows."

As the e-marketplace shakeout reverberates, the key is to "pick well and not wait," says Costello. "Even though there will be rapid proliferation followed by rapid consolidation, you should not let that act as an excuse not to leverage the benefits of online procurement markets."

Easier said than done given the potpourri of exchanges and other virtual marketplaces from which to choose. While some analysts advocate picking hubs with significant liquidity or joining several exchanges as a hedge against selecting a loser or two, there are attendant risks. "Selecting sites based on liquidity is a chicken and egg conundrum," says professor Andrew Whinston, director of the Center for Research in Electronic Commerce at the University of Texas in Austin.

"People won't come to a market unless there is liquidity, but you can't get liquidity until people come to the market."

Solving the riddle requires a "devil's choice," Whinston says. "If you bring in a major player in a market as a shareholder in your B2B venture you obtain liquidity, but that may scare off other players, given obvious privacy concerns about product and price."

Such competitive issues challenge exchanges like Covisint, the giant e-marketplace planned for the automobile industry and funded by three competitors: DaimlerChrysler, Ford and General Motors. But, given the FTC's recent approval signal, opportunities for studying this buyer-centric Net market model will be an interesting watch. An even larger exchange is Transora.com, a virtual marketplace announced recently by 49 leading food, beverage and consumer products companies among them The Coca-Cola Company, Kraft Foods, Proctor & Gamble and The Gillette Co.

The sheer number of companies coming together in Transora is unmatched in the B2B arena. "Transora will give us seamless, real time supply chain connectivity, efficient inventory management and reduced buying costs," says Ted Underwood, director of risk management at Boston-based Gillette, a global consumer products company with $10 billion in 1999 revenues.

Like Covisint, Transora ("trans" and "ora" together mean "crossing boundaries") spans the entire supply chain (from suppliers to manufacturers to retailers), providing procurement, supplier and product catalogs, online order management and financial services.

To be successful, exchanges like Covisint and Transora have to provide value to both buyers and sellers. "A tremendous amount of bargaining power is shifted to the buyers in a B2C strategy, via lower prices and softer benefits like increased convenience and lower search costs," Klasson says. "But a 'winner take all' proposition is not the answer."

If power is in the hands of buyers only, the exchange will work to its own detriment. For example, purchases will be made based entirely on price, "exclusive of such important product factors as quality, design and delivery behavior," Klasson explains.

"We find that when an exchange conveys more and more information about products, buyers are less inclined to execute transactions based solely on price," he adds. "Instead, they buy based on price and utility. The sellers gain higher margins because their products are delivering this utility."

In highly fragmented industries beset by inefficient supply chains, such as the paper industry, an e-marketplace can work wonders for both buyers and sellers. In the papermaking business, the return on capital is an abysmal nine percent, according to a Paine Webber analysis. To recover high, fixed-asset costs (papermaking machines typically cost $800 million) mills must run continuously. When demand ebbs, inventory soars. To move the excess volume, large and costly sales forces must be employed.

PaperExchange.com takes a machete to these costs, says Rod Parsley, vice-president for business development. "Our idea was to create a marketplace that aggregated buyers and sellers in a virtual trading pit," Parsley explains. "This would be impossible in the physical world because of the industry's fragmentation. Buyers comprise some 50,000 printers and more than 3,000 converters in the United States alone. The seller base is equally fragmented."

Getting all the players in one trading pit helps disintermediate expensive broking channels from the supply chain, reducing overall costs. Improved capacity utilization is also realized. Say a mill typically produces 185-inch paper rolls and has pre-sold 150 inches of that width. That 35-inch leftover usually ends up warehoused. Using PaperExchange, the mill can log on and scan RFQs from listed buyers. "It might see one buyer looking for 10 inches, another wanting 20 inches and someone else wanting 30 inches," Parsley says.

"Instead of warehousing the product, the company can post and sell excess machine capacity three weeks before making the product. That's a tremendous value proposition."

Procurement Kings

While B2C Internet ventures have garnered much of the attention in the last few years, B2B strategies will receive the lion's share in the coming decade, analysts say. "B2C was the talk of the town, but hasn't really panned out the way everyone expected," Costello says.

"B2B is another story altogether. We now have an e-business initiative that someone can stand up for in the boardroom and say 'We've spent this much money and are getting this much in return.' The ROI is very measurable. In my 20 years in this area, I have never seen anything having as demonstrable a positive impact on an organization as e-business procurement."

This fact has elevated the job of purchasing in the corporate hierarchy. "Procurement is no longer a lower-level management position," says Spieler. "In fact, it has become one of the most important roles in the future of e-business."

Whinston agrees: "Procurement people typically handled contracts in which prices were fixed and deliveries specified," he notes. "They were the ones who dealt with everyday problems like late shipments. In the New Economy, however, where prices are changing daily and delivery issues are never constant, they're the ones called upon to make sure their companies don't expose themselves to over-commitment at a high price. This is a marked change in their responsibility."

Spieler says procurement will become a much sought-after job in the future. "I see them in this 'Star Trek' environment, sitting in front of these huge monitors looking at global information on raw materials, or products and services in real-time," she says.

"Teams led by a CPO will be working 24/7, in order to buy fast and sell quickly. As the bandwidth pipes get bigger and bigger, the speed at which this information flows will be astounding."

Down the line, Spieler says procurement specialists "will be the ones depended upon to grasp the gold when it becomes available" seizing the best price for high quality direct and indirect materials. "The enterprise will depend on them to travel the virtual world for the best deals available, knowing their competition is probably doing the same thing," she says. "This is not your grandfather's purchasing department." Captain Kirk would surely understand.

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