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Top 67. Dec 19, 1999 10:13 PM

» JenL_2 - Get Ready For Dow.com

Rande recommended this cover article in 12/20 Barron's:

Get Ready For Dow.com

As old-line companies adopt 'Net strategies, will their stocks respond?

By Mark Veverka

When most people think of the transformative nature of the Internet, they tend to envision 25 year-olds with purple hair and nose rings working at Amazon.com or Yahoo. Although such upstart companies have achieved stockmarket values measured in the tens of billions of dollars, it seems to us that the 'Net's more far-reaching effects on American business are likely to be felt at behemoths like General Electric, General Motors and Wal-Mart.

To test this theory, we conducted a survey of the Internet strategies at the 30 companies in the Dow Jones Industrial Average. We found that chief executives at most of the companies understand the importance of the Internet and are implementing some sort of coherent strategy to deal with it. A handful of these strategies seem to be truly revolutionary. Others are timid, suggesting that the CEOs involved are moving ahead far too slowly or with a lack of vision. Most alarming, for five companies in the Dow, we were unable to find any meaningful Internet strategy to speak of ....

What does all this imply for the long-running bull market? There has been some speculation that the Dow could surge toward 15,000 as big companies use the Internet to increase their profits by cutting costs, eliminating middlemen and attracting new customers. Based on the fragmentary evidence we were able to assemble, however, investors shouldn't hold their breath waiting for this development. At best, it seems that profits at Dow companies could be increased by perhaps 1% or 2% over the next few years thanks to increased use of the 'Net. Over the next five years, profits at the most aggressive Dow companies could rise by 10% or more based solely on their 'Net efforts.

Such large profit increases aren't likely to come until after the year 2001, however. One reason is that putting an Internet strategy in place costs lots of money -- so much so that, in the early years, spending on new Internet systems can offset any cost savings or increases in revenues.

Honeywell intends to use the Internet to cut costs by $500 million-$1 billion no later than 2005. Chairman Lawrence Bossidy
Many chief executives were only vaguely aware of the 'Net's possibilities before August 1995, when Netscape launched its colossally successful initial public stock offering. For CEOs, Netscape's debut was the proverbial shot across the bow. Whether they liked it or not, the ease of use heralded by Netscape's Navigator browser meant that the Internet was going to change their companies and their customers like no other technological innovation in their lifetimes.

Still, most CEOs back then did little more than command their troops to launch static Websites, now referred to as "brochureware." Not until this year did many companies start to genuinely implement aggressive, wide-ranging Internet strategies designed to squeeze costs out of their massive corporations.

Even today it is fairly rare to find a chief executive who is willing to foment radical change to his existing business model in exchange for a shot at building an Internet company. "Having finally gotten started, I think most CEOs have been slow to move," says Boston Consulting Group's Philip Evans, co-author of Blown to Bits, a study of how companies must destroy their business models in order to reinvent themselves. "It is absolutely mind-boggling how many people at top echelons of large corporations still don't get it."

"Évery dealer in this country has about 70 days of supply. In simple truth, there's tremendous waste in that." General Motors CEO Jack Smith
One guy who does "get it" is Honeywell International Chairman Lawrence Bossidy, though even Bossidy concedes that he could have been faster off the mark. "I think it wasn't until last year during the Christmas holiday that we began to see how much retail business was done on the 'Net," he says. "It was a rude awakening."

If further reinforcement is needed, it will likely come soon. Shoppers are expected to snap up $6 billion of goods via the 'Net this holiday season, up from around $3 billion a year ago.

At the new Honeywell, which has been formed by the merger of Honeywell with AlliedSignal, Bossidy is demanding that 50% of the company's transactions be conducted via the World Wide Web by as early as 2003 and no later than 2005. And he envisions Honeywell's costs being trimmed by $500 million to $1 billion during that time. This is fairly significant for a company that is expected to have operating profits this year of $3.5 billion on revenues of about $24 billion.

"There's no reason why we can't go after this with as much intelligence as we can muster," says Bossidy.

Privately, some CEOs are estimating that Internet applications could reduce their operating expenses by as much as 3% in a few years' time. All else being equal, such 'Net-related efficiencies could add 10% or more to the average Dow stock's earnings. But all else will not be equal. It can cost hundreds of millions of dollars to build state-of-the-art Websites and put entire companies on the Internet. "We're spending a lot of money, frankly, putting these systems in place," explains Caterpillar Chief Executive Glen Barton.

And remember, revenues at some Dow companies will be crimped by competition from upstart Internet companies. This is particularly so in fields such as media, retail and financial services.

Although the response of some old-line companies seems sluggish when compared to pure-play Internet concepts, others are quite remarkable.

Walt Disney, for example, is looking at ways to digitally distribute movies to theaters around the world, and General Motors hopes to cut "billions" of dollars in costs by selling made-to-order autos via the 'Net.

Unfortunately for the Dow 30 -- with the exception of the recent newcomers Microsoft, Intel and SBC Communications, plus old-timer IBM -- the old guard has allowed the competition to build up a sizable lead on the Internet. Compared to other technology titans, even Microsoft and IBM have in the recent past been accused of being indolent in articulating winning Web strategies.

Of course, IBM and Microsoft would argue that they have since gotten their e-business acts together and no longer trail their more nimble digital brethren, such as Sun Microsystems, America Online and Yahoo. Indeed, Microsoft, IBM, Intel and Hewlett-Packard stand to increase their profits not only by applying the Internet to their own businesses but, more importantly, by helping myriad other companies cope with the 'Net.

On Thursday Microsoft announced that it would take a $200 million stake in electronics retailer Best Buy. The deal calls for Microsoft to help Best Buy sell goods on the Internet, and for Best Buy stores to peddle Microsoft's Internet services. On the same day, Wal-Mart, the nation's largest retailer, announced a similar deal with AOL. Under the arrangement, AOL will hawk Wal-Mart products on the 'Net, and Wal-Mart will promote AOL's Internet service in its 2,485 U.S. stores.

Wal-Mart has long been recognized as a technologically advanced operation. In, fact, early next year, it is expected to unveil an e-tailing site. Some have accused Wal-Mart of letting outfits such as eToys and Amazon.com take the lead on the Internet. That criticism has some merit, but as Sears Roebuck, J.C. Penney and countless local merchants can attest, no one has yet won by betting against Wal-Mart.

Another Dow stock that's been accused of fumbling its Internet promise is Hewlett-Packard. Despite H-P's high-tech pedigree, the company didn't even seem to be in the dot.com game until Chief Executive Carly Fiorina appeared on the scene in July. Since then, Fiorina has the technology giant playing an aggressive game of catch-up. "At H-P, there is not a product or a process or a growth opportunity that is not leveraging the Internet, being driven by the Internet or being accelerated by the Internet," she says.

GE's Jack Welch is widely perceived to be one of the first big-company CEOs to be persuaded of the Internet's potential to transform industrial America. Welch's now-famous "destroyyourbusiness.com" edict, which was delivered last January at a Florida meeting for top GE executives, is commonly viewed as a milestone in the effort to rally Corporate America to embrace the 'Net.

Over at General Motors, CEO Jack Smith says the wonders of the Web were first introduced to him by his wife, Lydia, who was an early Web-surfer. "You could just see the power that was there," Smith notes. But the Web's slow connectivity and persistent site crashes turned Smith off. His early assessment was that "this thing wasn't ready to handle that kind of demand."

Once those early problems were fixed, GM got started in earnest on a comprehensive Internet strategy. Last August, the automaker created e-GM, an online initiative that aggregated all of the company's dozen or so Websites. A month later, GM took a step toward integrating the 'Net into its corporate culture by equipping its entire automotive strategy committee with Palm Pilots and holding its top-level meetings without paper.

One of the biggest opportunities the Internet presents to Detroit is eliminating its fattest layer of inefficiency: car inventory that collects dust on lots before being sold. Between 30% and 50% of all distribution costs in the auto industry are bereft of value to the consumer.

"Every dealer in this country has about 70 days of supply," says Smith. "In simple truth, there's tremendous waste in that. We don't need that many cars in inventory." Figuring ways to use the Web "to get out all of the waste is a huge opportunity for us," Smith says.

GM has assigned an internal task force to totally redesign how the company builds, ships and sells cars. This is no easy task. "It isn't automatic that we can put a new system in place and that everybody will be fine with that," Smith admits. To begin with, the carmaker's influential and sometimes temperamental dealers are worried about their future under a more direct distribution system. The dealers' fear is that the 'Net could transform their operations into pure parts and service outfits, void of most point-of-sale revenues. "We have a selling job to do with them. All of this is not a chip shot," Smith reminds.

Already you can order a car online from GM at GMbuypower.com. Customers order vehicles at the dealers' best prices and pick the dealerships where they want them delivered. One problem: The experience is hardly conducted at Web speed. The process takes a rather dismaying six weeks.

Smith realizes that won't do. "Speed is really the factor that we see changing because of the Internet," he says, adding, "When you take out time, you take out cost."

The GM chief sees his company saving "billions" over the next few years by Internet initiatives on both the retail and manufacturing fronts. He would not say what the company's Internet-related cost-savings would be in 2000, but billions is a considerable amount. This year, GM is expected to earn $3.9 billion in profits on revenues of $147 billion.

Caterpillar's approach to the Internet is quite different. Cat sees its dealer network as a crucial advantage, not as a layer of fat. Although cars can be repaired pretty much anywhere, Caterpillar equipment is far more specialized. The relationship between buyer and dealer can go on for decades, if not generations. That helps explain why Caterpillar Chief Executive Glen Barton says he has no intention of reducing the role of Cat's 200 independently owned dealerships worldwide. At Cat, he says, there will be no selling direct from the factory to its customers. "The dealer organization is often termed to be one of our biggest assets, if not the biggest asset we have," Barton says. "The difference between us and most companies trying to do business on the Web today ... . is that our product really does require support."

That's one reason why Barton isn't concerned about the emergence of a "bulldozer.com." Of course, other makers of construction machinery could try to sell direct via the 'Net to customers, but Barton is betting that his buyers will pay a little extra to have Caterpillar's dealership system.

Nonetheless, Cat does intend to take advantage of the Web to increase manufacturing efficiency and to make its dealers more responsive to customer needs. In fact, Cat plans to have a corporate Website with individual virtual storefronts for each of its dealers. "This Web-based information is designed to be dynamic. It's not just a bunch of information that's been scanned in and is only as good as the date when the picture or the spec sheet or the product catalogue was scanned," says Barton, adding that as many as 40 dealer sites will be linked to Cat's corporate portal by yearend.

Like most industrial companies, Caterpillar expects Internet initiatives to further reduce operating costs. Already a zealous cost-cutter from its massive restructuring in the 1980s, Cat expects Internet use to slash inventory costs by filling dealer orders faster and streamlining communications links between suppliers, factory floors, parts-distribution centers and dealers. Barton would not say how much 'Net-related savings Cat would muster next year. Whatever the number, Barton cautions that Cat's spending on Internet initiatives will outpace any cost saving in the short run.

Few Dow companies know more about dot.com spending than Walt Disney. As a media and entertainment conglomerate trying to compete with unprofitable pureplay Internet companies with multibillion-dollar market values, Disney has had to pour barrels of cash into its Internet investments. Disney's Go.com portal had losses exceeding $1 billion in fiscal 1999, ended in September. And that was on top of a loss of about $991 million the previous year.

The good news for Disney is that Go.com's 1999 revenues jumped about 53% to $200 million. That's still far short of what Disney's spending on its 'Net properties, but the revenue growth is encouraging.

To counter Internet rivals, the Magic Kingdom completed its acquisition of the Infoseek search engine in November and is creating a tracking stock for all Disney's Internet properties. These new Internet shares should provide Disney with some "Web wampum," and that will help in two ways. First, Disney will now be able to retain talent and lure new recruits by showering them with options and warrants on the newly created shares. Second, the tracking stock will give Disney the Internet currency it needs to acquire more Internet properties.

Like a lot of his compatriots in the old guard of American industry, Eisner stresses that the race to exploit the Internet isn't a sprint but a marathon. Right now Eisner has his eye on the arrival of "broadband," the wider pipe that will allow video, audio, data and graphics to zoom across the Internet and into America's living rooms. Once you take into consideration the depth and variety of Disney's vast entertainment and media properties, ranging from ABC and ESPN to the film studios to the theme parks -- topped off with Disney's stellar brand name -- it isn't hard to envision Disney streaming endless content over the Internet.

"The Internet is going to be about a lot more than the ability to call up stock quotes," Eisner says. "It will really explode for us when broadband arrives."

While Disney is preparing for that day, the company is investing in digital technology that offers some immediate benefits. For the distribution of Disney and Pixar's animated film Toy Story II, which is now playing in theaters, Disney delivered the movie to a small group of theaters on a videodisc the size of a pizza instead of on reels of film. Not only is the digital format more durable and less costly to duplicate and ship, it is also of higher quality than film prints, which can get scratchy. While video disc distribution isn't brand new, Disney's shipment to eight theaters of Toy Story II this fall was digital's biggest test yet. Ultimately, Eisner believes movies may be beamed digitally from satellites to theaters, eliminating reels and discs altogether.

In the end, Disney could beam movies and television programming via satellite through broad band Internet service providers, such as AT&T, or even directly to home-installed dishes. "I don't know where all of this is going to end. I know only one thing: We are going to be there technologically," Eisner argues.

Eastman Kodak hopes to be there as well, but its core business is under siege. The Rochester, New York, imaging concern has embraced digital photography with a vengeance. It has had little choice, as venture capitalists pump hundreds of millions of dollars in start-up capital into Internet photo concepts, such as eMemories.com and PhotoPoint.com.

While printed photography isn't going to vanish, Kodak's revenues from chemicals and paper are expected to erode as digital photography begins to take off. That's why Kodak must attack the digital-photography market as if there were no tomorrow.

Unlike some Dow 30 businesses, such as Boeing or International Paper, Kodak's products are perfect for transmission over the Internet, making it extremely vulnerable to Web-based newcomers. "It's hard to put a bar of soap on the Internet, but we sell a product, pictures, that can be easily converted to digital form and distributed over the Internet," explains Kodak President Dan Karp, who is slated to succeed Chief Executive George Fisher next year.

Kodak expects revenues from digital imaging to grow to about $2 billion this year. That's up 25% from last year's level and a significant chunk of Kodak's overall 1999 revenues of $14 billion. The growth of Kodak's digital business has been driven by new initiatives, especially "You've Got Pictures," Kodak's online-photography venture with America Online. And for those Web surfers who aren't AOL subscribers, there is Kodak's PhotoNet, a service that makes digital copies of the pictures available to customers over the 'Net.

Indeed, virtually all of Kodak's revenue growth this year will come from digital imaging. "The Internet is as big a deal as the cartridge-loaded camera, which Kodak introduced in 1963," Karp says.

One chief executive who isn't losing sleep over the Internet threat is International Paper's John Dillon. He isn't worried that some 'Net wizard may be dreaming up a scheme to sell tons of bulk paper on the Web. "You just can't afford to ship paper via Federal Express or UPS across the country," Dillon quips.

That's not to say that Dillon isn't taking the Internet seriously. He's just not operating at Web speed yet.

International Paper has launched four or five pilot Internet programs aimed at reducing its inventories and removing intermediaries in the supply chain. But the real impact of the 'Net on IP is likely to be the emergence of business-to-business Websites that will act as commodity exchanges for various types of paper products. These exchanges could allow rival paper companies to get timber supplies at rock-bottom prices, and they could also allow buyers to demand better deals from IP.

Dillon is well aware of the various Internet models designed to create electronic marketplaces for commodity goods, ranging from chemicals to steel to paper. The conventional wisdom, however, is that major players like IP are large enough to demand that their suppliers deal directly with them. "We're looking at the dot.com business models, and deciding whether we should try to do that ourselves," Dillon says.

Is this a sage strategy on the part of a veteran industrialist or naive thinking by an old-school business leader afraid to destroy his business?

Evans, the consultant, fears it's the latter. "When the Internet doesn't fit on top of the current business model, that's where even well-run corporations will tend to hesitate," Evans says. "And that's where the insurgents will tend to gain advantage."

Our best guess is that the laggards among the Dow companies will eventually be prodded by market forces to adopt more aggressive Internet strategies. As the vanguard companies like GE, WalMart and AT&T continue their 'Net efforts, profits will climb. But it looks like it will be a few years yet before such Internet initiatives, on their own, produce enough earnings to warrant Dow 15,000.

.....Jen

-- posted by JenL_2

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