Washington Post article........
Internet's E-conomy Gets Real
By Mark Leibovich, Tim Smart and Ianthe Jeanne Dugan
Washington Post Staff Writers
Sunday, June 20, 1999; Page A1
The fanfare, inflated stock prices and overnight paper fortunes that
surround the Internet's manic incursion into American life have obscured
an important shift: The industry is graduating from a speculative casino into
a measurable force that is changing nearly every corner of modern
capitalism.
The Internet is rapidly slashing costs between suppliers and companies,
and between companies and customers. As it creates entirely new
businesses and realigns old ones, it is scrambling notions of corporate
value, giving birth to a new business math that remains volatile but
increasingly draws from real numbers about sales, productivity and even
profits.
The precise impact of the Internet is still hard to quantify. One reason is its
sheer rate of growth: Every second, another seven people around the
globe tap in for the first time. But enough data have begun to emerge –
and several companies have established enough of a track record – that
the glimmerings of a new business era are becoming visible, one that
should endure through eventual recessions.
Earlier this month, after perhaps the most comprehensive study
undertaken on the subject, funded by network equipment maker Cisco
Systems Inc., researchers at the University of Texas said the Internet
generated about $301 billion in U.S. revenue in 1998 – closing in on the
automobile industry.
Business-to-business commerce alone is likely to swell thirty-fold, from
$48 billion last year to $1.3 trillion in 2003, according to technology
consulting firm Forrester Research Inc. Forrester estimates that consumers
spent $8 billion buying computers, books, CDs, clothing and other items
on the Internet last year.
The impact is increasingly measurable at the company level, too. Boeing
Co. says it has saved hundreds of millions of dollars by moving its
cumbersome system of spare parts sales and technical aircraft
maintenance manuals to the Internet. Airlines have reduced the cost of
processing a ticket from $8 to $1 by discarding paper copies for
electronic tickets, or e-tickets. And McLean entrepreneur Frank Borges
LLosa, 24, took an idea for a nifty way to eliminate floppy disks using the
Internet and, five months after creating his own company, sold it for
almost $1.7 million.
One astonishing aspect of all this is that only five years ago, the Internet
was essentially a fringe tool, the province of selected government officials,
university researchers and geeky hobbyists. Executives mostly ignored it,
and some called it a fad; politicians never mentioned the medium, let alone
took credit for it. Few declared it revolutionary.
In fact, the speed of change is what has made it so difficult to place a
value on Internet companies, their stocks or their technological
achievements. For instance, when big Internet companies acquire smaller
ones, a key component of the purchase price often is how many days of
development the acquirer will save by buying the target's technology rather
than trying to develop it independently. Compared with industries where
markets are growing more slowly, the value of "Internet time" is enormous
– to a company waiting to sell on the Internet, days are worth months of
ordinary business time, and months are worth years.
Lanny Baker, an electronic media analyst at Salomon Smith Barney Inc.,
said he can make a rational case for some of the sky-high valuations
investors have placed on what are now called "blue-chip" Internet
companies.
Baker notes that on average, media companies earn about $5 per
subscriber (at the high end, major newspapers can generate about $128
per subscriber, he says). America Online Inc. earned a respectable $8 per
customer in profit last year – but is likely to earn $45 per subscriber this
year.
Meanwhile, the online population continues to climb. Currently, about 80
million Americans are online, according to the Commerce Department. In
3½ years, Baker predicts, that number will grow by about 60 percent to
about 130 million – or half of the nation's population. Both the potential
for new customers and the possibility that AOL could earn as much per
subscriber as a successful newspaper justify AOL's lofty stock price,
Baker said.
As of Friday, the market value of AOL's stock – $114 billion – was
bigger than the value of Time Warner Inc., Times Mirror Corp., the New
York Times Co. and The Washington Post Co. combined.
Net.Capitol Inc., a three-year-old Internet software firm that crams all 18
of its employees and a dog into a rented Capitol Hill town house, recently
went through a similar valuation exercise.
Net.Capitol develops software for political groups. With just 150
customers, it is a small business by any traditional measure – except that
traditional measures don't apply in this new world. Last month a potential
buyer materialized and offered a stock deal that is potentially worth $12
million to $15 million.
Net.Capitol's assets – a handful of employees, its software and a
collection of computing hardware – would struggle to bring even $1
million by objective standards. But "real world notions of value are just not
relevant here," said Oron Strauss, the com- pany's 26-year-old founder
and majority shareholder.
When Strauss sat down to negotiate with Net.Capitol's suitor – a
soon-to-be-public company based in the western United States whom he
declined to name – they had to consider a whole new set of factors. What
is the value of the "Internet time" it takes to build an online brand? How
much is an Internet employee worth? How big might the political market
be if every campaign uses the Internet?
But despite emerging hints of a science to the valuation, economist Lester
Thurow, who sits on the board of online stock brokerage E-Trade Group
Inc., concedes that he has come up with no comfortable way to value
Internet stocks. He attributes the lofty valuation of some Internet stocks –
greater than that of many of their brick-and-mortar competitors – to a
simple game of chance. "I think it's the lottery model," he said. "Americans
buy millions of lottery tickets knowing they're going to lose money." But
one in a million wins big – and that keeps everyone buying.
Low Costs, High Revenues
The Internet's impact can be much more clearly quantified in businesses
and industries, which have seized upon the World Wide Web's speed and
accessibility to reshape many basic operations. The airplane, a creation of
the Industrial Age whose use and manufacture is among the most
labor-intensive and costly of any product, offers a glimpse of how the
network can create big efficiencies.
A quarter-century ago, there was an airline ticket office on many
downtown street corners in the nation's big cities. Then the airlines
gradually withdrew from the retailing of tickets, passing the job off to
travel agents whom they paid 10 percent or so to process tickets.
Lower-paid agents replaced the airlines' often unionized agents.
Now, it is the travel agents who are being replaced, by the Internet, as
airlines start their own direct-sell Web sites where travelers buy e-tic-
kets. The more adventurous airlines have even joined forces with the likes
of Microsoft Corp. and online bazaar Priceline.com to sell seats to a
wider audience of potential customers.
"Clearly the Internet is the low-cost method of distribution," said David
Swierenga, chief economist for the Air Transport Association. "When you
do the e-ticket, it's the customer's computer talking to the airline's
computer. No people involved."
The cost of processing a ticket online is estimated by the industry at about
$1. That can be as much as 85 percent cheaper than using an agent or
some hybrid of agent and computer reservations system, he said.
But the Internet can do more than lower costs. It can also raise revenues.
It is allowing airlines to fill seats that otherwise would be empty when the
plane takes off. Every day, airlines have as many as half a million empty
seats available.
In 1996, American Airlines began offering unused seats at sharp discounts
to frequent fliers who chose to receive weekly fare offers by electronic
mail. The service began with 20,000 subscribers, but today the airline is
sending out more than 2 million e-mails a week. One recent offer: a
round-trip ticket from Reagan National to New York's JFK for $69.
Priceline.com has taken the concept even further. It allows would-be
travelers to name prices they're willing to pay for airline tickets that would
otherwise go unsold, then uses the Internet to communicate those bids to
airlines such as Delta. "An airline like Delta in the past could not see the
customer it wasn't getting," said Priceline.com Inc. founder Jay Walker.
"It's kind of like an X-ray into the market. Only in the age of the Internet
can you imagine a business like this."
And only in the world of the Internet can you imagine the economics
between Priceline and Delta. When it was starting up, Priceline needed the
airlines more than they needed it. So Priceline offered Delta a deal: Give
us seats in exchange for rights to acquire Priceline stock once the
company goes public. Today, Delta's stake is worth as much as $1.8
billion, more than Delta earned from its entire business last year.
The Internet is also reshaping aviation maintenance. Boeing, for example,
is using it to sell aircraft parts to its airline customers and to share millions
of pages of technical drawings and maintenance manuals with mechanics in
the field. The Seattle plane maker says the Internet is helping it save
"hundreds of millions of dollars" annually.
Last year, Boeing's online parts-distribution Web page handled 1.6 million
transactions, more than double the volume of the prior year. The company
also has an online system whereby airline mechanics can download
technical drawings and maintenance manuals in minutes rather than relying
on fax, telephone or mail for the information.
All this greatly speeds the pace at which planes are serviced, increasing
the profitability of airlines as they minimize the amount of time that planes
are out of commission.
Without the Internet, aircraft maintenance often requires mechanics to sift
through thousands of documents and drawings on tiny cardboard cards
with picture windows filled with microfilm-like images of parts until they
find what they need. Sometimes, mechanics have to fly between airports
to bring parts or technical drawings to a waiting plane.
Boeing Senior Manager Bill Shaproski recalls a recent event where a
Cathay Pacific 747 sat idle in Tokyo while mechanics searched high and
low for information on a damaged bracket that held an auxiliary power
supply in place. Though not a life-threatening problem, it had to be fixed
before the plane could fly again.
"They looked all over their drawing files, their aperture cards, millions of
which are kept in a library," Shaproski said. "They couldn't find this card."
Eventually, the specifications on the part were located, in a database at a
Boeing supplier, and the bracket was replaced. But not before the flight
was canceled.
With Boeing's new electronic parts and technical data system, though,
situations such as the one in Tokyo should become a thing of the past.
"Something that in the paper or microfilm world would take maybe five to
10 hours you can do in about five seconds," said Shaproski.
On a more mundane level, LLosa launched a simple notion last December:
a "virtual floppy disk" service that spared personal computer users the
nuisance of carrying disks around. Instead, they store data on a Web site
and get it from there when they need it. LLosa employed just one full-time
person (himself) at his NetFloppy.com LLC, and three part timers. He
worked out of his basement in McLean.
Soon after NetFloppy started, online community Xoom.com took an
interest in it. Negotiations ensued. Were his employees willing to move to
California, How much was LLosa's idea worth? How about the five
months of building a brand? In May, LLosa sold the basement outfit to
Xoom.com Inc. for $1.65 million in cash and stock. His share: $1 million.
Not bad for five months' work.
"We didn't even have time to print up NetFloppy business cards," said
LLosa.
© 1999 The Washington Post Company
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