The Internet's trivial pursuits
By T. Michael Nevens, McKinsey & Co., Special to ZDNet
June 14, 2000 2:29 PM PT
"Over the past 5 years, global spending on the Internet and related IT infrastructure has been somewhere between $7 trillion and $10 trillion. More importantly, this capital stock can be leveraged by any new product or service that embraces Internet standards.
It is no accident, then, that this opportunity has produced a set of software, hardware and services companies that have grown at compound rates of 30 percent to 50 percent and had rates of return on capital of 40 percent to 50 percent for 5 or more years. While large companies such as Sun Microsystems, Dell Computers and Cisco Systems have led this parade, the rate of innovation opens the door for new players every day."
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The poet Allen Ginsberg provided the best description yet of the rush to build Internet businesses: "I saw the best minds of my generation destroyed by madness." (Of course, he wrote those words in 1956, but he is no less correct for having been prescient.)
Sadly, Internet businesses have attracted plenty of talent and capital that could have been put to better use.
Instead, lemming-like, the industry has dabbled in trivial pursuits, chasing everything from e-tailing, to B2B marketplaces, to portals, when they should have been paying more attention to the fundamentals of what the Internet is about -- driving interaction costs to zero.
How low can you go?
The Internet increases the value of the best products and services by lowering the cost to deliver, sell and support them -- in other words, decreasing the interaction costs.
These cost reductions flow in part to customers and are in part retained by those companies quick enough to be the first to exploit them.
It is the magnitude of the cost reductions that makes this point so significant.
Across the U.S. economy as a whole, interaction costs account for about 51 percent of total labor costs.
Since labor costs account for 70 percent of total costs, this means roughly 35 percent of total costs are interaction costs. The Internet enables reductions in interaction costs by 80 percent to 95 percent, meaning total costs can fall by 28 percent to 33 percent!
These numbers are borne out by Ariba's claims of 2 percent to 20 percent savings for customers, Free Market's claims of 2 percent to 25 percent, and Purchase Pro's claims of 22 percent savings.
The catch is that, in many cases, the savings flow all the way through to end customers; neither the buyer nor the marketplace captures much. By the way, if the seller can reduce sales and marketing costs and gain a bit of the market share, they may not suffer much either.
A wide-angle view
The problem with even the current rage -- business-to-business marketplaces or exchanges -- is that they are too narrowly focused on capturing a percentage of the transaction. They argue that they are going to keep just a small slice of the costs of the transaction. In making this argument, however, they fail to keep in mind that any percentage of zero is still zero.
Given the consequences of falling interaction costs, where is the new opportunity in the Internet? It is in selling the infrastructure needed to build the Net, and in building the services layer that enables established brick-and-mortar companies and consumers to lower their interactions costs.
Over the past 5 years, global spending on the Internet and related IT infrastructure has been somewhere between $7 trillion and $10 trillion. More importantly, this capital stock can be leveraged by any new product or service that embraces Internet standards.
It is no accident, then, that this opportunity has produced a set of software, hardware and services companies that have grown at compound rates of 30 percent to 50 percent and had rates of return on capital of 40 percent to 50 percent for 5 or more years. While large companies such as Sun Microsystems, Dell Computers and Cisco Systems have led this parade, the rate of innovation opens the door for new players every day.
New openings
The key to making it big on the Internet is to provide ways to make the Net perform better. For example, Akamai and Adero help improve performance by providing distributed caching of content to improve delivery over the Internet; BEA and IBM's WebSphere help enterprises connect legacy applications to the Net; and Verisign, RSA and Checkpoint Software help make the Net more secure.
These are the first of what we believe will be numerous companies providing a new layer of value-added services on the Net.
Opportunities remain in enhanced collaboration, reconciling online identity and privacy, guaranteeing transaction integrity, and so fourth.
The companies that provide these services will do very well. The other beneficiaries will be brick-and-mortar companies with rich content, strong brands, great products, reputable customer service, and low production costs -- and the foresight and agility to exploit the new services layers on the Internet.
The intangible assets incumbents have built up over years of operations, combined with a new generation of Internet services, will be a second real source of Internet value creation over the next few years.
Let's stop wasting talent and treasure on trivial pursuits and get on with building and using the infrastructure and tools that will enable the Net to lower costs and increase productivity for everyone.
Mike Nevens works out of McKinsey & Co.'s Silicon Valley office, where he is the managing director of the firm's Global High Tech Practice. He works primarily with clients in the Internet, computer, software, networking, semiconductor and telecommunications industries on a variety of management issues. |
