What We Learned In The New Economy


It's a foggy, rainy December afternoon at the port of Redwood City, California--the kind of day that makes reality hard to discern, even at a distance of five feet or so. But suddenly, there it is: Right on the shore, water lapping the marshy ground, are two competing business models. One is a creaky, ugly group of towers crushing sand and gravel next to another industrial site where cars are pulverized into smithereens. It's a noisy eyesore--and a fully functional one.

Just on the other side of the shoreline, a glistening mass of blue and green glass rises from the water's edge. The office park, Pacific Shores Center, is one of the most ambitious real-estate development projects ever undertaken in the area. With 1.7 million square feet in 10 different buildings, the $500 million center, opened in 2001, was set to transform this lonely lick of land into a glamorous technology hub. Featuring baseball diamonds and a 38,000-square-foot fitness center, it is, as the Web site proclaims, "a next-generation work environment designed to facilitate productivity, satisfaction, and balance for forward-thinking companies and their employees."

Yet Pacific Shores' gleaming glass windows hide something: "They built a city and no one came," says Jamis MacNiven, proprietor of nearby Buck's of Woodside, the funky diner best known as the favorite haunt of Silicon Valley venture capitalists. MacNiven is overstating the case a bit. The park has finally reached 70% occupancy. But at least two of its buildings stand empty. The original tenant for two structures, Excite@Home, never made it here, going bust in 2001 and leaving its own abandoned site off Highway 101. And lease prices are a fraction of what they once were-- $1.85 per square foot, down from more than $6 during the boom. So much for the promise of the New Economy. Like Pacific Shores, it hasn't been a total bust. But side by side, it looks as if pounding sand may have been the better bet.

It's quite a comedown from the shiny new world we saw at the end of the 20th century, when the business cycle as we knew it was declared DOA. The Internet was the chief herald of this new and unprecedented age, of course, but many other forces combined to propel us into what seemed a radically different state: the technology-fueled productivity boom, the soaring stock market, globalization, the replacement of budget deficits with surpluses, the apparent outbreak of world peace. We all bought in in some way, awed and inspired by a world where workers were treated justly and rewarded bountifully, where you could make critical consumer and business decisions from your desktop, and where the business status quo was to be discarded like a stale slice of bread. With such logic, it made perfect sense that Yahoo had twice the market cap of General Motors even though the car company had nearly 300 times its revenue; that UPS delivery guys steered their brown trucks with one hand and day-traded Nasdaq stocks on their Palms with the other; or that AOL had more than 2,000 millionaires in its employee ranks. As the glow of the New Economy shone well beyond economics, that boring cynicism we all know so well vanished. For a brief, halcyon moment, all the rules were toast, and anything--anything--seemed possible.

Then, four years ago, it all came tumbling down. The stock market crashed; surpluses became deficits; world peace became endless, ephemeral war; and vaunted CEOs became convicted felons. Instead of utopia, we got bankruptcies, backbiting, bitterness, and a wholesale rejection of everything the New Economy stood for. Zany optimism and creative juices were replaced by the sour feeling that we'd been had. This magazine itself paid the price for being identified by some as the pied piper of this new world.

And yet the business cycle--and yes, it is a cycle--gives us hope once again. Today, with the Nasdaq up a remarkable 91% since its October 2002 low, and with GDP growing at a steroidal 8.2% rate in the third quarter of 2003, a new enthusiasm is sprouting once again. Venture guru Steve Jurvetson was recently spotted in Buck's, his pen outlining a business plan on--yes! --a napkin. Add to that the much-anticipated IPO of Google (expected sometime this spring), our ever-growing dependence on the Internet, and the healthy sums of capital piling into such sectors as social networking and nanotechnologies, and you've got some serious mojo rising.

But have we learned anything at all? Are we doomed to live through another season of high hopes and dashed expectations? We are all older--like the grizzled sock puppet on our cover, who once starred in e-tailer Pets.com's $20 million ad campaign and who now toils as a pitchman for auto loans for people with bad credit (hey, at least he has a job). But are we any wiser?

Like Pacific Shores, the New Economy isn't dead. It just didn't happen in the way we all imagined. And now it's been long enough that we can think more analytically about which of the shiny and alluring ideas of the New Economy were lasting and real, and which were just the iridescent glint of a bubble.

Boom-Time Buzz: The Internet changes absolutely everything.
Cold Reality: Absolutist statements are absolutely a bad idea.

Finding a job was once an inky slog through the Sunday paper, a groveling call to those college acquaintances whom you never really liked, a random letter hoping for an interview. Then came Monster.com.

Quickly, it became a symbol of how the easy access, low cost, and ubiquity of the Internet was utterly transformational. Why would anyone go back to the old way when the new way was so efficient, cheap, and easy?

That, in a nutshell, was the religion of the Internet, practiced in the church of the New Economy. You could get anything, anywhere, at any time. The cost of information was no more than that of bringing the pipe into your home or office; the tiniest storefront could compete with the biggest; the middleman was toast.

There is no question that the Internet has been a technological earthquake, transforming the way individuals and businesses use information. When was the last time you visited a library to look something up? Went to a travel agent's office? Bought anything without doing research? "The first wave of e-commerce was about things that hadn't seen any innovation for 100 years," says Jeff Taylor, Monster's founder and chairman. Internet retailing continues to boom, with 2003 sales (excluding auctions and travel) expected to hit $52 billion, up 22% over 2002, according to comScore Networks.

But with the benefit of hindsight--and looking over the scattered graves of thousands of Net companies--the original exuberance seems rather naive. Existing as a stand-alone Internet business has proved to be much tougher than any of the purveyors of dog food or toilet paper ever anticipated. At General Electric, says former CEO Jack Welch, "[the Internet] created new distribution models. But that's all that came out of the Internet. I don't see any new inventions."

Some of the most successful Internet businesses, as it turned out, were embraced by seasoned brick-and-mortar companies, as when TMP Worldwide scooped up Monster.com, or when Toys "R" Us partnered with Amazon.com. A big reason they work is that they're parts of larger, traditional businesses. In other cases, such as Dell's reconfiguring of the online process for buying a computer, or GE's efforts to revamp its supply chain, the potential of the Internet to transform existing businesses became apparent only as other models collapsed.

And then there are the clear exceptions--the Amazon.coms, Expedia.coms, and eBays. What separates the winners from the dot-gones? Start with what you sell. The Internet gives an edge to products with unpredictable or fragmented demand, because it reduces risk by not forcing you to carry, say, an obscure book in every one of your stores. Yet it may also increase other costs, such as transportation (which isn't an issue for travel services or an online auction business in which third parties pay the freight). "The Internet facilitated certain business models and didn't facilitate others," says Sunil Chopra, an operations management expert at Northwestern's Kellogg School of Management. "Why doesn't P&G sell detergent direct to customers? Even if the Internet does let you, sending it to each individual customer's home is not an efficient way." The choice, he says, is stark: Either dramatically increase the efficiency of getting a product to market or offer something that others don't.

The Internet seems to work best alongside existing systems rather than, as the dotcommers believed, undercutting them entirely. That's the rationale for Connection to eBay, a new Web-based company that sets up a virtual storefront for larger companies that want to get rid of excess inventory on the auction site. Here, the Internet is not the sole distribution system but rather an alternative to liquidators and others. "I've never seen a business that can use one channel," says CEO Robin Abrams. "This is absolutely complementary." Now there's an absolutist statement.

Boom-Time Buzz: Free Agent Nation is a utopia. The Brand Called You makes you more marketable than ever.
Cold Reality: Free Agent Nation is a jungle. The Brand Called You is the only way to survive.

In the heyday of the New Economy, a sheepskin from Stanford University's B-school was a coupon for a six-figure salary, stock options, and a high-level position at one of the thousands of startups clamoring for young blood. Getting a job meant choosing from a wish list. Today, things are a little different. Even before school starts at Stanford, students take two mandatory classes, one about self-assessment and the other about developing strategies to manage their careers. "We call it career self-reliance," says Andy Chan, Stanford's placement director. "You have to do it yourself."

It may have been Fast Company, channeling Tom Peters, that said it loudest in its August-September 1997 cover story. "You don't 'belong to' any company for life, and your chief affiliation isn't to any particular 'function.' You're not defined by your job title and you're not confined by your job description. Starting today, you are a brand." We also popularized the concept (from writer Dan Pink) of Free Agent Nation--a new, powerful, and subversive economy populated by the self-employed.

Together, these notions came to symbolize the new world of work during the boom. Suddenly, college kids were supposed to have a better feel for this technorave world than anyone with actual work experience; foosball tables, bars, and outsized senses of entitlement became standard office equipment. "When you were hiring people in 1999 and 2000," says Joe Kraus, one of the founders of Excite.com, "people were asking in interviews, 'What are you going to do for me, and how are you going to guarantee me a million dollars?' And you're sitting here going, 'Are you crazy? I hate the idea of hiring you.' "

Ironically, the dramatic downturn has proven the staying power of both concepts--just not in the idealistic ways we imagined. There is most emphatically a Free Agent Nation today. The thing is, not all of the 9.3 million self-employed asked for citizenship: Downsizing turned many of them into refugees. Some of those who left secure, if staid, jobs for the freedom of free agency now find themselves struggling to pay the rent or offering to do the same work for the companies they left--for less money and fewer benefits. The hard reality turns out to be a bit more, um, real. You can run your own business, but it won't always be fun--or lucrative.

As for the Brand Called You, could there be an idea that's more relevant in today's jobless recovery? As of December 2003, there were still 8.4 million people out of work, 1.9 million for more than 27 weeks. In that context, being the CEO of yourself sounds silly only if you still believe that it means special treatment. "Once it was a luxury," says Peters. "Now it's a survival strategy."

Susan McPherson, director of strategic accounts at PR Newswire, would heartily agree. She worked seven years in sales at the company before leaving in 1997 to become a New Economy wanderer, circling the globe for three different companies. In late 2000, she was laid off. "I was devastated," she says. Seeking consulting gigs, she offered her skills to a local food company. They said, 'Sure'--provided she sling hash for them for a month. "I was knee-deep in coleslaw, and I was mortified," she says.

McPherson had stayed in touch with her old colleagues at PR Newswire, making a point of subtly letting them know her accomplishments, and sending gifts on special days and news clippings she thought might be relevant--just because it was good brand management. In 2001, PR Newswire offered her a consulting post that soon became full time. "It was the Brand Me that allowed me to get back here," she says.

Boom-Time Buzz: IT spending has fueled an unstoppable productivity boom that has ended the business cycle.
Cold Reality: Productivity is still strong--and so is the business cycle.

Monitoring your fantasy baseball team on the Internet when you're at work may not be good for productivity, but isn't just about everything else we do more efficient, thanks to the Net? The numbers seem to back that up. After averaging 1.4% annual growth between 1973 and 1994, productivity suddenly went turbo, rising 2.4% annually between 1995 and 1999. Even during the recession, we got more efficient, by 3.0% in 2000, 1.9% in 2001, 5.4% in 2002, and 3.6% through the third quarter of 2003, according to the Bureau of Labor Statistics.

The explanation seemed obvious: Increased spending on information technology and the cost savings from the Internet had spawned a kind of second Industrial Revolution, making us all superworkers at hypercompanies. But while it's true that IT spending went up dramatically in the late 1990s, its link to productivity is not nearly so neat as the New Economists proclaimed. The McKinsey Global Institute has found that more than three-quarters of the U.S. net productivity gain came from only six sectors: retailing, securities brokerage, wholesaling, telecom, semiconductors, and computer assembly, which together make up just under one-third of GDP. Other sectors spent with equal abandon, but never saw the payoff. "The original conception was that IT was something like pixie dust," says Diana Farrell, director of the institute. "You could just sprinkle it around and get productivity. But that picture does not hold up."

The truth, according to the McKinsey folks, is as much about competition as it is about technology. In sectors where there was a lot of competition, businesses had no choice but to innovate, sometimes with tech but also with new management practices. In the hotly competitive retail sector, for example, Wal-Mart spent big on warehouse and transportation management systems, as did Kmart. But Wal-Mart also reworked its supplier relationships and logistics, while Kmart did not. The rest is history. In only one sector--online trading--did McKinsey find that the Internet made a direct and major contribution to productivity. By contrast, online banking has had little impact on banking-industry productivity.

Ignored in the rush to deify the Internet was the simple fact that certain technologies take root faster than others. Instant messaging is one example of an Internet tool that was easily adopted; yet complex enterprise software can require the reordering of major processes and the retraining of many employees. "Some apps diffused quickly and some didn't," says Shane Greenstein, professor of management strategy at Kellogg.

The productivity boom is also a mixed blessing for us humans. Unquestionably, the Internet allows us to do far more, far more quickly, whether it's accessing a customer's payment history or training thousands of people at different locations. Yet while that's good for the economy as a whole, drill down a little bit further and you hit a raw nerve in the form of lost jobs, careers, and livelihoods once considered secure. Since 2001, more than 500,000 American tech workers have lost their jobs, with another 500,000 losses expected by the end of 2004. Nor do the recent trends toward outsourcing of skilled white-collar jobs overseas show any sign of abating. "It is an unstoppable force," says George Colony, CEO of Forrester Research, who predicts that 3.3 million jobs will go offshore by 2015. A more productive world, it turns out, is not always a kinder one.

Boom-Time Buzz: Move first--or die.
Cold Reality: Move first without a real business--and die.

To succeed in the New Economy, you must get there first. First-mover advantage means everything. And with those five words, billions in capital and millions of employees were off to the races, spending frantically to build an e-commerce platform or lawn-chair distribution network or a global brand compelling enough to attract everyone to a Web site first.

Could there have been a concept more misunderstood or oversimplified? Although first-mover advantage had been part of the lexicon for a long time, the speed of the Internet made it seem suddenly critical. Certainly, there were companies that moved onto the Internet first--and are still standing today. "First-mover advantage was the most fundamental thing that Jeff Bezos had at Amazon. It was the only thing that eBay had," says Vinod Khosla, a general partner at venture firm Kleiner Perkins Caufield & Byers.

But then think Google, Microsoft, and Wal-Mart. If being the first mover were the only key, they'd all have been dead long ago, and Webvan, which blew through $1.2 billion building warehouses in 26 cities, would have turned the grocery industry on its ear.

As always, the reality was more complex than the pundits, journalists, and cheerleaders would have had you believe. With Webvan, for example, it wasn't that people didn't want to order groceries online--the demand was there. The branding worked, too. But it could never do enough business to overcome the rate at which it was spending money. That was largely because too few customers had broadband connections, and nobody wanted to look at pictures of asparagus at 28k. In effect, first-mover advantage is what actually killed Webvan. Today, smaller, more focused competitors such as FreshDirect are proving the concept at fractions of the cost. "It was an issue of changing consumer behavior and the cost of the infrastructure," says George Shaheen, Webvan's former CEO. "We got it to work, but in retrospect, it was ahead of its time."

There have always been advantages to being the first in a market, New Economy or no New Economy. The key is knowing there's a true need for a product, and being able to respond when a competitor jumps in after you. "If you do it first and you do it right, you can win pretty big," says Kevin O'Connor, the cofounder of DoubleClick. "But it's much better to do it right than first."

Sounds obvious after the fact, but as Carl Prindle, CEO of Furniture.com, remembers, it wasn't so clear at the time. The onetime McKinseyite joined Furniture.com in 1998. The site grew to $84 million in sales, burned through $100 million, and went bust in 2000. "Rational businesspeople could see that what was being spent on marketing to deliver each order did not point to a sustainable business," says Prindle. "That said, the people funding these companies believed that the first mover would reap significant rewards." If you wanted the money, you had to go, go, go.

Unlike most other dotcom tales of woe, Furniture.com has a second chapter. In December 2000, Prindle and three others bought the remaining assets for $1 million and resurrected the company. This time, it has two brick-and-mortar partners--Seaman's Furniture and Levitz Home Furnishings. While it still sells to the consumer, Furniture.com's role is now much more to help existing furniture companies than to compete with them. "When major retailers start to think about going online," Prindle says, "we are seen as a proven solution."

Perhaps the better way to think about the first-mover notion is to split it in two, says Kellogg's Greenstein: the traditional first-mover advantage, and the attacker's advantage, where the first to move can put incumbents on the defensive. But attackers also need to remember that for every action there is a reaction. The big slow guys finally did get off their duffs and managed to learn quite a few things from the upstarts. The lesson: The first mover wins, but only if it also has lots of other vital requirements for victory.

Boom-Time Buzz: The Internet gives the customer new, limitless power.
Cold Reality: New power, yes. Limitless, no.

To understand how the Internet has changed consumerism forever, visit Bizrate.com, Shopping.com, or any one of the half-dozen other comparison-shopping Web sites that have survived the dotcom implosion. Search for, say, Sony's latest camcorder. You'll get not just dozens of reviews from consumers who have bought the camera before you but also a selection of a dozen or more retailers--also buyer-rated--selling it at prices that may vary by 30%.

Think about that. A decade ago, you bought a camcorder by reading Consumer Reports, then visiting two or three stores to see what they had in stock. Today, you can buy from a retailer who knows you know all about the camera, who knows you know what it's selling for anywhere in the world, and who knows you know his reputation. Is there any question which experience better serves consumers?

The Internet has delivered as promised: Greater market transparency, yielding more access to useful information, gives consumers more power. Some 20 million people a month get information about their health from WebMD; 2.5 million check Fedex.com every day to track the delivery of their packages. The payoff? Well, it's hard to prove yet on a grand scale, in part because a relative minority of people shop online. But consider this: In the 1980s and 1990s, consumer prices (excluding housing, energy, and food) rose nearly 50% faster than producer prices. Since 2000, consumer price inflation has averaged less than producer price growth.

Consumer power isn't universal, of course. As always, in markets dominated by one or just a few manufacturers or retailers, or where a popular product--Apple's iPod, for example--can't easily be replicated, the Internet doesn't make prices any more elastic. And in niches such as mattresses, sellers have successfully kept useful product and pricing information out of buyers' hands.

But "manufacturers' and merchants' ability to control information is going away," says Nirav Tolia, Shopping.com's COO. In more and more markets, "you can't control anything except building great products and providing great service." Tolia says that half of visitors who buy via Shopping.com choose a retailer whose price is in the lowest quartile of those offered. But price isn't everything: A retailer with a five-star buyer rating is 35% more likely to win the sale than one with three stars. And five-star products win twice the sales, per visit, of three-star rivals.

So while transparency is forcing prices down, that need not turn into a simple race for the bottom. Rather, "the process of value creation is changing, driven by the changing nature of patterns of intersection between consumer and firm," says C.K. Prahalad, a professor at the University of Michigan and coauthor of The Future of Competition: Co-Creating Unique Value With Customers (Harvard Business School Press, 2004). "Value does not reside any longer in the products and services that people create. Now it is the experience that creates value."

Prahalad (like Fast Company columnist Shoshana Zuboff) believes we are entering an era in which consumers and companies must create value jointly. Successful sellers, recognizing consumers' power, will abandon adversarial relationships and embrace cooperation. Exhibit A comes from none other than General Motors, whose Web site features "Auto Choice Advisor," which matches consumers' needs and tastes to appropriate vehicles--even those made by competitors. GM hopes to create a relationship with potential customers rooted in trust--and, not incidentally, to collect information on visitors' priorities.

"The relationship," Prahalad says, "has become mandatory." That's the real power of the Internet--one that sellers must reckon with or fail. Armed with nearly infinite information, the consumer-as-adversary will win every time. --Keith H. Hammonds

Boom-Time Buzz: Destroy your business, or someone else will.
Cold Reality: Incumbent businesses aren't so easily destroyed.

It was the late-1990s catchphrase for every big-company CEO facing the threat of dotcom-induced obsolescence: "Destroy your business, or someone else will." In the face of rapidly evolving technology, the thinking went, old-line business models were obsolete. And the only sound strategy was to continually reinvent strategy. The notion became scarily concrete in 1999 when General Electric, the decade's It Company, established destroy-your-business.com, a task force staffed by young hotshots charged with inventing Internet businesses independent of GE's mainstream units.

Giant incumbents weren't the only ones to feel threatened. Founded in 1947, Hal Leonard Corp. was easily the largest publisher of sheet music in the world, an old company in an old industry. And in 1998, it watched as an upstart called Music notes.com produced a powerful Web site that let musicians download and print sheet music directly from an online catalog.

"There is no more perfect distribution model for sheet music than the Internet," Musicnotes founder Kathleen Marsh says today. And she's right: On the Internet, customers can choose from thousands of songs and get what they want in seconds. A traditional music store may or may not have that song in stock; if not, ordering it can take weeks.

How did Hal Leonard respond? Cautiously. It didn't destroy its business. Instead, it upgraded sheetmusicdirect.com, a modest joint venture founded the year before with Music Sales Ltd., Europe's biggest music publisher, to sell downloads from a limited library. To avoid alienating the company's network of 10,000 traditional music stores, the mainstay halleonard.com site simply referred visitors to its retail partners.

Today, Musicnotes.com says it sells 87% of all sheet music downloads in the United States; its sales were up 60% in 2003. Ah, but downloads represent just a small portion of music sales. And Hal Leonard, with its retailers, its huge library, and its longtime licenses with music companies, is thriving. In the end, says president Larry Morton, "The Internet is just another outlet."

It's a telling lesson. At the dawn of the Internet era, many old-line companies were indeed unresponsive and inflexible, leaving themselves vulnerable to new competition. Many still are. But those big corporations, it turned out, had other things going for them. One was, well, bigness, which brings leverage over suppliers and customers, plus access to capital markets. Established companies also enjoy powerful distribution channels, brand awareness, and relationships that aren't toppled quickly.

So, "Destroy your business. . . "? "It's not true. It just didn't happen." The speaker: former GE CEO Jack Welch himself. "The new businesses just made people faster, more efficient, and more effective." Despite eBay's success, Welch points out, Wal-Mart still thrives. "The vast majority of beneficiaries of the dotcom era were old-line businesses that became more competitive--not by abandoning their businesses, but by enhancing them." As for destroy-your-business.com, Welch says it "turned out not to be a very good idea." It helped to shake up GE's culture, but it also isolated Internet technology from the company's mainstream businesses. Within 18 months, it was disbanded. --Keith H. Hammonds

Add New Comment

0 Comments