Profits on the Web -- No, Really

SAN FRANCISCO (09/05/2000) - Wedged between Appalachia and the Great Smoky Mountains, Kingsport, Tenn., doesn't look like ground zero in the new economy. But it's as good a place as any to see that e-commerce isn't just about selling books.

This feisty industrial city is home to Eastman Chemical Co., manufacturer of polymers, plastics and other products with annual revenues of more than US$5 billion. More than $200 million of that is coming via the Web - making a profitable business even more profitable. And no one's happier about it than Fred Buehler.

"This is nothing like I would have expected," says Buehler, Eastman's director of e-business. "They buy more from us because it's easier to buy online."

Eastman is one example of how hyperefficient Internet operations at old-line companies around the country have quietly begun to turn a profit.

That's right, a profit.

In fact, this year promises to be the first in which a broad range of real, old-fashioned companies - steel manufacturers, chemical companies, hotel chains - will see their Internet investments produce real, old-fashioned earnings. For some, their Internet businesses are boosting current profits. Others are tapping new profit streams all their own. Either way, these aren't just companies that "get it" - these are companies that are doing it and making money at it.

Already, Enron, Office Depot and others have seen their Internet ventures contribute to both revenue and earnings. Other companies, including Eastman Chemical and Alcoa, are moving businesses to the Web to reduce costs and bolster margins. And Procter & Gamble and others are slashing millions in costs by purchasing materials online. The upshot: The Internet's promised gains in productivity and efficiency are happening - now.

It probably should come as no surprise that some stodgy old companies are finding Net income faster than most dot-coms. Startups have to create a brand, get products and build infrastructure; brick-and-mortar companies already have all that.

Look at Office Depot. The Delray Beach, Fla., office-products retailer already had 20 warehouses and 2,500 delivery trucks for its mail-order business. When it launched its e-business site, all the company had to do was persuade customers - and its salespeople - to move purchases online.

They have. Online sales were up 161 percent in the second quarter to $184 million - compare that with store sales, which increased just 8 percent. For the year, Office Depot expects to sell about $800 million of goods online, more than twice last year's tally. And every online purchase saves money: The company estimates an online transaction costs 35 cents, that's vs. 90 cents for a faxed order and $2.50 to field a phone call.

And it's not only business-to-business e-commerce that's turning up profits. Hilton Hotels (HLT) expects to book about $200 million in online reservations this year, reservations that are 80 percent cheaper to handle than those handled by phone. "There's a terrific return on capital," says Bruce Rosenberg, Hilton's senior VP of e-business.

This is a big change from last year, when CEOs at many old-line companies were in a panic, fearing that dot-coms lurking in Silicon Valley garages were going to chew up their businesses, the way Amazon ate into Barnes & Noble's sales. Companies like Toys "R" Us tried to beat the dot-coms at their own game by creating separate Internet units, with separate corporate structures and autonomous staffs, and throwing venture capital at them. That strategy so far has failed.

But what does work is using the Internet to slash costs - something analysts have been promising for months. Goldman Sachs analysts Martin Brookes and Zaki Wahhaj reported in February that lower costs from buying materials online would have the "shocking economic effect" of boosting the gross domestic product of the U.S. and other major industrialized nations by almost 5 percent. For the U.S., that would mean $400 billion. And now those predictions appear to be panning out.

Hartford, Conn.-based United Technologies, a diversified manufacturing company with $24 billion in annual revenue, has saved $1 billion - that's a "b" - buying everything from air-conditioner parts to aircraft-engine parts online.

IBM may be the king of using the Web to cut costs. Struggling to boost revenue in some aging product lines, Big Blue turned to the Net to boost net income. In the first half of the year, the company not only sold $9 billion online; it also handled 42 million self-service transactions on the Web, saving itself $900 million. And approximately a third of all employee training was done via the Web, saving another $150 million.

And there's plenty more money to be saved. According to the Goldman report, some smokestack industries, like metal machining, forest products and shipping, could see savings of as much as 20 percent. Electronic-component manufacturers, Goldman maintains, could cut costs by a whopping 40 percent.

Consider Enron, the Houston-based energy wholesaler, whose Internet operation has exploded since it launched last November. Already Enron is seeing profits - not for its heralded fiber-optic strategy, but in its core commodities trading. The company's EnronOnline marketplace has handled more than 260,000 transactions worth about $125 billion. "It's 10 to 20 times bigger than what I expected," says Enron President and COO Jeff Skilling.

EnronOnline has had a major impact on Enron's income statement. In the second quarter, Enron's revenue soared 75 percent to $16.9 billion, and net income jumped 30 percent to $289 million. Skilling attributes a major part of that growth to the Web.

Of course, not every traditional company with a Net strategy is seeing it pay off. Some companies, like industrial-goods manufacturer Cooper Industries, simply started late. Other Net strategies haven't worked out as expected: Disney's Go.com and truck-parts manufacturer Meritor's Fleetworks.com, for instance.

And not every company is rushing to the Net. Auto-parts suppliers Delphi Automotive Systems and Eaton are already connected to their biggest customers and suppliers via expensive proprietary networks they don't want to give up. Still others, such as John Deere and Harley-Davidson, don't want to alienate their dealers by selling direct over the Web.

But by far the biggest reason many older companies have struggled online is that they have been encumbered by hulking mainframes and outdated software ill-equipped to handle real-time orders over the Web. E-business pioneers like Cisco and Dell didn't have these so-called legacy systems, so they made the move to the Web quickly (and are making money there). But most Fortune 500 companies have had to rewire their back offices and change the way they process orders before doing business online.

Companies like Eastman, Enron and Office Depot are ahead of the pack. Other businesses have completed the job but are moving cautiously. With good reason. When eToys fails to deliver a stuffed toy for Christmas, it might lose a customer. When a company like Eastman fails to deliver industrial polymers on time, it could lose a multimillion-dollar account.

It's a risk Sigma-Aldrich isn't willing to take. The St. Louis chemical producer says it will do about $50 million in online sales this year, or 10 percent of its U.S. business. But the company isn't pushing ahead aggressively - even if its Internet operation is profitable. "We've actually held our Web growth back over the past year or so to ensure we could handle the volume," says Brad Johnson, Sigma-Aldrich's director of e-business.

In the end, that step-by-step approach may be what allows older companies to thrive. While they're not measured solely by what they do online, every accomplishment is significant. UPS doesn't sell anything online - but that hasn't stopped the 93-year-old company from using the Net. UPS created an online order-tracking service that lets customers follow their shipments. Each time someone logs on, it costs UPS about a dime, compared with about two bucks for a phone call. With more than 2.5 million online inquiries a day, that difference is adding up, fast.

With the hype of an Internet-led revolution fading, the Net is no longer considered a panacea. But neither is it a mystery to companies in places like Pittsburgh and Des Moines. Places where it is already altering business practices.

"The Internet will fundamentally change the way business is done in our industry," says Eastman's Buehler. "The laggards will lose because the leaders will drive inefficiencies out and have a big cost advantage."

The people of Kingsport expect Eastman will be among those left standing.

Dot-coms in the Black

Cash eaters. Bottomless pits. Loss centers. The black epithets that hang over Internet startups these days have tainted the notion of putting "dot-com" on a company's name - an idea that a year ago was emblematic of the promise of the Internet Economy.

Like newcomers to a 12-step program, many dot-coms have turned from grand pronouncements of world domination to solemn vows of keeping their feet on the path to profitability. And sure enough, even as old-economy companies quietly tap their online divisions as a steady source of profits, the ranks of profitable Internet pure-plays are growing with each quarter.

Online broker Ameritrade, for example, posted profits in the first and second quarters of 2000, surprising Wall Street analysts who had forecast losses. Others are expected to break a chain of losses soon. According to consensus estimates by First Call/Thomson Financial, online-advertising firm DoubleClick, financial Web site Multex and real estate site Homestore.com will each go from losses to profits by the end of the year.

Looking at the companies that were among the earliest to reach the land of profits, some common elements emerge: Many were the first to establish a beachhead in their markets, and some resisted the temptation to spend lavishly on marketing in the name of brand building.

In content, companies like Yahoo and Lycos wrung out profits by avoiding the cost of developing content themselves. Portals that came later to the game didn't fare as well: The leads that Yahoo and Lycos established early on helped them build market share without major advertising.

"In the online media space it is not that difficult to make a profit," says Safa Rashtchy, an analyst at U.S. Bancorp Piper Jaffray. "You write once, publish many times. So the model itself is highly profitable." Still, of the major content portals, only Yahoo, Lycos and CNET are currently in the black.

CNET, which has shown steady profits for years, does develop content - but its content was directed early on toward the technology professionals that were the first to the Internet.

Still others latched on to a good idea and simply refused to let others have a chance. EBay, the bully in the online-auction neighborhood, enjoys an 85 percent share of the market. "It's infrastructure costs are so low," says Piper Jaffray analyst Greg Konezny. "There are no plants, manufacturing facilities or real estate - just sales."

Indeed, it's the dot-com corner of the Internet world - businesses built in large part, if not entirely, on the Net - that is missing out on the promise of profits. Among companies involved in building the Internet's infrastructure or creating its software, the list of profitable companies is longer.

Cisco, Ciena and Sycamore - to name a few - are among the most profitable Internet companies. Cisco earns $2.67 billion and has a 14.1 percent profit margin; Ciena has $60.1 million net income and an 8.4 percent profit margin; and Sycamore earned $20.4 million on a 10.3 percent profit margin. In software, Network Associates and Checkpoint Software are also both familiar with profits.

But unlike eBay's formula of high revenues with low costs, the majority of dot-coms' expenses are too high and sales too low. Those with an early lead in their markets have a leg up. For the others, it comes down to business sense that is old-fashioned - if not old-economy.

- Eileen Buckley

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