We live in an extravagant age. The stock market is at record levels; U.S. consumer spending is at all time highs; billionaires are practically commonplace; and almost everyone, from real estate developers to securities analysts, recognizes that just being famous is a desirable end in itself. Against that backdrop, electronic commerce could not have blossomed at a more auspicious time.

Whatever electronic commerce really is (and we all hope to get to an understanding of that one day), it is currently portrayed in the media as both the death knell and the salvation of business. It has produced fortunes by the thousands. And claims of its growth potential are lofty: annual forecasts of doubling, tripling and quadrupling are commonplace. Just how famous is electronic commerce? Do a Lexis/Nexis search on e-commerce news stories from the last week and you will be told that such a search cannot be done because it would yield too many results for your PC to process.

E-commerce is, in short, the most outrageous business story to come along in our lifetime. The stock market has validated the concept with valuations that continue to outstrip all traditional metrics. And although it is popular in some circles to denigrate Internet stock valuations, they do have two very important real-world consequences. First, they give companies a valuable currency with which to pay employees; and they result in a very low cost of capital for Internet companies. That low cost, in turn, gives them an advantage that their traditional competitors do not enjoy.

Sociology of E-Commerce

Beyond the extravagance of our times, there are certain other, let's call them sociological elements, that make the focus on the Internet so interesting. The late 20th century has seen the triumph of democracy and individuality worldwide, and the Internet is, after all, thought to be the ultimate empowerment vehicle. The Internet has the potential to level the playing field between professionals and amateurs, and between buyers and sellers, by giving everyone a platform (a Web page) from which to speak.

Although the Internet has spread globally--and will surely spread even faster as other countries attain enough PCs and the cost of usage inevitably drops--it began in the U.S. and remains a very American phenomenon, well suited to the American love of speed, consumption and independence. There is also a generational element in the success of the Internet. Just as baby boomers owned politics, generation X'ers own technology. General Electric, for example, has set up separate Internet organizations inside each of its businesses under the name "Destroy your business.com." Those over thirty need not apply.

Business leaders and stock investors have to work hard to get beyond the hyperbole and find out what this revolution, or evolution, really means. For instance, we have heard very little about what might happen to the growth of electronic commerce in a recession, when the desire to shop diminishes and corporations feel less benevolent toward each other. When profits are scarcer and stock prices softer, will electronic commerce still be seen as a structural change or just another tool for doing business?

Lack of Critical Analysis

Much of what is written about electronic commerce now is surprisingly uncritical. Indeed, the November 8th issue of Fortune suggests that traditional "bricks and mortar" companies will be doomed by a failure to get on the electronic commerce bandwagon even though, the author asserts, "it's still unclear what really works on the Internet!" There is also a presumption that early advantages will not change; some Net retailers, like Dell and Amazon, are lauded for collecting from customers before they pay their suppliers, but this is a situation that Internet-enabled suppliers or competitors may try to change

If the Internet makes it easier to retain customers by providing them with lower prices and more specialized services, won't competitors have equal access to the technology that makes all of that possible? In a fast changing, highly competitive business environment, will producers, suppliers and customers always be as open with each other as electronic commerce enables them to be? The future, after all, remains uncertain, and no company will want its shareholders to bear a risk that could be passed to another company's shareholders along the supply chain.

When investors focus on the value of the e-commerce enterprise versus the value of the traditional enterprise, they tend to implicitly accept at least one premise. Namely, they assume that it is easier for the new e-entrant to move backwards into (or to control the outsourcing of) production and even fulfillment than it is for the traditional enterprise to move forward into open e-commerce sales and marketing. But common sense seems to imply that--with hundreds of new Web businesses being created every day and few new GM's, GE's or Kraft Foods--the Web end may be the plentiful resource.

The Essence of E-Commerce

Electronic commerce offers an extended reach beyond traditional geographic markets at reduced costs and at high speed, and it has the potential to make these offerings to everyone equally. Therefore, one of the first consumer battles fought on the Internet is the battle to become a broadcaster and attract the most participants. Major sites or portals, such as Yahoo and AOL, seek to become the dominant place to sell--in effect trying to become the New York Times or the NBC of the Internet.

Reaching that goal can be expensive. These companies spend heavily on advertising and promotion (ironically in the old media of TV and print), while their own sources of income still undergo change from advertising and sales fees to licensing and subscription fees. There is even the question of whether some net companies actually have any revenues or they are just bartering advertising space and time among themselves.

The desire to become the Internet broadcaster co-exists with the notion that one of the real strengths of the Internet is its ability to pinpoint and sell to certain groups--so-called narrowcasting. The cable industry presents a model: channels that were once narrowly focused, like Court TV, CNBC or the Turner channels, have all expanded their product offerings, yet new narrowly focused cable channels (pets, gardening, decorating) emerge every day. In both media, the expansion of choices can confuse consumers. This confusion creates opportunities for new intermediaries, or "bots," to help consumers narrow their options and save the time they were promised in the first place. Consumers may wonder, though, whether the "bots" operate impartially between buyers and sellers.

Perhaps the greatest strength of the Internet is its ability to unite disparate groups to disparate groups, and to facilitate contact among the scattered for the exchange of goods, services and information. Recognizing the value of that function has produced some of the most successful early Internet players, the on-line auction sites. They are the ideal infomediaries in the Internet space, with few of the philosophical or organizational conflicts (in particular, the problem of fulfillment) that bedevil others in the same space.

Other functions that appear likely to thrive on the e-commerce model include the delivery of financial products and other services. The problem of fulfillment, which has plagued many retailers whose virtual infrastructure is not always prepared for the practical aspects of having to deliver a physical product to a physical place, does not apply to services and financial products because their content is not physical. In that case, the Web itself becomes the fulfillment vehicle

Business-to-Business Applications: The Next Wave?

Most industry experts expect that the next force in electronic commerce will be business-to-business exchanges, and most of the new companies entering the public marketplace are participants in this arena. But will business be as quickly transformed by electronic commerce as consumer retailing has been?

We start with the premise that a consumer purchase is a discrete event--both in general and in particular on the Internet, because the essence of the Net is to provide enough information to encourage the consumer to move from one seller to another (not, obviously, the seller's desire). So a consumer can buy one shirt from LandsEnd.com, another from JCrew.com and not be at a disadvantage at either site when he buys a third shirt. Airlines try to hold consumers with mileage programs and other offers. Brand loyalty is a time saver, but consumers generally pay no price for shopping around.

Business-to-business transactions, however, are different. Business is a process, not a discrete event. Actions taken by businesses in the 1980s and 1990s to streamline purchasing, inventory, billing and collection functions have tended to bring many players in the value chain closer together and become more dependent on each other via the networks of the Electronic Data Interchange (EDI). In manufacturing, component suppliers must be vetted and meet exact product standards set by their corporate customers.

Indeed, a recent IBM ad, which shows Japanese corporate executives choosing an unknown valve supplier from Texas over their higher-priced local supplier, is unrealistic. You would not want the air-handling systems on a jumbo jet relying on valves purchased on the basis of price (or availability) alone. For essential components, the on-line auction model doesn't work as well as it does in the consumer market. Obviously, there are some instances in which this model does work for business-to-business transactions--especially those for standardized commodity products and things like office supplies. But it is not clear that the stories companies tell about getting 50 to 60 percent discounts from requests for proposals they put on the Internet are very widespread.

The other barrier to a smooth adoption of the business-to-business e-commerce model is the amount already invested in the systems of the electronic data interchange of EDI. Moreover, the 1990s have seen considerable concentration as a result of the huge wave of mergers and acquisitions. More industries are looking more oligarchic, so it seems reasonable to assume that the biggest producers of turbines or generators, for example, are already connected via EDI to their suppliers and customers. Moving away from EDI would, for a while at least, not produce game-changing benefits to those producers. It might even be excessively disruptive.

Most businesses are also highly complicated structures, operating in complicated markets. Almost every company has selling and buying functions that can be categorized as disparate to disparate, concentrated to disparate, concentrated to concentrated or disparate to concentrated. These intricate structures and the investments in the networks that support them may mean that companies will have to adopt a variety of electronic commerce strategies in place of the classic business e-commerce model that industry experts now forecast. Of course, the adoption of multiple models will take more time.

The Classic B-to-B E-Commerce Model

Total adoption of the B-to-B e-commerce model is the equivalent of deregulating a business. In the power industry, for example, utilities once knew in advance their pricing and cost structures because they were established by rate boards and stayed in place for years. They also knew in advance their customers, most of whom could be seen from headquarters, and their competitors (there were none). Deregulation changed all of those relationships, and many believe that electronic commerce could do the same

The business-to-business e-commerce model is based on an open system of information that can move swiftly and cheaply along the value chain from the earliest commodity suppliers to the ultimate customers. Unlike legacy systems, where producers create inventories of products from which consumers can choose (supply chain driven), the e-commerce model makes the consumer the trigger that begins the process (demand chain driven). This is mass-customization, or the ability to build huge numbers of products, each tailored to a specific set of customer requirements. Mass customization has always happened in the auto industry, where buyers can choose cars augmented with a variety of options.

In fact, mass customization drastically shortens the lead-time because information about needed components can move speedily along the Net from suppliers to producers. It also extends the principle to lower priced goods. (Mattel's Web site, for example, lets consumers customize a Barbie doll. Although this is an appealing concept, it did little to offset other problems at Mattel, which caused the shares to lose almost half their value in three days last October---a reminder that other factors besides e-commerce still affect businesses.) The lower costs of Internet-carried data (versus EDI) should also help to open up smaller companies to the possibilities of mass customization.

Many believe that the openness of information between companies in the e-commerce model will lead to more outsourcing of non-core functions. The idea is that the assembly line moves away from a vertical function inside individual companies and becomes a horizontal function across companies. This shift should reduce operating costs, inventory and procurement costs, and hasten both billing and receivables collections.

Implementation of the model, however, creates serious questions that all companies will have to address. Opening the enterprise up to the outside world creates issues of vulnerability, especially when proprietary processes and patents are involved. Because these things are usually carried on the balance sheet as assets, managers will have to ask if the value created by the new model exceeds the value that might be destroyed. Does the narrowness of function--a concentration on core competency--raise or lower the risk for stockholders?

The conventional view is that e-commerce empowers employees further down in the organization--a sort of distributed system versus the old mainframe of centralized management. But strong corporate cultures and leadership are needed in organizations to guide them through a constantly changing business landscape. In fact, we think the argument can be made that after two decades of restructuring and downsizing at the hands of their own management, companies may need more centralized control to enable them to survive pressures coming from outside the organization.

What All Companies Are Likely to See

The changes fostered by e-commerce will likely affect all businesses, whether they fully adopt the e-commerce model or not. For one thing, how companies determine pricing will change. Traditionally, price derived from costs, but in the e-commerce model, costs are constantly changing because they are based mostly on the level and customized nature of demand. Should volume buyers get bigger discounts than those who buy just a few items? Should prices vary by geography? And will price be the only basis on which e-purchasing is done? In fact, studies are beginning to show that buyers chose e-vendors for service capabilities as well as price. Marriott says that rooms sold over the Net actually carry a higher price tag than those booked by travel agents because Marriott adds extra features, like local maps, to the Web transaction--for which consumers are willing to pay. If that is so, electronic commerce may not be the long-term deflationary force that some have predicted

Strict adherence to the e-commerce model makes the presumption that a focus on core competencies is best, with all other functions outsourced to more efficient providers. But e-commerce creates a conflict between narrowness and scope. Because overhead does not rise in the e-commerce model when volume rises, companies in the future may wish to consider mega-mergers instead of divestitures. In fact, many companies in pharmaceuticals, financial services and in Net commerce itself have followed the merger path. The goal of these mergers is to create a richer product line to sell to an existing customer base.

Companies of all kinds will have to rethink their relationships with their sales force and distribution systems. Channel conflict is a big risk. Could companies like Home Depot ultimately become major competitors with their own suppliers? Or will suppliers bypass the HD distribution system, go direct to the consumer and try to keep the distributor's margin for themselves? The value of brands and proprietary processes becomes more complex in the e-commerce model. Well-established brands may increase in value as they help products stand out from the increasing clutter on the Internet. But they may also appear more vulnerable in a totally open system, and, if price comes to dominate e-commerce transactions, even the strongest brands and processes could be undermined.

E-commerce models allow global reach, and e-commerce reduces barriers to entry; startups are cheaper, results can be seen more quickly, and the price for failure appears low because there are few investments in fixed assets. Companies in the future will have to face a constant barrage of new competitors with new business models and new tactics. The cozy days of a producer responding to the pricing policies of a competitor down the road--say, Ford offering rebates when Chrysler does--may be over.

Older companies must figure out ways to capitalize on their existing strengths. It is important to remember that beyond the transaction done over the Net, someone still needs to maintain the infrastructure for delivering the physical product to the buyer. Fulfillment is usually a strength of the brick and mortar world and a weakness of the e-commerce world. Companies like Fingerhut and Grainger have used their expertise in traditional parts of the value chain (namely, distribution) to become outsourcers to Web newcomers.

Because of the ubiquity of information in the e-commerce model, advocates expect markets in the future to be much more efficient. If fact, e-commerce could produce nearly perfect markets by eliminating transaction costs; electronic billing and payment reduces administrative and float costs to almost zero. In such a market, size shouldn't matter and big companies should have no advantages over smaller ones. But where will small companies come from? In a less perfect world, inefficiencies in pricing and cost structures can create an umbrella that encourages new competition to enter. Without that umbrella, new entrants may be only those with a revolutionary new idea, which is rare. The lack of new entrants could slow growth, lead to monopolies and even undo the democratization of the business process that electronic commerce brought on in the first place.

Social consequences of business decisions are not a popular topic, and when GDP growth is robust and unemployment is low, economies can easily absorb those dislocated by the adoption of new processes and new systems. In such an environment, the vision of an ever-changing, unstable business world may not be so frightening. But there will likely be a time in the future when such dynamic change conflicts with declining growth. Stranded assets, whether human or capital, will have a cost to be borne by even the most flexible of enterprises. Readers might take the end of the Cold War as an analogy: The euphoria of the early years overshadowed the cracks beneath the surface. Today those cracks are widening into greater political and social disorder. Balance sheets, the pricing of and need for capital, and the ratios by which successful companies are measured are all likely to change in the e-commerce model. Instant payment systems will affect payables, receivables and working capital ratios. Dell is said to have negative working capital, a goal to which General Electric, with $110 billion, aspires. Inventory should be hard to find, and the need for short-term capital to finance it, like commercial paper, may disappear. Do long-term contracts, leases and licensing agreements mean something different in an era of demand-driven pricing? Are brands and goodwill more or less valuable? Is an actual customer an asset that should be depreciated? Are the marketing costs to get that customer (costs that are now expensed to current income) really the equivalent of capital costs in the legacy world and should they be capitalized? And will the virtual nature of e-commerce put fixed assets in the same "stranded asset" situation in which utilities found themselves when the power industry was deregulated?

Before despairing over the ever-shifting financial ground beneath the e-commerce model, readers may want to consider a comforting irony: Amazon.com, the quintessential e-commerce creation, is now investing more in distribution centers. Gateway computers has retail stores. Are these companies really so far ahead or are they demonstrating that in the long run, e-commerce will really be just another tool in carrying out the traditional business model--a clever way to establish a revenue stream before making heavy asset commitments?