Stanford GSB: Stanford Business February 2000

Stanford Business

February 2000, Volume 68, Number 2

e-Players

Online entrepreneurs make first moves in the high-stakes dot-com game.

By JENNIFER REESE

IN DECEMBER 1995, I wrote a story in these pages about young GSB alums who were starting cool little companies on the World Wide Web. It was a small and random cast of characters, testing out precarious business models on the Internet when most people (including me) had never even been online. What they were doing seemed abstract, brave, and extremely uncertain.

Boy, have things changed.

It's not just because people have flocked online and companies like those I profiled in 1995 have started selling them stuff. It's because they're using the Internet to sell differently, to sell more, to sell better. They're selling in ways that save people time, trouble, or money, sometimes all three. They're tracking what customers buy, and they greet them with apt suggestions when they show up at the door.

And the smartest e-businesses are letting the Internet change more than how they sell. These companies are letting the Net change how they procure, market, and distribute goods. It's informing how they advertise and make decisions about strategic partnerships. It changes how they interact with each other. A lot of Internet companies aren't even selling to consumers at all—they're helping companies that do by helping them staff projects more efficiently and get their products to customers more expeditiously. A lot of Internet companies aren't household names. They don't even want to be.

IT'S NOT EXACTLY news that the small circle of GSBers doing e-commerce is now a well-publicized, stupendously funded pack. It includes everyone from independent e-commerce consultants to luminaries like eBay vice president Jeff Skoll, MBA '95, the first full-time employee of the enormous online auction firm.

"There's a lot more money in the industry than there was back then," says venture capitalist Jason Strober, who was featured in the 1995 Stanford Business School Magazine story. "There are a lot more people, and frankly, there's a lot more fun."

"I'd guess at least 20 percent of my class went to work for Internet companies," says Jeff Reed, MBA '99, president of BestOffer.com, a used-car auction site. "And among my group of friends it was more like 75 percent."

What Reed is describing—the stampede of young entrepreneurs online—is known these days, somewhat predictably, as "the gold rush." "It's a unique time when there's this huge opportunity to establish a brand and a presence," says Reed, "before all the established companies start making their moves."

Reed and GSB friend Pratap Mukherjee, MBA '98, knew they wanted to start a company. The question was, what kind? One afternoon while Reed was still a student at the GSB and Mukherjee was doing research, Mukherjee heard a radio ad for eBay followed by a spot for a used-car dealership. Bingo. Why not an eBay for used cars? Certified company mechanics could inspect vehicles and file their impartial reports online, enabling shoppers to make informed bids. This would help bring reliability to a business notorious for sleaze. Mukherjee and Reed spent spring break of Reed's second year sending out 1,500 emails and writing a business plan. They were fully funded by graduation.

Here's another Web-enabled solution to the exact same problem. Go to iMotors.com, fill out a request for the recent-model used car of your dreams, and iMotors will find it, buy it, tune it up, and sell it to you for less than the Blue Book price. If this sounds too good to be true, well ... iMotors has been fulfilling more than 300 orders a month in California and is launching nationwide later this year. In its fourth round of funding last fall it raised a whopping $58 million. "We cut out cost by not having retail facilities or inventory," says cofounder Eli Halliwell, MBA '98. Talk about efficient supply chain management: You order; iMotors stocks. "I've got a dozen plans sitting on my desk, all dot-com or e-commerce companies, and I'm seeing a big trend to more sophisticated business-to-business models."
—Jason Strober, MBA '95

What makes these stories interesting—beyond the youth of the players, beyond the possibility they will make fortunes, beyond the fact that their extraordinary access to capital is now fairly commonplace—is the way the stories epitomize the unexpected ways the Internet can change business. Everyone knows that buying a used car is a dreadful experience, and everyone puts up with it. That's the way of the world. Then here comes the Internet. Reed, Mukherjee, and Halliwell looked at the $350 billion market for used cars, figured out what people hated about it, and came up with two very elegant—and different—Web-based solutions.

Here's another example, about as far as you can get from used cars. Mariam Naficy, MBA '98, never liked buying her makeup from the pushy women in lab coats who pounce when you walk into a department store. Who does? "What other product is kept in a glass case, with no prices displayed, sold in this intimidating way by people who are getting a commission?" asks Naficy. "It's incredibly archaic." Moreover, a lot of desirable brands regularly featured in fashion magazines weren't even available outside New York and Los Angeles. What if you lived in rural Kansas? Naficy saw an opportunity. In 1998, she and a friend founded eve.com, a high-end online cosmetics store, signing up partners ranging from Elizabeth Arden to Calvin Klein. Eve.com does an end run around the ladies in lab coats and makes luxury cosmetics available to a much larger group of women.

Of course, there are always going to be women who want to try on their lipstick before they buy it. Makeup counters aren't going to disappear. Nor are stores. But they're getting competition from the Internet, and for customers, that's generally a very good thing. Bricks-and-mortar retailers are having to figure out how to do what it is they do even better. And frequently this means, yes, using the Internet.

"People might argue e-commerce is a paradigm shift. But there's a possibility it will end up being glorified mail order," says Thi Thumasathit, MBA '96, who is hedging his bets by banking on the survival of real-world stores—and the Internet. His new company, ShoppingList.com, is a search engine for sales in bricks-and-mortar stores. Type in your ZIP code and you'll be given a list of all the advertised sales and specials on shoes, sheets, or sauvignon blanc in your area. "We're using the power of the Internet to drive traffic into physical stores. It's definitely a zig while everyone else is zagging," says Thumasathit. "We're using the power of the Internet to drive traffic into physical stores. It's definitely a zig while everyone else is zagging."
—Thi Thumasathit, MBA '96

BUT A LOT OF THE BUZZ around e-commerce these days has nothing to do with shopping. There's been a huge surge in companies using the Internet to sell products or services to other businesses. "I've got a dozen plans sitting on my desk, all dot-com or e-commerce companies, and I'm seeing a big trend to more sophisticated business-to-business models," says Strober, a principal at VantagePoint Venture Partners.

One reason: It's prohibitively expensive to launch a consumer-oriented site, says Strober, requiring a massive outlay for advertising. Reaching a group of targeted corporate clients is a far less demanding proposition.

For instance, Joel Ullmann, MBA '99, director of product development at a startup called ForeWard Links, knows exactly who his potential customers are. In fact, he can count them: 16,000 small golf pro shops scattered across the United States and 1,800 golf merchandise manufacturers and other suppliers. Until very recently, the shops and the manufacturers did all their business via paper, phone, or fax. "It's not a very tech-savvy industry," says Ullmann.
ForeWard Links, founded by Jim King, MBA '98, is essentially a vertical hub for the golf industry. It helps suppliers and pro shops do business online by managing the electronic infrastructure and training them in the use of e-commerce tools. "We basically stand in the middle. When a commercial transaction occurs, we take a portion," says Ullmann.
"What other product is kept in a glass case, with no prices displayed, sold in this intimidating way by people who are getting a commission? It's incredibly archaic."
—Mariam Naficy, MBA '98

CREATING AND MANAGING HUBS for specific industries has become a popular business model. There are now hubs where businesses can trade chemicals, lumber, and even manpower. Jason Salgado and Rich Menendez, both MBA '99, cofounded a company called WorkExchange that hooks up freelancers with employers. If you want a corporate logo designed, you fill out a request form online and WorkExchange will very quickly put you in touch with the relevant designers in its database. "We're a Nasdaq for human capital," says Salgado, who launched the site last November.

A more tightly focused firm with the same underlying concept is eJobShop, a Web-based provider of custom Java development services. Type in your needs, and eJobShop will get back to you, often in minutes, with a list of people who can do the work. "That usually catches people by surprise," says Steve Schmidt, Sloan '92, who runs the company out of his home. The eJobShop database includes Java developers everywhere from Novosibirsk to North Carolina. A Bay Area company can hire a top-notch Java developer in Calcutta to build its Web application for a fraction of what it would cost to hire someone from the Sunnyvale Yellow Pages.

Affinia, the latest e-venture of Kris Hagerman, MBA '94, takes a different approach to creating online relationships: It hooks up small Web sites with online retailers. Say you run an eccentric little cooking site. In five minutes, for no charge, Affinia will construct a nifty storefront on which you can list items for sale: your favorite cookbooks, a great cast iron skillet, and the best brand of molasses. The storefront is a new "sticky" feature for your site—something that keeps your audience coming back. But you don't actually have to stock or sell any of the products you list. If a customer clicks on one of the cookbooks, say, the storefront whisks him to Amazon. com, which makes the sale. The top 10 portals on the Web account for less than 15 percent of the total page views: One way to win customers is to infiltrate all the nooks of the Web, the odd boutique sites where Nascar enthusiasts, bird watchers, vegetarians, and windsurfers like to hang out. "I'd guess at least 20 percent of my class went to work for Internet companies. And among my friends, it was more like 75 percent."
—Jeff Reed, MBA '99

SO RETAILERS ARE WILLING TO PAY small Web sites a fee to funnel customers their way. The little Web sites don't have the resources—or perhaps the desire—to sell products, so they partner with the stores. This is not how things operate in the "real" world, where you walk into Macy's, give your money to a Macy's employee, and walk away carrying a Macy's bag. The process of selling online—acquiring customers, taking their money, and putting the item into their hands—has been broken into distinct segments, and it's not uncommon for a different company to handle each of those segments. "Things move so quickly, there's no way for any company to do all the pieces that need to be done," says Katie Roper, MBA '91, an independent e-business consultant in Los Altos. "It's become vital for everyone to do partnerships. There's always something new and cool and amazing—and guess what? It's already been built. As opposed to spending six months building it, you get a partnership and there you go."

One part of the equation that's been getting a lot of attention lately is ostensibly the least high tech. It's also arguably the most crucial: Who actually puts an item in a customer's hands? For every product ordered and purchased online, someone has to carry it to a specific address somewhere in the real world. This is starting to look like a potentially very solid and lucrative chunk of the e-commerce economy. Webvan is, to all outward appearances, a sleek online grocery store in the San Francisco Bay Area. But it's investing millions of dollars in trucks and warehouses that will enable it to efficiently fulfill and deliver online orders. And maybe not just groceries. Webvan is shaping up as a potential competitor not just to Albertson's but to UPS, says GSB professor Garth Saloner. One day soon Webvan trucks dropping off milk and bread and grapes could become fixtures in your neighborhood. How long before they start dropping off videotapes and sweaters and books too? "There are huge economies of scale in delivery," says Saloner, who is heading up a new academic initiative on e-commerce (see sidebar). "Once a van is in the neighborhood, the marginal cost of dropping off an item at one more house is very low." "Big, successful companies have to face killing their own revenue streams, and it's extraordinarily hard to do that."
—Chris Larsen, MBA '91

THE SILICON VALLEY STARTUPS have been getting all the press lately—and there's no question they have taken the lead in e-commerce. But big established companies have not all been slow to respond. E-business is what happens when Charles Schwab, MBA '61, aggressively moves his thriving discount brokerage online—losing money in the short term, but grabbing 42 percent of the new market. It's what happens when John B. McCoy, MBA '67, starts WingspanBank.com, a completely separate online competitor to Bank One that is free to poach customers from the parent.

Generally, though, it seems to be harder for big companies to make bold moves into e-commerce. John McCrea, MBA '93, started two new Web businesses during the five years he worked for Silicon Graphics. He's now vice president of business development at startup Affinia, and he much prefers it. "Intrapreneurship is a heckuva lot tougher than entrepreneurship," says McCrea. "All the forces are for entrepreneurs—good capital, stock options, a chance to go public. The risks and rewards are aligned in a startup, and they're completely skewed in an internal startup. Bigger companies are losing employees left and right to start-up opportunities."

There's another reason big companies are slow: A lot of them are doing just fine, thank you, turning nice profits and taking it easy as they always have. There's no pressing reason for them to find new ways to do things faster or cheaper. There's no obvious reason for them to throw themselves at the Internet. Certainly not at first.
"Big, successful companies have to face killing their own revenue streams," says Chris Larsen, MBA '91, CEO of E-Loan, which evolved out of an existing bricks-and-mortar mortgage company. "And it's extraordinarily hard to do that. The track record of companies making those kinds of decisions is very bad. We're not burdened by this, there's nothing we have to shut down."
"Things move so quickly, there's no way for any company to do all the pieces that need to be done. It's become vital for everyone to do partnerships."
—Katie Roper, MBA '91

E-Loan allows customers to take out mortgages online—but unlike banks, which offer only their own products, and traditional mortgage brokers, which offer only a small handful of options, E-Loan provides a choice of more than 70 different lenders, letting its online customers shop around for the best deal. E-Loan has also eliminated commissions, which saves borrowers an average $1,500 per loan. That's pretty revolutionary, and it's something only a hungry newcomer would do. No fat, happy lender is going to slash fees so long as there are plenty of people willing to pay them. And, for the moment, there are: The low-cost online mortgage business is but a picayune 1.5 percent of the market.

The problems for traditional mortgage lenders arise when on-line borrowing starts to catch on in a big way. And most analysts think that's going to happen. It's just a matter of time. Analysts expect the online mortgage business to swell to between 10 percent and 30 percent of the market by 2003. Those traditional and complacent lenders may one day find themselves in trouble. And out of business.

OR MAYBE THEY WON'T. Most theories about e-commerce these days are highly speculative. It is wise to remember who made money in the first California gold rush. The miners, some of them, yes, but also the people who supplied them or connected the West with the rest of the country: Levi Strauss started as a dry goods merchant selling to the miners, Henry Wells and William G. Fargo's wagons carried their gold, and Leland Stanford amassed his fortune by building the transcontinental railroad. How this new gold rush will shake out is anybody's guess. People who are serving the dot-coms and other Internet businesses could be among the biggest e-commerce winners: Cisco Systems, FedEx, UPS, security software systems, credit card companies. "All the forces are for entrepreneurs—good capital, stock options, a chance to go public. The risks and rewards are aligned in a startup, and they're completely skewed in an internal startup."
—John McCrea, MBA '93

"The reason this is such a vibrant and exciting time is that nobody knows with much certainty what the final equilibrium is going to look like when all the forces have played themselves out," says Saloner. "People are placing very big bets, and there are going to be huge winners—and huge losers."

New E-Commerce Center at Business School

By JANET ZICH

One day "every business will be an Internet business," Andrew Grove told a GSB audience last year, and that prophecy, made by the Intel chairman and Business School lecturer, is coming true faster than anyone might have expected.

"The impact of the Internet is pervasive. It grows and changes daily," says Garth Saloner, the Robert A. Magowan Professor of Strategic Management and Economics and codirector of the School's new e-commerce center. "It is a technological revolution that will fundamentally alter the way most goods and services are produced and find their way to consumers, changing industry structures, competitive positions, and organizational structures forever along the way."

The GSB already is a giant step ahead of other schools in the study of e-commerce. Established research initiatives have examined key areas of electronic business such as the computer industry and supply chain management. A quarter-century of teaching and encouraging entrepreneurship led to the founding of the School's Center for Entrepreneurial Studies, where numerous dot-coms have been hatched. The study of electronic business is already integral to the MBA core course in information management and is included in many electives. This quarter Saloner, with former dean Michael Spence, is teaching a new elective, Electronic Commerce, featuring 15 GSB case studies written since last summer. A new executive program focused on e-commerce will be introduced this fall.

To continue leading the way in understanding electronic business and disseminating ideas about it, the Business School recently joined with key corporate partners to launch the $20 million Center for Electronic Business and Commerce (CEBC), which will serve as a clearinghouse for research, course development, case writing, student resources, and interaction with industry practitioners.

Perhaps the most exciting thing about CEBC is that it will facilitate an extraordinary amount of new research in all areas of business. Says codirector Haim Mendelson, the Theodore J. Kreps Professor of Information Systems and Management: "The Internet captures data from customers, users, and Web site visitors in a volume and at a speed never before experienced. The center will provide opportunities for groundbreaking research through the acquisition of unique data sets."

First-round financing for the CEBC was provided by three e-commerce pioneers: the investment firm Charles Schwab & Co., which boasts the world's largest online trading operation; General Atlantic Partners, a private equity investment firm focused exclusively on the global information-technology industry; and online auction company eBay, which hosts the world's largest personal online trading community. Other donors include BP Amoco; General Motors; Jeff Skoll, MBA '95; and Carl and Marilynn Thoma, MBA '73 and '74.

Saloner likens the effect of e-commerce to that of electric power, which prompted first incremental changes and then such revolutionary improvements as the assembly line and the restructuring of entire industries. "What we're seeing now is incremental," says Saloner. "But what we're going to see is a restructuring of the supply chains and logistics of a number of industries. We're going to see huge new corporations coming into existence to fill a need in the new structure, as well as established firms pursuing fundamentally different strategies. Stanford Business School is perfectly positioned to lead the rest in understanding this new revolution."