COVER STORY
Builders of the New Economy
Companies that provide the Net's nuts and bolts are cleaning up big time
There's a dirty little secret in techdom. All the fuss may be over online shopping. And Wall Street may be just E-lated about the E*Trades, eToys, and eBays of the cyberworld. But if you want to know who's really making a mint off the Web, look for the companies that are digging the trenches, laying the pipe, and getting their hands dirty building the new Internet economy. They're the standouts in BUSINESS WEEK's second annual Information Technology ranking of the 100 best-performing companies.
In the top 20, it was practically a clean sweep for the industry's virtual carpenters, electricians, and plumbers. Among them are six companies that provide the networking and telecommunications gear that links companies and consumers across the far-flung Internet--including No. 5 Cisco Systems Inc. There are three telecom carriers that zip E-mail, data, and voice calls around the globe, led by Britain's Vodafone Group PLC at No. 4. A trio that sells the high-powered servers that keep Web sites running--Dell Computer, Sun Microsystems, and IBM--has cashed in. And contract manufacturers hired by the brand names to churn out the equipment that keeps the Net humming catapulted into the top. Ever heard of Solectron Corp.? You will. The Milpitas (Calif.) manufacturer came in at No. 3.
Now here's the real mind-bender: Not a single consumer Web-site company is in the upper tier. The top finisher among them, eBay Inc., may be the toast of Wall Street, where the four-year-old company is valued at $20 billion. But when it comes to sales and profits, it's a milquetoast. The company finished at No. 23, and while it may become hugely successful, for now it's more razzmatazz than revenues. ''There are the glamour companies, and then there are the companies that are building the new Net economy,'' says Edward J. Zander, president of Sun Microsystems Inc. ''We're the lumberyard for the Internet.''
Nothing could be more crucial than such basics at this stage--call it the Big Dig for the Information Age. A half-dozen years ago, the Internet was just a geeky communications link between scientists and universities. Now, it's on its way to becoming the world's central nervous system. More than 170 million people around the globe are wired into the Web--fetching information, fashioning products, chatting, and shopping. Corporations are hurling themselves madly into cyberspace: Each day during 1999's first quarter saw the launch of some 10,000 new Web sites. And a stunning 3.5 billion E-mail messages now shoot across the Net daily.
BUILDING BLOCKS. It's little wonder that the companies building the underpinnings--the wiring, routers, switches, computers, software, and other gear--are cleaning up. Last year, U.S. corporations spent $60.4 billion on Internet-related equipment and services, according to market researcher International Data Corp. (IDC). Construction work is far from over. U.S. companies should more than triple spending on Net equipment, to $203.2 billion, by 2002. ''We're probably only one-third of the way along the road to building the Internet infrastructure,'' says IDC analyst Anna Giraldo.
No company knows that better than America Online Inc., No. 1 on the Info Tech 100. While AOL spent years building a proprietary online service, it wasn't until the explosion of the Web that the company really cashed in as an Internet access provider. Now it wants to become the premier intermediary between consumers and Web retailers. During the 1998 Christmas season, AOL subscribers spent $1.2 billion shopping online. But Barry M. Schuler, president of AOL Interactive Services, warns that if the Web doesn't get much faster and easier to use, the flood of new Web shoppers could slow to a dribble. ''You can build it, but they won't necessarily come,'' he warns. That's why AOL will spend $500 million over the next four years to beef up its network with gear from Sun Microsystems, No. 9.
Online merchants will no doubt have their day in the sun, too, boosting them higher in future Info Tech rankings. To get there, though, they will have to show profits--a goal that many are willing to forgo today in favor of expansion and investment. For instance, Amazon.com Inc., No. 40 on our performance scale, has 10 million customers, yet it isn't expected to be profitable until 2002. Instead, the company is pouring money into improving a shopper's experience while also spending heavily to expand into such new markets as toys and online music clips. ''To throttle back on investment now would be shortsighted,'' says CEO Jeffrey P. Bezos.
Our ranking gave no special advantage to the long-established companies. We started with tech companies taken from the database of Standard & Poor's Compustat and then added non-U.S. companies through our network of bureaus around the globe. We sliced the list into eight sectors, including hardware and the Internet. Since revenue growth is the hallmark of technology, we eliminated companies that didn't grow as fast as their category. Those remaining were then measured on four criteria that were given equal weight: revenue growth, total size, shareholder return, and return on equity. The builders of the Internet, with both robust growth and healthy profits, zoomed to the top.
QUICK STUDIES. Why these particular companies? How did the likes of Dell, Solectron, and Cisco power ahead of scores of other companies that also sell tools for the Internet Age? And how will they stay ahead of the pack once the Web's pilings and girders are in place and equipment buying tapers off?
The elite are a study in making good use of what they sell. They have been some of the first to understand the revolutionary possibilities of the Web and have quickly retooled their own internal operations to take full advantage. By using the Internet as a communications backbone, they have linked up with their suppliers, contractors, and customers, collapsing time and space to deliver products faster--and at less cost. They are the first big beneficiaries of frictionless capitalism.
Cisco has been one of the biggest believers in what is now called E-engineering. Today, nearly 78% of the company's orders come over the Web--averaging $25 million a day. Of its customer-support inquiries, 71% are handled online. And nearly half of its online orders are passed through to manufacturing partners and suppliers without being touched by Cisco staffers. The result: net profit margins topping 18%. Combine that with best-of-breed engineering and 35 acquisitions, and you've got a company that dominates virtually every category of networking equipment. ''We believe that we're the only company in the industry that controls its own destiny,'' proclaims Cisco CEO John T. Chambers.
PATHFINDERS. Others are just as quick to trumpet their Internet savvy. Dell Computer Corp., for instance, is trouncing its competition in the PC industry by handling 30% of its orders over the Web. That direct approach is so efficient that Dell gets paid by its customers before it has to pay its suppliers. That has helped hold it at No. 2 in this year's ranking, after taking the top spot last year. And, according to CEO Michael Dell, getting one-third of its total sales over the Web is just the beginning. ''I actually think this is going to grow to 70% or 80% in a couple of years,'' he says. Being a Web pioneer pays off in other ways, too: Dell gave the lowdown on how his company uses the Web in a February speech to executives at AlliedSignal Inc. That helped him beat out IBM and Compaq Computer Corp. to land the company's desktop computer business--about 17,000 PCs a year.
The trick is offering customers a path to online success they would not necessarily be able to find for themselves. Consider Solectron. It's capitalizing on the PC industry's need for efficient, high-quality manufacturing by building its own worldwide network of 21 plants. Now, in partnership with distributor Ingram Micro Inc., it's aggressively using Web connections and collaboration tools to create a build-to-order manufacturing system that it's hawking to the likes of Compaq and Hewlett-Packard Co.--two that failed to latch on to the Net last year and that didn't make the cut in our ranking.
Like other Info Tech 100 highfliers, Solectron is girding itself for the day when sales of Internet gear will slow from their current torrid pace. To ensure continued growth, it's launching a slew of services--including product design, logistics, and product repair--aimed at building even tighter relationships with its customers, while developing new revenue streams (page 124).
GRUNT WORK? Indeed, the Internet is bringing new cachet to a very old business: service. It was only a few years back that many tech companies shunned service as grunt work for Electronic Data Systems, Arthur Andersen, and the like. But with prices on computers, chips, and other components in free fall, continuing annuity-style revenues have fresh appeal. At IBM, for example, services now account for 17% of its profits. That helped fuel the turnaround at IBM and lifted it to No. 17 on our ranking. Oh, sure, the $82 billion computer giant supplies gobs of infrastructure gear--computer servers, disk drives, networking equipment, and database software--but it's services that are boosting its growth. Today, IBM has more than 30 E-commerce services, which generated $3 billion last year (page 130).
Others want in on the E-service action, which is expected to explode. Experts figure worldwide sales of Internet services will jump from $7.8 billion in 1998 to $78.5 billion in 2003, according to IDC. John M. Thompson, group executive for IBM's software division, predicts services could amount to as much as 60% of overall corporate Internet spending.
The most promising new Internet business these days is application services. A new breed of info tech outsourcing companies is setting up huge server ''farms'' to manage clients' important computing systems, such as finance, manufacturing, and human resources. Clients' employees log in via browsers and the Web. This puts large and complex applications in the hands of specialists--which can save corporations upwards of 30% in overall costs, according to IDC. Forrester Research Inc. figures this will boost the market to $6.4 billion in 2001 (page 134).
That's big enough to attract an eclectic gaggle of rivals--including chipmaker Intel Corp. and telecommunications player Qwest Communications International Inc. The telecom upstart expects to be operating seven hosting centers before the end of the year. President Lewis O. Wilks says the company must expand its horizons beyond selling bandwidth--which is fast becoming a commodity. ''We want to move up the value chain,'' he says. ''It's a radical change in the economic model of our industry.''
''WACKO.'' Make that a bunch of industries. Software giant Oracle Corp. is so convinced that application services are the wave of the future that it has just launched its own hosting operation (page 138). Then again, for better or for worse, Oracle is never reluctant to try the next big thing. CEO Lawrence J. Ellison pulled the plug on all non-Internet projects two years ago. ''People thought I was wacko,'' he says. But his seemingly loony move paid off. Now, Oracle is out ahead of its competitors in providing software that gives customers access to their corporate applications over the Web. That helped Oracle creep up the Info Tech ranking: from No. 34 last year to No. 28.
Even the major computer makers are trying to get a piece of the action in Web application hosting. They're cultivating service providers, hoping to sell them expensive hardware and collect steady fees in the process. Early on, Sun spotted the emerging market for selling high-powered computers to the swelling ranks of Internet access providers. Thanks to such foresight, it's the leader in a worldwide Internet-server market that hit $13.3 billion last year and is expected to grow to $38 billion by 2002, according to Dataquest Inc.
Now, Sun is going after the next generation of Web hosting companies--rolling out a 20-point plan aimed at helping these service providers succeed in a fast-moving business. One element is called Quickship, which gets new computers into their hands in a matter of days--rather than weeks or even months. Sun-Tone is another. This is a quality-assurance program aimed at assuring corporate customers that they can entrust their critical data to hosting upstarts. Sun also is experimenting with new selling schemes that it hopes will win over customers that may not have the cash to pay up front for expensive computers. In some cases, rather than sell machines outright, it's letting customers buy processing power or storage on a pay-per-usage basis.
Just because you're Sun and you caught the first Internet wave doesn't mean you'll ride the crest of the next. ''If you miss an inflection point these days, you're fish bait,'' says analyst Carl Howe at Forrester Research. Even Cisco is vulnerable. The latest trend in networking, so-called ''virtual trunks,'' are central post offices for data, video, and voice transmissions that could replace Cisco's routers in the Internet backbone. ''I wonder if John Chambers loses sleep over this,'' says John McQuillan of networking consulting company McQuillan Ventures. ''This could be his worst nightmare.''
Or maybe not. Cisco is fighting back. It just began selling a so-called virtual switch controller that it hopes will replace not only some of its own routers but also the circuit switches in central telephone offices. A virtual switch controller allows a single network to carry both voice and data traffic.
PROBLEMS AHEAD. That's the key for all of these infrastructure builders--a willingness to tear up their current business plan and try something new. AOL dominated as a dial-up online service and then kept its momentum going by offering access from PCs to the Web. Now it's scrambling to make deals for delivering its services over cable and wireless networks. ''As more devices emerge that bring PC-like capabilities to cell phones, that's convergence--and it's now happening on Internet time,'' says Chairman Stephen M. Case. And even mighty Microsoft Corp. is fiddling with its DNA by branching out into everything from TV set-top boxes to handheld devices. Thomas Koll, who handles relationships with Internet service providers, admits that the company's dominant Windows operating system isn't the answer to every computing need. ''We know the legacy software won't do it,'' he says.
Given the unforgiving nature of competing in the time-squashed Internet Era, there's no simple recipe for lasting success. But companies that can figure out how to deliver tools for building the Net economy are well on their way to assuring themselves vital roles--and financial rewards--as long as the Big Dig goes on.
By Steve Hamm in New York, with Andy Reinhardt and Peter Burrows in San Mateo, Calif., and bureau reports
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