BW: The E-Biz Surprise

BusinessWeek:: It wasn't all hype. For companies as well as consumers, e-commerce is hotter than ever

Since mid-2000, when the stock market slump began turning dot-coms into dot-goners, the popular perception of the Internet has spiraled ever downward. By last year, Internet bankers and analysts, those onetime masters of the business universe, were targets of government investigations. A book titled dot.con, deriding the Net as "the greatest story ever sold," became a best-seller. One academic even claimed that porn, gambling, drug-dealing, and the like comprised more than 70% of e-commerce. The bold and transforming vision of the Net, it seemed, had dissolved into a digital dud.

Now, though, the Internet crowd may well have a response to the critics: a loud Bronx cheer. To the surprise of many, the Net is actually delivering on many of its supposedly discredited promises. Granted, they didn't all pan out as fast as the hypesters predicted. Public online exchanges, for example, withered as quickly as they sprouted up.

Still, it's now apparent the Internet is connecting farflung people and businesses more tightly than ever. It is helping companies slash costs. It is speeding the pace of innovation and jacking up productivity. And even some of those seemingly harebrained business models are working. Says Andrew S. Grove, chairman of chipmaker Intel Corp. (INTC ): "Everything we ever said about the Internet is happening."

And more. Remember those starry-eyed projections in 1999 that had U.S. e-commerce between businesses reaching a staggering $1.3 trillion by 2003? Turns out they were too low. Networked business-to-business transactions now stand at $2.4 trillion, says Forrester Research Inc (FORR ) . That means that just as investors were reeling from the collapse of Internet stocks, the technology was taking off. And Forrester's bold 1999 prediction that U.S. consumer e-commerce would reach $108 billion by 2003 wasn't so far off. Despite recession, terrorism, and war, the number is expected to come close, at a projected $95 billion this year. Says Gartner Inc. analyst Avivah Litan: "The hype is gone, but the numbers are in."

And how about those Brookings Institution claims a couple of years ago that productivity gains from e-commerce would pump as much as $250 billion a year into the economy by 2005? Again, too low. With overall productivity running higher than expected last year, gains from businesses using the Net to sharpen forecasting, keep inventories lean, and communicate instantaneously with suppliers could reach $450 billion a year by 2005. Spread across the economy in lower prices, that would add $4,500 annually to the average U.S. household's income -- more than three times the amount of President Bush's 2001 tax cut. Says former Federal Reserve Vice-Chair Alice M. Rivlin, now a senior fellow at Brookings: "We know it's a real business transformation because it survived the economic downturn."

Even Internet companies themselves -- poster children for business excess during the boom -- are finally turning the corner. Of the publicly held Net companies that survived the shakeout, some 40% were profitable in the fourth quarter of 2002, the latest for which consolidated figures are available. Meanwhile, online advertising is staging a comeback, boosting the fortunes of everyone from Web pioneer Yahoo! Inc. (YHOO ) to search startup Google Inc. If Wall Street forecasts hold, fully half of the publicly held Internet companies will be profitable by the end of this year. That's spawning a new rush on Net stocks -- along with fears that a second bubble is taking shape.

How the heck did all this happen? As it turns out, many consumers and businesses never mistook the overinflated Internet stocks for the underlying value of the Internet. They kept going online, and didn't pull back just because Amazon.com's (AMZN ) shares dropped or the fallen highflier Webvan Group Inc. stopped delivering groceries. "E-commerce continues to broaden its appeal," says Margaret C. Whitman, chief executive of online auction juggernaut eBay Inc. "More consumers are coming online every day."

That's not to say that a lot didn't go wrong. Eager venture capitalists poured more than $100 billion into nearly 6,000 high-tech and Net startups over the past decade. Of those, 2,000 have gone under or merged with other companies. Investors' wild ride with the 450 Internet companies that went public ended with more pain, as many saw their stocks fall by 90% or more. And about a third of the economy -- including agriculture, construction, and health care -- has barely been touched by the Net-driven productivity boom, says New York Federal Reserve Bank economist Kevin J. Stiroh.

Still, in the eight years since the Web went commercial, it already has shaken up many industries. Music fans sharing 35 billion song files annually are battering the recording industry. Predation by dot-coms such as Expedia Inc. (EXPE ) -- now the top leisure-travel agency, online or off -- helped shutter 13% of traditional travel-agency locations last year. Powerhouse Dell Computer Corp. has muscled its way to industry dominance by building its sales and manufacturing around the Internet. The choice facing Dell's rivals, from Gateway Inc. (GTW ) to Hewlett-Packard Co. (HPQ ) , is simple: adopt many of Dell's Net-efficient methods or exit the business.

And much more change is coming. Winning Net strategies have sent a warning to companies around the world. Businesses are responding by focusing their diminished tech budgets on the Internet. Even as spending on technology has fallen 6.2% since 2001, management consultant A.T. Kearney Inc. says e-business budgets rose 11% in 2002. They comprise 27% of total tech spending. And though the growth in e-business spending has slipped to 4% this year amid war tensions, that's still double the growth of overall estimated tech spending. Dan Starta, a Kearney (EDS ) principal, thinks e-business will continue to outpace tech outlays for at least two years.

So what lies ahead? For the next year, don't expect to see many of the big, brassy e-business schemes of old. These have been flushed away, along with the other excesses of the dot-com boom. Instead, companies have spent the last three years figuring out what really works and what delivers a return -- quickly. Now, they're breaking up e-business tasks into bite-size pieces. Kinko's Inc., for example, is boosting spending this year, but focusing it on targeted projects that pay off in six months or less. One deal with Microsoft Corp. (MSFT ) will let people send documents from Microsoft programs over the Web to Kinko's for professional-quality printing. Says venture capitalist Vinod Khosla of Silicon Valley's Kleiner Perkins Caufield & Byers: "Runaway tech projects don't work. You need the revolution by 1,000 small cuts, not one big dramatic change."

Further out, bold new projects will unfold, providing a glimpse of the next generation of e-business. The range is every bit as vast as the Internet itself. It extends from drug researchers collaborating in virtual labs to computers monitoring thousands of diagnostic machines on three continents. It features gobs of wireless systems for tracking inventory, reading electric meters, and connecting with customers. And on the far fringes of this next Net are tiny silicon chips, so-called "smart dust," that may well be built right into roads and bridges, ready to send Web alerts if the wind blows hard or a pylon pries loose.

Plenty of obstacles, though, could darken this dazzling vision. Government policies on the use of broadcast spectrum could well stifle innovations such as the wireless networking technology known as Wi-Fi. Court decisions on music-file sharing could squelch the growth of online entertainment. Differing views on privacy and free speech threaten to interfere with cross-border bus