The E-Biz Surprise It wasn't all hype. For companies as well as consumers, e-commerce is hotter than ever MAY 12, 2003 SPECIAL REPORT -- THE E-BIZ SURPRISE

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. It's now apparent the Internet is connecting far flung people and businesses more tightly than ever. It is helping companies slash costs. And it is speeding the pace of innovation and jacking up productivity. Says Andrew S. Grove, chairman of 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 projected to be $95 billion this year. Says Gartner 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: "We know it's a real business transformation because it survived the economic downturn."

How the heck did all this happen? As it turns out, many consumers and businesses never mistook the over inflated 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.

In the eight years since the Web went commercial, it already has shaken up many industries. 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, 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, an A.T. Kearney principal, thinks e-business will 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. 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 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 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. And it features wireless systems for tracking inventory, reading electric meters, and connecting with customers.

Some obstacles, though, could darken this dazzling vision. Government policies on broadcast spectrum could stifle innovations such as the wireless networking technology known as Wi-Fi. Differing views on privacy and free speech threaten to interfere with cross-border business.

The biggest challenge, though, is cultural. Corporations learned in the early days of e-business that costly new systems by themselves accomplish little. They can sow confusion and resentment among employees who figure they did just fine the old way. To get a true e-bang for the buck, companies must redesign their business processes to take advantage of the new capabilities.

General Motors Corp. (GM ) learned this lesson in 1999 when the auto maker briefly set out to follow Dell Computer's lead, offering tire-kickers custom-made cars. But when the executives realized that they had to drag parts makers into this new networked world and retrain dealers across the nation, they put the project in deep freeze.

Since then, pharmaceutical giant Eli Lilly has figured out how to break through hidebound routines. Two years ago, Lilly had 7,500 employees in research and development. Today, it has nearly triple that number — except they don't show up on the payroll. Lilly created an online scientific forum in mid-2001 called InnoCentive Inc., where the company posts thorny chemical problems and offers cash to anyone who can solve them. The site spurs solutions to problems that have stumped its own researchers. And Lilly pays for their time and effort only if they get the right answer. These purses run up to $100,000, although most carry rewards of $2,000 or so. To date, engineers from New Jersey to Russia have solved problems and been awarded $420,000.

It's not always so easy. Adjusting to e-business is often a wrenching process, and we're still in the early days. Dell President Kevin B. Rollins calculates that his company, the leader in Web-powered business, is merely halfway to using the Net's potential. And the rest of the pack? Rollins estimates that they're barely a fifth of the way.

For now, businesses are focusing on gains in productivity. The heartening message from industry leaders is that productivity gains speed up with the years, as companies adjust their processes to new technology. Cisco Systems CEO John T. Chambers says that productivity payoffs accelerate fully four to six years after installing new systems. "It shocked us," he says. "But we're one of the few companies that is beyond year three of the process." Chambers predicts that as the U.S. progresses toward e-business, productivity will rise from the current 1% to 3% annually, to as high as 5% -- potentially doubling the U.S. standard of living within 14 years.

Sound like promises from the late '90s? No doubt. But in 2003, business and consumers alike are far better positioned than they were a half-decade ago to profit from the Internet. Why? The Net is far more powerful, thanks largely to broadband. In the past year, broadband usage in the U.S. has shot up to 19 million households, doubling since 2001, and is expected to reach 40 million by the end of 2004, predicts Forrester.

While broadband speeds up the Net, the wireless radio-based networks known as Wi-Fi untether it. For corporations and e-merchants alike, Wi-Fi carries broadband nearly everywhere a laptop can go, from meeting rooms to the factory floor.

The payoff is productivity. GM may have fallen flat with its Internet effort to customize cars. But the auto maker is faring much better with a Wi-Fi project. In more than 90 GM plants, Wi-Fi devices are mounted on forklifts and placed in the hands of employees, who use them to track engine parts and car seats, helping to speed production. And some execs, keep tabs on operations in Asia and Europe by logging on to the corporate network from secure Wi-Fi connections at home. "It helps us compete in a world where everything is moving faster," says GM Chief Technology Officer Anthony E. Scott.

Autonomic Systems: At the other extreme are machine-to-machine systems. That's the Internet on autopilot. The idea is to let machines tell each other what to do — while humans are free to carry out more important work. Some companies, such as Ford Motor Co, are using the Web to allow machines to monitor each other, track products as they move through warehouses, and even make decisions without human intervention.

Beckman Coulter links the blood analyzers and other medical equipment it sells to a computer back in its factory. The computer, unlike humans, works every minute of the week to monitor that everything is running smoothly. When a problem crops up, the computer alerts a Beckman technician, who can often make repairs before the machine breaks down. Beckman expects this system to save it as much as $1 million annually. But the far larger benefit is customer satisfaction for a company that fixes the machines it sells before they show signs of malfunctioning.

Computer scientists envision vast networks of smart machines, each smaller than a grain of rice. Researchers at Berkeley and Palo Alto Research Center Inc. are developing tiny chips, equipped with microscopic antennas. These flecks of silicon could be embedded in materials or products to sense problems or relay data wirelessly to a computer network. The first practical hints of this vision are in a project sponsored by Wal-Mart, Gillette, Procter & Gamble, and 84 other companies that could dramatically change supply chains. These are next-generation bar codes, which communicate every move to the network.

Now in the pilot stage, the Auto-ID Center project involves slapping chips with identification numbers on individual packages of razors and bottles of shampoo. As the merchandise winds its way from warehouse loading docks to stores, electronic readers track its progress and pass the data to a network. Everyone in the chain can see where each shipment is. The payoff should be just-in-time efficiencies and stocked shelves. The radio tags are pricey. But in the past four years they've gone down from $2 to 10 cents — and they're heading to a fraction of a penny within three years, says Gillette.

These are the visions drawing companies toward the next generation of e-business. It's already starting to turn into a different scene, one where the Web connections are fast, untethered, on automatic pilot, everywhere. For many, the temptation will be to hold back. But while tight budgets call for restraint, a withering race for productivity will push them to take the leap. "It will take visionary leadership to keep investing in this environment," says Krishna Kolluri, CEO of networking-equipment startup Neoteris Inc. "But if you're standing still, you're losing a step every day."