Global Business 2000

the business case of AOL-Time Warner

After the sensational acquisition of a blue chip representative of the old economy, Time Warner, by AOL, a representative of the new economy, nothing seems to be Holy anymore. Nobody can deny that the world in the last years has changed drastically. We seem to be in the grip of a new power concentration in which future market strengths online may count more than shareholders' value in the short term. Not only do entrepreneurs promote this thinking, but much of the well-known "solid" financial world does as well. Are we definitely facing a new value model or are we working on a new concept for the emperor without clothes? That is a question we will try to answer in this article, along with another - Is a crisis already close-at-hand or will we maintain economic growth in the next few years?

the struggle: new entrants versus old laggards?

Wal-Mart is partnering with AOL in a co-branded ISP (Internet service provider). Yahoo and Kmart, with backing from famous venture capitalists, Softbank and Seagate, are doing the same. They offer free net service under the brand name BlueLight.com. Best Buy and Microsoft/MSN via Internet access are demonstrated and sold in stores. Best Buy is advertising on MSN service. Circuit City and AOL made a similar deal to that of MSN and Best Buy, as did MSN with Radio Shack. Is this a serious threat for retail giants like Sears, Ahold, Carrefour and Metro?

WebMD/Healthion conquered the medical information community in less then one year in the USA with the help of giants like Thomson Publishing, Dupont, ETrade, Microsoft and News Corp. Law.com and LRN, the legal knowledge company, are now attacking -again with the help of Softbank- the tax and legal community of US lawyers in a manner comparable to WebMD's. Vertical.net and Bizprolink are successful professional niche portals. Companies like Reed Elsevier, Wolters Kluwer, and Thomson could be exposed to the impossible situation of being subcontracted to customers whom they thought were theirs. Must they accept these new entrants as market leaders and watch as they attempt to destroy their traditional publishing businesses?

ETrade and Charles Schwab forced respected houses like Merrill Lynch to drastically cut their stockbroker tariffs. ELoan, with mortgages and now car loans, created a rapid growing market place. A brick and mortar company such as Metlife is using the Internet very aggressively. Quicken is perhaps the best example of a financial supermarket with co-branding. With their approach they could destroy the business of superpowers like City-Travelers, ING, and Fortis. Surely this is also true because they dont understand the necessary partnering models in E-commerce and remain convinced that their own strengths are enough. Stockbroker Consors quickly penetrated the respected German market and markets in other countries. Again, the question is: is this all part of a heavy transition and if so, what will happen with the traditional companies?

finally utopia?

Propagandists of the new economy stress the thesis that inflation might be banned in the future because of the continuing growth of productivity. At the same time we have to expect that the digital revolution will change everything. The AOL - Time Warner case can teach us that new economy representatives could "eat" more and more traditional companies because the latter cannot compete in this big match for productivity. Traditionalists will notice that their content and products will quickly become part of a much broader offering of products and services based on empowered partnerships.

Boosted by booming stock market prices, the new economy representatives seem to be able to buy almost any company and to realize an enormous continuous value-creation. And indeed there are many indications that in the coming years this will happen more often and more rapidly.

• The combination of many competencies in a dedicated "one to one" market approach, for each consumer or client, will create a tremendous efficiency and consequently cost reduction.
• The revenue stream of these new giants will grow rapidly and become profitable even if this is not yet the case, i.e. Amazon.com.
• Finally, assets will be used much more effectively. Intangibles like brands and networks will be increasingly important.

It looks as if Utopia, the ideal world, has finally begun with continuous real growth and no inflation. But is this a true picture? In the long term, it is perhaps the case, because productivity increases seem to be assured. To paraphrase the Economist on January 15, 2000: the industrial revolution 250 years ago was the source of real wealth creation. But this quality newspaper is not sure that this will happen again and who can blame them; nobody can be sure about the future. Early in the industrial revolution, dramatic changes created enormous poverty and miserable social conditions such as the demand for very young children to work intensely. There are indeed a few considerations that raise doubts about the economy's growth again in the coming years.

the end of mega-mania?

First of all, mergers and acquisition according to many past investigations have often turned out to be disappointing and to lack sufficient synergy. Secondly, nobody has the experience to lead a giant combined company like AOL- Time Warner with its mixed culture of new and traditional economies. Thirdly, stock prices are now substantially higher than a few years ago. In a country like The Netherlands the average price earnings ratio for companies is now 30 compared with a P/E of 14 in the beginning of the 1990s and we can determine the same trend in many other industrial countries. Internet companies like Yahoo have a price-earning ratio of more than 800 and others have sky-high valuations not-withstanding the fact that they have never shown and still do not show profit.

Regarding these high- or over-valuations, a stock market crash like that of 1929, which was the beginning of a deep economic crisis in the thirties, could occur again. Of course, we have more advanced instruments to control the economy but at the same time the economy is reshaping itself into unknown dimensions with the existing IT and E-Business wave, and a new revolution, the biochemical, already knocking at the door. As a result, there is more and more uncertainty about the effectiveness of the control mechanisms that have been used in the past. A crisis could temporarily end the innovative Mega-mania and force us to return to tremendous cost reduction and other types of mergers; this would trigger massive layoffs and unemployment.

an economic crisis?

The chance of imminent crisis is strengthened by economic as well as psychological reasons. Success stimulates self over-estimation and we have already faced a nearly unprecedented growth period, nine years of success in the recent past especially in the leading economy, the US. Growth in the US is stimulated by the fact that consumers in this very rich country are spending more then they earn, so that the rest of the world has to save money for them. Poverty is increasing in the under-developed world mainly because the population is growing too fast. WTO discussions focus more and more on the fact that the rich western part of the world is not willing to pay the price for their welfare, and certainly not for the pollution they create. We saw this in the world environment conference last year in Kyoto.

Furthermore, Western countries like to protect their industries. Certainly this is true of agriculture, which is the main area of competition with under-developed countries. The shortage on the US trade balance is reaching record highs of more than $20 billion per month and is another sign that the US is consuming structurally too much. The Far East is recovering from the economic crisis of 1997, but the financial structure of their economies is still largely at risk. Finally, Europe is still unaware what kind of change is on the future horizon. The old continent maintains the selfish neo-romantic feeling that government and the business establishment have an important role to play in every part of social-economic life. The costs for social welfare are far too high and the labor market is still very inflexible.

Many companies, especially in Europe but certainly also in Asia, will pass into American hands because the US is far ahead in technology and in no-nonsense, market-driven entrepreneurship. This will lead to deep frustration over the lost opportunities and perhaps even to social unrest in other parts of the world. So there is a paradox, on the one hand America is the driving force in economic growth and technological innovation, while on the other hand they live continuously above their rank and means. Altogether, these are enough reasons to foster an unavoidable economical crisis. But when?

time table for an economic disaster?

Despite all the arguments for the possibility of a quickly emerging economic crisis, there is nothing so urgent that we may expect it soon. We have known for years about most of the emerging dominating factors; the main part of the industrial world is still optimistic about the future. The digital revolution creates a new fantastic dynamic pattern of growth and all the talented people, indeed all those who are able to work, have work. It is more the ongoing disease of a bubble economy with stock market increases lacking real value that will do its fatal work. The longer the economic crisis is postponed, the deeper the socio-economic damage could be. Therefore, in a few years there might be a most catastrophic scenario - an escalation of dramatic events resulting in a real crash.

A fall of more then 50% of the stock market prices is possible, bringing the price earnings ratios into a more acceptable range. It would further bring many people and institutions into bankruptcy. We could face a deep recession with high costs for social welfare. Trade wars and protection could result, possibly meaning the end of the WTO or even the United Nations. Many sexy Internet companies could become cheap acquisition targets for more solid traditional companies that avoided excessive risks in the past. This would not be the end of the digital economy but the power structure would change in favor of solid, well-financed companies.

This worst-case scenario is a dilemma for leaders, certainly those in global businesses. On the existing stock market, quarterly results are the only things that matter. But a long-term strategy means that each company has to involve itself with E-Business. A transition to that level is costly, causes short-term pressure on profits as the revenue streams change and there may be cannibalization of the old more profitable margins. When a company is moving too quickly into transition, it may be mostly bad news for its shareholders and it could become an easy acquisition target. If the company doesn't change, it has no future and will be bought or driven into bankruptcy. So, timing is extremely important. What are we to do with all these uncertainties?

most traditional companies saved by an economic crisis?

Most traditional companies should in fact be very happy if the economic crisis comes immediately; it would give them a better chance to survive independently. But the chance of this happening soon is not great; this is not totally bad news. On the contrary, first we should expect a further boom for Internet companies and therefore many annexations of traditional companies. But it cannot last. Three years from now the economy could be over-mature from all these "successes" and quickly turn into the described disaster. The more entrepreneurs we have the less chance there is that this will maintain for a long term; European companies especially will have to change a lot because they are almost all still in the traditional phase.

statements

1. Many of the respected companies in Europe will lose their independence to US global players because top management needs too much time to make decisions and is unable to make the right choices because they dont understand the new business models.
2. We will face big merger disasters, especially in the US, because they combine unknown dimensions in business (as well as in scale). The main experience in the past of relying on cost synergies through streamlining will not work any more. With the exception of a few IT companies like Cisco, most companies do not have a clue about the desired culture for the new combination.
3. An economic crisis is merely the result of a psychological factor like the overestimation of people after many years of successes, rather than the result of an economic factor. The excessively high prices for stocks, the increasing number of big deals, and the over consumption are part of an "it will never end" mania.
4. Wealth is again created for too few people. A big part of the world has no substantial benefit from economic growth. This will threaten the existence of organizations as WTO and perhaps even the UN.

De bijdragen in m@n@gement van onze voormalige correspondent in Silicon Valley oogsten veel waardering. Burt Rost van Tonningen heeft zijn bijdragen verwerkt en gebundeld in een integrale visie op E-commerce, E-organization en E-strategy met als titel: "PREPARING FOR THE E-TORNADO: Observations from a European in Silicon Valley". Klik hier om het on-line te bestellen.