In With The New

The "new economy" isn’t so new anymore, but companies still struggle to adapt their business models to the Internet age.
Jason KaraianJuly 10, 2006

Being under siege is nothing new at HMV. The £1.9 billion (€2.7 billion) UK retailer of music, books and movies has seen its market attacked by the likes of and other internet discounters since e-commerce took off some ten years ago. Plenty of pure-play online competitors have come and gone in that time, but HMV knows all too well that the disruptive power of the internet remains as potent as ever. For a reminder, HMV needs only to look at Apple, which has captured some 80% of the digital music download market since launching its iTunes online music store in 2003.

Where does this leave HMV? Wanting its share of the online action, naturally. After all, online retail sales will reach nearly €80 billion in western Europe this year, according to consultancy Forrester. Though this is only 4.5% of total retail sales, forecasters say it will rise to around 8% of total sales by 2009. (See chart below.)

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Last September, HMV launched its own online music store and will fight for “the other 20%” of the digital music market that doesn’t belong to Apple, says Mark Bennett, the firm’s head of digital operations in the UK and Ireland. The company, which opened its first store in 1921, also hopes to leverage its offline presence with a “clicks and mortar” strategy, so that, for example, customers can download music and games from special kiosks at stores. HMV’s stores will be revamped, according to Bennett, to include “entertainment zones where people can experience a lot of content and walk out from the store with a T-shirt, CD and five downloads on their mobile phone. That’s how we are going to make the most of our platform over the next few years.”

HMV isn’t the only corporate old-timer armed with a new web strategy. And if a CFO gets a sense of déjà vu, it’s with good reason. “Technology-driven business innovation is back on the boardroom agenda,” says Mike Altendorf, co-managing director of Conchango, a UK e-commerce software company. “In saying that, I can hear the groans of CFOs.”

Fair enough. Most finance chiefs can recall all too vividly the spectacular dot-com failures of the 1990s. That’s why finance, so often sidelined during e-commerce’s frenzied first wave, is now at the forefront of efforts to overhaul business models for the internet age. This way, the thinking goes, any strategic shifts, however bold, will be bolstered by a firm financial discipline. But while CFOs have learned from the mistakes of the 1990s, many old conundrums remain. A case in point: how to cope with the speed at which the web can transform an industry and catch companies off guard. “CFOs need to be brave enough to anticipate things that they can’t quite measure yet,” says Pippa Wicks, a managing director at turnaround consultancy AlixPartners and a former interim CFO. That wasn’t easy in the 1990s, and it’s not easy today.

Channel Surfing

Companies in all sorts of mature industries under attack by the internet face the same fundamental question: should they simply ride out current business models and hope for the best, or fight as aggressively in the internet space as they do in traditional markets?

Belgacom has chosen to fight. Under the watch of CFO Ray Stewart, the €5.5 billion Brussels-based telecoms company recently began looking to the internet to help it get a foothold in a completely new market—television.

Belgacom’s new focus picked up speed last year, when it successfully bid for the broadcast rights to Belgium’s top football league, paying €36m for the three-year contract. But what is a telco doing in the television business? For Stewart, who has been finance chief at Belgacom for the past ten years, it’s not as strange as it might seem. As voice traffic moves to the internet, where delivery costs are low, Belgacom’s traditional cash cow has become an endangered species. “Clearly, the per-minute voice traffic revenue model will disappear over time,” the CFO says. Just as phone calls can be beamed as packets of data over the net, so can videos, making television “just another service that can travel over a broadband pipe into the home.”

But because no ordinary broadband pipe can handle web, voice and television traffic all at once, Belgacom is spending €350m to lay fatter, faster pipes into homes across Belgium. This initially worried analysts, who questioned the value of the project when Stewart ran road shows for Belgacom’s IPO in early 2004. But the finance chief is adamant that basic access charges will cover the company’s cost of capital on the infrastructure investment, with the “upside” coming from the new services, like television, that the new pipes enable.

Since its launch last summer, Belgacom’s television service has attracted more than 50,000 subscribers. Nearly 40% of these customers also use Belgacom for basic internet access and 20% for traditional circuit-switched voice services. Though the television unit reported a €11m operating loss in the first quarter of this year, Stewart is convinced that it will play a big role in attracting and retaining customers over the long term.

Now that the per-minute pricing model that served Belgacom well for decades is making way for tiered, flat-rate packages of voice, internet and television services, the CFO says that the way he steers the business is also changing. “What will change over time is the focus on margins—I am not so hung up on margins as I am on absolute Ebitda,” says Stewart. “If you’re buying content to resell it, I guarantee that the margin on that revenue is a lot lower than the margin on voice traffic revenue, but you don’t care as long as you’re making money over time.”

The Direct Route

Feike Brouwers knows a thing or two about making money online. He joined ING in 1997, when the Dutch financial services giant launched ING Direct, its online-only bank, and served as CFO for four years before recently becoming finance chief of the unit’s small but fast-growing French business. Last year, ING Direct boosted pre-tax profits by 42% to €617m, growing nearly three times faster than the ING group as a whole. The online bank now has 15m customers and €200 billion in funds under management.

Though its balance sheet “looks the same as a regular bank,” managing an online bank raises its own set of challenges, Brouwers notes. “If I had to make a distinction between our business model and that of a traditional bank, it’s marketing,” he says. “I often say that we’re not a bank, but a marketing machine.” Marketing is ING Direct’s number-one cost, while employees typically account for the greatest costs at traditional banks.

E-commerce experts praise ING Direct’s emphasis on reaching out to its online customers. Most banks don’t do that, usually neglecting online marketing and customer service because they only see the web as a way to promote customer self-service, and therefore cut costs. That is asking for trouble, says Holger Maass, managing director of Fittkau & Maass, an internet consultancy in Hamburg. After all, with the proliferation of self-service tools, banks have actually been “educating their customers on how to go to the internet and shop around for alternatives,” he says. Neglect customers, and they’re just a click away from a competitor.

Customer focus is not the only reason ING Direct stands out. Astute performance monitoring is another. Brouwers says he’s been readjusting performance metrics to reflect the differences between an online and an offline business. “In this sense, we look at similar measures to mobile telephone operators,” the CFO says. So rather than, say, using profit and customer metrics per square metre of branch networks, he looks at acquisition cost per customer and churn rates. The internet bank has also smartly addressed cannibalisation, an issue for all companies whose online businesses threaten their offline markets. To prevent that from happening at ING, the group doesn’t offer ING Direct in countries with an existing physical branch network, like the Netherlands. As a result, ING Direct is treated as a “growth engine” that helps the bank break into new countries, Brouwers says.

Paper Tigers

But what happens when the web makes old, reliable growth engines break down? It’s a question that CFO Herbert Meyer has been grappling with at Heidelberg Druckmaschinen, a €3.7 billion German printing press manufacturer.

Around half of Heidelberg’s sales are to commercial printers in the publishing and business-forms industries, both of which are “moving sideways” since the advent of digital media, explains Meyer. To get an idea of what that has meant for Heidelberg’s business model, 2003 and 2004 were not just the only two years of losses that Meyer has experienced during his 12-year tenure as CFO, but the only losses that company has made in its entire 150-year history.

So the CFO is taking action. The biggest step is shifting focus from publishing and business forms to packaging , which currently accounts for around a quarter of Heidelberg’s sales. “As long as you can’t send milk or bananas through the internet, you will need packaging,” Meyer quips. Heidelberg is also targeting packaging markets in emerging economies, where supermarket penetration is low. “Packaging demand in India and China will grow 15% year-on-year for the next 30 years,” Meyer predicts, adding that industrial countries spend €400 per person on printed material every year compared with €10 per person in China. Emerging markets now account for 43% of the group’s sales.

It’s too early to know whether new strategies like Heidelberg’s will hit the mark. What is clear, however, is that if the first ten years of e-commerce have left a company’s business model unchallenged, it should consider itself lucky. It’s unlikely that the next ten years will be so kind. After all, it wasn’t so long ago that a bank without branches or a shop without a storefront seemed an impossible idea.