Does the “E” in E-Business Stand for “Exit”?

Consider Compaq’s current dilemma. It sells through dealers but knows that Dell’s build-to-order Internet sales model is much better. Compaq executives know that their current dealer network will stop selling their products if the company begins orienting more of its sales toward the Web. Because it takes time to prepare for selling online, such a shift could cost Compaq 6 to 12 months’ worth of sales. During the interim, customers that change suppliers might be lost forever, and Compaq’s stock price would be adversely affected by sharply falling sales. Compaq executives know where the company needs to be, but achieving this profit-maximizing point is difficult, expensive and perhaps impossible.

The problem is not peculiar to the computer industry; companies in other areas will be facing similar scenarios. Wal-Mart, the biggest customer for many retail suppliers, and other firms have announced that they will instantly quit selling any product that suppliers directly sell on the Internet. As the auto companies move to direct sales and build-to-order models to ensure their own survival, they face the same problems vis-à-vis their dealer networks.

To date, no major company has been gutsy enough to take the short-term losses in order to shift channels — and perhaps they shouldn’t.

Because losses will come early and gains much later, using discounted net present values, it is possible — perhaps likely —that the current discounted net present value of the profit stream that leads to extinction (i.e., sticking with the old sales channel) will be greater than using the current discounted net present value of the profit stream that leads to long-run survival (i.e., moving to the new Internet sales channel).

The conventionally correct economic answer to this problem is as simple and straightforward as it is brutal: Choose the old sales channel that leads to economic suicide. The “right” strategy is, in fact, an exit strategy.

To avoid this Hobbesian choice, some of the auto manufacturers are experimenting with a mixture of the old and the new. They try to involve their dealer network in the new electronic transactions and share with their existing dealer network the revenue that flows from the lower costs associated with Internet sales.

This compromise cannot possibly work. A new company that does not have a dealer network will enter the industry, keep all of its profits, and use this advantage to undercut the selling price of those sharing profits with their old dealer network. Gradually, these newcomers will take the existing market shares away from companies that are sharing profits. In addition, this sort of profit sharing shields the existing dealer network from shrinking as quickly or as much as it should, and the cost reductions that are inherent in Internet-sales models are not fully realized.

Another option is to start selling on the Internet using a different brand name. In all likelihood this isn’t going to satisfy the existing dealer network. They will quit selling the old brand even if that name is not being used on the Internet. In addition, a company must incur the additional expenses of establishing and supporting a new brand name.

One can, of course, persist in the belief that conventional retailing is going to survive and that remaining loyal to the existing dealer network is the right answer. In some areas, this is obviously true. In other areas, it is just as obviously not true. But for at least a generation, no one will clearly know what commodities belong in which category.

Sociology always beats technology, but eventually sociology changes. What my generation finds strange and uncomfortable (e.g., buying a car on the Internet without a test ride) will seem completely normal to our grandchildren. Having downloaded Sony racing games as children, they will be willing to download a simulator from Ford and drive a Jaguar around a racetrack in cyberspace, crash the virtual Jaguar, and learn much more about the actual car’s characteristics than I will ever learn by taking a sedate test ride around the block.

The economic dilemma can be simply stated. The present sales strategy will lead to extinction, but firms are unable to navigate to the sales channel that leads to survival. No one willingly plots an exit strategy, but perhaps that is the right answer in many cases.