E-services Strategy Shift - Industry Trend or Event

Well into the year 2000, e-business services firms continued to enjoy phenomenal growth rates, soaring revenues, and marker adulation. At the end of June 2000, Scient Corp., San Francisco, reported year-over-year growth of 457%! Boston-based Viant Corp. came in at 251%, and Agency.com, New York City, reported growth of 95%.

Then came the summer of their discontent. By late August, iXL Enterprises Inc., Atlanta, and Razorfish Inc., New York City, reported stock dips, as well as executive departures. San Francisco-based Organic Inc., Viant, and iXL projected revenue shortfalls. Other e-business services firms are facing challenges as well. What do these changes mean for the buyers of e-services?

Already, there are signs that e-business services firms are starting to shift their positioning and marketing tactics. Yet, it still remains a sellers' market for e-business services. Many firms continue to turn away business and still amass large backlogs of work.

E-business services firms are becoming more discriminating about their buyers, and are seeking loyal, long-term, lucrative relationships with well-established corporations. Many buyers, some of whom were burned by the "speed at all costs" mantra, are focusing more on quality service rather than haste. At companies like Scient, executives indicate that customers are becoming more concerned about the quality and profitability of their Internet initiatives, and less focused on "time to market."

Many factors are exerting pressure on the e-business services market. Buyers should be aware of those factors, and understand how they help, hinder, or simply change the way that e-business services are purchased and delivered.

To begin, buyers should consider the differences between the more mature IT services market and the e-business services market. Whereas more traditional IT services were forged on long-term relationships, with contracts often lasting years and producing millions of dollars in revenues over their lifetime, e-business services are strikingly different. They are typified by a high degree of churn, with short-term contracts generally lasting under a year and producing in the range of $1 million to $3 million in revenues. Until recently, long-term relationships were unheard of, partly because of the immaturity of the market, partly due to the preference for easy money rather than cultivating clients, and partly due to the narrower, Internet focus of the service offerings.

The marketing campaigns of the e-business services firms also reinforced the notion of "churn," advocating constant change for companies that wanted to stay ahead of their Internet competition. Dot-coms were perceived as ideal clients because of their total lack of conservatism and obstructive, accumulated baggage. They provided the perfect forum to test and showcase a service firm's cutting-edge strategies, designs, and technologies, and to generate market buzz.

These early-stage strategies work well in a high-growth market with constrained supply, but they aren't nearly as successful when demand abates and supply catches up with demand. They don't build a reliable base of repeat customers, and they make it difficult for companies to find replacement clients at a time when demand slackens and competition increases. It is also quite costly to continually acquire customers. Based on these strategies, it would be almost impossible for an e-business services firm to grow into a $500 million concern relying on 250 client contracts worth $2 million apiece, when there is an 85% annual turnover rate.

E-business services firms have begun to take several steps to alter their strategies and maintain their high growth rates while protecting their market share. What can the buyers of their services expect?

Improved Access, High Cost

Every e-business services firm is highly focused on expanding its professional consulting staff to cope with the overwhelming demand for services, as well as to grow revenues. With a direct correlation between number of bodies and revenue growth, these companies must continually increase headcount to fuel their expansion. In the second quarter of 2000 alone, Razorfish, grew headcount 16% over the earlier quarter, Sapient Corp., Cambridge, Mass., grew 11%, and Chicago-based Diamond Technology Partners grew 12%.

At the end of the summer, though, iXL announced a layoff. It remains to be seen if others in the sector will face a similar situation.

Headcount growth to date has been coupled with substantial billing rate increases. Strategy-heavy firms like Diamond Technology Partners charge hourly rates upward of $300, while Scient and Viant charge in the range of $280 per hour. In contrast, strong technology companies like Sapient and Chicago-based MarchFirst Inc. charge in the range of $150 to $170 per hour. Although rates are climbing among all firms, the technology-heavy firms will always have lower rate structures than their digital strategy counterparts because the market does not value technical skills as highly as strategy skills. Billing rates and revenues per consultant are good indicators of where a consulting firm's strengths lie. The lower the figures, the more technology-oriented the firm; the higher the figures, the more management consulting-oriented the firm.

Many e-services firms are also expanding geographically, both in the U.S. and overseas. Proxicom Inc., Reston, Va., has opened a Boston office, Scient has a presence in New Jersey, Razorfish has three offices in Germany, and Sapient is growing its European operations. Most are eyeing foreign expansion as a way to keep revenue growth high, especially since analysts predict a huge amount of pent-up demand for e-services in foreign markets. Yet, companies that have ventured abroad have also encountered resistance to the high billing rates charged in the U.S., which has pulled down average billing rates.

For buyers of e-services, these expansionist trends have several implications. First, the headcount growth and additional local offices increase the odds that buyers will not only be able to sign up with their desired service provider, but they will likely have a better choice of providers in their immediate area. Depending on the quality of the staff; a buyer may even be able to enjoy the typical benefits of local delivery--quick access to talent, low expenses, and stronger relationships.

Second, even as the ranks of professionals swell at these services firms, companies can still expect to pay premium prices for e-business consulting services. Digital strategists will command the highest premiums (see table, p. 27). Average creative and technology skills will command the lowest rates. Top-tier, specialized creative or technical talent will have rates somewhere in the middle. It is doubtful that companies can expect relief from these high rates anytime soon. Companies can, however, create their own lower, "blended" rates by mixing e-business consultants with traditional IT consultants whenever possible. In the current market, traditional IT consulting firms have lower rate structures than their e-business counterparts, and are financially attractive for projects that don't demand highly specialized e-business skills.

Third, there is a finite supply of high-technology expertise, and no e-business services firm has cornered the market on talent. Not every firm will be able to hire the best and the brightest, and companies should be leery of paying top-tier rates for recent college graduates with little real-world experience.

Check resumes carefully. Moreover, companies that are considering hiring and building their own crew of e-business staffers should carefully evaluate the competition. Most companies can't match the salaries and associated stock options the e-business services firms are paying, and will find it hard to attract and retain top talent with benefits that are below market rates.

Shifting Client Profile

To grow their recurring revenues and boost credibility, every e-business services firm is in the midst of shifting its client base to more established businesses with "deep pockets." Dot-com or venture-backed companies will still be part of the client mix, but they comprise a smaller percentage with each passing quarter due to their perceived credit risk and short-term revenue nature. Earlier this year, the bankruptcy filings of dot-com companies Verde Media and Inacom, both Scient clients, caused Scient's stock price to fall amid fears of nonpayment. It is ironic that the same services firms that trumpeted their dot-com clients last year are now crowing about the diminishing percentage of dot-coms that they service. In its Q2 2000 earnings press release, Lante Corp., based in Chicago, noted that "while these smaller [dot-com] ventures will continue to be an important part of our business, we are shifting our e-market activity toward more established companies." Meanwhile, Dallas-based Luminant Worldwide Corp . stated that 90% of its work in the second quarter was associated with Global 1000 and other major corporations.

So what does this shifting focus mean for buyers of e-business services?

Dot-coms are "out" unless they are well funded, have a strong business model, and give an e-business services firm an opportunity to try out new, leading-edge work. The exception would include spin-offs of major corporations (Staples.com) or online exchanges or marketplaces that have powerful sponsors (Autoexchange.com with Ford, GM, and DaimlerChrysler).

In the near term, small- and medium-size, established businesses are "out" unless they have a clear growth path that would lead to higher recurring revenues for an e-business services firm. These companies should look to smaller or regional e-business firms to fill their consulting needs. In the future, when the services market contracts, these companies will become more attractive clients.

Larger, established companies are clearly "in." These companies are attractive clients because of their hefty IT budgets, potential to generate recurring revenues, and successful business profiles. For example, iXL Enterprises touts its blue chip clients such as General Electric, Delta Airlines, Chase Bank, and FedEx. Mainspring Inc., Cambridge, Mass., points to American Express, Chase Manhattan Bank, GE Capital, IBM, and NY Life as users of its e-strategy services. Since the Global 2000 is now the most sought-after group of clients, companies in this category should use their status to their advantage, and demand the best terms possible from their e-services firms.

Nth-Generation Web Sites

The e-business market has been driven by hype right from the outset, and there's no reason to suspect that things will change in the immediate future. The consulting firms supplying the bulk of the e-business services have contributed to the hype for the simple reason that it drives buyers to purchase their services.

The problem with creating demand based on hype is that it takes a continual bombardment of hype to keep demand levels inflated. The first wave of Web sites, c-commerce sites, and online exchanges has come and gone, so e-business services firms must now sell the market on creating next-generation Web sites and enhanced functionality. As more research data is available on the behavior and expectations of Internet users and online buyers, services firms have new ammunition to justify another round of Web site updates, functionality upgrades, and creative redesign. According to these services firms, constant change is a necessity to stay ahead. But the true value-added benefits of those changes often prove elusive.

While every company seeks to create a sense of urgency in its target market, buyers must beware of false urgency. False urgency pushes companies into making poorly considered decisions. An example of false urgency has been the emphasis on "time to market" over quality and durability in most Internet initiatives. Many companies are now in the process of completely redesigning poorly conceived Web sites and applications that were rushed into implementation.

For example, Wal-Mart had worked with Cambridge Technology Partners, Cambridge, Mass., and others to create a quick-hit commerce site, but users found the site difficult to navigate and deficient in product information. In July 2000--a mere six months after it launched its original Web site--Wal-Mart admitted that it had been working with Sapient to improve its site design and navigation.

Almost every c-services firm offers strategy consulting, and it is through strategy recommendations that these firms will push next-generation technologies and designs. But combining strategy with delivery is a double-edged sword. On one hand, combining the two areas offers a certain amount of efficiency. On the other hand, it leaves a firm open to conflicts of interest. While one hopes that strategy recommendations are objective and independent, it would be naive to think that consulting firms don't also want to promote their creative and technical work. Big Five consulting firms also suffer from this image problem, while pure strategy firms like Boston Consulting Group and McKinsey & Co. are favored precisely because they do not have a built-in conflict of interest.

Warnings aside, advances in Web-related techniques, designs, and technologies will almost certainly be useful, meaningful, and valuable to those who can leverage them properly. The point is not to discard these advances out of hand, but to help companies see that they don't have to jump on each new incarnation, that they have time to choose the most sensible course of action that fits their situation.

Before succumbing to the marketing hype for Nth-generation Web sites and functionality, a company should develop a business case for the overhaul, If a company has an obvious problem or deficiency with its Web site operations, as Wal-Mart found, then it should consider upgrading its site and functionality at the same time that it takes corrective action. Similarly, if applying new techniques would unquestionably lead to greater visibility, more buyers, higher revenues, lower costs, and/or the ability to offer lucrative services, and these benefits can be quantified and justified, then there is sufficient reason to take the plunge. On the other hand, if the Web site is functioning well and users are happy, there is no pressing need to change things.

Likewise, if the business model underlying the site is faulty, if revenues are poor, or if consumers just aren't interested, then applying next-generation Web advances is unlikely to solve the problem. Companies must differentiate among problems with their business model, problems with the market, and problems with their site. Adding new bells and whistles won't cure business or market problems; the real fix may be to change the business model, wind down online operations, or focus on alternative channels.

Which areas are generating the most buzz these days? The hot new sector is wireless networking and Internet access. Almost every e-services firm has started a wireless practice, and Razorfish is in the lead with 12% of Q2 revenues from wireless work. Technologies supporting interactive television, e-learning, and entertainment, such as broadband and rich media (animation, streaming video, music, sound, and 3D), are also in vogue. Agency.com, New York City, was an early entrant in this category, and Sapient has joined the fray through its acquisition of rich media developer Human Code last August. Improved customer personalization techniques and supporting technologies are also being heavily marketed.

More Capabilities and Services

E-business services firms are also expanding their capabilities and offerings. Firms broaden their competencies for two primary reasons. The first and most obvious reason is that broader services equate to a larger market share and higher revenues. The second reason is that a broader range of service offerings can provide important differentiation vis-a-vis competitors.

Just about every e-services firm has eschewed niche status, with the exception of Mainspring, which focuses solely on e-strategy. Now every firm claims end-to-end e-business capabilities, from strategy consulting to creative design to technical implementation. In the last year or so, e-business services firms have been on an acquisition spree to add competencies they formerly lacked. Razorfish acquired i-Cube to add technical depth; Whittman Hart and USWeb/CKS merged to create MarchFirst, combining their creative and technical forces. These acquisitions have allowed firms to lay claim to end-to-end capabilities, but questions remain as to how well they have integrated their services and the true depth possessed in any single category. For example, if five out of 1,000 technicians have legacy systems experience, then an e-services firm has a very weak claim to legacy integration expertise and could not adequately staff several concurrent legacy integration projects.

E-business services firms will continue to broaden their capabilities as long as it makes financial sense. When, and to what extent, they begin to add more non-Internet consulting expertise is the open question. If they dilute their offerings by adding non-Internet capabilities, then they lose their unique focus, and start to appear like (and have to compete more directly with) the huge pool of IT consulting companies.

Nevertheless, customers can expect to find e-business services firms branching into new areas. Wireless, broadband, rich media, CRM, personalization, and supply chain practices are either currently being offered, or will be in the near future, by most e-services firms. Various firms including MarchFirst, Proxicom, and Viant are promoting Web site hosting, ASP-like services, and variations of Web application outsourcing. Expect more business process outsourcing of Web functionality in the future.

The field is still dominated by "me too" marketing, though. To the average buyer, most e-services firms look alike. It takes a certain amount of digging to find out a firm's competencies. Things like revenues per consultant, weighted capability scorecards, and analyst insights can provide clues. As a first step, examine the components of your e-business initiative and determine if any one component is more critical than another. For these critical components, you may want to consider engaging a best-in-class services firm. For example, a financial services company may be somewhat less concerned with the creative design of its Web site and more focused on superior performance, security, integration with legacy systems, and technical architecture--skills that are strongest in a technically oriented e-services firm. Or a company that wants to spin off its online business may need to explore various business models-- expertise that is abundant in more dedicated strategy consulting firms.

No Easy Task

Buying e-business services is not an easy proposition. In a sellers' market, buyers have little clout and may even find it difficult to engage a consulting firm, depending on their particular profile. Rates are incredibly high, and customers can't be assured of receiving best-in-class services unless they do their own research, At the same time, buyers need to resist the hype and focus instead on creating a quality site and functionality that will endure for a reasonable length of time.

Despite these obstacles, the e-services market shouldn't intimidate buyers. A buyer in the "preferred class" of Global 2000 companies has significant appeal to the e-services firms. These firms derive tremendous marketing and PR value from having this type of company as a client, and buyers can use this value to their advantage.

But buyers that don't fit this profile can still get a great deal, and often better service, by working with more general IT consulting firms or smaller regional players. The ball may be in the court of the e-services firms right now, but as Bob Dylan sang, "The times they are a' changin."

Ian S. Hayes, founder and president of Clarity Consulting Inc., Hamilton, Mass., specializes in strategic consulting on issues surrounding the management and support of corporate business systems. He is the co-author of two best-selling Year 2000 books, The Year 2000 Software Crisis: Challenge of the Century and The Year 2000 Software Crisis: The Continuing Challenge (Prentice Hall). E-mail him at clarity@clarity-consulting.com.

COPYRIGHT 2000 Wiesner Publications, Inc.
COPYRIGHT 2000 Gale Group