Strategic Defense Initiative

By Nicholas G. Carr

It wasn't supposed to be like this. Just a year ago, everyone was peddling some form of hockey-stick chart, proclaiming that demand for all manner of e-things was about to explode. Online retailing, b-to-b trading, broadband media, mobile commerce - they were all sure bets.

Instead, as the general economy has slowed, the growth of Internet businesses has begun to plateau. The hockey sticks have been flipped on end.

The current slowdown really shouldn't come as a surprise. After all, e-commerce, particularly in the consumer sector, is biased toward discretionary purchases. People go online to buy books and CDs, MP3 players and CD-RW drives, flowers and pornography. Those things are all nice to have, but they're not essential.

When it comes to buying necessities such as gasoline, milk and beer, people don't boot up their computers or whip out their PDAs; they head to their local markets. (Sorry, Priceline and Webvan.) There's a reason those heaps of bricks and mortar are called "convenience stores."

So when buyers get nervous, as they are now, online commerce might take a disproportionate hit. Far from eliminating business cycles, the new economy is as much at the buyer's mercy as old-fashioned smokestack industries. Indeed, the numbing effect of a slowing economy is further magnified on the Internet as people put off upgrading their computers or moving to speedier but more costly broadband connections. The spread of the Net's richest offerings is thus curtailed.

But as painful as the current situation is for stock speculators and paper millionaires, it will in the end make for a healthier Internet Economy. Boom times ultimately undermine profitability because easy money brings more sellers and more capacity into markets. The resulting expansion of competition and supply makes it harder for everyone to make a buck. The shakeout that inevitably follows clears out the weakest competitors and forces the strongest to get even stronger. Companies become more efficient and markets become more profitable.

We're now in the midst of the Internet's first shakeout. In this phase of market evolution, the keys to success are very different than in the expansion phase. Speed, creativity and incestuous partnering become relatively less valuable, while patience, efficiency and ruthless competitiveness become more valuable.

The winners will be those who act strategically rather than tactically. They'll set their prices, for example, not simply to attract incremental customers, but to boost profits in some sectors while inflicting maximum pain on struggling competitors in others.

Amazon.com (AMZN) is already doing this. In online bookselling, where it holds a dominant position, it has been quietly raising its prices. At the same time, it is offering aggressive discounts in electronics, where it is not as dominant. Here, the goal is simple: Drive the competitors out of business.

Industry shakeouts also place a premium on acquisition skills. With investors dumping virtually every technology business, the valuations of companies are falling sharply. Many of them are bad companies and should be allowed to fail. But others are attractive, offering valuable technologies or strong customer bases. During the consolidation phase, wise executives don't just retrench. They extend their control over markets by buying up key competitors on the cheap - and then integrating them successfully.

No doubt, things look bad today. But while we may have gone from dot-com to dot-coma, the patient isn't dead yet. In fact, the prospects for Internet business may be better than ever.

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