The Era of Efficiency
Just six months ago, the top brass at retailer Staples Inc. (SPLS ) had clear marching orders for its tech staff: Buy computer gear by the boatload so the company could launch new e-businesses such as its Staples.com Web site. Like executives in every other industry, from autos to real estate, Staples bosses were determined not to eat the dust of dot-com or bricks-to-clicks rivals. So Max Ward, vice-president for technology, spent $125 million loading up on computers, software, and networking gear to build Staples into an e-commerce heavyweight. Ward didn't fret about whether Staples was squeezing every last bit of oomph out of the equipment he was installing.
Not anymore. Staples is feeling the brunt of the downturn, and Ward has new marching orders: Find the oomph. While Staples is folding its Staples.com e-commerce subsidiary back into the company, it's not backing off technology to reach out to customers and make itself more efficient. Ward is installing technology for an online help desk where store managers and clerks can go for handy answers. He typically aims for a 17% return over four years on his tech investments, but the online help desk could boast a 60% return. He expects to save $10 million through a $2.5 million investment in a better way of storing data. "Prior to this year, 85% of our tech spending was to drive business growth," says Ward. "Now, 40% is for things that will lower our costs. We want the most bang for the buck."
With Internet exuberance barely cold in the grave, a far more sobering period has arrived: the era of efficiency. The days of free spending on technology and wide-eyed optimism about the Internet have given way to clenched pocketbooks and pure pragmatism. Suddenly, today's executives are no longer asking about technology that will help them launch new businesses but about gear that will cut costs and wring more efficiency out of workers. "We're leaving an era in which incremental improvements were pooh-poohed as a waste of time, like trying to improve the buggy whip," says Geoffrey A. Moore, managing director of Chasm Group LLC, a Silicon Valley consultancy. "Well, it turns out the buggy whip isn't quite done yet. And there's a heck of a great business in helping customers be more efficient."
For evidence of this, one need look no farther than BusinessWeek's fourth annual ranking of the 100 best-performing technology companies in the world. The Class of 2001 is dominated by companies that have either achieved the efficiency long promised by the technology revolution or that sell products and services to help others improve their bottom line. Topping the list is unsung Celestica Inc., a contract manufacturer that churns out big earnings despite a 3.7% operating margin--so thin it's scary. IBM (IBM ), whose slow growth made it a no-show last year, came in at No. 6--thanks to big demand for its consultants, who demystify and make the most out of tech gear. And software maker Siebel Systems Inc. (SEBL ) nabbed the No. 14 spot because its sophisticated software helps companies better cater to customers.
As for the Internet revolutionaries, they are MIA. Gone from the Info Tech 100 is Web portal Yahoo! (YHOO ), e-commerce software pioneer BroadVision (BVSN ), and upstart Vignette (VIGN ), whose technology manages millions of Web pages on the fly. Even the Big Three--AOL Time Warner (AOL ), Amazon.com (AMZN ), and eBay (EBAY )--couldn't muster either enough profits or enough investor confidence to make the grade. "We've gone from category killers to cost-cutters," says Hal Varian, dean of the School of Information Management &amp; Systems at the University of California at Berkeley.
In the end, however, the cost-cutters may be the real heroes of the Internet Revolution. As companies demand more ways to streamline and reduce expenses, they will increasingly turn to the Net as a cheap communications backbone for everything from buying ballpoint pens to linking complex supply chains, spanning scores of countries. The transformative nature of the Internet was never in online banner ads or auctions of Beanie Babies. Instead, the big bang lies in being able instantly and effortlessly to work as one with employees, suppliers, partners, and customers--all over the Web.
Lured by that promise, in the past five years, thousands of corporate technology czars went on buying binges. As enthusiasm for the Internet reached a crescendo, companies snapped up servers, software, routers, fiber optics--anything they thought would arm them for an Internet future. Between 1996 and 2000, companies invested $1.7 trillion in technology--nearly double the amount spent in the previous five years, according to the U.S. Bureau of Economic Analysis.
MICROSCOPE. Now customers want to absorb the technology they already have and put it to better use before gobbling up more. A peek into Schneider Logistics, a Green Bay (Wis.) company that moves supplies and materials for the likes of General Motors Corp. (GM ), highlights the problem. Schneider has the technology in place to handle all its orders electronically. That means if GM is depending on Schneider to get it even something as mundane as 20,000 napkins by Tuesday, it can use the Net to reach the supplier instantly, order the napkins, and arrange warehousing and delivery. Yet only 70% of Schneider's transactions are handled online. The problem: Suppliers need training on how to use the Web. Chief Information Officer Steve Matheys says that once 95% of Schneider's orders are handled electronically, it will give the company a 10% to 20% productivity boost. "We have all the technology we need, but the processes have to be worked through to get the business opportunity," says Matheys.
This isn't the first time that technology buying has outpaced the process of putting it to good use. In 1985, after five years of runaway growth, the PC market skidded to a stop as companies realized the productivity gains just had not materialized. It wasn't until the early 1990s, after thousands of companies had worked through the complexities of local-area networks and e-mail, that the payback came. The lesson: It takes time for customers to apply technology. And the more binge buying that takes place, the more protracted the period for digesting it.
Indeed, the economic slowdown has forced many companies to turn the microscope on tech spending. In a May survey of 260 chief information officers conducted by Deutsche Banc Alex. Brown and CIO Magazine, the planned growth for the next 12 months in tech budgets fell to 4%, down from 19% last November. So what projects are top priorities? Some 70% say Net technology is critical, according to a June survey of 150 senior execs by consultant DiamondCluster International and the Wharton School of the University of Pennsylvania. Of those surveyed, 46% say that using the Net for customer service will be a boost, while 48% say that they can get benefits from wiring their purchasing. What's not so hot? A May survey of 225 corporate CIOs by Morgan Stanley Dean Witter &amp; Co. showed that the areas most likely to be cut are consulting and new custom application development. Translation: Corporate bigwigs don't want big, complex, and expensive computing systems.
The tech companies that will prosper the most are those that have figured out both halves of the efficiency game: how to live it by the way they do business internally and how to sell it through profit-boosting products and services. There's no bigger disciple of this than Toronto's Celestica (CLS ). The company's revenues have ballooned from $3.2 billion in 1998 to $9.8 billion last year. Having expanded from 15 plants in 1994 to 36, it now builds everything from Motorola (MOT ) cell phones to Sun Microsystems (SUNW ) servers far more quickly, reliably, and cheaply than those companies could do themselves.
How does Celestica do it? For starters, it boasts a lean management structure. Only 3.5% of Celestica's workforce is in management. Instead, Celestica banks on technology. Three years ago, the company pumped $60 million into new computer systems, including supply-chain and database software to handle the $8 billion worth of parts that the company bought in 2000 for its plants, located in 12 countries.
That proved a lifesaver when the tech industry went into reverse last fall. While orders fell roughly $700 million as the slowdown hit Celestica's customers in the March quarter, inventory rose by only $300 million. The company avoided $400 million in additional inventory. Having the plants wired proved critical. Celestica keeps one huge database of parts it buys so that each plant manager can see what other plants have, so they can find a home for excess parts. And if that doesn't take care of the glut, a supply-chain SWAT team at headquarters sees it in real time and can use the company's huge buying power to get suppliers to roll back on orders. "I can see almost instantly whether another plant has the inventory," says Andrew G. Gort, Celestica's executive vice-president for global supply-chain management.
Examples like this are prompting companies to turn over the jobs they can't do cheaply themselves. Despite slowing sales, Sun Microsystems Inc. ranked No. 65 on the Info Tech 100, in part because it has kept costs down by outsourcing the manufacture of its low-margin products to Celestica and others. For Sun to build a 1.1 million-square-foot factory to manufacture workstations and servers would cost $350 million in capital expenses and another $300 million a year to operate, says Marissa Peterson, operations chief at Sun.
OUTSOURCER'S APPRENTICE. That's why our list is chock-full of outsourcing companies--from contract manufacturers Samina Corp. (No. 12) to chip foundry United Microelectronics (UMC ) (No. 8) to payroll processor Automatic Data Processing (ADP ) (No. 46). All are prospering through a laser focus on jobs their customers typically consider scut work.
To compile our IT 100 list, BusinessWeek started with financial data from Standard &amp; Poor's Compustat, a division of The McGraw-Hill Companies that has compiled data on 10,000 publicly traded companies. From this universe, we cull our tech leaders and then add non-U.S. companies suggested by our network of foreign correspondents. To make our final cut, companies are measured by four criteria given equal weight: revenue growth, total size, shareholder return, and return on equity.
Downturns, as it turns out, can be upturns for outsourcers. "This is the best of times because no one ever wants to do their own manufacturing again," says Michael E. Marks, CEO of contract manufacturer Flextronics International Ltd. (FLEX ) (No. 25). Marks says Flextronics' best year in the past decade was 1992, the year after a tech slowdown. "2002 is going to be just a huge year for our industry."
How do contract manufacturers make money on the tasks that bleed others dry? Since they live and die on tiny margins, they go to great lengths for every ounce of efficiency--say, to invest in a $1 million vibration chamber for making sure industrial gear can take a good shaking. Such equipment can help the contract manufacturer meet its customers' marketing promises and avoid costly returns in case the gear isn't up to snuff. While the computer maker would never be able to get a return on investment, contract manufacturers get a payback in short order. The reason: The computer maker might use the machine only 5% of the time, but the contract manufacturer could keep it humming 30% of the day as it cranks through products for many different companies, says Pam Gordon, president of market analyst Technology Forecasters.
On the flip side of that efficiency equation are the companies that outsource as much as possible. Perhaps no seller of technology hardware has latched on to this as much as Juniper Networks Inc. (JNPR ) (No. 56). Nearly all the 1,300 employees at Juniper's Sunnyvale (Calif.) offices either design or sell the company's Internet routers--nothing else. The company outsources everything from payroll to the production of its high-speed networking gear. The glue that holds all these outsourced tasks together is the Internet, where Juniper can stay in constant touch with the work being done. "There's a lot of information we get that is of a real-time nature, where quick decisions need to be taken," says Pradeep Sindu, chief technical officer. "That's why the Internet is being used. It allows you to do things much more efficiently."
Mastering the art of being a "virtual" company has made Juniper a productivity champ. Its sales per employee were $615,000 last year, compared with an average of $258,000 for the communications sector. And it has helped Juniper wrest 30% of the router market from powerhouse Cisco Systems Inc. (CSCO ) over the past three years--and earn an impressive $16.7 billion market valuation from Wall Street.
Just leaving the driving to others doesn't assure success. Networking giant Cisco Systems relies on others to do most of its manufacturing, yet it slipped from No. 25 on the IT 100 list last year to No. 155 this time around. The company failed to spot a sudden decline in orders and ended up having to write off $2.2 billion in inventory and lay off 14% of its staff.
"FOR REAL." Technology companies that can help their customers avoid ending up like Cisco have plenty to do these days. That's everybody from Web-smart consultants to cutting-edge chip designers to sellers of network storage devices that can help customers warehouse their bits of corporate information more efficiently. Software makers such as Siebel, SAP (SAP ) (No. 30) and PeopleSoft (PSFT ) (No. 33) make software that helps companies move quickly and control costs.
We're not talking small change. Colgate-Palmolive Co. (CL ) saved $430 million by installing SAP corporate software for managing its financial accounts and planning throughout its worldwide operations. The bulk of the savings, $280 million, came from consolidating 80 data centers scattered around the world into one highly efficient one in New Jersey. Smarter software helped, too. Last year alone, the company trimmed its inventories by 13%, saving $150 million, with improvements to its planning systems. The software allows the company to attach its ordering system directly to thousands of cash registers at Wal-Mart Stores Inc. (WMT ) and Kmart (KM ). It can monitor sales right up to the minute and quickly adjust its production plans. That way, the company is able to predict demand accurately 98% of the time and ship just the products the stores can sell. "This enterprise software isn't hype," says Forrester Research analyst Charles Homs, who studied Colgate-Palmolive. "This will not die. This is for real."
While demand is slowing for PCs and computer servers that run Web sites, there's plenty of business for some specialty hardware makers that enable companies to lower their costs. For instance, many companies now spend 70% of their hardware budget on so-called storage area networks--systems that link storage devices together--up from 30% a few years ago. That provides a boost for Brocade Communications Systems (BRCD ) (No. 59), which sells a storage switch that lets companies make do with far fewer disk drives. While the slowdown will prevent Brocade from repeating its 379% sales growth in 2000, the pain won't be too great. Merrill Lynch &amp; Co. expects the company to grow 58% in 2001. Says Staples CIO Brian T. Light. "Storage is like candy. You just can't get enough of it."
FULL MENU. In information-technology services, big is back. Past highfliers such as Exodus (EXDS ) or Viant (VIAN ) that specialized in one service--say, hosting Web sites or offering advice about the Internet--have fallen off our list. Yet old tech specialists such as EDS (EDS ) (No. 48) and IBM are going gangbusters. That's because they offer corporate clients the full menu of services, including the consulting expertise, software products, and giant data centers from which they can run outsourced tasks. Customers can't seem to get enough of IBM's services. In the first quarter of this year, IBM signed $10.2 billion in information technology service deals--up from $8 billion a year ago. "When economic conditions drive business to be more efficient, services help them reduce costs," Chairman Louis V. Gerstner Jr. told analysts last month. "A lot of those services offerings look pretty good right now."
Bottom line: The tech elite are a study in making good use of what they sell. Siebel Systems CEO Thomas M. Siebel's fanatical devotion to using his own software for managing customer relationships appears to have paid off. He can analyze the status of deals all the way down to the individual salesperson because they are required to enter all information, everything from conversations with customers to the figures they're quoting during contract negotiations. The company has a measuring stick to match up sales goals with what's actually happening in the field--and quickly step in when something has gone amiss.
Last quarter, the CEO saw sales slowing down just five weeks into the quarter. He knew that with expenses growing it was going to be tough to meet Wall Street's expectations. So he laid off 10% of his workforce, curtailed executive bonuses, and cut expenses--all within 30 days. In the end, the company was able to meet both expectations. First-quarter revenue was $588.7 million, up 87% year over year, while net income was $76.9 million, up 118%. "I know exactly what is happening," says Siebel. "I may not like what I see, but I know what is happening."
In the post-Net boom era, two things will become clear: Selling efficiency is good, being efficient is better, and doing both is the new recipe for success.
By Peter Burrows
With Ira Sager and Steve Hamm in New York and bureau reports