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.

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