The application of our framework will accelerate the emergence of click and/or walk organizations. In fact, it may well be that these enterprises will dominate the face of business-to-consumer (B2C), business-to-business (B2B), and consumer-to-consumer (C2C) commerce for the foreseeable future. And this could result in significant wealth creation for the stakeholders and more choices (but maybe not lower prices) for consumers. Yet the click and/or walks must move forward decisively. Wall Street has a way of penalizing indecision with low market capitalization.

A plethora of Internet pure plays have created an online presence with the hope of disintermediating the traditional retailers. Two of the best-known examples, of course, are Amazon.com and Buy.com. All of these companies share a common vision of making online shopping easy for the end-user through a large selection of merchandise, ease of navigation and browsing, and hassle-free shopping from the comfort of one's own home or office.

Oftentimes that vision has been clouded by the harsh realities of having to fulfill customer orders on time and with close to perfect service. As realities set in, the original online concept of totally disintermediating the retail sector begins to appear highly infeasible—and the e-tailers have had to change their expectations accordingly. An example of shifting business strategies is provided by Amazon.com. At its conception, the start-up's goal was to be an infomediary and sales agent with no ownership of product or final delivery. But because Amazon.com also wanted to provide superior customer service, that initial model was abandoned for a hybrid one—a model that included the addition of 3,000,000 square feet of warehouse space spread across multiple distribution centers.¹

The traditional bricks-and-mortar companies like Nordstrom, Best Buy, Circuit City, and others have decided that the perceived disadvantage of having physical stores actually can be converted into a competitive edge. For their online business, they believe, the physical assets can be leveraged to handle fulfillment and product returns more efficiently while at the same time cross-promoting the brand name. The challenge that these established retailers face as they move into the online world, however, is what governance model to use in their new click and/or walk businesses.

A number of approaches have been tried to date. A company like Nordstrom.com, for example, seeks to leverage the parent firm's credibility, brand awareness, customer loyalty, vendor relationships, and existing store and distribution infrastructure.² Nordstrom management has articulated such goals as "to serve the customer wherever they want to find us" and "to provide a seamless continuum of shopping experiences across all distribution channels." In the future, Internet customers may be allowed to locate special items that are not available online but may be found in the stores.

Another emerging click and/or walk leader is Best Buy.³ This company's online business plans to leverage existing Best Buy retail stores for Internet returns, advertising, promotion, and warranty. Both the physical and online entities also will engage in brand awareness and cross-promotion initiatives. In fact, the company's CEO has been quoted as stating that the synchronization of the consumer experience among all of Best Buy's channels—retail stores, catalogs, and the Web—ultimately will be the company's most powerful offering.

The Best Buy and Nordstrom examples show a high level of cooperation and coordination between the physical and the online operations. Yet there are many more examples of companies that have not reached that level. They are sharing infrastructure in some cases and, in other cases, not. In still other instances, organizations are adopting a mixed strategy—consolidating some functional areas between the physical and online businesses while keeping others separate.

These diverse examples reflect the complexity involved in determining the infrastructure sharing, delivery channels, and process content that is optimal for wealth creation of both the online and physical enterprises. We have found that approaches vary with pre-existing business conditions. That is, some companies can make the transition from physical only to click and/or walk simply by adjusting their existing business practices to accommodate the new sales channel organization. Others need to redesign the business models from the ground up.

No approach has been found to be clearly superior to any other. Wall Street analysts have discussed the tremendous online potential of bricks-and-mortar retailers. At the same time, the analysts are cautioning traditional retailers that they must capitalize on this potential in a coordinated fashion in order to contain costs. But interestingly, the stock market has provided neither notable punishment nor strong reward for any of the companies making click and/or walk plays.

Many of the retailers appear to understand the benefits of consolidating certain functions as they develop their click and/or walk strategy. And some have implemented consolidation or shared service solutions. Few, however, have communicated effectively the strategic intent of their retail and dot-com growth either to the management of the two entities or to Wall Street. This not only causes distrust and confusion among executives but also leads to market capitalization fluctuations.

It's interesting, by the way, to see some of the retailers creating tracking stocks for their online business. The logical inference is that at some time in the future they will create two separate business entities, which brings into question how much synergy will remain. Ultimately, this may lead to a spin-off of the online business or an initial public offering.

The governance options for click and/or walk corporations span a continuum from total independence to optimized use of shared services and joint ventures. To date, no option has emerged as the clear-cut choice for click and/or walks to follow. It should be noted, however, that some companies have experienced erosion of market capitalization because of a perception that the mainline business is continually subsidizing the online operations.

The three options presented here go across the spectrum of asset leverage—from complete separation of the click and the walk worlds to a close integration of the two. Exhibit 1 summarizes the degree of separation for the three options along the key components of physical infrastructure (stores, distribution centers, fulfillment hubs, administrative space); information (systems, data, and market intelligence); and process (business planning, back-office functions, relationship management, and so forth).

Option 1: Separate and Operate

The simplest solution is the separate and operate option, in which each entity operates as a self-funding line of business. The parent corporation can either choose to relinquish control of both organizations or remain on the boards of both. The equity allocation is defined for each organization in a manner that allows for aggressive recruiting and retention of key talent for both operations. The physical infrastructures and other fixed capital investments are adjusted for a one-time split allocation by both corporations as line items on the P&L (profit and loss). The same is true for the investment in working capital for both companies.

In this option, each organization maintains its own accounts payable process and infrastructure as well as its own information technology, business planning, merchandising, and supply chain operations units. External facing activities such as customer relationship and trading partner alliances are handled individually as well.

There are some advantages to this model. One is that each entity controls its own destiny, which often is perceived to be a prerequisite for any dot-com's eventual success and profitability. Another is the ability to make and execute key decisions in "Internet" time without having to plow though a cumbersome corporate bureaucracy. Costs are allocated fairly easily except for the one-time adjustment in fixed and working capital. This one-time allocation can be performed by using static growth projections of revenue, lines of business, and projected SG&A (sales, goods, and administration) costs.

But there are disadvantages to the separate and operate model, too. Our analysis of some of the major click and/or walks shows this option to be the most expensive. This is due to duplication of management structure, reduced system compatibility, uncoordinated supply chain activities, lack of merchandising leverage, higher levels of working capital, and inadequate leveraging of brand equity.

Option 2: Share and Operate

A middle-ground option often is the share and operate arrangement between the bricks-and-mortar company and its online counterpart. This approach brings to bear some well-established and key operating philosophies—namely, shared services for key activities and the effective use of metrics to drive consensus. Shared services is not a new concept in industry (consider, for example, the outsourcing of shared information-technology services). It's also common in the financial sector for items such as check clearing, printing, and accounts payable. Recently, new companies have emerged that provide asset-based services for large-scale distribution. These services have proved attractive to small and medium-sized retailers seeking to share logistics services between the online and physical entities.

Some of the key activities that can be shared under this model are accounts payable, information-technology services, and supply chain execution support. The two organizations retain a high degree of independence with regard to the physical infrastructure and supply chain planning. However, some physical store leverage may be used, such as in-store kiosks that attract customers to the online brand or joint advertising by the two businesses.

A big advantage of the share and operate model approach is the focus and accountability that each corporation brings to its business and supply chain planning. There's also greater compatibility of information flow to and from the end-consumers as well as better management of working capital.

As the degree of shared services increases with this option, however, so does the difficulty of cost and revenue allocation that goes hand in hand with asset leverage. A convergence of three major activities needs to occur to provide the appropriate leverage of assets for both the physical and online entities. These are:

• Activity analysis—A fairly detailed and dynamic activity-based costing analysis of the shared activities needs to be performed. Particular attention must be paid to the inherent differences between handling of bulk vs. multiple smaller order quantities. Also, the physical layout of the key pick, pack, and ship facilities tends to be significantly different for the online vs. the offline world. Accordingly, all of these activities need to be analyzed carefully as well.
• Scarce-item allocation system—An optimized scarce and excess inventory allocation and adjustment system must be developed that takes into account total landed cost, business growth, customer priorities, channel priorities, and historical usage rates of the units. This allocation method protects the smaller business (typically the online corporation) from being shortchanged when items are in heavy demand. It also protects them from having to bear the cost of higher investments in working capital required of the physical corporation.
• Metrics—The activity analysis and scarce-item allocation system are used as inputs to the third critical activity—developing metrics. Time and time again, we have found that compensation-related metrics drive executive behavior. Where joint modes of operations are involved, the metrics for senior executives need to be tied into the overall well-being of the entire corporation while at the same time maintaining a healthy balance for the individual P&Ls. Metrics used to foster shared success effectively are cash-to-cash cycle time, order-to-delivery response time, total delivered cost, delivery performance, and return on assets. These metrics, among others, can serve as an "executive management measure" that would be reviewed on a frequent basis to ensure the asset leverage.

Option 3: Joint Operation

Much has been written about how some bricks-and-mortar corporations with a high degree of brand equity have been able to turn the asset disadvantage into a distinct competitive differentiator. In fact, Wall Street analysts, investment bankers, and financial advisors are predicting that the companies that are able to optimize the leverage of their assets (physical and intellectual) will be the eventual winners. The third option, which we have termed joint operation, most closely approximates that paradigm.

The optimized use of assets in this option involves a high degree of shared services between the two corporations. The shared services or joint operations include information technology, physical assets (such as using stores for order fulfillment and reverse logistics, co-branding and promotion, and joint promotion planning), intellectual and process capabilities (like vendor relationship management, inventory and deployment planning and execution, merchandising, and marketing), human-resource functions, and all back-office capabilities. The effective joint operation of these activities will result in superior customer experience both online and offline. Importantly, it also will lead to a higher return and wealth creation for the shareholders.

It is possible to use a framework similar to the share and operate model for this joint option. However, the share and operate framework is not the best method of executing asset cost and profit-sharing allocations. A more rigorous approach typically is required to eliminate subjectivity from the process. Such an approach also can be applied to assess the allocations in the horizontal trading exchanges. (Examples include the automotive exchange involving Ford, GM, and DaimlerChrysler, and the aerospace exchange with Boeing, Raytheon, Lockheed Martin, and BAE).

The joint operation approach attempts to ensure that when an entity takes a cost increase in its P&L statement for the betterment of the entire corporation, it is compensated accordingly. All other cost-allocation methods, such as fair share and usage rates, ignore the issue of motivation—that is, why the corporations or participating functional group should accept an allocation that exceeds its independent opportunity cost.

The joint operation methodology is composed of four phases:

1. Joint permutation analysis. This first phase involves estimating a joint cost function for all the possible permutations of corporations that are sharing assets either online or offline. In the case of exchanges, this would include all participating companies. The joint cost function for a permutation is the least total delivered cost of serving all participants in that permutation. The guiding idea behind this activity is to share the cost when all participants work together.
2. Joint incentive plan. Phase two involves the design of a joint incentive plan, in which all entities participate. This incentive plan treats everyone equally in the event of business upswings and downturns. In other words, we need to ensure that the sum of all cost allocations equals the joint cost function for the corporations, and that for every possible permutation the sum of individual allocations is less than the joint cost function for that permutation. The rationale for this is simply to ensure that no participant is charged more than its stand-alone cost.
3. Business validation. In phase three, we ensure that the allocation scheme satisfies some basic business principles. This means making certain that cost functions add up from an accounting standpoint and ensuring that as participant contributions to all permutations increase or decrease, the allocations remain proportionate. It also involves ensuring that the allocations are viewed as universally fair so that no participant would need to renegotiate because of fluctuations in currency values or future hedges.
4. End-goal computation. In phase four, the actual allocation of the costs can be computed by using a variety of methods.⁴ One method that works well when corporations are signed up in random order is to determine the incremental marginal cost of being included at the moment of signing up or being included in the joint operation venture. In this method, the marginal cost is the total cost of that corporation (in an e-market, for example) or a function (in the case of two corporations) relative to the entire participating group.

In helping companies apply the options described above, we have found that the separate and operate approach is the most expensive. In fact, its cost runs approximately three times as much as that of the joint operation option. The share and operate approach provides a middle ground from a cost standpoint. Yet it often proves cumbersome because of such issues as channel cannibalization and scarce-product management. These problems can be overcome, however, through (1) metric-driven executive behavior and compensation and (2) process discipline and open communication among the executives.

The more involved approach of the joint operation option provides the optimized allocation numbers. In addition, it tends to be easy to implement and maintain as business executives and conditions evolve.

There are other differences among the options as well. As shown in Exhibit 2, companies experience a huge gain in incremental business benefit as they move from the separate and operate to the share and operate model. But implementation complexity increases as well. And as a company approaches the joint operation model, it really starts to become a factor. This implies that after a certain amount of joint leverage, the incremental benefit may not justify the improvements in business benefit. The trick is to define your most advantageous position on the complexity curve. To move to a true joint operation, organizations will need to demonstrate total flexibility and adaptiveness.

There is no single option that best defines a solution for any given company. The separate and operate option, for instance, tends to work well for companies that are setting up joint ventures with other partners to enter foreign markets or new market segments. The share and operate and joint operation options work better when the existing supply chain infrastructure can be leveraged across both the physical and online businesses.

The benefits of choosing and implementing the correct model can include fixed and working capital savings that range from factors of one to three over existing levels. We also have found that customer satisfaction in the form of enhanced service and better user experience leads to higher retention levels. These advance from 10 percent to 30 percent as you move from the separate and operate option to joint operation.

e-Commerce and e-markets are fundamentally changing the landscape of businesses. The established bricks-and-mortar brands are fighting back and converting themselves into click and/or walk corporations. In the mad rush to gain ground, many are ignoring some fundamental business concepts. These shortcomings will eventually catch up to them and have a significant (and negative) impact on the overall shareholder value. We need to continue emphasizing that business fundamentals are not going away with the advent of the Internet, but that they need to be adapted to the new connected and digital economy.

Our work demonstrates that only those corporations that adhere to strong fundamentals in finance, delivery chain planning and operations, integrated sourcing, and brand leverage will survive the onslaught of the Internet upstarts and continue to demonstrate healthy growth in market capitalization. These will emerge as the click and/or walk winners.