01/19/98 COMMENTARY: HAS NETSCAPE HIT THE 'INNOVATION CEILING'?

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COMMENTARY: HAS NETSCAPE HIT THE 'INNOVATION CEILING'?

Netscape Communications Corp. was supposed to be the next Microsoft. Its trailblazing World Wide Web browser and lightning pace of development helped reset the thinking of the entire computer industry--and earned it an overwhelming 85% share of the Web browser market, to boot. It was Netscape that pioneered the Internet business model of giving software away to build up market share and then sell related products. The company even posed the first serious threat to Microsoft in years--and forced the software giant to double-time its Net efforts.
Oops. On Jan. 5, Netscape shocked Wall Street by disclosing that it expects to post a loss of up to $18 million in the fourth quarter because of a steep drop in Web-browser sales and fierce price competition for server-software sales from Microsoft Corp. and IBM. The Mountain View (Calif.) company says it expects revenue of $125 million to $130 million--far below earlier expectations of $165 million. That's because Netscape's browser sales fell 37%, to $17 million, in the fourth quarter, vs. $27 million in the previous quarter. A key reason: Microsoft copied Netscape's plan, giving away its Internet Explorer while the startup began charging a few dollars. And now, Netscape is down to a 60% share.
''LINE OF FIRE.'' Where does this leave Netscape? In a jam. While the company still has promising technology, it may not have the financial might to go up against rivals that can afford to heavily discount products without a blink. If giveaways persist, Netscape's best chance may be to either focus on a niche or sell out to a company that can afford these high-stakes Web tactics. ''You don't want to invest in the line of Microsoft's fire,'' says analyst David Readerman of NationsBanc Montgomery Securities.
That's chilling news for Netscape, but it could be even more so for the industry. Netscape's fourth-quarter loss raises the specter that startups, no matter how innovative or pioneering, can't cut it in these digital times. Today, all tech companies are Web-obsessed, especially the deep-pocketed titans such as Microsoft, IBM, Oracle, and Sun Microsystems.
Microsoft Chairman William H. Gates III may be right when he says that innovation in the computer industry has not been stifled. But Netscape shows there is an innovation ceiling. Tech startups can thrive if they pick a lucrative niche. Venture into a potential megamarket, however, and bigger competitors will stomp on you but fast. Thus the chances of a young company growing into a multibillion-dollar giant such as Compaq Computer Corp. or Cisco Systems Inc. are becoming rare. Instead, hot cyber-startups such as WebTV, Hotmail, and Diba Systems are selling out to the big guys, Microsoft and Sun.
In the digital age, volume equals power. The captains of today's technology heavyweights--Gates, Oracle's Larry Ellison, Sun's Scott McNealy, and IBM's Lou Gerstner--are great believers in the power of PC economics; that higher volumes enable them to spread costs over a larger base and therefore charge less for their products. ''Competition has heated up in terms of intensity and on the price side,'' says analyst Alan Braverman of Credit Suisse First Boston. ''Gates has been in the industry for a while, and he has ratcheted up the intensity, cut prices, thrown more bodies at it, and done more marketing.''
Netscape CEO James L. Barksdale understands PC economics, too. He brought the ultimate version of it to the Internet--giving away Netscape's Web browser to capture market share. But he abandoned that strategy to shore up short-term revenue. Netscape may thrive as a niche company that sells complex Internet setups to large corporations, but the company will have trouble keeping up with Microsoft and IBM without big browser volumes. ''If you don't own [browser] market share, you don't sell servers or get the benefits of traffic from the Web site,'' says Merrill Lynch & Co. analyst Bruce Smith.
Barksdale doesn't agree, although he says he is considering going back to giving the browser away to stem the drop in Netscape's market share. He says the company is now focusing on server software for electronic commerce and building computer networks that let companies share information with clients and partners. ''We don't see that as nearly as competitive a marketplace as the others we're in,'' he says. Barksdale keeps trying to move Netscape to higher ground, but he keeps bumping up against the innovation ceiling.
By Heather Green

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