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It's an easy bet that an Internet entrepreneur won't be Time's Person of the Year for 2000. In 1999, it was Amazon.com CEO Jeff Bezos, whose growing customer base, billions in stock market value, and hearty guffaw exemplified the awesome potential of the New Economy. This year's Web is characterized by plummeting stock prices, thousands of layoffs, fleeing senior execs, and shuttered sites.
Wondering how the dot-com boom could turn to bust in a just few short months? Follow the money. While the current Internet meltdown has several root causes, probably the most fundamental is greed.
The Net boom started, rightly so, with some exciting new technologies and entrepreneurs' often vague notions that a feature -- such as a search engine or a huge online catalog of books -- could be turned into a profitable business. Venture capitalists came in and threw money at those ideas. As a business emerged, investment bankers sold stock to an all-too-eager public. With only a limited number of shares available, stocks of these exciting new companies soared, and Net mania was born.
SMART MONEY, DUMB IDEAS. The flood of money that followed funded even more ideas, including some that didn't really make sense, and others that were just copying someone else's good idea. "Basically, there became a funding frenzy," says David Suzuki, partnership director for VC firm Worldview Technology Partners. "That allowed a lot of companies that should not have been funded to be funded -- and they got funded substantially."
Still, venture capitalists were able to reap huge returns as investment bankers pushed fledgling businesses out the IPO door at an ever-earlier stage in their development. Wall Street analysts wrote glowing reports, and journalists (mea culpa) penned breathless stories about the companies' huge potential.
All that money attracted a new type of Internet entrepreneur. "The first generation of Internet executive was not at all into greed," says Eric Kintz, project manager for the e-commerce practice at consulting firm Roland Berger & Partners. "It was a true adventure. The later generation of executive was clearly attracted by the huge market caps and the options," he says. "From 1994 to 1998, it was a question of changing the world. By 1999, there was more of an element of greed."
LOSS LEADERS. The money also attracted a new type of investor. Through 1999, dot-com stocks traded at ever-higher prices on valuation measures that had nothing to do with profits. Companies were rewarded for attracting "eyeballs" (industry jargon for Web-site visitors), locking up Internet "real estate" (forming expensive partnerships with dominant portals), and gaining "share" of what was forecast to be a gargantuan online market.
"They were told not to worry about profitability, to go for market share, and they would reap the benefit of leadership later," says Peter S. Cohan, a Marlborough (Mass.) Internet consultant. At one point, Amazon's market cap was more than the total value of all books sold by all retailers in the English-speaking world. No problem. Amazon quickly expanded into new areas, such as electronics. Others, like Priceline.com, followed suit, moving from airline tickets to selling groceries and gasoline online.
"They thought once they got [customer] names in their database, they could sell people anything," says David Sable, president and CEO of database-marketing firm Impiric New York. "The catalog industry knew for years that wasn't true." Meanwhile, to gain the all-important market share, e-tailers began rampant discounting -- another flawed strategy, says Sable. "Retailers know if you get someone to buy on a discount, the chances of getting them to buy a premium product are pretty low."
ADS RUN AMOK. Internet startup managers became convinced that the traditional rules of business no longer applied. Instead, they listened to Wall Street's siren song: Don't worry about mounting losses -- spend money on marketing. With the cacophony of competing dot-com ads reaching a crescendo, companies resorted to sometimes whimsical, sometimes shocking, ad campaigns that did them little good.
"I was nauseated," says Sable, who points out that the ads often had no relation to the company's product or service. "It was advertising run amok." Thinking back to the Super Bowl last January, when unprofitable dot-coms spent an estimated $2 million a piece per spot, he says, "The amount they spent was based on what they had to spend. They should have spent a lot less, targeted more, and allowed for a slow build of their business."
As the new millennium was ushered in, greed became pernicious. There probably wasn't anyone tied to the industry who thought the mania could last. Even the most bullish analysts, such as Henry Blodget of Merrill Lynch, stated that the vast majority of Internet companies would eventually disappear. Investors bought stocks for no other reason than that they were going up -- hoping to sell at the top after one more doubling of the share price.
CLUELESS OPERATORS. In the meantime, entrepreneurs founded new companies, not because they loved, or even knew, the business, but because they hoped to sell out to a bigger company in an anticipated wave of consolidation. Consultants and investment bankers from traditional businesses jumped online to make millions, perhaps a little late. "In the business-to-business (B2B) world, you had people starting online marketplaces who didn't have any idea how that business -- for example, a meat market -- was operated offline," says Kintz.
Around March, the virtuous cycle turned vicious. Signs started to crop up that the economy and Internet growth rates were cooling. As second-quarter results at companies like eBay and Amazon proved that revenue growth was slowing dramatically, investors suddenly wanted out. The IPO market dried up. Without hope of taking Net startups public, and with the value of their own funds sinking, VCs stopped funding risky ventures. Eventually, the investment banks wouldn't help raise money for the very same companies they had brought public a year earlier.
Startups with fancy offices, hundreds of employees, and lavish marketing plans were stranded with unworkable business models -- and no closer to turning a profit than they had been when first hatched. Many are closing shop. On Nov. 16, WebMergers.com, which helps dot-coms find buyers, reported that 130 Internet companies had folded since January. Moreover, the rate of closings is accelerating, with 21 companies closing in the first two weeks of November.
NO MONEY, NO BUSINESS. Many dot-coms are trying to reduce their spending, cutting off advertising and slowing equipment spending, which is hurting the industry more and creating ripple effects in hardware, telecom, and media industries. "Everything in the industry is connected," says Scott Kessler, an Internet analyst with Standard & Poor's equity research group. "There is a domino effect."
Instead of digging in their heels, some top-flight managers from traditional businesses are bailing out. "Some people were expecting to get millions from it," says Kintz. "Now it is often just a case of managing a restructuring." Cohan concurs: "They got in too late. They did it because they wanted to make a whole bunch of money really fast. Now the money isn't there, and there isn't even a business to manage."
Meantime, investors are getting tougher and tougher. First they just demanded dot-coms show a "path to profitability," says Kessler. Now they also want to see "reasonable valuations" relative to their offline peers. Even Internet companies with a viable business model that might take a few years to develop are suffering. "That is the irony of this whole market," says Kessler. "Companies were pushed out too early -- and now they are being expected to deliver too early."
"DOING A BOOMERANG." The new world of the Internet? Investors who wanted to make a quick buck are gone, says Cohan. Also leaving are the employees who have seen the worth of their stock options evaporate. "Employees who left secure jobs in non-dot-coms are now doing a boomerang and trying to go back where they started and hoping there will be a job for them," he says.
That is just one of the ways the shakeup is creating opportunities for traditional companies to build dot-com businesses. With established brand names and the racket of competing dot-com startups subsiding, they have the deep pockets to build Web sites without Wall Street's help. Take Wal-Mart, which is only now making a serious effort to sell online. "Going forward, it is going to be much more important and interesting to see how more traditional companies use the Internet to advantage in their businesses," says Rob Leathern, an analyst with Jupiter Research.
Many analysts argue the dot-coms' boom and bust was inevitable. "I honestly believe you need this whole chaos and hype to generate one successful model," says Kintz. Some companies that played their cards right will surely make it through the shakeout. And others remain to be founded on viable business models, with the lessons of earlier mistakes to build upon.
Now that the greed is being ground out of the Web, you can bet that the new dot-com investors and entrepreneurs won't be so obsessed with making quick fortunes. But there's still plenty of opportunity to build a valuable brand, create some decent jobs, and -- yes -- make some money on the Web.
Associate Editor Stone follows dot-coms for Business Week Online Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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