OCTOBER 5, 2000
SPECIAL REPORT--THE NET'S FUTURE
Analysis by Amey Stone
Beyond Today's Turning Point for Net Business | As the Web's weak pure plays keep falling away, and strong bricks-and-mortars gain, a sound business model will be the only means of survival
| It looked like just another manic Wednesday on Sept. 27, when Priceline.com warned that it would miss -- ever so slightly -- analysts' estimates for the third quarter. In these days of such volatility, the 42% one-day drop in Priceline's stock price was hardly that unusual. But taken another way, the company's miss signaled a new turning point in Internet business.
Sure, since March, plenty of Internet stock values have plummeted, dot-coms have laid off thousands of workers, and many online retail businesses have closed shop. But those problems could largely be brushed off as an inevitable outcome of the speculative excess that marked the Web's early history. The problems were largely confined to dot-com startups with ridiculous business models, inexperienced management, and profligate marketing strategies.
Priceline, in contrast, was supposed to be different: a bona fide Web success story. It set up a new kind of auction that only the Internet made possible, where consumers could name their own price for airline seats and other goods and services.
ET TU, PRICELINE? Now analysts are speculating: If Priceline can't yet make it to profitability, where does that leave all the other Web pure plays? Internet stocks, which had been basically dead in the water since April, fell another peg on Sept. 27, with some of the biggest percentage losses suffered by other true Web standouts like Yahoo! and eBay.
Investors shouldn't have taken Priceline's bad news as a sign that trends for businesses serving consumers were deteriorating even further, argues Robertson Stephens analyst Lauren Cooks Levitan in a research note. Trouble is, she says, "it most certainly was interpreted in exactly that way."
The warning signs don't just include deteriorating Web fundamentals. At the same time that dot-coms are struggling, many traditional companies have figured out how to use the Net to make a lot more money. Consider Southwest, the airline that announced on Sept. 11 that it had already done $1 billion in ticket sales over its Web site in 2000 and expects to save $80 million this year through online bookings.
LEARNING FROM MISTAKES. In fact, analysts believe one reason Priceline's sales growth lagged behind projections is because traditional airlines have gotten so much better at selling seats over their own sites. That dynamic can be seen all over: Dell Computer is thriving by selling computers online, while electronics e-tailers are failing. Merrill Lynch and Morgan Stanley Dean Witter are bringing their massive customer bases online, while discount Web brokers are floundering against mounting competition and higher customer-acquisition costs. And bricks-and-mortar department stores like Wal-Mart are finally stepping up to the plate to build ambitious new Web arms, while e-tailers are going bankrupt.
The reasons more traditional companies are succeeding on the Web while dot-coms struggle are complex. But they usually have something to do with moving to the Internet later, allowing these companies the benefit of seeing mistakes the dot-coms made earlier. With corporate parents that held back on cash, bricks-and-clicks couldn't dig too deep a financial hole.
Now the latercomers' income base provides them with resources at a time when capital markets are drying up. "These companies get to sit back and figure out what is going to work," says Tim Clark, a senior analyst at Jupiter Communications. "Then they step into a proven market with bigger resources."
STUDIES IN CONTRAST. General Electric seems to be doing just that. In March, while stocks of so-called business-to-business exchanges were plummeting, it ponied up hundreds of millions to create GE Global eXchange Services. The new company grew out of GE Information Systems, which already does more than a billion electronic transactions a year totaling $1 trillion in sales of goods, generating more than $250 million in revenues, says Harvey Seegers, president and CEO of the division. Now it's bringing that liquidity to the Web, with the August launch of its Express Marketplace.
In contrast, startup Ventro, which created several B2B exchanges from scratch, is struggling. Its stock, which soared as high as $244 in February, fell to $9 after trading over its online marketplaces failed to ramp up this year. "In general, there is an awakening taking place that all of this is a lot harder than people thought," Seegers says.
This isn't to say that all traditional companies have the answer to doing business on the Web -- just certain very well-managed ones. To thrive on the Web, a company needs "a new breed of manager" who has an entrepreneurial spirit and isn't afraid to junk old plans and change directions on a dime, says Eric Kintz, head of the e-commerce practice at Roland Berger & Partners, a global management consultancy. Agrees Peter Cohan, whose Marlborough (Mass.) firm consults to businesses on Internet strategy: "Ones that aren't that well managed in the offline world aren't going to be able to put anything that spectacular together in the online world."
HYBRID VIGOR. In fact, it's increasingly clear that all companies need a combination of "real world" and online assets. Not only will traditional businesses beef up their online components but it's also likely that more dot-com pure plays will morph into the bricks-and-mortar world. In this context, America Online's pending acquisition of Time Warner, which seemed bold when first announced, now looks positively prophetic.
Amazon also raised eyebrows when it announced in August that it's partnering with Toys 'R' Us to create an online toy store. Amazon will handle the site development, while the giant retailer will oversee product selection and inventory management. The deal makes sense because it allows each company to focus on what it does best, argues Greg Kyle, president of Internet-research firm Pegasus Research.
Randy Selman, CEO of Visual Data, a producer and distributor of multimedia content on the Web, believes dot-com pure plays will survive online if they provide a service to the bricks-and-mortar world. For example, he thinks Yahoo! will win because it can deliver an audience to traditional businesses' Web sites. But Selman believes Amazon and other e-tailers are in trouble, because they compete head-on with the traditional companies.
FUNDAMENTALS ARE BACK. Folks such as Selman are suddenly sounding more like seasoned professionals than Internet naysayers. Mounting evidence suggests that the fundamental business questions that were brushed aside earlier during the Internet gold rush have a sound basis. Isn't e-commerce really just another form of catalog shopping? Kintz believes only 10% of commerce will migrate online. Does advertising on the Internet do any good? Perhaps not when so-called click-through rates on banner ads average less than 0.5%.
And on the B2B side, why would suppliers want to participate in new industry marketplaces being set up when such pure competition clearly puts them at a disadvantage? Out of roughly 6,000 online industry marketplaces today, only 75 have any liquidity, Kintz says.
Chalk it up to experimentation. Just one problem: "The way I look at it today," Cohan says, "the Web is the most expensive petri dish in human history."
LESS THAN ZERO. Surely, some Web sites will be hugely successful. But to date, when a concept has worked, the Web's low barriers to entry have allowed too many new startups to jump in, creating the kind of competitive pressure that has driven businesses to give away services or massively discount goods (consider online-trading commissions going to zero). And while companies such as Priceline and Amazon that were first to market with good ideas have held their lead, they expanded too quickly into areas that seem less suitable for their strategies: Amazon into hardware and tools, and Priceline into groceries and gasoline.
Once swimming in venture capital, dot-coms now are facing a cash crunch. "A lot of companies out there still don't have sustainable models," Kintz says. "They are going to run out of cash." While some dot-coms have slowed their spending, Web companies in aggregate actually burned through a bit more of their precious cash in the third quarter than the second quarter, $1.8 billion vs. $1.7 billion, according to Pegasus Research.
There's still enough capital flowing into the sector to keep alive the companies that have viable business models, but some are "getting by on fumes this year," Pegasus' Kyle says. "Companies were spending aggressively without any thought to profitability. Suddenly, in the space of three months, they have to wake up and realize there's no guarantee that the capital markets will always be open."
TOO FAR, TOO FAST. It appears that Internet time has come back to bite the Internet. "My expectations were far exceeded the first two or three years," says Mike Levy, CEO of CBS SportsLine, adding that in 1995, he never would have guessed the Web would attract so much money and grow so fast. "Now all of us are spoiled." The last two years, he expected high-bandwidth connections to homes to be ubiquitous, along with wireless access that works well. He believes his fast-growing, but still money-losing site will benefit as those technologies are eventually rolled out.
A whole new wave of companies are pinning their hopes on broadband and wireless services to create new Internet business models that work. For example, Tsola, launched in July, is writing Internet software that will deliver relevant Web content, such as traffic reports and directions, directly to wireless devices. Tsola CEO Sunir Kapoor believes portals that partner with his company will be able to charge for this service. "Mobile professionals feel enough pain and will be willing to pay real money to have access to this service," he believes.
Some sites, particularly content-oriented companies following a media-business model (which takes years to reach profitability, both on and off the Web) may simply need more time to turn their massive audiences into profits. Mari Baker, general manager of BabyCenter.com, a division of eToys that provides information and sells goods to parents, says experience is teaching the company what will work on the Web (such as its best-selling item, a $250 breast pump) and how to reach its target audience. Already three-year-old BabyCenter boasts that it attracts one-third of all pregnant women in the U.S. to its site. "That seems pretty successful to me," Baker says.
"STAYING FOCUSED." Meanwhile, a new group of companies is coming to the Web, one that is perhaps less ambitious but more realistic than the first generation. Zoho, for example, runs an online marketplace for the hospitality industry. That means automating hotel functions and putting handheld devices in the hands of housekeepers to help them stock soaps and towels more efficiently.
This may not sound that exciting, but Zoho is building a service the hotel staff will use every day, says its president, Bill Fraine. "We're staying focused and not getting caught up in a get-rich-quick scheme and building a real business," he says. "Today that involves a Web site. Maybe tomorrow we'll find a new way."
Stone is an associate editor of Business Week Online
Edited by Beth Belton
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Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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