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Making Money on the Internet
The Internet is a lot of fun. Even the terminology employed to describe its use-"surfing the Web," for instance-is rooted in leisure. And yet, as a great many entrepreneurs and venture capitalists have discovered over the past two years, having fun isn't enough. There is also the troublesome little matter of making money. It's a problem that has been, to put it colloquially, one tough nut to crack.
Worse, it has been almost impossible. "One thing that is clear, almost a decade into the commercial Internet, is how hard it is to make money," observes Robert X. Cringely, host of the popular PBS technology program "I, Cringely." "ISPs, with the exception of AOL and maybe Earthlink, just scrape by. EBay makes money, as do some online brokers and travel sites, but most of the other profits go to equipment and software providers, not to Web sites or data services."
Indeed, "we have been through half a dozen business models in search of one that really works. Portals, search engines, B2B (business-to-business), B2C (business-to-consumer), P2P (peer-to-peer), industry-specific exchanges, and banner ads have all pretty much come and gone," he says. "Yet every month there are more people online. Internet use is now up to 170 million in the U.S. and 400 million worldwide. Surely, with numbers like those, there ought to be many ways to make money."
Seems reasonable enough. But if so, why have so many Internet companies gone broke in the race for the gold? Cringely offers two reasons: "First, like any new information industry, it takes time to find what you are good at. Alexander Bell intended his telephone to be used to bring music to remote audiences. Television was supposed to be a videophone. Second, the people who have been leading this process of discovery, the venture capitalists, generally don't know what the heck they are doing."
Well, one can't accuse Cringely of mincing words. Indeed, I would go even further, adding another pair of items to his list. The third explanation would be bad management. Small and startup companies in any industry, as a rule, tend to suffer from weak management, due largely to the inexperience of their owners. But Internet companies, often run by young and idealistic technologists with little business background, have been particularly prone to such difficulties. Flush with money in a great many cases, they also have been less diligent in implementing such necessary business practices as budgeting and realistic long-term forecasting.
Paving the Way to Profitability
A fourth reason for the sufferings of the Internet sector, I am convinced, is an unwarranted degree of arrogance. While confidence in oneself and one's ideas is an essential ingredient in any business undertaking, and while most Internet company executives have been diligent and prudent business leaders, the Internet sector has experienced more than its share of the "I'm king of the world" mentality. The personal diaries of Internet refugees are filled with stories of chief executives who thought they could suspend the rules of economics, were convinced that they knew more than the people they were trying to sell to, or were blindly confident that they could almost instantly transform human behavior in ways that other business ventures, over decades, had been unable to accomplish. For far too many, these over-confident beliefs proved only to be an illusion.
But these managerial problems notwithstanding, there are also a number of more substantive reasons why such a large number of Internet companies to date have failed to make money. As the managerial expertise in Internet companies matures and as the flagging U.S. economy recovers, it is vital for would-be Internet entrepreneurs to master these more substantive challenges if the Internet is to live up to its financial promise. If these companies fail to do so, the Internet economy may well be in for more dark days ahead. But if Internet companies take these challenges seriously, there is every reason to expect that the Internet sector will become just as profitable and enduring as every other major sector of the American economy.
Herewith, then, a few suggestions with which, I am convinced, entrepreneurs and investors alike can pave the way for greater Internet profitability in the years ahead:
1. Develop a business model
It seems so basic, but a great many of the Internet sector's profusion of startups lacked even this simple element: they developed splendid and intriguing technologies, but failed to devise any effective way to make money with that technology. Among the greatest offenders in this regard were the free Internet services, like online calendars and email providers, that lost more money with each new customer they recruited, since their per-user marginal revenue fell far short of their marginal costs. It wasn't surprising, therefore, that almost all of these companies either went out of business in 1999 and 2000 or else were absorbed by portals or other broader technology ventures. Indeed, even venerable land-based businesses, like Day-Timer (which knew a thing or two about calendaring and maintained a very successful packaged software business), failed to translate their established brand into Internet riches with the "free services," model, and so ultimately abandoned their online efforts.
In the face of this experience, it is encouraging that a lesson appears to have been learned: many of today's most promising Internet businesses, like Salesforce.com and WebEx, are subscription-based services that actually charge customers for using their services, and that make a significant per-unit net profit for each new customer they sign up because their fee structure is designed from the start to generate marginal revenue in excess of marginal costs. Web-based subscription services like these are almost certain to be an important part of the Internet's future, and both entrepreneurs and investors would do well to begin exploring this model more thoroughly.
2. Develop a business model that makes sense
Among the many troubled segments of the Internet industry, at least the online commerce companies did succeed in developing a business model, one in which they would make money by selling products over the Internet at a lower cost (or at least with greater convenience) than what land-based retailers could provide. The idea sounded great in theory, and in some product sectors, particularly commodity products like books, music CDs, and airline tickets, the concept has actually worked well in practice.
But in other segments, the commercial equation proved less compelling. Sites like Furniture.com and Living.com were attractive and well-designed, but most potential online customers, it turned out, were not inclined to buy expensive home furnishings, whose value depends so much on comfort and the touch and feel of the fabric, without first examining samples of these items in person. No surprise that companies like these eventually went out of business, and that most of the segment's survivors, like Pottery Barn and Restoration Hardware, are the online companions of successful land-based retail stores. Likewise, companies like Pets.com and Petopia, though backed by experienced leadership and exceptionally well-executed marketing campaigns, failed because their products were not well-suited to online buying.
Companies that wish to sell online therefore should think carefully about whether their customers would be likely to buy online. If so, then an e-commerce venture may be worthwhile. If not, then other avenues should be pursued, such as providing product descriptions with links to retail stores where the products can be found, selling gift certificates, or providing content that helps not only to reinforce one's brand, but that conveys information that makes readers more likely to buy the products being marketed.
3. Think big
One of the earliest proposed principles of online success was something called "first mover advantage," the notion that the first horse out of the gate would win the race. There was something to the idea, but it was somewhat misstated. Merely being first to the Internet market wasn't enough. The key was being the first with an offering that added significant value to the customer's life-a value often rooted in the breadth and depth of the offering.
Consider the book market. Just as superstores like Barnes & Noble and Borders crowded out small independent booksellers in the land-based world, the earliest bookselling successes on the Internet were the online megastores. However, Amazon, the undisputed bookselling leader, wasn't the first to market. A company called Books.com, at the time a part of the Netmarket.com portfolio, had appeared a few months earlier, offering an inventory of more than a million book titles. While this was far more than lined the shelves of any land-based retailer, one could just as easily order the same titles from the customer service desk of the Barnes & Noble or Borders retail stores. Then along came Amazon, which not only offered an equivalently massive product selection, but included site features like customer reviews and collaborative filtering that added appreciable value to the customer's book-buying experience. Amazon thought big-not just in terms of sheer numbers but also in terms of concept-and won out as a result.
4. Think small
While some of the largest e-commerce companies have failed, thousands of smaller companies not only survive but do quite nicely. While few of the executives in this latter group of firms are becoming multi-millionaires, most are making a comfortable living because they have grown at a pace that their business model and resources could sustain. In the toy retailing field, for instance, despite selling more toys online than any other company during Christmas 2000, eToys collapsed because its costs of operations were too high. Yet scores of specialty toy companies, including catalog retailers like HearthSong and Toys to Grow On, are thriving online because their inventory and distribution costs are much lower. In fact, some of the Internet's most profitable retailers (in terms of percentage profit) are the proprietors of Yahoo! stores or Amazon zShops or who are active sellers on eBay. Although these businesses' revenues are dwarfed by those of the online superstores, their operating costs are minimal, resulting in a significant per-unit profit margin.
5. Minimize distribution costs
One of the most publicized Internet failures during 2001 has been that of WebVan, the online grocery delivery company that, at its height, had an operating or planned presence in more than 20 major U.S. metropolitan areas. Its site was well-designed and its product selection adequate, but the well-financed company was ultimately overwhelmed by the costs of hand-delivering groceries to a widely distributed customer base. Unfortunately for WebVan, attempting to recover the delivery costs through high delivery charges would not have made sense, for it would have risked eviscerating the company's already tenuous revenue flow. The business model, in short, was never really workable. Contrast WebVan's collapse with the growing success of NetFlix, a DVD-rental service that allows customers to view as many movies per month as they want-and for as long as they want-for just $20. The catch: customers can "check out" only three movies at a time, and must return them before they can receive more. NetFlix's cost-control secret: rather than distributing the movies by hand (as not only WebVan but failed local delivery service Kozmo did), they deliver the DVDs by ordinary mail, resulting in a very low-cost operation that yields significant profit margins.
6. Minimize marketing costs
During the 2000 Super Bowl, the majority of the event's very expensive television ads were purchased by Internet companies-perhaps the most pronounced symbol of the marketing extravagances of the dot-com era. Now, recognizing their life-or-death need to conserve cash, Internet companies have largely abandoned the Super Bowl, and many have turned to much more cost-efficient if less spectacular marketing techniques like direct email, pay-per-click banner advertising, and affiliate programs. Other Internet companies are building cost-efficient marketing strategies into the very fabric of their enterprises. Robert Cringely points to the example of a new Internet real estate venture called Wheretolive.com, which creates Web sites for real estate agents. In contrast to consumer-oriented real estate sites like Homestore.com, which despite spending tens of millions of dollars are yet to turn a profit, Wheretolive.com expects to become profitable only a year after its founding, primarily because of its minuscule marketing costs. The key to the company's financial success: it markets to individual agents through relationships with the large agencies (one client boasts more than 6,000 individual agents), allowing the firm to conduct very focused and low-cost marketing campaigns with a high rate of return.
7. Minimize operating costs
While the deaths of high-profile Internet commerce sites have been widely reported, a less often noted area of failure has been that of Internet content sites. From Web-based entertainment ventures to online magazines like Slate and Salon, virtually every Internet-only commerce company has either gone out of business or limps along on a long road to viability. A key reason: operating a daily or weekly original content business, regardless of the manner in which the content is delivered, is very expensive. Scores of writers and editors are required for a content site, and generally none of their output directly produces any revenue-the content is merely a lure for viewers, whose numbers can then be publicized in order to attract paying advertisers. Video production like that employed on the Web entertainment sites is even more expensive, which explains why so few online entertainment companies are still in operation.
Indeed, virtually the only online content companies that have succeeded-like BusinessWeek.com, WSJ.com, and CNN.com-are those that have been able to repurpose and draw upon content created for other media, like established print publications or broadcast outlets. Likewise, the highest e-commerce success rate has occurred among retailers with an established presence in the land-based, catalog, or television home-shopping arena, precisely because these companies already possess product sourcing, inventory, fulfillment, and related operations-a major component in the startup costs of online-only retailers. The multi-channel strategy can even work in the reverse. For instance, some of the most successful Internet retailers, like the online gift store Red Envelope and art and accessories retailer eZiba, have begun to distribute paper catalogs, while other retail companies, like Paris-based Sephora.com, have used their online success as an entry point for opening land-based retail stores in the United States.
8. Differentiate yourself
Amazon, as noted above, succeeded in dominating the online book market not just because it offered a larger book inventory than its competitors, but because it presented its inventory in unique ways, with customer reviews and personalized recommendations, that proved exceptionally compelling to book buyers. In the same way, eBay provided its customers with the unique ability to attend what were in effect virtual garage sales throughout the world from the convenience of their own computer. And Priceline.com, though not without its own financial struggles, defined a unique "name your own price" auction concept that has helped it to remain one of the leaders in the online travel services industry while other top-tier online travel companies were either forced to merge (e.g., Preview Travel) or shut down (e.g., BizTravel).
As important as it is, however, differentiation can be carried to extremes. Some Web ventures-the original Boo.com comes to mind-were unique to a fault. But while beautiful to look at, Boo and its kindred were slow to load, difficult to navigate, and in general offered quite unrewarding shopping experiences. In other words, their uniqueness (unlike Amazon's or eBay's) failed to deliver customer value. It is for this same reason that e-books or online entertainment are not likely to succeed in their current format, because-while unique-they add too little value to the user experience while demanding fundamental (and not terribly pleasant) changes in the ways in which people normally read or watch entertainment programming. On the other hand, online news sites and live broadcasts have been more successful because the value they deliver-such as their depth, random lookup capabilities, and particularly immediacy-go a long way to compensate for the unpleasantness of having to read long passages of text or watch staccato video on a small computer screen.
9. Deliver unique value
Yahoo! and other Internet portals originally addressed a pressing need: to organize the Internet's vast store of information, and to make it easy for Internet users to find what they were searching for. As they grew, however, portal companies acquired a grandiose vision of becoming media giants along the lines of NBC or Time-Warner. A scant few-Yahoo! and AOL, for example-can legitimately claim to have achieved this status. But most of the others became indistinguishable aggregations of syndicated data sources that were available in numerous places on the Web. Why, for instance, would one go to Lycos to look up weather data licensed from Wx.com when the same data was available, just a click away and in much richer form, at the Wx.com Web site? At best, portals evolved into the equivalent of a cable television system with exactly one broadcast channel, one news channel, one comedy channel, one movie channel, and so on. If you happened to like the channels offered, great; if not, you had to look elsewhere.
Worse, in the process of trying (and generally failing) to become media companies, portals allowed their main value to languish. Their Web site directories became filled with so many hundreds of thousands of trivial sites that it became hard for users to quickly locate the best sites. Portals search engines likewise began delivering reams of meaningless or inconsequential search results. But where the portals failed, other sites stepped in to fill the gap. Google became one of the most popular search engines because it did one thing-search the Internet-and in the process delivered vastly superior results compared to what was previously achievable. Dedicated industry portals, like CEOExpress for general business use, AccountingWEB and CPADirectory for the accounting profession, and Law.com and Hieros Gamos for the legal profession, now provide much richer access to industry-relevant information than do the major portals. And a number of specialized search tools, like SearchBug and FindArticles.com, do a much better job of directing Internet users to specific types of information than do the more general search engines. These newer vintage sites, in short, deliver unique value that once was the exclusive province of Internet portals, and so continue to chip away at portals' perceived value for a great number of Internet users.
10. Don't even try to make money on the Internet
In the early days of e-commerce, Web sites that did not attempt to sell something or to otherwise "monetize eyeballs" through sales of ad banners were derided as merely re-purposed marketing brochures. In retrospect, that was an inappropriate accusation: marketing brochures and other non-sales related vehicles serve a very valuable business function, both online and off. Consider: most television and magazine advertisements never sold any products or services directly, but few analysts would question their commercial importance. To create a double standard for the Internet-to require Web sites to conduct commerce just because it is possible-is to ignore some of the Internet's greatest potential.
In fact, a well-executed marketing Web site can serve a range of commercially vital purposes. A number of computer software sites offer helpful interactive tours or downloadable "test drives" of their software-a very cost-efficient method of promoting the sale of a product, even though the ultimately transaction may ultimately take place at an online or land-based retailer unaffiliated with the software vendor's Web site. Similarly, one of the most exquisitely designed commercial Web sites-that of Mercedes U.S.A.-sells nothing online, and yet the site's rich images and depth of technical information surely do a great deal to persuade the site's visitors to consider buying a Mercedes. In other words, there is nothing wrong with using a Web site solely as a marketing or information-capture tool as long as the appropriate expectations for the site are established ahead of time and as long as the site's strategy is closely integrated with the rest of the company's marketing and sales program.
10. Don't even try to make money on the Internet
During the mid-1990s, the emerging Internet economy was often referred to as "the new Gold Rush," an apt comparison since both the Gold Rush of the 1840s and the Silicon Rush of 150 years later were centered in the San Francisco Bay Area. The comparison is even more apt since, as in the Gold Rush of the 1840s, a few Internet prospectors during the 1990s became fabulously wealthy, some continue to struggle along, and a great many others have gone broke.
But there is also a profound difference between the two periods. The Gold Rush of the 1840s was a one-time event-an aberration-and the hunt for gold did not become a permanent part of the American economic landscape. The Silicon Rush of the 1990s is likely to be much more enduring. Indeed, even though the initial Internet Gold Rush is over, if Internet firms follow prescriptions like those outlined above, the Internet and the companies that exploit it are apt, in the years to come, to generate innovations, wealth-and, yes, profits-as yet untold.
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