Business Week e.biz -- Special Report
What's the Trick?
Some dot-coms are actually making money. And others predict profits this year
When Bob Diener, the president of Hotel Reservations Network, talked to investment bankers last year about taking his company public, they chided him for turning a profit. In their view, his Web site--which helps consumers make discounted hotel reservations--should have been spending millions on marketing to spike sales. "We told them that's not the way we did business," says Diener.
No kidding. Thanks to the company's tightfisted ways, HRN got to have its cake and eat it too. Though it lost $9.7 million last year, it has since turned the corner. In the first quarter this year, it made $1.2 million on revenues of $55.3 million, which more than doubled from $22.9 million a year earlier. Diener's shareholders sure aren't complaining: HRN's stock has climbed to $37 since it went public in February at $16.
And you thought all that Net companies knew how to do was lose money. Sure, many of the highest-profile Web upstarts have been spilling tankerloads of red ink. That's because investors were willing to tolerate huge operating losses while pioneers like Amazon.com Inc. tried to claim early control of what is expected to be a $600 billion consumer Internet market by 2005 (up from $45 billion today). Investors are having none of that now, pummeling the stocks of consumer sites 50% or more since the beginning of the year.
So it may come as a shock that there are Internet moneymakers. While many startups are burning through cash, others like Diener's HRN have built sound, profitable businesses. They offer a glimpse of what's possible if Web execs abandon their get-big-fast-at-any-cost strategies and get back to business basics. "There is only one real way to evaluate companies in the long run: profits," says Daniel H. Schulman, CEO of Priceline.com Inc., who says his company will hit profitability by yearend.Quiet surprises. Who are these Men in the Black? To find out, we asked research firms First Data/Thomson Financial and I/B/E/S International Inc. to compile earnings estimates for 350 Internet-related companies based on the projections of Wall Street analysts. We screened for those companies that were profitable in 1999 as well as those expected to make money this year or next. The search turned up some familiar names, including Net-access star America Online Inc. and uber-portal Yahoo! Inc. But the real surprises are a group of smaller, quieter companies like Multex.com Inc., which collects and distributes financial data for businesses and consumers.
Of course, Wall Street earnings estimates are just that, estimates. There's no guarantee that the companies analysts think are going to turn a profit in 2000 and 2001 will actually do so. Most Street analysts are spoon-fed their financial projections by the companies they cover. So in effect, most of these companies are themselves projecting profitability.
On first glance, the group seems a random mix of Web heavyweights and obscure niche players. They do share, however, some common traits. For starters, experience matters. Older, more seasoned managers are much more likely to lead a company to profits than scruffy twentysomethings. The 41-year-old Diener spent 10 years managing hotel and airline reservation businesses before trying to make HRN a profitable Net company. Perhaps most important, making money starts with the right attitude--an Old Economy stinginess when it comes to adding employees or managing marketing programs. "Dot-coms may play paintball in the cafeteria, but these are dead serious businesses," says Priceline's Schulman. "They require discipline, process, and more discipline."
Clearly, no manager is good enough to make money off a bad business plan. So just what kinds of businesses are proving themselves worthy? Forget e-tailers: Not a single one is projected to make money through 2001, according to First Call and I/B/E/S. Online entertainment is a money-losing proposition for the foreseeable future, too. Rather, profitable Net companies tend to have, at their core, a unique way of using information. They take advantage of the Web to do what it does well and cheaply--collecting, arranging, manipulating, and sending massive amounts of data. "The vast majority of companies are not using the unique attributes of the Net," says Scott Kurnit, CEO of About.com Inc., a site that uses Websurfers' opinions to guide visitors to helpful information and is predicting profitability a year from now. The aspects of the Net that create profits, claims Kurnit, are "low-friction distribution, interconnectivity, and viral marketing."Digital inventory. Net auctioneer eBay Inc. is the classic example. Acting merely as an automated broker between buyers and sellers, it takes a cut of up to 5% whenever anything is auctioned on its site. It's the prototype for frictionless business, since it never takes possession of the goods and thus has no inventory. That formula helped it make $10.8 million last year on revenues of $224.7 million. The concept is much the same at TMP Worldwide's Monster.com, the leading job and recruitment site. It has collected some 8 million resumes, and charges employers a fee to take a peek. TMP reported net income of $7.4 million in the first quarter on sales of $244 million--its second consecutive quarter of profitability.
Typically, Net companies that make money possess a sustainable competitive advantage. One consistent plus on the Web is what economists call "network effects": the notion that if more people use a system, its value rises geometrically. Network effects should help Homestore.com--which is expected to lose over $25 million in 2000--reach profitability by 2001, according to analysts' consensus. As a marketplace for 2 million home and apartment listings, it attracts more suppliers as traffic grows. "They use technology to create real value," says Peter S. Cohan, author of e-Profit: High-Payoff Strategies for Capturing the E-Commerce Edge. "They do something that couldn't be done without the Web."Reusability. Using core resources over and over also pays off. Consider New York's Multex.com. In 1993, the company began collecting and marketing financial reports and analysis from Wall Street brokerage and research houses. Today, it processes reports from over 750 sources, and spent nearly $100 million building a sales and data infrastructure to sort and publish the information. Now it can take the same data and sell it to different audiences, from sophisticated Wall Street brokerages to consumers. "The same infrastructure supports everything," says President Jim Tousignant, who last year lost $25 million, but cut his first-quarter loss in half to $2.1 million. "It gives us a lot of leverage."
Even more important than technology and strategy, however, are people. It's no surprise that the companies on the moneymaker list are run by executives who came of age before the greed-greased months of late 1998 and 1999. ZDNet, sprung from the publishing empire of Ziff-Davis, generates the same traffic as rival CNET, but with one-quarter the ad budget and half the editorial staff. NetBank Inc., an online-only bank, sets its advertising budget only after it computes its quarterly profit. Even at AOL, a $122 billion company, many top managers don't have expense accounts. Contrast that mindset with Boo.com, the now-defunct retailer where managers lived by the three C's--champagne, caviar, and the Concorde. "I'm old-fashioned," says NetBank's 53-year-old CEO D.R. Grimes. "To me, the word `business' implies a profit motive."
These penny-pinching companies have found innovative ways to generate business at low cost. Just check out Internet.com, a Web portal supplying information and services for the technology industry. With its network of 117 Web sites and 171 e-mail newsletters, it's able to cross-promote its services by, say, putting an ad for its new fee-based site, SiliconAlleyJobs.com, into several newsletters--for virtually nothing. "It's a beautiful model," boasts CEO Alan Meckler. Analysts expect the company to hit profitability in 2001.
HRN's Diener is no slouch when it comes to cheap promotions either. The company gets most of its customers from 2,500 affiliated hotels that feature links to its database of 20,000 hotels directly on their sites. When a customer books a room, the referring site gets a 5% commission. "We're just not spending a fortune on all kinds of advertising," says Diener. "We can grow our business at triple-digit rates and still maintain profitability." And as Diener well knows, profits may not have mattered to Wall Street a year ago, but they do now.By Dennis K. BermanReturn to top