One month before the April 2000 stock market plunge that
signaled the burst of the dotcom bubble, Senior Editor Joe
Gold saw troubling signs of an e-retail industry afloat on
investors' good will and high hopes. But the laws of marketing
gravity had not been repealed.
ART THOU, PROFIT?
by Joe Gold, Senior Editor
Profit was once the most important word in the business
vocabulary. No doubt it will be again. But in these Wild
West days of an economy transforming to life online, profits
have been put out in the back 40. What matters during this
transition is grabbing share of mind and establishing a
business with a firm enough foundation that it will outlast
its competitors and reach the promised land of black ink.
How long before the promise of a rosy e-tail future requires
proof through profitability?
The price of e-tail entry is so much lower, and the "neighborhood"
you serve so large, turning a profit ought to be a snap,
right? No high-rent retail locations, no construction costs
and delays, no clerks with attitude, no fancy floor displays.
Customers can shop in their underwear—or less. Store
hours are 24/7. Traffic jams (at least the automotive variety)
are irrelevant. What’s not to love?
A few—maybe you—will become big players down
the road. Investors who missed the Microsoft bonanza have
been generous in backing e-tailers that could generate Microsoft-like
profits. In this second California gold rush, Silicon Valley
is only the epicenter of commercial tremors that are rattling
All we need to do is outlast the flood of competitors before
the investors bet on who can still make it and who’s
going to fall victim to the inevitable shakeout. The up-and-down
on once soaring Internet stocks suggest that round one of
the shakeout has begun.
For all those people who didn’t get on board the
Microsoft Investor Express, e-tail and other promising technology
issues offers another chance to latch on to a Microsoft-like
economic engine that can eventually churn, churn, churn
out the dollars.
Is this a glamorous business or are we afloat in a bubble
that can’t help but burst?
A cautionary view
One person less than giddy with expectation is David M.
Alschuler, vice president for e-business and enterprise
applications in the Boston office of Aberdeen Research.
"Retail is the most miscast rocket in the fleet,"
he said. "Retail has always been a cyclical business
running on thin profit margins. The Web reorganizes the
retail business model with different selling costs."
How long can e-tail continue floating in red ink? "As
long as the capital markets allow it to," Alschuler
said. He sees the market for tech stocks more than the e-tail
promise that’s filling the bubble. "There is
so much more demand for stock than stock available in traditional
companies. There is something wrong with a company being
valued as though they have achieved profitability. These
companies have a hell of a lot of risk. Capital markets
represent people’s fundamental belief that people
want to hop on the bandwagon. If and when the bubble breaks,
having a real business will be essential."
In the meantime, Alschuler recommends e-tailers stay focused
on down-to-earth issues. "A reasonable expectation
is managing a plan that makes sense, a business model that
has average revenue equal to or better than average cost
at some breakeven point. You can’t make money online
until the cost is spread over hundreds of thousands of customers."
Alschuler finds the present market for stocks, especially
dotcom stocks, a unique opportunity. "Right now the
market is supplying the liquidity to buy customers. We’ve
never seen a market like this. Window not just open, there
are incredible amounts of resources available, and that
slows the need for immediate profits."
Lose now, profit later
The prize for e-commerce winners is huge. In the long run,
it’s worth enduring a few years of losses to ramp
up to be a big player in a decades-long game. At least,
that’s the judgment of those investors who continue
pumping cash into dotcoms that show promise.
In ActivMedia’s sixth edition of its 193-page report
Real Numbers Behind ‘Net Profits 1999, the company’s
vice president of research, Harry Wolhander, says "Internet-generated
revenues in 2000 will reach $226 billion, nearly six times
the $38 billion observed in 1998. Typical growth rates for
many mid-range players are even higher, and some companies
will experience online revenue growth of over 2000 per cent.
Naturally, e-commerce programs that see growth rates three
to four times higher than average are going to budget more
for Web site development today in order to handle the expected
future business. These companies understand that success
online will create the leading companies of the new millennium."
The report points out that "Web sites anticipating
profitability in two to five years had far higher development
budgets than sites that were already profitable or expecting
profitability in the near term (averaging $59K, vs. $26K),
a demonstration of their appreciation of long-term potential
for the web, and commitment to success online."
Branding and buying
But at this point, Pets.com is reportedly collecting 43
cents and rival Petsmart.com 63 cents for every dollar they
spend on merchandise and delivery. They are in that all-important
"branding" phase. Certainly when your store doesn’t
have a corner on a city block, when your competition is
a click away, mind share is even more important than it
is to the bricks-and-mortar guys whose edifices are a constant
reminder of their existence. For virtual retail, getting
mind share requires spending marketing money to generate
the public relations buzz and advertising to create awareness.
What they get for their massive marketing expenditures
are results measurable as hits, click-throughs, and visitors.
But there will be a day of reckoning when sites have to
out-market their competitors and make enough sales that
they generate an actual profit. And again the question pops
Is 24 months enough?
Faisal Hoque is an entrepreneur and author of E-Enterprise:
Business Models, Architecture and Components. He told
OneChannel.net "You have to make an investment to create
infrastructure and branding for a new product and service
offering. Is 24 months enough of a time frame to do that?
I would say so.
"By then you need to have some sign or some proof
point" he says, such as how customers are reacting
in terms of satisfaction, and traffic, but ultimately in
sales. "At least some part of your business should
be profitable. Within the next two to three years, if people
don’t start showing profit, investors will question
the basics. The reason you are in business is to make money."
Hoque acknowledges that "branding is a good thing,
but whether it is effective or not does not come from people
knowing your name. It comes from people actually buying
or not. Pure play (online retail) does not make you anything
special. At the end of they day you’re a business."
Business is in business to make a profit. But with venture
capitalists to help a struggling new organization get up
and running—and we at OneChannel.net fall into that
category as well—the time from launch to going public
can take longer. From there it’s up to the stockholders
as to how much patience they exercise.
Concern over ongoing losses
Not everyone believes that investor patience can last much
longer. AMR Research produced a report on retail application
strategies predictions for 2000 that anticipates investors
demanding concrete results soon, especially as the e-tail
is replaces as the investors’ new darling.
"Most Internet retailers will spend the first months
of 2000 retooling their business plans because their investors
are unwilling to stomach ongoing losses, particularly after
the holiday season showed glaring weaknesses in some operations,"
the AMR report projected. "As Wall Street satisfies
its appetite for e-business investments on more promising
business-to-business and e-commerce infrastructure markets,
many Internet retail wannabees will be hard pressed to find
cash to feed their money-hungry branding and marketing campaigns."
The AMR prediction becomes more dire: "Established
sites will increase traffic and transaction volume and expand
into more categories. By year’s end, only a few of
the many hopefuls that cluttered the airwaves with ads in
November and December will still be around, and most of
the departed won’t be replaced."
How much patience is reasonable for an e-tail startup?
"There is no answer," said Dr. Ezra Zuckerman,
an assistant professor for strategic management at Stanford
University, the spawning ground for the vast majority of
Silicon Valley dotcoms.
"If the eventual opportunity is big enough, it would
make sense for an investor to be very patient in waiting
for profits. However, what seems clear is that when one
looks at Internet stocks as a group, it is impossible for
them to generate the level of profits that current valuations
imply," Zuckerman said. "So while it may be possible
to justify waiting quite a while for profits on a given
stock, the amount of waiting (and the amount of money expected)
for future profits implied in current valuations is ludicrous."
Professor Zuckerman said "Profitability clearly means
less to investors these days, though that will not last.
Remember, the proximate determinant of a stock's price is
what the marginal investor will pay. What determines what
the marginal investor will pay? For any stock, there must
be a theory that interprets available information and translates
it into a valuation. However, that theory is just that—it
can be significantly at variance with reality. And to the
extent that the stock is in a new, untested industry, so
are the theories.
"Eventually though, the market learns to have a better—though
always far from perfect—theory that looks at the same
information and places a different value on it. It is my
belief that this will happen to Internet stocks, but it
is anyone's guess when this change will occur."
OneChannel.net was an online e-commerce
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