Avoiding the Dot-Com Crash

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Many dot-coms are going under this year. People are saying they knew it all along, but they were unwilling to say so before for fear that the bubble would burst (which it has) or that they would have been thought old-fashioned and out of date (which they would have been).


So, how can you predict a successful dot-com from a loser? Here are some rules that have universal validity.


• Profit is essential.


By now, everyone knows that any business must project and make a profit within the foreseeable future. All successful businesses are based on taking in more revenue than they pay out in expenses. This has always been true. Why did so many people forget this principle in the past few years? Because of the AOL model.


AOL became the powerhouse that it is through giving six free disks to every man, woman and child in America over a four-year period. By this brilliant strategy, it gained overwhelming market share and beat or bought all its significant competitors. Then it flaunted its success by buying Time Warner.


Seeing this example, all the dot-coms of the world decided, "Forget profits, market share is everything." How do you gain market share? By signing up millions of people for free services. When you have millions of customers, you will be able to have a successful IPO and your venture capitalists and employees will become rich. What happens after that? Fuggedaboudit. Let's get rich.


What people seem to have forgotten in the AOL analogy is the change AOL made in the middle of the game. It switched from pay-per-view to a flat monthly rate. When it did that, it was swamped with users trying to get their money's worth. It had to invest a fortune in modems to meet the demand.


Many said AOL was foolish and would lose credibility and market share as a result of the bad PR. On the contrary, it was a brilliant move. The change meant that the millions of customers AOL signed up were paying more than $20 per month, month after month. Its eventual profit was ensured. Few, if any, of the dot-coms that tried to follow the AOL model had a monthly income from their customers.


• Advertising will not support most sites.


Too many dot-coms based their business plans on Web advertising. Site after site with no visible revenue counted on millions of dollars from banner ads that would be placed on their sites as soon as they gained sufficient market share.


The trouble with this idea was that the dot-coms were not able to, or did not, run tests to see whether their idea could be true. Years ago, Citicorp scored a massive database failure with Reward America, a supermarket frequent-shopper card system. Citicorp's idea was that revenue would come from selling the names of frequent shoppers to the manufacturers of packaged goods such as Crest toothpaste or Alpo dog food. The trouble was that the manufacturers did not want the names because there was no way they could make money with them. Database marketing does not work with most packaged goods. Citicorp did not know this and did not test the idea in advance. It lost $200 million on the project in 1990. Those who do not study history are bound to repeat it.


Why won't Web advertising alone support a new dot-com venture? Because the barriers to entry in the dot-com world are so low. Anyone can start a Web site for a few thousand dollars, and millions are doing it. Advertising pays for TV and radio stations, magazines and newspapers because there are only a few thousand of them. Starting successful mass media enterprises such as these is expensive. That keeps the numbers down and the cost of advertising up. Not so on the Web. You can't charge high prices for ads when you have millions of competitors. Advertising alone will never support a successful Web site.


• Margin is important.


To achieve a profit, you have to take in more revenue than you pay out in costs. The profit is the margin. Supermarkets, for example, typically have a very low margin on sales. The grocery business is fiercely competitive. The chains can stay in business only because of the huge volume of total sales and because their goods are essential. People will always have to eat. With a tiny margin, you will run a loss if you add any extra expense. That is what happens on the Web.


Peapod, HomeGrocer, Webvan and others are trying to enter this market with home delivery of groceries. It is a wonderful idea, but they will all fail. There is not enough margin to make long-term profits even a remote possibility. People have to eat, but they don't have to buy groceries on the Web. You have to add the cost of taking orders on the Web, picking, boxing and home delivery to the regular cost of the products, and make at least as much profit as the supermarkets. It cannot be done.


What's more, supermarkets count on impulse buying for a substantial portion of their sales. Who has ever gone to a supermarket to buy a quart of milk and come home with only a quart of milk? Everyone buys other stuff that they see as they walk through the aisles. That does not necessarily happen on the Web.


Much consumer e-commerce may not succeed. Amazon.com is a wonderful institution. Everyone admires Amazon and Jim Bezos. While they have yet to turn a profit, everyone assumes -- I believe correctly -- that they will eventually succeed. Books and music can be sold successfully on the Web. Travel reservations also work, as do financial services, auctions and computer sales.


That does not necessarily hold true for most consumer goods. Goods sold by catalog companies can be sold on the Web, but we are finding out something interesting in this field. Most Web customers have the print catalog in front of them when they are shopping. They don't have the patience to navigate the Web to find a sweater they want.


Try it yourself. Take any clothing catalog you have received and find an item you would like to buy. Then go on the Web site without the catalog and try to find that same item. With the Lands' End catalog, it took me 14 seconds to find a men's sweater I wanted to buy. On the Lands' End Web site, the same sweater took me 124 seconds to find. Once I knew what I wanted, however, the Web was the best way to buy.


• So what does this mean for the Web?


You probably cannot sell consumer goods profitably on the Web without a paper catalog. If you don't have a paper catalog, you will be beaten by those that do. So the Web is not a selling tool. It is an ordering tool. The catalog is doing the selling.


Where are the profits? There are two commerce areas in which the Web is already, and will continue to be, highly profitable: customer service and business-to-business.


In customer service, the Web has saved companies several billion dollars and will save billions more. Call FedEx with your tracking number and its operators will tell you where your package is right now. Those calls cost FedEx a lot of money. Customers also get put on hold. Go on the FedEx Web site and you can find the location of your package in three seconds. That saves you time and saves FedEx hundreds of millions of dollars.


Companies are putting thousands of pages of technical data on the Web to reduce tech support calls and costs. Customer service and tech support is the biggest growth area on the Web today. Any company that is not investing in this area is making a big mistake. Companies are learning to let their customers "come behind the counter" and wander through their warehouses, shipping departments, accounts receivables and engineering departments to find what they want. They love it.


In BTB, the possibilities are almost infinite. Here, the customers already know what they want. They have the catalog or they have the products for which they need supplies or upgrades. The average order size is typically more than 100 times the consumer order size, so the margin pays for the cost of ordering, packing and shipping. The big growth area here is not in ordering but in linking the customer's computers to the supplier's computers through the Web.


Intel's computers use the Web to study the stock of processors in each Dell factory. They ship Dell more processors three times a week to make sure Dell's factories do not run out. FedEx has taken over National Semiconductor's entire product delivery system from the FedEx warehouse in Singapore, permitting National to eliminate seven warehouses and a complex inhouse shipping system.


What have not yet succeeded in BTB are the stand-alone dot-coms designed to consolidate business buying and selling. Thousands of these sites are springing up today, and most will fail because the barriers to entry are so low. Anyone can get into this kind of business. The ones that succeed will be those linked to an established company with warehouses and a delivery system.


There are plenty of surprises ahead for all of us as Web commerce expands. Some things that we never thought of will succeed, and many current dot coms will fail. This is a great time to be alive.


• Arthur Middleton Hughes is vice president of strategic planning at MS Database Marketing in Los Angeles. He is the author of "Strategic Database Marketing, 2nd Ed." Reach him at ahughes@msdbm.com.
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