The Dot-Coms Go Back to Basics

No, the Internet is not shutting down.

Neither are dot-com companies. Though many have lost dizzying amounts of stock value in the past six months and hundreds have closed, analysts are seeing the current shakeout as just that: a return from cash-infused, growth-centric hysteria to a philosophy where simple, sound business practices rule.

“To oversimplify, some of the [dot-com] business models just weren’t successful,” said Rob Zidar, portfolio manager of the Merrill Lynch Internet Strategies Fund.

But there have been successes in the dot-com economy, from pure Internet companies that managed to stay at the top of their game to tiny, private shops who slipped under the stock market’s radar.

ABCNEWS.com talked to several Internet economy analysts and examined several different companies in order to make sense of what’s working, and what’s not, as the economy teeters on the brink of its first real downturn since the dot-com mania began. Take a tour of the online world in 2001, and see why the winners won and the losers lost.

The Flameouts

Dot-coms are dropping like flies. According to industry benchmark Web site f —-company.com, nine failed last week alone. At least 210 bit the dust last year, according to webmergers.com

The problem, analysts say, is that they weren’t paying attention to building a good business. In the heady days of the dot-com boom, venture capitalists were throwing money at anything online without applying simple rules from Accounting 101 to see whether they’d succeed.

Businesses need a big potential market, competitive advantages, a well-marked road to profitability and the ability to carry out their plans, said Scott Kessler, an Internet analyst with Standard & Poor’s. Many e-retailers fell to their online competition. Content companies, meanwhile, fell to a lack of advertising revenue and disappointing market sizes.

The much-hyped Digital Entertainment Network had almost no market at all for its TV-style Web shows, which most people couldn’t download easily through telephone connections. And they shed huge sums of money on parties, salaries, and talent.

Online pet store Pets.com, which closed its doors in December, was felled by tough competition, and a profitability plan that didn’t factor in the enormous shipping costs of sending huge bags of pet food long distances, Kessler said.

“You’re talking about 20-pound items — the cost to ship it is more expensive than the prices people were paying,” he said.

Analysts also said you have to prove that people would want to buy something online as opposed to going to a store.

“It’s not even clear that people want to buy pet supplies on the Web. I’m not sure that you need five highly capitalized companies selling pet supplies online,” Zidar said.

Jeff Fieler, a consumer Internet analyst with Bear Stearns, adds another criteria for building a good business: starting small. Venture capitalists threw money at Net firms, allowing them to start in the big leagues without proving their skills first, he said. New companies were burning through rounds of financing, basing their business plans on the assumption that they’d easily find further financing. When the money dried up, the companies went bust.

“Typically, businesses are built a few customers at a time. That’s really the major difference between how a lot of Internet companies were built” and the offline world, he said.

See case studies of three major dot-com flameouts: one beaten by competition, one former party central and the fastest flameout ever.

The Successful Pioneers

You can’t make money selling things online, the conventional wisdom goes — and you certainly can’t make money from online advertising. Unless, that is, you’re mega-Web portal Yahoo! or auction site eBay.

These two successful pioneers have been profitable for years by being the first and biggest in their sectors, analysts say. They took advantage of their early starts to collect money and move into profitability before the markets got skeptical of dot-coms. And they’re well-run and reliable.

Both have fended off long lists of competitors to stay at the top. They’ve built on their “first-mover advantage” to build their brands and completely dominate their markets, Zidar said.

“The market doesn’t need any more than one eBay and any more than one Yahoo!. They were early, so they were permitted to lose tons of money in order to build the site and build the brand,” he said.

And Yahoo! and eBay keep a rein on their expenses, which is important, analysts said. The carnage among online pet supply companies has left petsmart.com the only one standing because it spent the least on its Web operations, Fieler said.

“Keeping expenses low can be important, especially in a period of time when you don’t have access to capital,” he said.

Yahoo! said last week it is being hit hard financially by the Internet slump, but it's still in the top tier of viable firms.

Ebay spokesman Kevin Pursglove said the company has always focused on being a profit-making business — unlike many of the flameouts.

“In the late 1990s, I think there was a bit of confusion around operating a company and having a title … and actually operating a business that was providing a service that consumers wanted or needed,” he said.

And Yahoo!’s and eBay’s expansions have stayed focused on their core businesses. EBay has bought an online payment company, an offline auction house, and a e-tailer, all related to their core mission of buying and selling online.

“We’ve had a very singular focus since 1995,” Pursglove said.

See case studies of three big players in the dot-com world: profitable Yahoo! and eBay, and unprofitable Amazon.

The Mystery

So what to think about amazon.com?

The Internet’s biggest retailer is a massive financial hemorrhage. It’s been around since 1995, consistently losing huge sums of money on even huger sales. It dwarfs other Internet retailers, but isn’t aiming to show a profit until 2002. And some analysts are saying they’re less than thrilled with its practice of gobbling up new retail sectors, from lawn furniture to health products.

“Not only do they not make money, but they haven’t demonstrated that the ability to make money is anywhere in the near future,” Kessler said.

Don’t look for an Amazon collapse any time soon. They stockpiled cash before the current financing crunch, so they have enough to keep going, Fieler said. Customers love them, analysts said. And Amazon’s core book business is profitable. But now they have to prove to the markets that their land-grab strategy is going to pay off in the future, Kessler said.

“I might like the company from a consumer perspective and think they have a lot of opportunities in the future, but right now their business model is a bit questionable,” he said.

The Mom-and-Pops

There’s still room for the little guy on the Net.

You may have never heard of Walkabout Travel Gear, but they’re an almost entirely pure e-tailer that’s made a profit for the past five years. And Amazon may be crushing competition such as Barnes & Noble, but small catalogue and e-tailer A Common Reader is doing just fine.

What they have in common is a clear appeal to a niche market, analysts say.

“If someone has a unique item and they’re just using the Internet as a distribution channel, why wouldn’t you use it?” Kessler said.

Walkabout, run by Brad and Gia Boyle out of their basement in Moab, Utah, has been selling gear for independent travelers since 1995. When the Boyles go on the road, they take a large mobile home full of wireless Internet equipment and enough stock to fulfill orders. (They leave a part-time employee back in Moab in case a really big order comes in.) They clear $300,000 in sales a year — about half of one percent of Amazon’s 2000 sales — but that’s enough to keep them afloat.

“We’ve always treated it as a business and the Internet as a tool of business. It’s probably harder [to enter the market] today than in 1995, but I think for people with a niche market, who keep it small and keep it organized,” they can succeed, he said.

A Common Reader, with “40-odd” employees in suburban New York, has been running a catalog business since 1986. Like their catalog, their Web site caters to discriminating, intelligent readers and makes a profit. The huge size of Amazon creates an opportunity for small booksellers, company president Jim Mustich said. Every book on ACR’s site is read, judged, and approved as worthy by the company’s staff — which makes it possible to browse the online shelves without becoming overwhelmed or confused.

“We don’t deal with the books about which we have nothing to say or are not interested in selling. That sense of selection is valuable to customers in a marketplace where 70,000 books are published each year,” he said.

See case studies of Walkabout and A Common Reader.

The Click-and-Mortars

Though pure e-tailers have been taking a beating recently, there’s been a lot of buzz around “click-and-mortars” — the online arms of traditional retailers like Target, J. C. Penney and Circuit City.

Penney’s online arm, for instance, is seen as more successful than its struggling offline stores. The company is leveraging its decades of catalog-sales experience, with its knowledge of how to process and ship orders into a smooth Internet shopping platform, Fieler said.

“The best retailers around are thinking about the Web as just another medium with which to distribute products,” Zidar said.

Some companies such as K-Mart have also experimented with tricks like providing free online service to get shoppers online. That’s proved a financial challenge (K-Mart eventually had to limit its users’ free time online) — as has merging the cultures of hip online subsidiaries with old-line management and staff.

And click-and-mortar doesn’t mean automatic success. The online arm of book retailer Barnes and Noble has been struggling to differentiate itself from its much larger competitor Amazon.

“I think people have probably made their choice about whether they’re going to buy those kinds of product online, and they’re going to buy them from Amazon,” Kessler said.

Toys R Us found another solution to online sales. After a disastrous 1999 holiday season where they had problems getting toys to kids on time, they partnered with Amazon. Amazon provides the online shipping expertise, Toys R Us the knowledge of the toy market.

“That’s a company that took its old-economy experience and really applied it to the online world,” Kessler said.

See case studies of three major click-and-mortars: Barnes & Noble, J. C. Penney and K-Mart.