Focus on Internet start-up companies

To conclude the chapter, we review how to evaluate the potential of new Internet start-ups. Many ‘dot-coms’ were launched in response to the opportunities of new business and rev­enue models opened up by the Internet in the mid-to-late 1990s. We also consider what lessons can be learnt from the dot-com failures. But Table 1.1 showed that innovation and the growth of Internet pureplays did not end in 2000, but rather many successful online companies such as digital publishers and social networks have developed since then.

1. From ‘bricks and mortar’ to ‘clicks and mortar’

These expressions were introduced in 1999/2000 to refer to traditional ‘bricks and mortar’ enterprises with a physical presence, but limited Internet presence. In the UK, an example of a ‘bricks and mortar’ store would be the bookseller Waterstones (www.waterstones.co.uk), which when it ventured online would become ‘clicks and mortar’. Significantly, in 2001 Waterstones decided it was most cost-effective to manage the Internet channel through a partnership with Amazon (www.amazon.co.uk). In 2006 it reversed this decision and set up its own independent site once more. As mentioned above, some virtual merchants such as Amazon that need to operate warehouses and shops to sustain growth have also become ‘clicks and mortar’ companies. An Internet ‘pureplay’ which only has an online representa­tion is referred to as ‘clicks only’. A pureplay typically has no retail distribution network. They may have phone-based customer service, as is the case with office supplier Euroffice (www.euroffice.co.uk), or not, as is the case with financial services provider Zopa (www.zopa.com), or may offer phone service for more valuable customers, as is the case with hardware provider dabs.com (www.dabs.com).

2. Assessing e-businesses

Internet pureplay companies are often perceived as dynamic and successful owing to the rapid increase in visitors to sites, or sales, or due to initial valuations on stock markets. In reality, it is difficult to assess the success of these companies since despite positive indications in terms of sales or audience, the companies have often not been profitable. Consider the three major socal networks: Bebo, Facebook or MySpace – none of these was profitable at the time of writing the fourth edition.

Boo.com is an interesting case of the potential and pitfalls of an e-commerce start-up and criteria for success, or one could say of ‘how not to do it’. The boo.com site was launched in November 1999 following two significant delays in launching and in January 2000 it was reported that 100 of its 400 employees had been made redundant due to disappointing initial revenues of about £60,000 in the Christmas period. Boo faced a high ‘burn rate’ because of the imbalance between promotion and site development costs and revenues. As a conse­quence, it appeared to change its strategy by offering discounts of up to 40 per cent on fashions from the previous season. Closure followed in mid-2000 and the boo.com brand was purchased by an American entrepreneur who still continues to use the brand, as you can see on www.boo.com.Boo.com features as a case study in Chapter 5.

Boo.com sold upmarket clothing brands such as North Face, Paul Smith and Helly Hansen. Its founders were all under 30 and included Kajsa Leander, an ex-model. Investors provided a reported £74 million in capital. This enthusiasm is partly based on the experience of two of the founders in creating bokus.com, a relatively successful online bookseller.

As with all new companies, it is difficult for investors to assess the long-term sustainability of start-ups. There are a number of approaches that can be used to assess the success and sus­tainability of these companies. There have been many examples where it has been suggested that dot-com companies have been overvalued by investors who are keen to make a fast return from their investments. There were some clear anomalies if traditional companies are com­pared to dot-coms. You can read more about the fate of lastminute.com in Case Study 2.2.

3. Valuing Internet start-ups

Desmet et al. (2000) apply traditional discounted cash flow techniques to assess the potential value of Internet start-ups or dot-coms. They point out that traditional techniques do not work well when profitability is negative, but revenues are growing rapidly. They suggest that for new companies the critical factors to model when considering the future success of a company are:

1. The cost of acquiring a customer through marketing.
2. The contribution margin per customer (before acquisition cost).
3. The average annual revenues per year from customers and other revenues such as banner advertising and affiliate revenues.
4. The total number of customers.
5. The customer churn rate.

As would be expected intuitively, modelling using these variables indicates that for companies with a similar revenue per customer, contribution margin and advertising costs, it is the churn rate that will govern their long-term success. To look at this another way, given the high costs of customer acquisition for a new company, it is the ability to retain customers for repeat purchases which governs the long-term success of companies. This then forces dot­com retailers to compete on low prices with low margins to retain customers.

A structured evaluation of the success and sustainability of UK Internet start-ups has been undertaken by management consultancy Bain and Company in conjunction with Management Today magazine and was described in Gwyther (1999). Six criteria were used to assess the companies as follows.

3.1. Concept

This describes the strength of the business model. It includes:

• potential to generate revenue including the size of the market targeted;
• ‘superior customer value’, in other words how well the value proposition of the service is differentiated from that of competitors;
• first-mover advantage (less easy to achieve today).

3.2. Innovation

This criterion looks at another aspect of the business concept, which is the extent to which the business model merely imitates existing real-world or online models. Note that imitation is not necessarily a problem if it is applied to a different market or audience or if the experi­ence is superior and positive word-of-mouth is generated.

3.3. Execution

A good business model does not, of course, guarantee success. If there are problems with aspects of the implementation of the idea, then the start-up will fail. Aspects of execution that can be seen to have failed for some companies are:

• promotion – online or offline techniques are insufficient to attract sufficient visitors to the site;
• performance, availability and security – some sites have been victims of their own success and have not been able to deliver fast access to the sites or technical problems have meant that the service is unavailable or insecure. Some sites have been unavailable despite large-scale adver­tising campaigns due to delays in creating the web site and its supporting infrastructure;
• fulfilment – the site itself may be effective, but customer service and consequently brand image will be adversely affected if products are not dispatched correctly or promptly.

3.4. Traffic

This criterion is measured in terms of the number of visitors, the number of pages they visit and the number of transactions they make which control the online ad revenues. Page impressions or visits are not necessarily an indication of success but are dependent on the business model. After the viability of the business model, how it will be promoted is arguably the most important aspect for a start-up. For most companies a critical volume of loyal, returning and revenue-generating users of a service is required to repay the investment in these companies. Promotion from zero base is difficult and costly if there is a need to reach a wide audience. An important decision is the investment in promotion and how it is split between online and offline techniques. Perhaps surprisingly, to reach the mass market, traditional advertising was required to get the message about the service across clearly to the numbers required. For example, Boo had major TV and newspaper campaigns which gener­ated awareness and visits, but didn’t translate to sufficient initial or repeat transactions. Some of the other start-up companies such as lastminute.com and Zopa.com have been able to grow without the initial investment in advertising. These have grown more organically, helped by favourable word of mouth and mentions in newspaper features supported by some traditional advertising. Promotion for all these companies seems to indicate that the Internet medium is simply adding an additional dimension to the communications mix and that traditional advertising is still required.

3.5. Financing

This describes the ability of the company to attract venture capital or other funding to help execute the idea. It is particularly important given the cost of promoting these new concepts.

3.6. Profile

This is the ability of the company to generate favourable publicity and to create awareness within its target market.

These six criteria can be compared with the other elements of business and revenue model which we discussed earlier in this chapter.

4. The dot-com bubble bursts

The media played a key role in the dot-com story. Initially the media helped produce stratospheric prices for dot-coms by tempting investors with instant gains when companies went through IPOs (independendent public offerings). The media could then also report on the newsworthy spectacle of the failure of many of these businesses. As failure of more and more dot-coms was reported this also impacted on the share prices of the more successful dot-coms such as Yahoo! and even other technology stocks. Popular analogies for the dot­com collapse are the bursting of the South Sea Company’s bubble in 1720 and the wilting of the fortunes invested in tulips in the 17th century.

5. Why dot-coms failed

At the end of Chapter 5 we review the reasons for failed e-business strategies and, in Case Study 5.3, examine the reasons for one of the most spectacular dot-com failures – Boo.com. We will see that in many cases it was a case of an unsound business strategy, or ideas before their time. Many of the dot-coms were founded on innovative ideas which required a large shift in consumer behaviour. A rigorous demand analysis would have shown that, at the time, there were relatively few Internet users, with the majority on dial-up connections, so there wasn’t the demand for these services. We see in the Boo.com example that there were also failings in implementation, with technology infrastructure resulting in services that were simply too slow with the poor experience leading to sales conversion rates and return­ing customer rates that were too low for a sustainable business.

Remember, though, that many companies that identified a niche and carefully con­trolled their growth did survive, of which ‘boys’ toys site’ Firebox (Mini Case Study 2.3) is a great example.

6. The impact of the dot-com phenomenon on traditional organizations

The failure of so many dot-coms has accounted for much adverse publicity in the media and e-commerce and e-business were perhaps perceived by some as a fad. However, for every story about dot-com failure there is perhaps an untold story of e-business success. In the background, traditional companies have continued to adopt new technologies. The changes made by existing business are aptly summed up by David Weymouth, Barclays Bank chief information officer, who says (Simons, 2000):

There is no merit in becoming a dot-com business. Within five years successful busi­nesses will have embraced and deployed at real-scale across the whole enterprise the processes and technologies that we now know as dot-com.

What then is the legacy of the dot-com phenomenon? What can we learn from the dot-com successes and failures? We look at the strategic reasons for many of the dot-com failures in Chapter 4 and Case Study 5.3 on Boo.com highlights many of the classic problems of dot­com businesses.

The following guidelines can be suggested for managers developing e-commerce strategy for their own companies:

1. Explore new business and revenue models.
2. Perform continuous scanning of the marketplace and respond rapidly.
3. Set up partner networks to use the expertise and reputation of specialists.
4. Remember that the real world is still important for product promotion and fulfilment.
5. Carefully examine the payback and return on investment of new approaches.

As a conclusion to this chapter, consider Case Study 2.3 which highlights the issues faced by a new e-business launched in 2005.

Source: Dave Chaffey (2010), E-Business and E-Commerce Management: Strategy, Implementation and Practice, Prentice Hall (4th Edition).