9780814406045

Chapter One

NETENOMICS AND VAPOR MODELZ

"Let's be honest and admit that the 'New Economy paradigm' affected the

rational judgment of a lot of small and institutional investors alike."

--Investor in controversial Internet Services Provider World Online, which closed on June 16, 2000, at Euro 14.85, 65% down from the IPO price at launch on March 17.

Every major movement with broad economic and social implications brings its own set of jargon. During netPhase I, those seeking to ensure that the VC-IPO deal assembly line lasted as long as possible counted upon dubious pseudo-economic phrases and Net "business models" to sustain the mass hallucination.

WELCOME TO NETENOMICS 101

Welcome to your class in Netenomics 101, where you can create instant valuation principles out of thin air.

Metcalfe's Law

The granddaddy Net principle-sometimes called "network effect"-is named after Bob Metcalfe, co-founder and former chief executive of 3Com. The 'Law,' as generally interpreted, goes as follows: the value of the network enterprise increases with the square of the number of participants.

Sounds good, and is universally cited by every self-respecting Nethead. Metcalfe's Law even rates periodic interpretation and comment from Wired's and MIT's Professor Nicholas Negroponte.

Whoops. As also explained in Chapters 6 and 7 in addressing the changing nature of competition in e-procurement, Metcalfe's Law only works in the case of monopolies and oligopolies. In most markets, the Net spawns the exact opposite conditions: ruthlessly competitive markets subject to multiple waves of fragmentation, thanks to too-easy entry and too-slow exit by entrenched competitors.

In theory, it's great to think about setting up your own worldwide online flower ordering and delivery network. You don't have to be a contestant on Regis to know that if you completely control a market, additional customers can be added at decreasing marginal cost.

Unfortunately, the problem is that a dozen others already thought of your online flower business first and are busily deploying their own Web-based business models, fragmenting demand. NetPhase I nosebleed valuations make the excess entry crisis far worse. One day, your own mom tells you she has this great idea for an online business, and she's just spent your college money on a server, and, well dear. . .

Sure, that report from Rings O' Saturn Research showed that the eventual demand for your business is two trillion dollars by 2006. And Rings can always be counted on to be accurate to the nearest trillion or so. But that full long-term market potential takes years to develop. In the near term, demand is so fragmented that no one reaches critical mass and all participants risk going broke.

xcessive competition is behind the now characteristic pattern of a severe split between Net victors and victims. In a B2C segment of, say, six competitors, today's emerging pattern is one stellar success, one challenger barely at the cash flow break-even line, and four cripples awaiting elimination.

Last-generation search engines not associated with major portals. Commodity dial-up ISPs. And-oh yes-flowers. In B2C sector after sector, Metcalfe's Law turns out to be just more Net hype that appears great but doesn't work.

Ah, but Metcalfe hailed from the one part of the Net that lends itself to monopoly-oligopoly type-structure: e-infrastructure. As explained in Chapter 6, Cisco Systems was broadly perceived as the sole provider of huge core routers before Scott Kriens and Juniper Networks came along. Juniper's recent market share is generally estimated at 20%. 2 Today, the result is a duopoly, a market in which Metcalfe's Law actually applies.

Class Grade (for your repeated use of "Metcalfe's Law"):

A: if you restrict usage only to large-scale segments of the e-infrastructure segment, such as the Cisco-Juniper core renter segment

B: for B2B

F: for B2C markets plagued by excessive new entry yet slow by withdrawal, unless forced by withdrawal of financing

Viral Marketing

Brad Wieners of Wired refers to RocketTalk as the showcase example of this alarmingly named Netenomics principle.

RocketTalk's business plan called for offering free software at www.rockettalk.com. In the past, the software was designed to allow you to download music to share with your friends. But with Napster entangled in litigation, it is of course just a coincidence that RocketTalk Beta Release 1.6 (mid 2000) features other applications, such as streaming video downloading.

RocketTalk founder Jeff Weiner (a different last name) says, "we are a hardcore believer in viral marketing," which to the best of our understanding means making personal recommendations only, and at nanospeed, on the Net.

Wired's editor points to Colorado's Blue Mountain Cards as the quintessential viral marketing example. Founded with late 1960s idealism, the business is often cited as the ideal example of Net high-speed growth by word of mouth. 3 Oh so egalitarian, at least until it came time to cash out.

Two problems limit the plausibility of this particular bit of Net baffleprose. First is competitive noise: The same din from rivals that caused Dot-Com advertising costs to soar and ad effectiveness to plunge is also a problem here, as too many word-of-mouth companies enter. There are few barriers to entry, and the results show: massive overkill as opinion-setters who might sustain growth by word-of-mouth are besieged with requests.

Second, viral marketing can and sometimes does operate in reverse. Put out a release that causes the Palm Vs to crash when connected and every customer knows about it days before you. Damage control is tough if not impossible on the Net. It might be said that first-generation PointCast "push marketing" (an early Netenomics term since killed off) software was the victim of viral marketing as rumors spread almost instantly that the software might cause hard disk crashes.

Class Grades: B: but as support approach, only. Hint! Don't blow much of the company's marketing budget on viral marketing-it is too easy for competitors to imitate.

Scalability

Jim Seymour (jim.seymour@zd.com) of the Seymour Group, consultants, makes an important distinction between engineering scalability and business-model scalability in his discussions with us and in his column at TheStreet.com.

Cutting hairs? The Texan insists not. Engineering scalability here refers to the capacity and resiliency of a network to handle increasing volume until, at some point, the operator must dig deep and increase the scale and cost of critical investment up to a higher plateau. The operator must break down and buy that new core router.

Regarding business-model scalability, Seymour cautions that:

[This] has a completely different, though clearly related meaning. In the business world, and especially in Web businesses, managers speak of the scalability of their revenue models, by which they mean that after reaching a certain, predictable mass in terms of capital investment and numbers of users signed up, they can then serve many more customers with almost no additional costs [emphasis added] . . . Essentially, if not quite, zero. 4

Net alchemy. Even better than the notion of turning lead into gold is the hallucination that once someone makes a single major front-end investment, then no further investment is necessary. Under such assumptions, the marginal cost of acquiring new customers plunges. Acquisition costs per customer plunge toward nearly zero.

To most, such theories long ago went the way of the perpetual motion machine. The Net holds tremendous potential to change the internal economics of businesses implementing the right Internet programs, but (near) zero marginal cost? We've got a virtual Brooklyn Bridge we'd like to talk about if you swallow that.

It is that if the company/business plan is "scalable," then additional fixed investment decisions can usually be deferred for a while, as the market grows into the Dot-Com's capacity that is already in place. But additional fixed investment must eventually be made, at some point, or growth stalls. The growing segment is abandoned to the competition.

Class Grade: B: But only if your use of "scalability" corresponds to the limitations of the engineering interpretation.

First Mover Advantage

You are expelled from school simply for asking about this turk-e.

"FMA" is one of the welcome casualties of Spring Break 2000 and a particularly lethal form of Dot-Com baffleprose. Ever since the market's netPhase I hypnotic trance was snapped in the weeks after March 10, 2000, any Dot-Com spinner spewing "First Mover Advantage" is likely to hear a brusque retort from private financiers "Yes-first to bankruptcy."

But that's today. In Net pre-history of 1999 and before, Netscape, Spyglass, Digital Equipment (in the form of its early AltaVista portal), Boo.com, CDNow, and Peapod all were proclaimed by Net zealots as achieving FMA in one form or another. How did those early Dot-Com darlings prosper? Most didn't, or haven't. Because FMA is incidental, rather than causal, to Dot-Com success.

Is Amazon.com an example of FMA? Try again. Barnes & Nobles dropped the ball along with an early chance to blow away Bezos & Co. The failure of a natural rival to mount a true challenge is not at all the same thing as FMA.

Net First Mover Advantage means nothing because of entry speed. It doesn't make any difference that you're first to market. The companies that arrive second, third, and fourth will each separately blow you away into last week if you make the mistake of actually listening to any of your own FMA market propaganda.

In those hazy, crazy days of netPhase I easy financing (e.g., 1999), when Net high jargon still reigned supreme, we asked those who founded an excellent me-too clone of a US auction site to describe their firm's key advantage. You know the response already: FMA.

Business Arithmetic, Reinvented

Growing understanding that discounted free cash flow propels corporate value-and NOT earnings per share-means increasing emphasis on cash flow-oriented financial data.

The good news is that more and more valuators come to rely on methodology proven for decades, rather than on homespun counterfeits tolerated temporarily because of the Net's novelty.

The bad news is that the shift to cash flow-based valuation is interpreted by some opportunists as an open invitation to try to disguise true performance with a whole new set of disguises: partial reporting, confusion of revenues with profits, laughable risk and term assumptions in the discounted cash flow (DCF) valuation method.

The combination of a creditable DCF methodology plus equally creditable input is powerful. As analysts' interpretations of company future discounted cash flows shape corporate valuation, Dot-Com management enhances shareholder value by supplementing reported GAAP earnings per share data with credible DCF forecasts to the extent permitted. 5

Problem is, situations such as the 1999-2000 Staples' reporting controversy with First Call arise from time to time, and such episodes are sometimes confused with the DCF forecast data issue.

In Staples' case, the debate with online reporting service First Call, as we understand it, centered on which data was presented, and how , rather than on incompleteness of any required information. The base argument seems to be that management has the right to put its own financial information in the most favorable light possible, as long as there is also timely and complete disclosure of all required data. 6

The distinction between merely presenting data for optimal effect and borderline distortion of data arises in the case of the more aggressive attempts to devise "adjusted" earnings. Larry Dignan's feature article from the April 28, 2000, ZD Interactive is presented in a tongue-in-cheek style. But the subject is serious. 7

Sometimes, the motivation for "creative" treatment of Dot-Com performance centers around the challenge of growing a combined clicks 'n mortar enterprise.

The Dot-Com side of the business provides a frothy valuation boost for a while, but operating losses of the Dot-Com business may eventually threaten to cancel out some or most of the profits from the "Old Economy" part of the two-headed business.

Champions of GAAP earnings per share become concerned that their string of 20 consecutive quarterly EPS increases may be jeopardized. Despite the facts, some will always be convinced that EPS trends, not DCF projections, drive value.

Business Arithmetic, Ignored (Or, Profits Are SO Twentieth Century)

A related but somewhat different "numbers" dilemma arises when the Dot-Com spin doctor throws out the improbable notion that positive cash flow doesn't really matter that much. The spinner looks up to see if anyone is nodding their head in agreement. After all, Mark Twain said that you can fool some of the people some of the time.

But there aren't many head-nodders following the 34% percent plunge in the Nasdaq Composite we refer to as Spring Break 2000. Once upon a time, proclamations that Profits Don't Matter might have identified the bold 'n brash Dot-Com value star who disregards short-term results in favor of those things essential to the business.

That hypnotic spell is now broken. Fling out the Profits Don't Matter in a meeting with financiers trying to shore up the company's cash position because IPOs are no longer available, and the proclaimer might find that he is the one flung-out of the room.

To many, Profits Aren't Important and similar clever netPhase I themes are symbolic of all that was wrong with the system in that they sped future bankrupt companies to the IPO marketplace.

As with most of the other Netenomics phrases, there's a grain of sanity here. Fast-growing, high potential capital-intensive businesses are expected to show investing-in-the-future losses in early years. Unless that company's profit pattern mimics the early years' dip in "soup ladle" curve, observers who knew the pattern of profitable companies fear that the later, high profit stages of that curve will be missed, also.

Then there's the misguided corporate beancounter who turns down all investment projects that do not appear likely to reach profitability in the first 12 to 18 months. Initially, he fools himself and others into thinking that he's creating value, as there are fewer loss-generating projects. But the opposite is true, instead.

This myopic manager destroys value in three ways. First, through adverse selection, the projects that show unexpected profits too early also tend to be short-lived. Second, the too-narrow selection criteria causes the corporation to miss some major value opportunities. Finally, the value opportunities that are missed go to the competition instead.

FADS: FREE, ONLINE ADVERTISING, DARK MODEL

Three Netenomics terms transcend separate Internet business models. The three are "free," online advertising, and the Dark Model.

Free, and Last

The notion that giving away something for nothing is a great way to build a Web-based business is nothing new, except for the Web part. For years, eager marketeers have assailed their bosses with great plans to open up all new territories with massive giveaways. They will buy something from us in the future at a profit is always the justification.

In Chapter 1, we suggested that self-interest is the key to interpreting individual valuation schemes especially in the case of the Dot-Com company temporarily "valued" at, say, 100 times revenue multiples when that company will probably go bust within two years.

Self-interest also dominates in the free description. Except that instead of a salesman, there's a Dot-Com CEO who knows that the scarcity of solid data means that he can fool at least some of the financiers. Giveaways create value? Sure, dude.

At least during netPhase I, this spin was possible. The period following Spring Break 2000 is another matter-as described in Chapter 6. There's also the Net-cultural aspect of "free," which seems to have endured from the early days when the Net depended on selflessness to survive.

Separate rhetoric from reality, and companies giving away a "free" ISP (Internet services provider), information service, or the like must generate some profits to survive. Online advertising (see below) is one possible revenue source. The backup argument is the dubious concept that having been given something once, twice, or three times for free, B2C or B2B customers will now buy that product/service (or something close to it) for cold, hard cash.

No chance. Reinforced by the free Net culture, businesses instead risk becoming profitless shells as they discover sometime later that they have instead conditioned their customers to expect that nearly every future service they demand will also be provided to them as valued customers, without charge.

Another rationale for free is sometimes cross-marketing. This is the marketeer's dream, that appeal of one unrelated product creates demand in another product or service. Cross-marketing is only marginally achievable at best in terrestrial markets. Online, the concept is a non-starter.

Sounds good, doesn't work.

Once a segment "goes free," there is no return. Just try to resurrect browsers as a charge-for market after Microsoft made it a giveaway. Although we admire services such as TheStreet.com who try to charge fees when lesser competitors give their services away for free, we fear that the Net is now a land of lowest common denominator pricing. Count on less knowledgeable customers plus saturation advertising to sometimes blur the distinction between legitimate services and pretenders.

Advertising: Demise of 95-centDollar.com Dozen an original Net idea, it's only because you don't know about the two who are already implementing it. We actually thought once that we originated the story of the pretend Web site that makes a business by giving away dollars for 95 cents each and then receiving seven cents in ad revenue, all with zero development cost (this is where the magic of viral marketing can work, fast).

By last count, we were about the thousandth to take credit for the concept. But concepts like the 95-centDollar.com "site" endure, sustaining the tenuous logic of nurturing a business from advertising alone. This is a form of support that even its fiercest champions still described as tremendously underdeveloped, as of mid-2000.

But that's only half of it. We see recurring instances where corporations trying to justify a new B2C operation or project set a maximum for the amount of advertising revenue that they will accept in the justification model to well less than 50 percent or less. At one client firm, it is 25%. Seventy-five percent was the maximum prior to Spring Break 2000.

Whatever the reason-excess competition, advertisements that don't work, reduced ad budgets in that more stringent post- Spring Break era-few will argue that a major change in reliance on advertising as a revenue source has occurred. Even before the March 10 Nasdaq Composite peak, when year 2000 Super Bowl marked the last hurrah for ego-trip, ineffective ads from Dot-Coms with more cents than marketing sense. Advertisements for Dot-Com companies on previous generation media remain nonetheless: television, radio, billboards.

Dark Model: Value Endgame, Even before You Get Underway

Our contention is that there are many more hidden profitless industry segments around than many would admit, and more are coming daily. Even though Web hosting is still far away from achieving its full potential, the tough truth is that excess entry opportunities position this as the new low-profit Dot-Com sector, following in the footsteps of dial-up ISPs and wholesale Net access as the next profitless shell industry.

The notion of Dark Models is fiercely contested by everyone trapped in one. Commitment to maximizing shareholder value ends when it threatens that person's job.

IDENTITY, PURPOSES OF DOT-COM VAPOR MODELZ

Business Model.

The words roll easily off the tongue of the Dot-Com company management and even more smoothly off the silvered tongues of its spinners and financial intermediaries. Don't blow it on CNBC tomorrow when you answer the "business model" challenge question: This IPO must soar. Business Model. Somehow, what was one of the most ordinary business terms prior to 1994 now assumes magical dimensions. The model is key to billions, assuming that it is perceived to be the equivalent of a guaranteed successful marketplace strategy for the future. The stage is set for a lucrative Initial Public Offering.

In Dot-Com pre-history-that is, before the mid-1990s-"business model" meant nothing more than one hypothesis about how that business might operate into the future. A broad description of the business and little more, with no clue about whether that model was complete or correct, or even adequate in terms of covering the key questions central to that firm's future survival.

Business Model. We have absolutely no idea how this mundane phrase came to be elevated to mean so much more, but it did. During the heyday of netPhase I, the perception was that the model was close to a magical prescription, a unique selling proposition plus segment dominance combined. A solid blueprint assuring maximum shareholder value with a minimum of difficulties. Since those halcyon days, business model has slipped to depths of the corporate vision statement, and you don't see much of the latter today as just the word "vision" is a laughing stock in most management circles. Today both business models and vision statements identify the obtuse manager who puts form far before function. And worse, who cannot tell the difference.

Dot-com business modelz (we add a "z" to avoid confusion with legitimate, exacting simulations and analyses) are next, as cartoonists parody kids who make a business out of selling assets of bankrupt Dot-Coms. The joke would be funnier except that such vulture companies represent one of the faster growing Dot-Com segments after the Spring Break 2000 crash. The Dot-Com makeover-reconstructing the core Web-based business to improve prospects for future financing-emerges as a growth category from mid-2000 forward.

Some reconstruction is legitimate. But other efforts are valueless surface adjustments. For example, re-packaging the company's business model so that an investor will add more funds to keep old e-Bankruptcy2001.com alive a few months longer. Perpetrators of this shell game are some of the same oily consultants and other parasites who designated themselves as experts in developing new Dot-Com business concepts just a few years earlier.

But that still doesn't answer the question of how it is that such baffleprose was ever believed in the first place. Answer: Investors want to believe it's true.

Remember, the business model is just a slightly formalized version of the five-minute elevator pitch that each Dot-Com exec can deliver unconsciously. The model isn't designed to be plausible. Most aren't. It is merely intended to suspend disbelief, temporarily. Nothing more is necessary.

It doesn't make any difference that the first wave of medical information Web sites, such as DrKoop.com, had an Achilles' heel from the beginning because major medical organizations could always outflank the first-generation sites. Few raised this concern in 1996-99. It took the millennium plunge in the stock price to raise concerns about the business model.

In March 2000, Kate Bulkley asked management of online travel and reservations service Lastminute.com about its business model a few days after that company's controversial IPO. She questioned the logic underlying that Dot-Com's business model, as similar services were already available from many other online companies and channels at comparable prices. As the CNBC reporter suggested, Lastminute.com is a self-described online "aggregation," which goes against a basic business appeal of the Net to get rid of the middleman. 8

Some Dot-Com management relegate preparation of business models to third parties, treating the documents as a bureaucratic nuisance. The result is business modelz : long on Dot-Com hyperbole, short on intelligence-ensuring that the business is not a seventy-percenter.

This is a massive mistake. The business model is the closest thing to hard performance data that many Dot-Coms encounter in their early years, whether the company is an online only standalone or a clicks 'n bricks hybrid.

The fully-adequate business model is not some passive document for some junior staff number-cruncher to unconsciously process. The fully effective business model is the equivalent of a medical chart monitoring the status of a critically ill patient in a hospital, along with key tactics for what could be done, what should be done to ensure that the patient not only survives , but thrives . Absence of an effective new business model relevant for the new circumstances means that future viability is unproven. This deficiency may not hinder the Dot-Com in securing financing during money-mad periods such as netPhase I, but as financing becomes scarce the zero company model receives nothing.

IPO Day at CNBC Dot-Com all-smiles management accepts the gracious congratulations of the TV presenters, along with the perfunctory New IPO interview.

The Dot-Com CEO has every syllable of his business model explanation down pat when CNBC's Bill Griffeth asks the fateful question on camera, "Tell us something about your business model . . ."

The verbal download that follows takes about 30 seconds. The pitch has been timed before, as the CEO knows that he only has three minutes or so on screen. This could be E-Bankruptcy2001.com's only chance for national exposure. There are always other Dot-Coms crowding the airwaves, seeking to capture the public's imagination and, eventually, their funds.

The other reason for fast-paced delivery is more pragmatic. Rapid-fire delivery makes it harder for challenges to be mounted. So, in one breath and best carnival-barker rapidspeak:

BILL, Rings O' Saturn Research says that by 2004, every person in the universe will possess at least two of these indispensable items at 90% net margin, not to be confused with our cost of sales and churn rates, which are also 90%. We have first mover advantage and scalability and fully monetize our network effects. No one else can get in to the critical demand for Digital Online Only Migrane detectors-the DOOM market. Bill, there are technical problems with our raw killer ap. But we're confident that our technicians can fix the problems if we re-price their share options. We expect to become profitable by first quarter of 2005 because we can't get away with any date later than that. BILL (exhale).

How can they get away with this? Comparisons to more unbelievable business models are unavoidable, so there is some gentle follow-up questioning. For example, Mark Haynes or someone else will ask: So what makes your model so special-when this is the seventeenth search engine in a segment that can support six at most? Of course, in media-friendlier form.

DEBUNKING THE INTERNET VAPOR MODELZ

Following is adapted from a July 1999 VBM Consulting article (www.vbmresources.com), which helps explain why those who develop worthless models that have no relevance to the real world sometimes believe that even this deficiency cannot jeopardize their chance at IPO riches.

In the software community, "vapor" refers to a new update version that exists only in the mind of the developer. A trick, intended to divert and distort buyer behavior. The tactic may work temporarily but crashes (literally and figuratively) soon after.

A comparable series of developments emerge in the case of the whiz-bang Internet businesses, which are unprofitable today and possibly forever. "Model" replaces the word "vapor" in the case of these commercial releases.

Not to worry, all you new Internet company investors and founders. Even if the truth is already suspected by most, the secret will not get in the way of floating some ten-month-old company that in the past would not even qualify as a serious prospect.

After all, why shouldn't a pre-bankrupt company have the same chance at IPO riches as a company that actually might survive?

You see, there are lookouts on the corner ensuring that this particular heist succeeds. London City investment bankers drool at their Manhattan cousins' ability to secure lucrative accounts by providing access to the soaring first-day IPO profits. Never mind that the average individual Bubba investor has no chance at all to participate, or that the IPOs first-day headlines merely draw in the next wave of suckers.

Key to the Net is its model, a spreadsheet version of how the corporation is supposed to prosper into the future. Plausible enough long enough for the initial investors to get out of e-Bankruptcy2001.com and still be smiling.

One small problem: The models usually don't work . Which means that the average Dot-Com company has to switch from one model to another to keep the wealth illusion alive.

See if you can spot your Dot-Com's business model in the list that follows:

Model 1: Chapparal

This first-to-Net pioneer has precious little else going for it. Management's IPO strategy is to capitalize on fawning trade press and explosive statistics about the first-wave of users to sign up, hopefully before anyone realizes that such near-data means absolutely nothing as far as future prospects of the company are concerned.

As of mid-1999, the UK's minimal charge Internet Services Provider, Freeserve plc., was less than a year old and already had drawn more than 100 competitors, like iron filings to a magnet.

Each rival is poised to displace Freeserve with an even cheaper, faster, better deal. In another year, that number could easily double when one takes into account commercial no-access fee services: conventional companies that use "free" for marketing pull, while the actual Internet service is provided by a separate third-party carrier on contract.

Here's a question never to ask the nervous CEO of a Chapparal Net model company:

"Can you ever make a profit when growth of the number of users flattens and the number of competitors doubles? Be prepared to hear a swift: Next! From the frazzled chairman.

Model 2: Yankee Doodle Dandy (Doo)(So Long As They Stay Over There)

The model of an aspiring European online auction service is simple: Copy the Yanks. E-Bay, Yahoo!, and Amazon auctions have all enjoyed some success. Why not start a comparable service but without the American accent?

The coming crisis occurs when this is all the service offers, which is different from the coming American invaders.

"Buy American" never works particularly well in the US.

Why should "Buy You (Vous) EU?" be any more effective throughout Europe? Answer is, it isn't.

Net customers cut across national lines, which is part of the massive appeal of Internet commerce. The "we made it work, right" argument of the Yanks can be persuasive when extended to other parts of the world. The American invaders in auctions, online securities brokerage, insurance and travel services are parked just offshore, ready to grab the market with familiar American over-enthusiasm as soon as there is any sign of European demand.

Never ask the sensitive manager of the non-US based YDD model company:

"What happens to your business when leading US competitors enter your market with a customer proposition that is as good or better than yours?"

Model 3: Pinky and the Brain

A popular Warner Bros. cartoon features a balding rodent with an enlarged cranium who continually proclaims that he's "Going to Take Over the World." No, no, not anyone associated with a pioneer e-business based in Seattle. Brain is nothing more than a laboratory mutant with an overactive imagination and a penchant to control everything. Then again, Z-shops, www.drugstore.com? Hmmm.

This PATB model calls for entering (and later dominating) every Net market possible.

Sometimes because the Chaparral model is already unwinding and profits are plunging, one must leap to another model to ensure that the storyline is still intriguing to Bubba GreaterFool and-more importantly-to possible second-stage financiers.

Amazon.com expands from books to CDs to auctions, toys, drugs, and electronics, leaving its books' backside open to focused competitors (Fatbrain) and wave upon wave of online deep discounters.

The problem with becoming all things to all customers is that you ultimately become nothing to any of them. Site navigation becomes sluggish, as the number of Web site tabs and guideposts and ads resembles family photo albums after decades of neglect.

Then there's the ultimate threat of the one organization that deliberately points itself toward offering everything cheaper or less, which rarely enters a battle it cannot win. Yes, In Sam Walton We Trust.

Never ask the sensitive manager of the PATB Net model company this question:

"What happens to your business when Wal-Mart finally sets its online formula right, establishing the unassailable cost and performance advantage online that it does now in 'terrestrial' stores?"

Model 4: Everybody's Doing It, Doing It

Participants eager to join the growing Net category introduce slight, irrelevant, minor alterations that make their service cosmetically different from rivals. The distinctions mean nothing to customers. With no differences of importance between major competitors, marketplace dissolves quickly into fragmented commodity pieces. Each share is too small to sustain a business.

Even though there are far too many specialty search engines, that doesn't prevent new ones from bubbling up all the time, leading the reasonable observer to think that the motivation is less what the market needs than that this is something the Dot-Com entrepreneur can do . A treacherous trap whether starting or trying to remain in a business.

Look out for the tsunami wave of meaningless Dot-Com product/service differentiation. Search engines allow customers to sort by most popular response, most payment received from sponsors, preferred response of this or that "expert" group. Occasionally, even (gasp) a search engine that provides the best answer.

Over the near term, the danger to the investors still riding the crest of these high fliers is that another competitor will enter easily and draw away too much business. But that ease of entry suggests another, far more damaging threat: that the next generation of operating software may permit end-users to act as their own search engine managers, eliminating the need for these "infomediaries."

Never ask the sensitive manager of the Everybody's Doing It model company these questions:

"What is the minimum market share to survive, and what share do you expect to have in a year? Does the entry of new companies to the industry now fragment demand so that no one can survive?"

MOVING FORWARD

I think it's a very positive thing to have to physically drill down into business models to see if there will be profits three, five, ten years out.

--Mark Walsh, chairman, VerticalNet 9

Attitudes toward Internet businesses have changed dramatically since Spring Break 2000. The Dot-Com financing landscape has been hit by a severe earthquake, obliterating the VC-IPO model of netPhase I.

Post- Spring Break 2000, the Dot-Com category is adrift, without clear future financing direction. The crisis dictates one-off holdover temporary financing just to buy some time.

Twenty borderline-viable Dot-Coms in a portfolio run by three to four major financing sources evolve into five compact competitors. These are all-new Dot-Com stand-alones and hybrids (bricks 'n clicks) formed from post-IPO Dot-Coms surviving the collapse of netPhase I, plus the rare post-crash new IPO.

But survival financing will be available ONLY to a limited number of clearly No. 1 or No. 2 segment leaders. Companies with short, verifiable paths to positive cash flow and segment dominance.

Faced with this stark new era, Dot-Com management can be excused for believing that the first priority is to scramble around in search of all-new financing sources. Nope. The same thin, thin floats used to help "guide" netPhase I market values now mean that the Dot-Com company often has less than a year's cash left.

It isn't always the burn rate that creates the liquidity crisis. Sometimes Dot-Com management gambles that buckets of cash will always be available for a company with the ".com" suffix, at any point in that firm's life cycle. Whoops, lost that bet.

First Things First

Renewed emphasis on finding new sources of financing is certainly rational and reasonable. But not always optimal.

With trickle, trickle announcements about Dot-Com bankruptcies taking over the first page of the business press every day, finding and eliminating NIQ Dot-Coms as quickly as possible becomes Priority One for survival of the Dot-Com marketplace overall. Fail to remove the weeds quickly, and growth of viable companies stalls.

Throughout netPhase I, viability of the Dot-Com ranked among the lowest priority, regardless of rhetoric to the contrary. In Net We Trust prevailed. Even if the business model seemed childish, the mistaken belief flourished that this group of companies could continue to defy long-established survival percentages for start-ups at similar points in their development.

That delusion is now blown to smithereens. The opposite extreme assumption takes its place. Unless the financing or investor group management is convinced otherwise, its assumption is that the Dot-Com is a seventy-percenter with bankruptcy just around the corner.

Any proof to the contrary must come straight from the company's leadership, and must be clearly supported by verifiable intelligence from independent sources. No more perceptions- management exercises that duck basic questions about today's profits and tomorrow's prospects. Management in a B2B sector that thinks that mere access to business data alone is enough to displace Mark Walsh's VerticalNet in that relationship-driven segment are better off learning the tough truth now, rather than later. 10

Requisite Mindset: Your Model Is Already Broken-Fix It Right Or Disappear

Extended debates about whether or not the incumbent Dot-Com model "still works" merely increase chances of failure to nearly 100%. If not because of previously unseen challenges from competition, then because of cash starvation.

Radical, independent reform of the business model is not some bureaucratic distraction but rather, a pre-condition for present survival and future possible success. With questions of viability soft-pedaled in the past, direct financiers and others are not about to allow themselves to be fooled a second time.

The Dot-Com company that fails to radically challenge all parts of its business model after Spring Break 2000 and before pursuing new financing effectively is throwing in the towel. Giving up. Every day, management stresses the importance of operating at "Internet speed." Of understanding that industries, companies, and individuals face 180-degree changes every quarter or so. Failure to apply that same perspective to the corporation's blueprint for future survival and success is tantamount to saying that this company cannot succeed.

The "right" plan? There is no template model for re-making. Any standard formats and canned combinations of just the right magic words, content, and concepts died along with netPhase I.

Questions Designed to Separate the Value-Creating Dot-Com From Its Value-Destroying Cousin

There are some common sense questions that can help separate the non-viable Dot-Com doomed to fade into history from its "In the Black" relative. Two such issues are examined below:

1. Is there any solid connection between expenditures made and capturing additional share?

Numerous B2C late-to-market IPOs splashed out millions in TV and billboard advertisements during the critical Christmas 1999 season in a high-risk attempt to grab market share. New York Web traffic analysis company Media Metrix suggests that most of these desperation gambles by little-known Dot-Coms failed as eyeballs gravitated to familiar "Old Net" (e.g., better established) household names, such as amazon.com and eBay.

The sense of bets made and lost was confirmed on a spot basis as the gambling B2Cs' post-Christmas excuses turned into dust. One brassy Dot-Com manager explained that the millions spent during the season accomplished exactly the intended result, even though his firm was nowhere on the Media Metrix list. Sure, that could happen.

2. What are the barriers to entry, if any, and who within the segment are the most successful at erecting those barriers?

Market share gains are for nothing unless shares can be defended. With rare exceptions, first-to-market status alone fails to deflect competitors. To the contrary, the fact that the market has now been "legitimized" may actually increase competitive intensity. Unless the Dot-Com is one of the few corporations that have erected insurmountable barriers against churn, outlays splashed out for market share can easily disappear down the drain.

Direct, objective verification is essential to distinguishing the value-destroying Dot-Com from its value-creating cousin.

Everyone claims to possess infallible "glue" to retain today's customers. But be wary of churn, as new customers displace old ones with little market benefit. The "free" ISPs growth rate of new subscribers is only one statistic for assessing enduring strength. With dial-up ISPs a commodity Dark Model, key is how many are retained, as well. The question is not just who attracts the new customers, but also who retains them.

An even worse situation arises if nobody has discovered the key to preserving share gains once achieved. That situation in many B2C markets and some B2B segments points to a cyber commodity market, in which all participants are rendered unprofitable. If not today, then tomorrow.

Notes

1. Neal E. Boudette, "World Online's New World" The Wall Street Journal Europe , June 19, 2000, 25.

2. David Parsley, "The Man Who Would Take On Cisco," The Sunday Times (London), June 4, 2000, 3.13.

3. December 7, 1999, VBM Consulting interview with Brad Wieners. Also see his "Pass It On," Wired , July 1999, 60.

First we thought that viral marketing originated with Blue Mountain, as Wieners suggested to us. But then we saw the biography of Timothy Draper, at the IBF Private Equity Internet Investment Seminar, April, 2000. "His original suggestion to use 'viral marketing' in Web-based e-mail to geometrically spread an Internet product . . . was instrumental to the success of Hotmail . . ."

4. "Sussing Out Scalability, Real and Claimed: Part 1," May 3, 2000, www.TheStreet.com.

5. Combination

The importance of combination of methodology and input are referenced here because of distortion problems associated with "Contaminated DCF" as described in Chapter 1. A powerful base valuation methodology such as Adjusted Present Value (T. Luehrman., "Using APV, A Better Tool for Valuing Operations," Harvard Business Review , May- June 1997, 145-154), or some of the other generally available standard valuation models, is only as good as the input used in that model.

Assume a 10-15-year lifespan (t) for valuation purposes when businesses in that industry disappear every three years, and gross valuation inaccuracies are assured. Similarly, faux-data inputs for risk, growth rate, profitability, and assumed returns on fixed investment, R&D, and advertising components of the valuation model can and do destroy valuation credibility.

Analysts' Interpretations Are What Count

In Cash Flow and Performance Measurement , (Morristown, New Jersey: Financial Executives Research Foundation [FERC], 1996, 11), author Henry A. Davis refers to his multi-company research: ". . . value is best understood by institutional investors with a long-term perspective who base their analysis primarily on their estimates of future cash flows discounted at the company's WACC (weighed average cost of capital)."

The Dot-Com company that fails to provide full and complete cash flow guidance to analysts limits its access to future financing in today's more stringent funding environment.

6. No statement or inference made here suggests in any way that Staples' data or disclosure was incomplete or misleading in any form, degree, or manner.

7. For additional insight into some of these alternative measures and their uses, see Steve Harmon, "The Metrics for Evaluating Internet Companies," originally developed February 23, 1999, from The Internet Stock Report , May 16, 2000.

8. Media darling LastMinute.com went public at the beginning of the five-week Nasdaq plunge referred to in this book as Spring Break 2000. Within days of the disappointing IPO, the online travel service became a magnet for general criticism directed at late netPhase I B2C IPOs that just made it to market before the crash.

9. Larry Dignan, "B2B Stocks: From Boom to Bust to Boom Again," ZDNet Interactive Investor (www.zdnet.com), April 21, 2000.

10. Arlene Weintraub, "The Be-All and End-All of B2B Sites?," Business Week , June 5, 2000.

Amazon no longer offers textbook rentals. We do!

Amazon no longer offers textbook rentals. We do!

We're the #1 textbook rental company. Let us show you why.

Net Value

0814406041

Summary

Table of Contents

Supplemental Materials

Excerpts

Rewards Program