The commercial’s storyline was a fairy tale, straight out of Mother Goose, only digitally re-mastered for Generation X.
With microphone in paw, a dog-on-the-street reporter—looking remarkably like a black-and-white sock puppet—interviews fellow canines about products their masters purchased through a new Web site, Pets.com, one of thousands that supposedly would revolutionize buying patterns.
For consumers, the moral of the story... er, commercial... was clear: The future is here; declare your independence from traditional middlemen. Entrepreneurs heard a subtler message: You, too, can get rich quickly while radically changing capitalism.
Reality, however, had other ideas.
Last November, Pets.com went out of business only 21 months after raising $82.5 million in an initial public offering. The failure was so staggering that when another Internet company—eTranslate, which designs multilingual Web sites—moved into Pets.com’s old offices in San Francisco, management hired a Chinese troupe to perform a traditional lion dance to purge the place of evil spirits.
The supersonic growth of dotcom businesses—and their equally supersonic collapse—is one of the most spectacular developments in technological and commercial history. Webmergers.com, a research and consulting firm, reports that 555 new Internet companies worldwide failed between January 2000 and June 2001. More than 75% of them floundered since November.
But not only the flashy, trendy Web sites felt the pain. Cisco Systems, a developer of Internet routers and networking switches, estimated in April that its second-quarter sales would fall by 30% from the previous quarter and eliminated 8,500 jobs, or 18% of its work force.
Despite the gloomy scenario, engineers and computer scientists can benefit if they understand why the collapse took place and how they can position themselves in the aftermath.
Rush to Judgment
Analyzing the dot-bomb phenomenon begins with realizing this fact: Entrepreneurs, investors and technology professionals became so infatuated with the Internet’s potential that they rushed to develop Web capability without considering the best ways to use that capability.
“The whole of society banged the drum for how the Internet and the PC were going to change the world,î says Jeffrey Young, founding editor of MacWorld magazine and a contributing editor to Forbes magazine. “The broadband revolution was going to make us all healthier and wealthier.”
Consequently, venture capitalists tumbled over themselves to fund Internet startups. Any e-idea seemed to be a good idea; venture capitalists spent a record $103 billion last year on nearly 7,000 new companies, Internet and otherwise. Meanwhile, established businesses made massive investments in routers, servers and other network hardware.
“Clearly, there was an unhealthy ingredient of hype and greed,” says Ralph Oliva, executive director of the Institute for the Study of Business Markets and a marketing professor at Penn State University. “It was an attitude of, ïGee, I’d better get on this bandwagon. I don’t fully understand it, but I’d better put some money into it.’”
But in their haste, venture capitalists failed to determine whether these new e-businesses had competent management to go along with a sound business plan.
“A lot of these dotcom executives were not worthy of being CEOs,” says M. Lewis Temares, vice president of information technology and dean of the College of Engineering at the University of Miami. “The people who started the company were either technocrats or sales people who didn’t have the experience or knowledge of how to operate a business. It was a game.”
“An entrepreneur should not get money until that idea is translated into a great business design,” Oliva says. “If all venture capitalists are doing is funding ideas and the business infrastructure hasn’t been put in place, then a very important part of the capitalist system has broken down.”
Buoyed by seemingly endless financial support, dotcom entrepreneurs devised an experimental, untested—and ultimately fatal—theory: Spend extravagantly on marketing, labor and capital investment to gain a dominant position in the market. Eventually, they hoped, sales would outstrip costs.
That theory proved disastrous. In 1999, the year it went public, Pets.com lost $61.8 million. It spent $21 million in advertising to earn $5.4 million in sales. As a result, the worth of one share in Pets.com plummeted from $12 after the IPO to 22 cents when the company folded.
“Companies were spending over 12% of their annual revenue on marketing and advertising,” says Sandeep Varma, vice president of New Strategic Initiatives for Stern Stewart and Co. in New York. “It’s a huge amount if you consider a traditional business plan. But the premise was to attract more traffic to the site and get as much market share as possible with no regard for profitability.”
The founders of Webvan.com, an e-grocer, believed so firmly in the eventual obsolescence of traditional supermarkets that they spent millions on capital infrastructure before the income from online orders could sustain it. Such investments included a $40 million, state-of-the-art computerized warehouse and distribution center in Oakland, Calif.
Instead, Webvan.com became obsolete. The company filed for bankruptcy in July after losing about $830 million since its inception. A share of Webvan stock, valued at $34 shortly after the IPO in November 1999, cost merely 6 cents upon the firm’s disintegration.
“People still like to see the products and the specials; they like to see, touch and feel,” says Temares, who worked in his father’s grocery store as a teenager. “These Web companies never did market research. Guess what else they didn’t realize: There ain’t no profit margin on groceries, and the competition is fierce.
“So if you’re going to offer this service, you’re going to charge $1.35 for the giant Pepsi and customers see a sale on Pepsi at their local supermarket for 99 cents, they want to know why they’re not spending 99 cents with you.”
Many e-firms also failed to offer any unique products or services that would distinguish themselves from the competition, as Young discovered while helping develop Forbes.com.
“We started with high hopes of adding incredible value to the Forbes brand,” says Young. “It became apparent that all we were was an advertising billboard for the magazine and that’s probably all we really should’ve been. The Internet engendered a really ugly thing, I think. There was the belief that you essentially didn’t have to make the product. Fundamentally, that doesn’t work.”
Compounding the Web’s commercial limitations was its technological ones. As Cisco discovered, corporate customers spent a lot of money on technology that they didn’t need and couldn’t use.
“There really hasn’t emerged anything on the Net that’s compelling,” Young says. “Napster was the only broadband application that really emerged, and it came out two or three years ago. But corporate buyers continued to buy Internet access at prices they wouldn’t have accepted for something essential to their product line. By the middle of last year, when the first dotcom group hit the wall, it was starting to become apparent.”
Nevertheless, some “brick-and-mortar” firms are successfully integrating a digital approach into their business plans. Such established companies as Charles Schwab, Dow Chemical, Eastman Kodak and Whirlpool are starting to use the Internet to increase production, improve supply, enhance customer relations and reduce the cost of purchasing supplies.
Take Cemex of Mexico, the world’s third-largest cement producer, which has become a model of digital business. Its satellite system coordinates production at all 11 plants and dispatches cement mixers so efficiently that delivery time has shrunk from three hours to 20 minutes.
The corporate Web site furnishes the latest financial information and enables corporate customers to access an e-catalog of products. Another Web-based system allows customs brokers and executives to obtain real-time information on shipments and duties. In October, Cemex announced plans to expand its e-presence through IT consulting and online marketplaces for supplies.
Cemex has spent more than $200 million on digital infrastructure. In return, sales have increased from $2.1 billion in 1994 to $4.8 billion in 1999.
“Once the current market anomalies are over, I feel there will be an incredible demand for people who really know how to coach in this converging economy,” Oliva says. “As firms choose to explore digital business designs and follow the Cemex model, there’ll be some really exciting career opportunities for IT-trained professionals who really have a handle on business.”
Learning From the Net Mess
Oliva’s last statement offers the key for engineers and computer scientists to exploit such opportunities: a solid understanding of business principles and practices. Employers are demanding it.
“More and more technical people are being looked on as business people,” says Dan Greenberg, founder and president of The Allegiance Group, an IT consulting and staffing firm. “Prospective employers are looking for technical people who are going to be able to understand the business and communicate with higher management. They’re looking for people who can convert the needs of the company into information technology.”
Greenberg recommends that college students majoring in engineering or computer science take not only business classes, but also courses designed to enhance their communications skills. Their ability to think in non-technical ways and their capacity to manage people is essential.
“They should learn how accounting systems work,” Greenberg says. “They should know just the general nature of financial systems so they have a general sense of how the company they’re working for is doing, so they’re part of the environment.”
College students also can find basic business knowledge especially useful when asking prospective employers about their companies during interviews.
“Students should ask some basic questions.” says Varma, “What’s your current profit level? Or, if the company is not profitable yet, what’s your profit goal? By what time frame do you expect to break even? They should also ask how seasoned the management is that’s running the company.”
Bill Gadless, president of the Web consulting firm EMagine Communications of Canton, Mass., advises caution.
“If I were a software engineer or a computer scientist, I would not work for a single company that had more than 50% of its business in the dotcom market,” Gadless says. “Even giant Web consulting firms that had more than 30% of their work coming from the start-up market have died. I would be looking for companies that focused on real companies with real business models.”
Understanding business also can enable technical specialists to read negative economic indicators and react in time.
“Technology is a very volatile sector; it is going to go through lots of ups and downs,” Varma said. “Technical professionals will have to look for some signs of slowdown all around the economy, not just in their sector. After all, it’s the other sectors that their sector sells into. They should take a cue from those things quickly and start retooling themselves.”
For anyone with an entrepreneurial bent, Young offers this advice: Don’t get fancy and don’t expect instantaneous wealth.
“There’s not a new economy or an old economy; there’s just good business and bad business,” Young says. “This whole new economy idea is worse than bankrupt; it’s negative. It makes people think it’s easier to be in business than it is.
“A couple of years ago, there was so much money out there that you didn’t have to put up your house, or your parents’ house, to start a business. That was a bad, bad stage. Since time immemorial, entrepreneurs had to put their own assets on the line. That meant you had to be sure not to make big mistakes. The most lasting upshot from this whole dot-bomb thing is that people are going to realize that if they want to start a business, they’d better be committed.”
The commercial wreckage might even provide the foundation for momentous technical breakthroughs.
“Frankly, if we had kept up that frenzy of moving off into every direction, it would have sapped all of the energy that would have gone into developing the true Internet as we will know it,” says Bob Senatore, executive vice president of Comforce Corporation in Seattle, which provides staffing and consulting to Fortune 500 firms.
“All the dotcom implosion represented was inning one of the Internet ball game,” Senatore said. “It may take as many as 50 years before we play out the remaining eight innings.”
So much for fairy tales.