From: Linda (email@example.com)
Date: Tue Jun 06 2000 - 04:23:56 PDT
Further to your discussion, I came across this article at Briefing.com yesterday on internet failures. Also including their article on
scalable business models which is of significance to those of us searching out fundamentally good companies to invest in.
Disappointments of the Net
05-Jun-00 02:11 ET
[BRIEFING.COM - Robert V. Green] In the early days of the internet, the enthusiasm for possibilities was undaunted. Now that we are a full
five years into the maturation of the internet marketplace, it is becoming clear that not all of the possibilities have actually happened.
Some have been disappointments.
New Markets That Didn't Happen
While internet stocks have been huge successes (at least some of them, and at least for a while), you can't say the same for internet
businesses. Many have just been flops, in terms of revenues. Nearly all have been flops, in terms of earnings.
Yahoo and America Online are the real standouts in terms of both revenue growth and building a true earnings model. But they stand as
exceptions to the rule.
For many internet companies, the expected market just never materialized.
Last week there were a couple of news items that underscore this point. Here is a brief summary of those items, with a conclusion about
what it means for the overall market for internet stocks.
News On The Internet: No New Brands, No New Businesses
At the beginning, (late 94/early 95) many argued that the internet would become a primary source of "news for the people." People would pay,
it was thought, for an new source of information, in contrast to the existing media.
But, with the sole exception of the Drudge Report, which is free, not one site on the net has "made it" as a news provider. (You might even
argue that Drudge has had his day in the sun, now that Monica is gone.)
A report released last week by InsightExpress came to a simple conclusion: people are not willing to pay for news online, in a subscription
format. In addition, they don't trust news that doesn't come a brand. COO Charles Hamlin was quoted, in a Reuter's news story, as saying
"Online news is more credible if it comes from an established, traditional source."
Ironically, the exact opposite happened when the TV medium arrived 50 years ago. The advent of TV created many new brands for news,
which are still powerful: CBS, ABC, NBC, and now, even Fox. At the time, newspapers held the role of preeminent news source.
But the internet hasn't created a new niche for news, not even a "free" niche. It just didn't happen.
Online Car Sales
Another dream that hasn't materialized is car sales on the internet. While there are still big visions behind Carsdirect.com and Driveoff.com,
and many others, the truth is car sales over the net have been disappointing, so far.
Even Autobytel (ABTL) and Autoweb (AWEB) have both flopped with their original business ideas: to be a referral service for car dealers.
No matter what spin the companies try to put on their results, there is simply no denying that internet referral services are not big
businesses. Both companies are trying to associate themselves with direct sales companies.
But add in the fact that GM is now pushing car dealers to cut their ties with direct sales services on the internet, in order to build
support for the GM BuyPower program, and you have a real disappointment for new business models on the internet.
A report issued last week by the Economist Intelligence Unit (www.eiu.com) came to one conclusion: the internet has not sold a single extra
vehicle, that wouldn't otherwise have been sold, over traditional methods. In a Reuter's story, EIU spokesperson Ian Robertson stated "The
projections were that 60 percent of car sales would be over the Internet by 2005."
It should be pretty obvious to even the casual investor that there is little to justify this claim today. In fact, in the end, the internet
may just drive out cost in the existing dealer network, and never really create a new, direct model.
What Is A Company Worth, Anyways?
Another example of how some internet dreams have been disappointing some can be seen in the purchase of AnyDay.com by Palm, announced
The press release states that the total purchase price was $80 million, in cash. But other news reports, by Associated Press, have indicated
that AnyDay.com had previously received about $20 million in venture capital investments.
No matter how you work the math, it adds up to one thing: venture capital in AnyDay.com is bailing out.
If the venture capital stake was 100% of the company, (not likely), then their return was 300%. If the $20 million invested bought the venture
capitalists 50% of the company, their return is only 100%. If the venture capital investment represented just 25% of the company, then the vc
return is 0%!
Since no one is revealing just how much the venture capitalists owned for $20 million, we can only guess what the actual return is.
But selling out now, for what is probably somewhere between a return of capital and a double, is not exactly a home run.
We can only deduce that AnyDay.com felt cashing in chips, whatever the return, for cash! is better than continuing to bet. For veenture
capitalists, who have seen 100 times their money in 18 months for the past three years, this has to be a disappointment.
We are in the fifth year of a twenty year cycle for the internet. It should be no surprise that many of the new models on the internet didn't
work out. That always happens in a new industry.
These three events of last week certainly don't indicate that new internet models are all failures.
But it does indicate we are heading into a maturation phase, where proof of a model will be expected, and expectations will be lower.
Maturity means stocks without clear paths to earnings will suffer even more than they have already. There are still plenty of them out there.
And they represent more disappointments.
But internet stocks with earnings, and a proven new business model, will thrive.
Comments may be emailed to the author, Robert V. Green, at firstname.lastname@example.org
Scalable Business Models
30-May-00 00:21 ET
[BRIEFING.COM - Robert V. Green] In the midst of this market turmoil, particularly for internet stocks, one thing should be kept in mind. The
internet created the possibility of very scalable business models. Despite what has happened to internet stocks in general, the right
investment in a good scalable business model could still prove to be a great investment going forward. What are scalable business models?
The term business model refers to a very simple concept: how a company receives revenues in exchange for value delivered. If you have a good
understanding of a company's business model, you can understand how the earnings of a business respond to growth of the business.
To understand any company's business model, you need to ask the following questions:
Who pays the company?
What does the company do to deliver the value, and to whom?
What does it cost the company to deliver that value?
How does the company get paid when more of its services are "consumed."
There are many business models where the person receiving the value is not the one paying the revenues. Broadcast television is perhaps the best
example. TV is free, but advertising pays for delivery.
Although it seems like a simple concept, there were, and still are, companies that became public over the past four years, without well
thought-out business models, scalable or not.
Many current internet business models still don't pass basic tests of credibility. For example, sites with pure advertising models are usually
unable to answer the most basic question about growth: "how big can you get?" The reason is that growth is entirely dependent upon increased page
views, either by more users, or more pages, offset by declining ad rates.
Both have upper limits, and most companies with advertising models have fixed costs exceeding current revenues. When you try to compute how
many page views a pure advertising model needs to generate just to cover fixed costs, it is usually baffling.
Scalable Business Models
A scalable business model is also a simple concept. A scalable model is one where:
Increased revenues cost less to deliver than current revenues
In other words, the operating margin increases as the company revenues grow.
Technology's greatest achievements have all been associated with scalable business models. The reason "Ma Bell" (American Telephone and
Telegraph, now AT&T) grew so powerfully in the last 100 years was that it had a very scalable business model, in an era where scalable models
Fixed Costs and Variable Costs
Another way to think about scalable models is to look at a company's fixed costs versus variable costs.
Fixed costs are costs that a company incurs whether it sells or not.
Variable costs are costs that a company can control, or which it incurs as it makes sales.
A company with a scalable business model will have variable costs that are small, per unit, or discretionary, as in R&D. The fixed costs
should be ignored, so long as you believe that revenue will be large enough to exceed the fixed costs, if not currently.
Not Economy of Scale
A scalable model is not the same as "economy of scale." The phrase "economy of scale" means that a company's variable costs become lower as
the company gets bigger. In addition, fixed costs can be spread over a greater number of units sold. This helps earnings, but economy of scale
does not ensure that operating margins increase as revenues increase.
Cost of Goods Sold
Another way of understanding a scalable business model is to examine the relationship between cost-of-goods-sold and revenue. Companies
which have a very low cost-of-goods-sold percentage generally have an opportunity for a scalable model.
Gross margin is the difference between revenue and cost-of-goods-sold. If the cost of sales and marketing, per unit or per customer, is less
than the gross margin, then the company's model is scalable. For every dollar spent on marketing, more than a dollar is generated in gross
margin, provided there is demand.
Revenue, cost-of-goods-sold, sales and marketing, can all be read from a company's earnings report.
Scalable business models have the potential for earning high profits. That potential is only fulfilled when demand actually drives revenues up.
Finding a scalable model is one thing. Finding a scalable model with evidence of booming demand is the ideal situation for an investor.
The most common example of an established scalable business model is software. Developing software costs a tremendous amount, but
delivering a "copy" of that effort costs next to nothing.
Microsoft took the concept of scalability further than any other software company, because they provide only a single "image" of the Windows
operating system to hardware vendors. The hardware vendors absorb all the charges for developing documentation and CD-ROM copies of
software. In essence, Microsoft receives revenues with zero cost-of-goods sold.
The internet is unique in that it is creating software delivered electronically which is the best of both worlds. The application software
world, where software was delivered in a shrinkwrap box, had costs associated with each unit sold.
The Application Service Provider (ASP) model delivers software at no additional cost per user. Provided that ASPs can actually charge for
services on a per user basis, the ASP model is very scalable.
Searching For Scalable Business Models
There are two ways to search for possible investments in scalable business models:
Look for companies that sell items with low cost-of-goods sold percentages
Use a stock screening database that allows you to compare the percentage increase in revenues with percentage increase in operating
Note that companies which both sell and deliver their service over the internet are the most scalable business models of all. Delivery of
services over the net costs nothing.
Internet stocks are paying the piper for the bubble of the last three years.
But while all the best known internet stocks are being slaughtered, there are still opportunities coming in internet companies. Most will
probably be new companies, brought to the market over the next two years. Many existing companies, such as Amazon.com, just didn't turn out
to be scalable, despite their great growth.
If you can uncover an existing company that has a scalable business model, and the market has depressed the price, it may be a great
investment. We are currently looking, and open to suggestions.
There is probably no hurry to rush into a new internet investment. But losing sight of the opportunity the internet creates, because of
the recent turmoil in internet stocks, would be a grave mistake.
Comments may be emailed to the author, Robert V. Green, at email@example.com
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