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"New Businesses Sharing New Business News "

Seeing the Net with Clearer Vision

By Alex Salkever

After cockeyed optimism gave way to extreme pessimism, an understanding of how the Web will really work is finally emerging

NEW YORK - When business historians look at the period from 1995 to 2000, they'll likely cite it as the most spectacular of booms and busts. Hundreds of billions in venture capital was invested and lost, most of it by people chasing the idea that the Internet could make business -- and life -- friction-free. As the dot-com bubble burst, a broad spectrum of technology industries that were supposed to benefit from the Internet's exponential growth turned moribund. Telecommunications, networking equipment, business software, e-commerce, and even PC makers have struggled with steep drop-offs in demand that caught them flat-footed.

Worst hit have been the Net startups. According to WebMergers, a consultancy that tracks closures and acquisitions of Internet-related companies, 716 Net-based businesses have closed since January, 2000. And over the past two years, more than 1,000 others have been acquired, in most cases at steeply reduced valuations. On Nov. 9, Web software and search technology company Infospace agreed to buy the portal assets of broadband-service and content provider Excite@home -- once valued at $6.7 billion -- for a mere $10 million.

NO SURE THINGS. The debacle has even pushed into bankruptcy companies that were formerly viewed as sure things, including the once-mighty Web-hosting concern Exodus Communications. Highfliers that soared with the Web, such as networking company Cisco Systems, server maker Sun Microsystems, and Web software provider BEA Systems, have suffered at the hands of investors. As of Nov. 13, Cisco, Sun, and BEA share prices are now off 62.4%, 70.7%, and 78.2%, respectively, from their 52-week highs. In early October, Sun CEO Scott McNealy decreed mass layoffs for the first time in his company's history. And in September, not a single company of any kind went public -- the first time that has happened in the U.S. since 1975.

Still, if it's true that it's darkest before the dawn, then the night of the dot-com meltdown should be nearly over. It isn't entirely clear what will rise with the new day, but many analysts believe that unrealistic hype and the subsequent extreme pessimism have given way to a clear-eyed view of the Internet.

The Net's potential is still great, and it will continue to merit major investment, but it will have prove itself according to the traditional measures of business success -- such as sales and profits -- rather than measures made up by Wall Street analysts with a flair for both fiction and salesmanship. The Net may no longer be revolutionary, but it still holds the promise of ample rewards for consumers and businesses alike.

A STEP FURTHER. Take the case of Owens & Minor, a Richmond (Va.) medical-supply business that grossed $3.85 billion last year. Chief Information Officer David Guzman has already shifted large chunks of the ordering process for his hospital customers to the Internet. His next goal: going a step further and letting individual doctors place highly customized equipment orders. A physician could order a kidney-stone surgical tray through a hospital's network, which would pass the order on to Owens & Minor. The company's computer system would check that all the ordered items are in stock, then spit out a purchase order for a warehouse clerk to fill.

Nurses would spend less time putting together surgical trays, doctors would fill out less paperwork, and hospitals could more easily track purchases. O&M would gain insight into ordering patterns and share this information with medical-equipment manufacturers that are also wired into the supply chain. All of these disparate elements would be tied together via public Internet connections using out-of-the box software that programmers had rejiggered to ensure smooth communications.

Guzman estimates that this type of coordination applied on a broader scale could save America's inefficient health-care system as much as 30% of its expenses. "The real effects are quite dramatic," he says. "The problem was that the hype of the Internet was focused too much around something that hasn't panned out -- the business-to-consumer space. It's in the business-to-business space, or internal operations, where real change is happening."

HIGH PRIORITY. Indeed, it has become clear that the value of bringing traditional business operations into a Web environment will outstrip the benefits of getting more consumers to use the Web. Granted, costly, often unsuccessful first-generation software designed to move business processes onto the Web made CIOs and information technology (IT) staffs wary in the beginning.

But corporations have since seen the light. According to a survey of 15,000 companies by tech consultancy IDC in the first quarter of 2001, businesses planned to increase their spending on Web initiatives by 30% this year. "That was after the economy was already going south," points out John Gantz, IDC's chief research officer.

The worsening economy notwithstanding, Gantz believes that businesses are still putting a high priority on Web projects. "I'm telling my clients that we're looking at IT spending dropping this year and being anemic next year," he says. "But the best sector will be business-to-business and initiatives that help companies put their own business on the Internet."

Perhaps that explains all the activity WebMergers has been tallying involving companies that make B2B software. In the first three quarters of this year, the firm found that the majority of Net-related merger-and-acquisition deals were among companies that make software for such uses as customer-relationship management, automating customer support, supply-chain management, and information sharing. All told, those deals have accounted for $4.9 billion in activity through September.

For big companies making long-term bets, the current Net downturn is a buying opportunity

This long-awaited consolidation should add stability to this once-volatile market because in most cases the acquirers are large technology-services companies and software businesses. Witness IBM's $129 million purchase in October of Crossworlds Software, which builds tools to connect and automate various e-business systems. Other large software companies that have purchased Net-business startups include enterprise resource-management giant J.D. Edwards and human-resources database specialist PeopleSoft. Indeed, for the big companies that are betting on the Internet long-term, the current downturn is a buying opportunity.

JUST ANOTHER CHANNEL. As in B2B, momentum in online retailing is swinging strongly to the established players. With a few key exceptions, the sector is becoming just another sales channel for giant brick-and-mortar retailers. Of the 20 top online-retail sites ranked by Jupiter Media Metrix, fewer than half are online pure plays, and some of those, such as Buy.com, remain largely unknown to the average Web surfer. Two of the pure plays, eBay and Half.com (which is owned by eBay) sell auctioned items and used goods, respectively, and hardly count as traditional e-tailers.

Of the hundreds of startups that hoped to build big online retail businesses, only Amazon remains as a major brand name. Questions about whether it will ever turn profitable continue to dog the company, which has found its highest-margin business is providing various Web and fulfillment services for other retailers. Responding to a barrage of public criticism, Amazon CEO Jeff Bezos has begun to rein in ambitious expansion plans that positioned Amazon as an online department store selling everything from kitchen gear to table saws. Thanks to Bezos' streamlined plans, traditional retailers no longer talk about getting "Amazoned."

Also worrisome is the slowdown in online shopping growth. The triple- and high-double-digit growth rates the sector enjoyed from 1996 to 2000 fell to 24.7% in second-quarter 2001, according to the Commerce Dept., as Web retailers spent fewer promotional dollars and several former giants, such as online grocery site WebVan and online convenience store Kozmo.com, punched out. The one hopeful sign for e-tailers is that online sales continue to grow faster than offline sales, which Commerce says rose at a 3.7% clip in second-quarter 2001, implying that e-tailing is still an immature business with room to grow.

NICHE SURVIVAL. Some types of online sales have caught hold, particularly travel. It has enjoyed phenomenal success, logging sales of $13.8 billion in 2000, according to Boston Consulting Group. Industry leaders Travelocity, Expedia, and Priceline have all bounced back from a post-September 11 slowdown to nearly the same level of business they enjoyed before the terrorist attacks. That could change again, though, in light of the Nov. 12 crash of an American Airlines jet in New York.

Meanwhile, dozens of other pure play e-tailers are surviving in niche markets. Diamond seller BlueNile.com has posted $50 million in sales in the last year with an operating loss in the single digits. It expects to turn profitable in the coming year. The company locked up an additional $7 million in venture-capital financing in late July, despite a near freeze on funding for e-tailers.

Another group that has seen its prospects change dramatically is news and information sites that aim to support themselves with advertising. Even though, for the most part, their audiences continue to grow, the majority are unprofitable and are likely to remain so until the economy -- and advertising -- recovers. Financial-news site TheStreet.com posted a third-quarter net loss of $8.9 million, only slightly down from a net loss of $9.6 million the year before, on flat revenues. While the company's subscription revenues surged to $2.3 million in the quarter, advertising revenues fell 67% vs. the same quarter in 2000. The company's cash kitty fell 19.6%, to $40 million.

As the economy recovers, so should online advertising

LONE SUCCESS. Sites such as Salon.com, CBS Marketwatch, and Cnet have also been pummeled by the online-ad recession and have laid off dozens of employees. America Online, the leader by a wide margin in audience size, is the lone success among the original dot-coms. Of course, it has been boosted by its offline role as a traditional publisher, courtesy of its Time Warner acquisition.

Meanwhile, the smaller Web operations at most other traditional media companies are feeling the pain. Web-site losses and layoffs this year have occurred at such venerable institutions as Condé Nast, Disney, The New York Times, The Wall Street Journal, BusinessWeek, and USA Today.

Ironically, many publications expect a rebound in ad revenue because of the failure of so many content sites, which has reduced the number of outlets for online advertising. It's expected that more sites will disappear before the turnaround. But in the meantime, online-ad agencies have also been hobbled. DoubleClick, the leader in the business, has suffered a major decline in its market capitalization since 1999 and has laid off 25% of its employees.

BIG-TICKET FAILURES. Entertainment sites, once powerful drivers of traffic to the Web, have been a surprising disappointment. Attempts to ship videos and music via the Web have sputtered, mainly because of slow download speeds for the dial-up modems that still power the majority of Internet connections in the U.S. Analysts also remain doubtful about the viability of selling music online thanks to the numerous restrictions the recording industry puts on the use of music that's delivered digitally. A number of big-ticket failures such as Pop.com and Digital Entertainment Network have soured investors on the business.

The entertainment sites' fizzle has been a significant factor in slowing growth in the total Web audience. In fact, some studies suggest the audience is no longer growing much at all. As a result, debt-laden telecoms that banked on the ever-expanding traffic from both consumers and businesses have taken a pounding.

JDS Uniphase, the largest supplier of specialized components that go into fiber-optic telecommunications equipment, fired 55% of its work force and wrote down a monstrous $45 billion this year. Big gearmakers Lucent and Nortel have both suffered tens of billions in write-offs and have laid off tens of thousands of employees. Both traditional carriers, such as AT&T and WorldCom, and upstart carriers, such as Level Three Communications and Global Crossing, are suffering from depressed share prices and anemic revenues.

SPYING A BOTTOM. That ugly tide may soon turn, though. Noted telecom bears Steve Levy of Lehman Bros. and Paul Sagawa of Sanford Bernstein have both become cautiously bullish on the sector's major players. Most notably, Levy now supports Lucent Technologies, the most beleaguered telecom equipment maker in the pack. And telecom consultancy RHK says it sees a bottom in spending for the industry's products next year. It even expects a bandwidth shortage within a few years as Internet-driven data communications, which is still expanding at double-digit rates, eventually absorbs the excess telecom capacity.

Companies that sell hardware to power the Internet could enjoy a similarly subdued comeback. Cisco Systems, the router company, beat analysts' expectations by 2 cents a share in the third quarter. The only problem: Its total earnings were 4 cents per share.

The Net-bust fallout has also hit sellers of Web services. Companies such as RareMedium, Viant, Scient, and Razorfish once fought for contracts against IBM, Computer Sciences, and EDS. Now the upstarts lie in a heap with stocks that languish in the dollar range, down 90%-plus from their boom-time highs while their old-line competitors are cleaning up.

IBM's share price has improved 9% over the past year, largely due to gains in its service business. Likewise, shares in IT consultancy Accenture have bumped up 20% over the past 13 weeks, according to figures from FirstCall. Investors in Computer Sciences have enjoyed an 8.3% gain over the past quarter and 19.7% in the last month.

DEEPER VISIBILITY. What has sparked investor optimism is the realization that Corporate America is still looking to the Internet to cut costs and improve operations. That means it needs to hire help to build custom projects that enhance existing systems. And that has seers like Alfred Spector, IBM's vice-president for services and software, pushing buzzwords that sound like Silicon Valley snake oil. His favorite right now: "continual optimization."

Spector is referring to a constant process of adjustment where businesses that are connected over the Internet can not only see what their own customers are buying but also what their customers' customers are ordering and adjust accordingly. "Companies want to know more about what is happening two steps removed, and they can use the Web to do that," he says.

That's the same kind of thinking that drives plans by Owen & Minor's Guzman for ordering surgical trays online. People like him and Spector make it clear that it while the dot-com revolution may be over, evolution is taking its place. Yes, shakeouts among media sites, Web software and equipment companies, and suppliers of telecom gear and services will continue. The survivors will be big brand names and a handful of lean upstarts. The rest will continue to melt away, even as the Internet grows in importance, size, and value.

. . . watch for more stories coming soon  

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