Heskett Column - Dot.Com Shakeout: Chess or Roulette?

In recent weeks the media have covered a number of stories about the merging, closing, or bankruptcy of high-profile dot.com organizations. We haven't seen anything yet. One reason is that the better-backed ventures had twelve to eighteen months of financing when the market for Internet-based start-ups tanked a year ago. Another is that, through relatively astute management, less well-financed organizations managed to survive by carefully husbanding their funds—avoiding the urge to make a Superbowl ad and paring down expenses—to lengthen the start-up "runway." However, without new infusions of funds or positive cash flow, literally thousands of these remaining organizations, even with the best and brightest ideas, management talent, products, and technical capability, are destined to face the same fate over the next six months.

At one level, one might take the view that this is free enterprise at work. Organizations that deserve to survive will do so. Of course, this assumes a near-perfect market, one in which the information is arrayed like pieces on a chessboard. It assumes that the most deserving dot.coms will get financed or bought. The question is, are the venture capital or strategic investment markets as perfect as the stock market? In their current states, are there sufficient investors able or willing to shell out relatively small amounts of money for control of the most promising dot.coms subject to this fire sale?

On another level, the question might be raised whether or not this game resembles roulette. For example, the corporate histories of the most famous start-ups of the last thirty years tell us that many required three years or more to achieve positive cash flow. Start-ups on "Internet time" don't appear to have that luxury. A number of the best of these start-ups are confronted with the chicken-or-the-egg dilemma. They are on the verge of closing the "marquee" deal that will produce the necessary financing but only if they can prove that they have the necessary financing. Still others are trying to negotiate a "marquee" deal with large organizations that are not marching (or running) on "Internet time." By the time these organizations are ready to close these highly attractive deals, they may find that their prospective partners no longer exist. By the time they are ready to transact or invest, that talent they found so attractive may be gone.

What is happening here? Is it free enterprise or pin the tail on the donkey? Chess or roulette? A business disaster or business opportunity? What do you think?

I think what you are going to see in this industry is a strong push to use the Internet as a means of communication instead of a source of revenue. The Internet is a great marketing device and an excellent way to gather useful demographic/psychographic information. This information can then be combined with offline sources of information and used to increase offline sources of revenue or used for direct marketing.

We all know that online commerce is glorified catalog sales. There is a market there but it isn't what people thought it was, obviously.

The next step for a lot of companies in this industry is going to be charging the users for services rendered over the Internet. Subscription services will be more and more important within the next 6 months. The major hurdle here is the perception that information and services are free on the Internet. Microsoft might be the leader in this change of perception only because they can afford to take the risk.

The surviving dot-coms have their plates full. The crashing of several of the dot-coms the entire last year and well into this year has only made things worse for them. It does not require great intelligence to guess that they have cut the expenditures down and increased the length of run-way successfully. But the burn rate is still on the negative side. They need funds to be in business.

The venture capitalists are wary, markets skeptical, and the investing public not too enthusiastic. It is a different story that start-ups over the past thirty years required three or more years to stabilize and establish a positive cash flow. The market reaction here is one of over-correction. Strange, but true.

It is my guess that the number of millionaires that the dot-coms have generated over a period of two years (though on paper) must have been the highest in the recent times. Maybe a bit of research might show that there were more millionaires generated in the last two years than in the entire decade!

Now that kind of wealth generation is not a common, routine feature of any economy. No doubt it attracted venture capitalists, financiers, and other investors by the thousands. Millions of dollars were made available as funds in a very generous manner. The principles of strength of operating cash generation leading to profits and return on equity were conveniently relaxed. The phenomenon of the Internet boom was miscalculated.

The over-correction that is being applied by the market is one that stems out of the above realization. An attitude of once bitten twice shy.

The surviving companies have to cope with depleting finances on one hand, generating more sales or contracts and thus generating more cash to keep the organization going on the other. They have to postpone several investment decisions and continue to be cash prudent till they find a willing investor. A far cry from the days when they were picking investors to go with!

Internet as a phenomenon has come to stay all over the world. There is an immense business opportunity and that is without a doubt. There is an immense business opportunity now for all the investing companies to pick up some very good dot-coms that have very sound business models. It is just that the principles of assessing the health of the dot-coms like fiscal prudence, robustness of the business model, clientele, client perception, and overall market share must be more than thorough.

It's all about risk; it's all about profit and loss; it's all about timing; it's all about wit and hard work; it's neither business disaster nor business opportunity BUT just plain business; it's the same ol' stories that span centuries of commerce. There's nothing mystical about the Internet, and thriving and succeeding on the digital platform takes lots of hard work, intelligence and time; NOT just blowing the horn of '.com' or preaching the digital utopia, period!

Out of every disaster, you can create an opportunity. The shake-up is realignment in the offing, the Internet still provides a window of opportunity. The only problem is that to remain competitive in this cut-throat business one has to create value for his customers, who determine your success in the marketplace. Recently I ordered a book from Amazon.com… Only when I had remitted the check to them (did) they write back saying the book is not available. Therefore most dot-coms don't provide what they purport to provide at the end. The customers who are not satisfied (will) look for alternatives, therefore rendering dot-coms out of business.

The answer is to your article's title is definitely closer to "roulette" than to "chess."

To the extent that venture capitalists are rational investors who backed (and continue to back) the worthy players within a given industry, there is some degree of strategy visible out there on the playing field.

To the extent that many investors were (and continue to be) swayed by flashy presentations, bogus credentials, and analyst hype—and especially with those cases of investors who made their investment decisions on the basis of personal networking relationships—there is a seemingly random (or non-business) set of criteria determining which companies are running

out of cash first, which are going under, which are getting bought, and which are left standing.

This resembles a chance shuffling of the cards, where the winner of the game is guided mostly by luck and some limited strategy...and even some bluffing.

Maybe it's a poker game?

The shakeout is more inclined towards the supply-demand disparity that has occurred in the Internet industry. The Internet is here to stay and we are already seeing the private marketplaces of GE and Intel generating huge revenues from their online sales. The Internet will be an effective medium for integration and collaboration amongst business vendors and partners. The more stable companies that survive this shakeout have a fair chance of success in the B2B arena.

On the other hand, neutral marketplaces have their own set of woes that will prevent them from generating expected revenues. Marketplaces for intangible products and financial products will make a killing, though.

The investors are more cautious and not every business idea will get funded. The next generation of Internet companies to mushroom will be more sensible with a revenue plan in place.

Hence, this shake out basically will clean up the dead weight in the industry.