Who Will Succeed and Who Will Fail?
by Arthur Middleton Hughes

 

A lot of dot coms are going under this year. At this point, everyone is willing to admit that the Emperor has no clothes. People are saying that they knew it all along, but were unwilling to say so before, for fear that the bubble would burst (which it has), or that they would have been thought old fashioned and out of date (which they would have been). So, how can you predict a successful dot com from a loser?  Here are some rules that I think have universal validity.

Profit is essential

By now, everyone knows that to succeed any business must project and make a profit within the foreseeable future. All successful businesses are based on taking in more revenue than they pay out in expenses. This has always been true. Why did so many people forget this principle in the last few years?  Because of the AOL model.

As anyone who has lived in the last ten years knows, AOL became the powerhouse that it is through giving six free diskettes to every man, woman and child in America over a four year period.  By this brilliant strategy they gained overwhelming market share, and beat or bought all their significant competitors. Then they flaunted their success by buying Time-Warner. Seeing this example, all the dot coms of the world decided, ďForget Profits: Market Share is EverythingĒ.  How do you gain market share? By signing up millions of people for free services. When you have one or more million customers, you will be able to have a successful IPO, and your venture capitalists and employees will become rich. What happens after that?  Fuggedaboudit. Letís get rich.

What people seem to have forgotten in the AOL analogy is the significant change that AOL made in the middle of the game. They switched from pay per view to a flat monthly rate. When they did that, they were swamped with users trying to get their moneyís worth. They had to invest a fortune in modems to meet the demand. Many writers said that AOL was foolish, and would lose credibility and market share as a result of the bad PR. On the contrary, it was a brilliant move. The change meant that all of the millions of customers that AOL signed up were paying them more than $20 per month, month after month. Their eventual profit was assured.  Few, if any, of the dot coms who tried to follow the AOL model had a monthly income from their customers.

Advertising will not support most sites.

Too many of the dot coms based their business plans on web advertising. Site after site with no visible revenue counted on millions of dollars of revenue from banner ads that would be placed on their sites as soon as they gained sufficient market share. The trouble with this idea was that the dot coms were not able to, or did not run any tests to see if their idea could be true. Years ago, Citicorp scored a massive database failure with Reward America, a supermarket frequent shopper card system. Citicorpís idea was that their revenue would come from selling the names of frequent shoppers to the manufacturers of packaged goods like Crest Toothpaste or Alpo Dog Food. The trouble with this idea was that the manufacturers did not want the names, because there was no way they could make money with them. Database marketing does not work with most packaged goods. Citicorp did not know this, and did not test the idea in advance. They lost $200 million on the project in 1990. Those who do not study history are bound to repeat it.

Why wonít web advertising alone support a new dot com venture? Because the barriers to entry in the dot com world are so low. Anyone can start a web site for a few thousand dollars, and millions are doing it. There are 2.4 million web sites that offer loan services. Advertising pays for TV, radio, magazines and newspapers because there are only a few thousand of them. Starting successful mass media enterprises like these is expensive. That keeps the numbers down, and the cost of advertising up. Not so on the web. You canít charge high prices for ads when you have millions of competitors. Advertising alone will never support a successful web site.

Margin is important

To achieve a profit, you have to take in more revenue than you pay out in costs. The profit is the margin. Supermarkets, for example, typically have a very low margin on sales. The grocery business is fiercely competitive. The chains can stay in business only because of the huge volume of total sales and because their goods are essential: people are always going to have to eat, in good times or bad. With a tiny margin, if you add any kind of an extra expense, you will run a loss. That is what happens on the web.

Peapod, HomeGrocer, Webvan and others are trying to enter this market with home delivery of groceries. It is a wonderful idea, but they will all fail. Why? Because there is not enough margin to make long term profits even a remote possibility. People have to eat, but they donít have to buy groceries on the web. Somehow you have to add the cost of taking orders on the web, picking, boxing and home delivery of the products to the regular cost of the products, and make at least as much profit as the supermarkets who do not have these extra costs. It cannot be done. Whatís more, supermarkets count on impulse buying for a substantial portion of their sales. Who has ever gone to a supermarket to buy a quart of milk and come home with only a quart of milk?  Everyone buys other stuff that they see as they walk through the aisles. That does not necessarily happen on the web.

Much consumer e-commerce may not succeed

Amazon.com is a wonderful institution. Everyone knows about Amazon and has bought from them. Everyone admires Amazon and Jim Bezos. While they have yet to turn a profit, everyone assumes, I believe correctly, that they will eventually succeed. Books and music can be sold successfully on the web.  Travel reservations work. Loans work. Auctions work. Computers and software work.

That does not necessarily hold true for most consumer goods. As already pointed out, supermarket products cannot be sold profitably.  Goods sold by catalog companies can be sold on the web. But we are finding out something interesting in this field. Most of the web customers have the paper catalog in front of them when they are shopping. They donít have the patience to navigate the web to find a sweater that they want. Try it yourself. Take any clothing catalog that you have received and find an item that you would like to buy. Then go on the web site, without the catalog, and try to find that same item. With the LandsEnd catalog, it took me 14 seconds to find a menís sweater I wanted to buy. On the LandsEnd web site the same sweater took me 124 seconds to find.  Once I knew what I wanted, however, the web was the best way to buy. I avoided a phone call and being put on hold. I had simply to enter the number of the sweater on the LandsEnd web site, and I was immediately in order mode.

So what does this mean for the web?  You probably cannot sell consumer goods profitably on the web without a paper catalog. If you donít have a paper catalog, you will be beaten by those that do. So the web is not a selling tool. It is an ordering tool. The catalog is doing the selling.

So where are the web profits?

There are two commerce areas where the web is already, and will continue to be highly profitable. They are customer service and business to business.

In customer service, the web has already saved companies several billion dollars and will save billions more. Call FedEx with your tracking number, and their operators will tell you where your package is right now. Those calls cost FedEx a lot of money.  Customers also get put on hold. Go on the FedEx web site and enter your tracking number and you will find the location of your package in three seconds. That saves you a lot of time. It saves FedEx hundreds of millions of dollars. Companies are putting thousands of pages of technical data on the web to reduce tech support calls and costs. Customer service and tech support is the biggest growth area on the web today. Any company that is not investing in this area is making a big mistake. Companies are learning to let their customers ďCome behind the counterĒ and wander through their warehouses, shipping departments, accounts receivables, and engineering departments to find what they want. They love it.

In business to business, the possibilities are almost infinite. Here, of course, the customers already know what they want. They have the catalogs, or they have the products for which they need supplies or upgrades. The average order size is typically more than a hundred times the consumer order size, so the margin pays for the cost of ordering, packing and shipping.  The big growth area here is not in ordering, however, it is in linking the customerís computers to the supplierís computers through the web. Intelís computers use the web to study Dellís stock of chips in each Dell factory. They ship Dell more chips three times a week to make sure Dellís factories do not run out. FedEx has taken over National Semiconductorís entire product delivery system from the FedEx warehouse in Singapore, permitting National to eliminate seven warehouses and a complex in-house shipping system.

What have not yet succeeded in business to business are the stand alone dot coms designed to consolidate business buying and selling. There are thousands of these sites springing up today, and most of them will fail. Why? Because the barriers to entry are so low. Anyone can get in to this kind of business. The ones that succeed will be those that are linked to an established company with warehouses and a delivery system.

Conclusion

There are plenty of surprises ahead for all of us as web commerce expands. Some things that we never thought of will succeed, and many of the current dot coms will fail. This is a great time to be alive.

 


Arthur Middleton Hughes is Vice President of The Database Marketing Institute. Ltd. (Arthur.hughes@dbmarketing.com) which provides strategic advice on relationship marketing. Arthur is also Senior Strategist at e-Dialog.com (ahughes@e-Dialog.com) which provides precision e-mail marketing services for major corporations worldwide. Arthur is the author of Strategic Database Marketing 3rd ed. (McGraw Hill 2006). You may reach Arthur at (954) 767-4558 .


The articles on this web site are available to the general public to read, enjoy and for limited business use. If you want to reprint more than one or two of them for resale or use in a business or educational environment, send an email to Arthur Hughes at arthur.hughes@dbmarketing.com. He will give you permission by return email. The cost, depending on the number of copies you want to reprint, is very inexpensive.