Easy Dot Com, Easy Dot Go
A financial earthquake shakes the confidence of the Internet class
Ann Hamilton remembers when she caught dot-com fever. It was last summer. Internet stocks were rocketing skyward like rapid-fire missile launches; almost anyone with a Web-related idea, no matter how zany (ever hear of Bunions.com?), could raise millions; and IPO riches seemed almost as certain as death and taxes. Her friends, her former colleagues--indeed, just about everyone in Silicon Valley, it seemed--were all bolting from their jobs to join an Internet start-up. In fact, so many folks were taking the dot-com plunge that it no longer even seemed risky. "It just seemed like the natural thing to do," she says.
But Hamilton, 31, didn't strike it rich. Instead, she got five months of stomach-churning aggravation. After her first week, she got laid off. "So I packed up my desk and started to leave, and my CEO chased me out the door saying, 'Guess what? We just got more money,' " Hamilton recalls. The ups and downs continued--"I was laid off three times"--until the company, a high-end stereo equipment E-tailer named AudioCafe.com, finally folded in February. Her options are totally worthless, of course--AudioCafe.com never got close to an initial public offering. And the company still owes her several weeks of pay, she says.
Hamilton now plans a career as a professional photographer. In retrospect, she says a big clue that something was amiss came on her very first day, when the company's CEO claimed he didn't have the money to buy her a cup of coffee. "But I was so dot-com happy that I was willing to dismiss anything that might indicate this wasn't the path to take. I had dot-com dollar signs in my eyes."
She and countless others. But much to the quiet pleasure of the optionless masses, the dark side of start-up life is starting to get a lot more attention these days. Profitless companies that once boasted stock market values exceeding that of Fortune 500 corporations are suddenly running out of money--fast. Investors, both public and private, aren't willing to sink any more cash into them; and employees, whose loyalty can make or break a company on the edge, are growing more impatient by the day.
Like Hamilton, most dot-com workers gave up stable jobs for the excitement of joining a Web firm, not to mention the potential riches of huge stock option packages. Now, instead of planning their early retirement, many are wondering how long they should wait before jumping to a start-up with a better chance of success. Others are even considering a retreat--straight back to the warm embrace of the old economy.
The falling stock markets set this re-evaluation in motion. Though stocks rebounded last week after the horrific plunge on April 14, the main indexes are down for the year, with the Dow Jones industrial average off about 6 percent and the tech-heavy Nasdaq composite off 10.5 percent. Internet stocks fared far worse, falling almost 50 percent.
For two years now, venture capitalists and stock market investors had been happy to throw money at anyone planning a Web start-up. Last year, for example, venture capitalists provided some $20 billion in funding to roughly 1,800 Internet companies. Nearly 300 IPOs raised an additional $22 billion, according to research firm CommScan. But investors are finally coming to their senses. Just look at the stock prices. Virtually all of last year's IPO darlings are trading well below their offering price. Thirteen IPOs have been postponed or canceled since March 10--and analysts expect initial public offerings to fall off in the coming weeks and months.
Even companies like Buy.com and Pets.com, both of which raised boatloads of cash with IPOs this year, have been socked--hard. Buy.com is trading at about half its offering price, Pets.com about 30 percent. Why? Investors simply don't believe their business strategy will work. Buy.com loses money on the merchandise it sells but says it plans to make up for it with advertising, which investors find less than credible. Pets.com, which received attention for its goofy ads featuring a sock puppet, sells pet food and hopes to create an online community of pet owners. But the company is up against better-financed competitors like Petopia and Petsmart, which have offline stores in addition to Web sites. "Their slogan is 'Because pets can't drive,' " venture capitalist Bob Kagle, a partner at Menlo Park, Calif.-based Benchmark Capital, says of Pets.com. "It should be 'Because pets can't invest.' "
The shift in sentiment may be permanent. True, the stock markets may settle down and start climbing again. And no matter what the markets do, it's clear that the Internet will continue to revolutionize society. But most analysts agree that the easy money in the E-commerce revolution is gone for good.
Avoiding ".com." Indeed, the mood change has been so powerful that Jonathan Gaw, an analyst at International Data Corp. in Mountain View, Calif., reports that he just had a conversation with a new Internet company that deliberately refused to use the ".com" suffix in its name. Putting a dot com at the end of a company's name used to practically guarantee a higher stock price and easier access to cash. Now companies are worrying that it means they won't be taken seriously. "If you believe all commerce will be E-commerce, why focus on the 'E' part of it?" Gaw says.
It's not as if investors now know what business model works for a dot com. They most certainly don't. But they are increasingly sure about what doesn't work: blanketing the airwaves and billboards with advertising; generating revenue with advertising; and refusing to build an offline presence. Even Jeff Bezos, chief executive officer of Amazon.com and one of E-commerce's chief cheerleaders, is expected to set up offline stores for his customers.
"There isn't a lot of customer loyalty on the Web," says Michael Dermer, CEO of 800giftcertificate.com. "So how can it make sense to spend millions to acquire them?" Adds Forrester Research Chief Executive George Colony: "The idiocy of the hollow dot coms was embarrassingly revealed during this year's Super Bowl. Most of the ads were a phenomenal waste of money." The lesson, he says, is old fashioned but inescapable: Successful companies like Microsoft and Cisco don't get built overnight. They take "years of blood, sweat, tears, developed wisdom, and enlightened business decisions," Colony says.
The unwinding of the speculative excess is likely to be ugly. Right now, virtually everyone professes to be glad the bubble has been pricked. "The era is gone when you can come up with an idea and slap it on the Web and make a million dollars," says Andrew Kodner, account manager at ShortCycles, a business-to-business software company. "It doesn't help the economy and it doesn't help the world."
But probe further and one finds a renewed sense of mortality. "On a personal level, it's pretty scary," Kodner says. "I just bought a house with my fiancee." Already, bankruptcy attorneys are gearing up for a spike in business. Chris Celentino, a partner at Luce, Forward, Hamilton & Scripps in San Diego, says he has hired six new associates this year and, for the past two months, has been fielding 10 to 15 calls a week from unpaid dot-com creditors. "The novelty [of the E-commerce revolution] has worn off," he says--and it has been a bit of an education. "When we walk into one of these companies on behalf of creditors and demand to be paid, the management is surprised we won't accept the notion that sales will rebound," he explains. "Most companies with a pack of angry creditors at the door give you a plan about how they're going to cut costs and tell you when they think they can come up with the money. These guys say, 'It's just a blip in the marketplace. Consumer confidence will come back, and they'll buy again.' " What's particularly irksome is that some of the dot coms he has visited boast the fanciest office furnishings he has ever seen. "Let's just say there's a lot of mahogany," Celentino says.
The list of dot-com failures, forced sales, and those heading for trouble seems to grow larger by the day. TheStreet.com, the popular financial Web site, has hired an investment banker and is widely believed to be pondering a sale. Investors think CDNow, the music site; Drkoop.com, the health information site; and E-tailer Value America are running out of money. Two weeks ago, a cash crunch forced Peapod, the online grocery store, to sell itself to the Dutch grocery chain that owns Stop&Shop. On April 12, lack of financing led Healthshop.com to shutter its doors and lay off most of its roughly 70 employees. The online health-food store had gained attention for its hangover-fighting Y2K morning-after kits. "A year ago, it was all so exciting," says Maria DiGrande, 37, who just lost her job as Healthshop.com's vice president of merchandising. "Now things are starting to come to a head, and there's a lot more fallout than people expected."
Low on cash. Just last week InsWeb, a five-year-old company that sells insurance over the Internet, signaled that it was in deep trouble. InsWeb said State Farm--its largest customer, accounting for about 30 percent of revenues--would stop selling insurance on its site. Other companies that investors and analysts believe may not be long for the world include: iVillage, the women's site; MotherNature.com, another online health-food store; VitaminShoppe.com; and eToys. They, too, appear to be running low on cash, and it's entirely unclear where they are going to get more.
The beneficiaries of all this carnage, ironically enough, are likely to be the big, old-fashioned companies that just months ago were dismissed as old-economy relics. "A year ago, we all laughed and said the online companies were going to buy up all the offline companies. Now it looks like the reverse is going to happen," says Paul Joachim, a principal at Broadview International. Estee Lauder, the cosmetics giant, has just bought Gloss.com, a San Francisco-based E-tailer. Megaretailers Toys "R" Us and Wal-Mart are now in position to snap up ailing online toy retailers like eToys, if they so choose. Many believe Cisco Systems and Intel will resume their acquisitions tear.
What does it all mean? "A mad mergers-and-acquisitions scramble," says Forrester's Colony. "Fewer players, less advertising, and fewer IPOs." In other words, a return to what just a couple of years ago would have been considered normal.
CDNow
IPO $16
Peak $39
April 20 $3.81
Drkoop
IPO $9
Peak $45.75
April 20 $2.50
InsWeb
IPO $17
Peak $44
April 20 $2.53
Ivillage.com
IPO $24
Peak $130
April 20 $12.16
With Paul Sloan and Bill Holstein
This story appears in the May 1, 2000 print edition of U.S. News & World Report.