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7.3 The Slippery Slope from Dot.Com to Dot.Bomb

In January 2002, Amazon.com announced its first quarterly profit. This was huge news despite the fact that Amazon only made a penny a share. At last, Amazon, a dot.com company, had found a way to get its operations under control, and its huge investments were starting to pay off. Interestingly, one of the fastest growing and most profitable areas of Amazon's business is in helping other companies get online. As a result, its professional services organization has turned itself into a huge moneymaker for Amazon.

Well, before Amazon turned a profit, however, thousands of hungry entrepreneurs were watching its every move, and trying to figure out how they could sell everything from soup to nuts over the Internet. They were especially drooling over the prospect of not having to build a big and costly retail network in order to do retail sales over the Internet.

However, traditional retailers also were eyeing the Internet with eager anticipation. Many of these retailers had been experiencing moderate success in their efforts to sell their products, not only in their stores, but also by means of 1-800 numbers. Much to their delight, many of these traditional retailers were able to move fairly quickly into the realm of online Internet sales. Coincidentally, in 1996 and 1997, there were a number of relatively decent Internet products coming on the market, which made it easier for retailers to put up their electronic storefronts.

IBM was doing a lot of work in this space by offering its Open Market product, which represented the beginning of its very successful e-business initiative. IBM was helping to establish the interfaces that allowed companies to actually sell things over the Internet and to accept payment for these products.

At the same time, a new SSL protocol was introduced and accepted by credit card companies, retailers, and consumers, and, all of a sudden, this new avenue of commerce received a significant boost. The SSL is what ensures secure Internet sites and the ability to transmit information safely. Now, companies could actually sell items reasonably well over the Internet.

Amazon got a toehold in the door quickly because it already had a book distribution warehouse. As you may know, the book business is a tough business because retailers expect to return a fair amount of unsold books to the warehouses. (I humbly hope that such will not be the case for this, my first book!)

At any rate, the Amazon folks were lucky enough to come across a warehousing operation, which they purchased and leveraged to their great advantage from a retailing point of view. Amazon was also technologically skilled and able to apply this talent by creating a very inviting, broad catalogue of online books, accompanied by a fantastic search engine that could deliver customers to their favorite book choices in the blink of an eye. Next, Amazon focused on the rapid delivery of its products, each of which was offered at a fairly good price. Customers loved this experience, and they were buying books from Amazon at an incredible rate.

I remember visiting one venture capital company in 1997, and I literally discovered that every venture-funded activity it was launching was for an online retailer. I remember scratching my head and thinking, "Hasn't this venture capital firm realized that it is going to have huge transportation problems with some of the online retail operations it is starting?"

For example, the firm was funding online furniture companies. Imagine the logistics problems involved when customers would order a couch online, have it shipped to their homes, and then decide they didn't like what was sent because it was damaged in transit, or the fabric wasn't as expected or the color looked awful. How on earth would a customer prepare a couch for return shipment? The business model for customer returns would be a nightmare, which was one of the reasons why Furniture.com tanked.

Obviously, other products and services were better suited for an online environment. Consider online matchmaking, which has become a very big business. It's surprising how many true romances have blossomed over the Internet. There is no shortage of remarkable stories about people meeting each other that way and then falling in love and marrying.

On the steamy side of the Internet, I recall from my days at IBM that we made a Top 10 List which we were not particularly proud of. This was back in 1996, and Penthouse magazine had just published a list of the top corporations in America whose employees were accessing its Web site by using their corporate accounts. Imagine our shock and embarrassment when IBM showed up on that list.

What resulted was a very rapid education effort across IBM about the appropriate use of company resources. It reminded me of my earlier days at Indiana University, when we had Internet usage problems of a similar nature.

Anyway, at IBM, we knew we had a challenge on our hands. If we put a filter on our computer systems at work, we'd undoubtedly end up in the newspapers the next day, with headlines like "IBM Filters Penthouse." Therefore, our objective was two-fold: first, to educate our employees, and, second, to stay out of the press.

As it turned out, IBM did a nice job of stressing to its employees the importance of getting their online activity under control. Hits to the Penthouse site by IBM employees tapered off, and IBM quietly clamped a smut filter on its internal systems. I suspect that more than one company has faced this challenge in the Internet age.

The wacky world of online enterprises also included the curious entry of groceries into the market. The delivery problems with perishable commodities, as you can imagine, were a nightmare. However, people somehow thought that, because their groceries were being sold on the Internet, all of the basic rules of economics (for example, you shouldn't mix a low-margin business with an additional high-cost delivery model) were suspended. These online grocery operations had such a preoccupation with the retail experience they were delivering to their customers on their Web sites that they failed to focus on the entire delivery chain necessary to get the products from their warehouses to their customers' front doors.

Then, sites like eBay sprang up, and online auctions began to capture the attention of consumers. The beauty of these sites was that they made it possible for individuals to put items up for bid without having to create an underlying commerce infrastructure. It was an ingenious entry into the online world.

By 1998, conventional retailers started coming into the Web in a more meaningful fashion. Amazon's professional services organization was right there to help these folks establish their online presence. The nice thing about having conventional retailers on the Web was that a lot of the logistical problems were solved right out of the gate. For example, if a customer ordered a blouse from Nordstrom.com and it didn't fit, the customer could easily return it to a nearby retail outlet, rather than having to mess with mailing it back. All of a sudden, traditional brick and mortar companies were finding success as click and mortar companies.

Success was achieved because these folks began to think through all of the aspects of delivery and the total customer experience, not just the purchasing experience, as so many dot.coms had done before.

All in all, we were seeing a lot of folks taking their business to the Internet, dreaming about their forthcoming riches, and, more often than not, discovering that, if they were going to be successful, they were going to have to earn their money. It wasn't going to fall into their laps.

It is interesting that The Producers should be the top Broadway show in 2001. This old film classic, written and produced by Mel Brooks, is the perfect model for much of the dot.com industry. The theory behind The Producers is that, if you produce a flop, the investors will just write off their monetary losses and you can simply oversubscribe the production. To a large extent, the "dot.bombs" were more focused on "going public" than they were on building businesses. Most of the dot.bombs were lavishly spending someone else's money, and this applied to companies large and small.

7.3.1 Bomb #1: A Lack of Conventional Promotional Activities

During the late 1990s, too many marketing folks were thinking that all they had to do was create a presence on the Internet and instantly they would be making barrels and barrels of money. People were thinking, "Build it, and they will come!" What went wrong? Why did so many dot.com companies slide down the slippery slope to the world of dot.bombs?

First of all, a lot of dot.coms discovered that getting customers was harder than they thought. They were under the mistaken impression that all they had to do was put up a site and customers would magically appear. The lesson to be learned here is that it still takes promotion through conventional means to attract customers.

Steve Case knew this lesson well from his days at Proctor & Gamble. He instinctively knew how to reach customers. In fact, there was a joke going around recently about Steve Case and AOL. It went something like this: "Why is Steve Case upset that they've discovered life on Mars? Because now he has to figure out how to get an AOL CD up there!"

You've got to hand it to Steve, though. He has blanketed this country with AOL CDs, offering free hours on AOL. The CDs come in newspapers. They're delivered with the mail. They pop up in magazines. Steve Case is a consumer guy, and he sure knows how to promote his product. Believe me, he uses every conceivable conventional means at his disposal to promote AOL to consumers.

The funny thing is that most folks would agree that Prodigy and CompuServe had better products than AOL; they just hadn't mastered the marketing formula the way Steve Case had, which is what really distanced AOL from the pack. Steve just knew how to promote to consumers, and, as his installed base at AOL increased, he made additional investments in improved programming.

If you are considering taking your business to the Internet, I urge you to avoid one of the prime pitfalls experienced by the dot.bombs. They dramatically underestimated their customer procurement costs.

7.3.2 Bomb #2: Too Narrow a Value Proposition

The second major problem that many of the dot.bombs had was that they had too narrow a value proposition. They figured that customers were going to come to their sites magically, and, because so many people were flocking to the Internet, they could offer a very narrow value proposition and still get to a critical mass. Big mistake.

It's true that today's sophisticated search engines can lead customers to precisely the kinds of things they want, no matter how specialized these things might be. However, what happened from a business model point of view is that a lot of these dot.bombs assumed that their niches were going to be a lot larger than they actually ended up being.

The most successful players in the niche markets understood how to promote themselves and how to make sure that the various search engines out there would pick up their sites and drive customers to their doors. That required spending promotional dollars, just like it did in the physical universe.

Take a look at AOL. One of the things it has done so well over time is to continue to enhance its offerings. For example, right now AOL is adding digital imaging services, photo services, and similar products to its customer portfolio.

As you know, through its entire history, AOL has continued to add value to its bundle of services. Their purpose in doing that has been to keep customers loyal and to keep them paying that monthly subscription fee. It generally has been more cost-effective for AOL to design and introduce new services than it has been for it to offer a price reduction in its subscription fees.

The challenge for online service providers has been to hold their prices steady while continuing to add more value. Luckily, as the cost of computing and storage continues to fall, online service providers have been able to reinvest those cost savings into enhancing their services.

If you look at Amazon's Web site, you'll notice that it continues to evolve and expand its customer experience. This strategy has allowed Amazon to grow its retail base without dramatically adding to the capital costs of running the business. Of course, as Amazon has expanded, the logistics of fulfillment have gotten to be a gigantic nightmare.

7.3.3 Bomb #3: An Inadequate Delivery Chain

The third problem for the dot.bombs involved the monumental task of product delivery. Whenever these companies touched the physical universe in any way, unique delivery challenges arose. Whereas AOL is largely a consumer "experience," many dot.com folks had to worry about transporting their physical products from one location to another. The logistics involved in this endeavor were enormous.

A lot of companies that attempted to sell groceries and other perishables, and larger items such as furniture over the Internet ended up bombing. Factors such as road conditions, weather conditions, product availability, and the nightmare of product returns were all wreaking havoc on the balance sheets of some of these early dot.bomb companies.

7.3.4 Bomb #4: A Lack of Business and Financial Discipline

There are a few business rules of thumb I've learned over the years. The first of these is to know the source of your revenues. I've seen many folks get involved in the great eyeball race without the slightest inkling regarding how, exactly, they are going to reel in revenues.

Steve Case understood that AOL's revenues would come primarily from online advertising and secondarily from subscriptions. Having a revenue model in which both subscriptions and advertising contribute to the bottom line can often spell success for dot.coms. This is the traditional media industry formula: subscriptions, subsidized by advertising. This approach has stood the test of time since the early days of newspapers and magazines.

However, it is dastardly difficult for firms on the Internet to get consumers into the habit of paying for subscriptions. Online and wireless service providers have trained us to pay for their services, but, beyond paying for the connection itself, consumers are very reticent to pay for anything else. Without an audience or audience demographics, it's very difficult to get advertisers to pay.

Therefore, many of the dot.bombs held on to a faint hope that they could get some advertising revenue, without having the slightest thought about who would be buying this advertising space on their sites. The lesson to be learned here is know from whence your revenues will come before you go to all the expense of taking your business to the Internet. Many of the traditional publishing companies have made a nice transition to the Internet and have brought their advertisers along with them because they know their audiences well.

7.3.5 Bomb #5: A Failure to Prove the Viability of Your Cost Structure

For the most part, I believe that, if your firm has $3 million in revenues and you still aren't profitable, the odds are you'll never be profitable, especially with startups. First they need to prove out their revenue models and cost structures and then get things sized in a way that they can deliver profit, early and often. This takes a steadfast discipline from Day One. There are a lot of companies in the dot.bomb bone yard that just didn't have the discipline to tighten their own belts in order to keep their businesses viable. They had too many fancy offices, fancy cars, fancy perks, and not enough raw business sense. Most seem to have no concept that they were living off investors' money and that they had a fiduciary duty to put the business interests of their investors ahead of immediate enhancements to their personal lifestyles. Of course, some of the investors showed a surprising lack of judgment by all at once dumping big buckets of money at the doorsteps of the dot.bombs.

7.3.6 Bomb #6: Dawdle Mania

A lot of dot.coms became dot.bombs because they were too slow in launching their sites and spent tons of time and money just preparing them. Companies in the hot dot.com era were spending a year or two working on their launch strategies, and, by the time they finally brought their businesses to the Internet, customers no longer had an interest in what they had to sell.

Conversely, if you look at some of the most successful companies on the Internet, you'll notice that they got out there early and evolved their sites as rapidly as they could in order to add additional value. There's just no substitute for getting the experience with the user community early on, at a low cost, and then building on that value going forward.

That sort of development model is very foreign to the average company. Yahoo! was one company that was extraordinarily good at getting out there early and then enhancing its services after it had the initial technology breakthrough. Even today, Yahoo! is evolving on a daily basis. No dawdling is going on within its doors.

7.3.7 Bomb #7: A Failure to Communicate

The lesson to be learned here is that it is critical to articulate every step of the customer relationship process before you take your business to the Internet. Even today, I see so many retailing Web sites that are poorly instrumented from a customer interface point of view.

Of course, from Day One, Amazon knew that its relationship with its customers was central to its success, and, because of this, Amazon erred on the side of overcommunicating with its customers, rather than undercommunicating. Overall, Amazon has found a good balance between positive communication and intrusive communication. It's done a pretty good job of tracking its active users and communicating with them at appropriate times. If you're not an active buyer on its site, it's unlikely that you'll be receiving a lot of unsolicited messages from Amazon. The key to these communications activities has been to make them personal and relevant to the customer.

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