Lessons of the dotcom shakeout

Whatever fairy dust remained sprinkled over the once-magical Internet seemed to finally shake free and fall to the ground this week.

A shakeout of Internet commerce firms, which once seemed just a clearing of the underbrush, is also affecting the elite and blue bloods of the industry.

Yahoo!, a search engine that became the most-visited destination on the Internet, announced this week that it is looking for a replacement for CEO Tim Koogle, a move seen as a bid to revitalize the firm's bottom line.

Amazon, the trailblazer in online retailing, has beat back rumors of bankruptcy, but has analysts wondering about its viability over the long term.

And if the souring tale of the Internet needed a soundtrack, it might be music culled from Napster, the pop-icon website that once promised free music for all and is now fighting for its life. "There is no immunity," says Internet analyst Susan Billheimer of Zona Research, surveying the wreckage of a process that once seemed like the natural winnowing of a young industry. "Everyone is now feeling the effects."

The Internet was once thought capable of reshaping the American economy. Today, the reverse is happening.

As the economy has slowed, the process has magnified flaws in the firms that have made the Internet the sole platform of their business. Layoffs have soared, dotcoms have collapsed, and increasingly the Internet has looked more like a vehicle for extending and augmenting existing businesses, rather than a replacement for them.

While Napster isn't a victim of a souring economy, a court injunction this week requiring it to eliminate copyrighted music titles is a sign of Old Economy rules trumping contrary practices of the Internet.

Internet excesses started in the heady startup days a few years back. Anxious to be on the ground floor of the new Internet field, entrepreneurs and investment dollars flooded in. Venture-capital investments quadrupled from 1997 to 2000.

"What you ended up with was too much money chasing too few good ideas," says Michael Borrus, managing director of the Petkevich Group, a San Francisco merchant bank that caters partly to Internet firms.

That dynamic of loose money bred weak management and some faulty assumptions about the efficiencies of Internet commerce and the appetite of consumers for buying things online.

Party's over

A slowing US economy brought the party to an end. The Nasdaq Composite Index, a broad barometer of the technology sector, has sunk more than 50 percent from its peak a year ago. And the power of the downdraft has become such that even premier Internet sites, like Yahoo and Amazon, have been diving.

The picture is so glum that some analysts wonder if stock prices are near their bottom.

But whatever investors do, the Internet decline has shaken earlier assumptions to the bone. "I'm not sure there really is such a thing as the pure Internet sector," says Mr. Borrus.

His skepticism, shared by others, is over the viability of businesses that exist purely on the Internet. Companies can make money selling the technology and related services that run the Internet, say analysts. And firms like Ebay, the online auction site, look relatively strong because they have created businesses whose very existence is based on the Web.

But online retailers and media sites that essentially mimic brick-and-mortar businesses are finding the going extremely tough.

Partnership is one answer to the challenge.

The AOL-Time Warner merger gives the online site access to content built and sustained in the traditional media world. A host of other Internet sites have either gone out of business or merged with traditional businesses in the same field, in effect giving those companies an Internet outlet for their sales.

Amazon.com Inc., which paved the way as a major online retailer, has seen its stock price slump by nearly 80 percent over the past year.

But when reports circulated earlier this week that the company might join forces with old-line retailer Wal-Mart Stores Inc., Amazon's stock price jumped. Subsequent reports dashing hope for a partnership sent prices back down, a ride that showed how concerned investors have become of the once-high-flying Amazon making it on its own.

Rethinking efficiency

Part of what is at work with Amazon is the growing realization that online efficiencies have not turned out to be exactly as forecast, say analysts.

Selling goods online seemed to have built-in advantages, like eliminating the cost of retail store fronts and the accompanying sales force.

But online retail firms have discovered that, while they may not need brick-and-mortar store fronts, they do need storage and distribution centers. Likewise, they may not need a conventional sales force, but they do need fleets of customer-service employees to handle the volume of complaints, mistakes, and handling needs that go along with online sales.

In addition, says Borrus, consumers have proven a little less amenable to buying online than expected.

Online purchases are growing, but not at the skyrocketing rate some predicted. There are security concerns about buying online. Consumers have also proven they might prefer paying a little more for the reassurance of seeing and touching a product first and getting help from a live sales person.

Yahoo has long been seen as an exception to much of the struggling Internet industry because it actually makes a profit, or at least did until now.

The firm is forecasting it will break even this quarter. Part of the problem is that the firm's revenues are built heavily on advertising, which has proven very soft in a softening economy.

(c) Copyright 2001. The Christian Science Monitor