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The State of Connecticut’s Dotconomy
Among survivors, some hard-earned lessons in business fundamentals
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Business New Haven
5/14/2001
By: Deborah Ketai
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Whether powering an unprecedented economic boom or dropping like flies, dot.coms fill our daily news. They're hard to escape - and not all that easy to define.
Whatis.com, my favorite glossary of technology terms, defines a dot.com - also spelled dot com, dot-com or dotcom - broadly as “any Web site intended for business use.”
The media tend to use the term more narrowly to describe companies that rely on the Internet as a key component in doing business. Most of these firms fall into one of four categories:
- E-tailers (online retailers and distributors, especially “pure-plays” - Internet-only companies such as Amazon.com)
- Information or “content” providers (search engines, media outlets, etc.)
- Manufacturers and providers of the goods and services that enable Internet commerce and communication (e.g., DSL.net)
- Online communities (America Online, Geocities, etc.)
The Local Dotconomy
There's been no shortage of bad news about dot.coms. Last month, Challenger, Gray & Christmas reported a record number of job cuts in the U.S. Internet industry. Hoover's Online (www.hooversonline.com) even keeps a “Dot-Com Deathwatch List.”
The “Company Layoffs” section of that list recently included New Haven's own DSL.net (NASDAQ: DSLN). The Internet access provider operates nationally, targeting cities with populations of less than one million. But even in that niche market, DSL.net has been bumping heads with AT&T and SBC Communications. The company managed to wring a net loss of $105.8 million out of $17.8 million in sales last year. In the resulting rounds of cost-cutting, DSL.net has laid off more than one-quarter of its workforce. And in early April announced that it would need an infusion of capital to survive.
Down in Darien, Internet.com Corp. (NASDAQ: INTM) announced April 2 that it was eliminating approximately 15 percent of its total workforce as “part of an ongoing effort to increase the efficiency and effectiveness of its media operations.”
Two weeks later, Outpost.com announced a 30-percent reduction-in-force. Based in Kent, Outpost.com is the best-known branch of Cyberian Outpost (NASDAQ: COOL). Outpost.com sells high-end, mostly technology-related consumer products through its online superstore. CEO Catherine Vick was replaced by Founder and Chairman Daryl Peck.
With more than 1.3 million customers worldwide, the company's e-tailing arm has received high honors, including the rank of fifth fastest-growing technology company in Connecticut and the 45th fastest-growing technology company in the U.S. (Deloitte & Touche Fast 500). Forrester Research even named Outpost the top online computer retailer. But the company has yet to turn a profit, and its stock, once at $40 a share, now trades at under $1.
Last year, Norwalk-based Modem Media (NASDAQ: MMPT) racked up $134.3 million in revenues from such top-shelf clients as Citigroup, General Electric and General Motors. That left the online marketing and communication giant, formerly known as Modem Media Poppe Tyson, with a net loss of “only” $74.2 million for 2000.
Even Priceline.com (NASDAQ: PCLN), which generated a whopping $1.235 billion in sales for 2000, showed a net loss for the year of $315.1 million.
By late September, several rounds of layoffs had taken hefty bites out of the Stamford dot.com's staff. In October, the company shuttered its WebHouse Club division for lack of operating capital, leaving disappointed “members” (this writer included) unable to name their own price on groceries and gas. Priceline lost its CFO in early November. By the end of the month, founder Jay Walker was under investigation by the office of state Attorney General Richard Blumenthal for possible violations of state and federal employment laws. Walker resigned from Priceline's board of directors a month later.
Cash Crunch?
The dot.com slump has forced even non-dot.coms to watch their budgets.
May 9-10 marked the second annual ITEC show at the Connecticut Expo Center in Hartford. (ITEC is the nation's largest producer of regional IT expositions and conferences, with more than 55 regional events across the U.S.) Though pre-conference hype promised “upwards of 125 exhibitors showcasing their technology solutions,” the show sold barely more than 80 booths. ITEC event manager Mark Davey says the numbers were “a little bit down because of the economy; it's had a ripple effect throughout the IT community.” If cash is drying up among Connecticut's dot.coms, it's not for lack of sales, as the cases of DSL.net, Modem Media and Priceline show. Neither is funding the problem, even for startups. Technology-oriented companies tend to need disproportionate amounts of startup capital to lure talent, set up infrastructure and attract further funding. While outside investment used to be hard to come by for Connecticut tech firms, sources have proliferated in recent months.
Connecticut Innovations Inc. (CII), the state's technology investment arm, contributed part of the $17 million in venture financing that made New Haven's Achillion Pharmaceuticals (a non-dot.com) the biggest biotech start-up in the state. In September, CII partnered with Phoenix Home Life Mutual Insurance, committing $10 million to launch a venture capital group called NextGen (Next Generation Ventures, www.NextGenVen.com). NextGen will offer small amounts of seed-stage venture capital ($100,000 to $500,000) to companies planning to locate in Connecticut.
Then there's Sachem Ventures, which counts among its investors New Haven Savings Bank and Yale University. David Cromwell, an adjunct professor of entrepreneurship at the Yale School of Management and the former CEO of JP Morgan Capital Corp., started the fund, whose daily operations are managed by Yale MBA students. Sachem Ventures will invest about $1.5 million in early-stage business ventures, giving cash injections of $75,000 to $125,000 to New Haven-area startups with high growth potential. Also coming to Connecticut: Blue Harbor, a spin-off of Village Ventures. Village is a national VC group whose financial partners include Bain Capital and Highland Capital Partners. Blue Harbor is expected to bring about $15 million in seed-stage investment to Connecticut. Some companies are successfully attracting second-stage funding, too.
In the past three months, Netkey has raked in a cool $10 million - 95 percent of that from a syndicate led by New York's Hudson Ventures Partners and supported by Connecticut Innovations and two Massachusetts VC firms. Netkey, a Branford-based company that research firm Frost & Sullivan has dubbed “the premier provider of kiosk software,” solicited the remaining $500,000 from a Cleveland subsidiary of the executive search firm, Christian & Timbers.
The venture capital revival aside, however, some cash-starved dot.coms are still suffering from the continuing skittishness of the market.
Look at Synnap, a startup that seemed to be doing everything right. Last fall, the company worked out a lease for the former headquarters of Starter Sportswear. The four-story Fair Haven building was supposed to become a regional Internet data center, the flagship of a national empire of similar facilities. Synnap won financial commitments of both state and private money. The bulk of the capital it needed was to come from the sale of $25 million in institutional bonds issued by the city of New Haven under the federal Empowerment Zone program. Unfortunately, the bonds haven't sold. With investors now loath to sink money into anything high-tech, Synnap appears to be largely out of the play.
According to one source Connectciut Telephone had been interested in the Starter building but eventually decided to relocate to Hartford from Wallingford when the site was unavailable.
Synnap may still survive with less space, but if the lease falls through, Synnap will have to find a new site eligible for Empowerment Zone development in order to retain its bond authorization. Synnap's failure would be a loss for New Haven. The city cited the company's claims that it would create 360 skilled jobs within five years, offered preferentially to residents of the city's Empowerment Zone neighborhoods, when it sought $25 million bonding status for the company.
Back to Business as Usual?
Now that the financial community is acknowledging the emperor's nudity, the fantasy is evaporating: Dot.coms possess no magic immunity from the basic laws of business. Failure to heed those laws can put the engine of hypergrowth into a stall, or even a crash.
The prime directive is a simple one: Turn a profit. Exponential growth without profits resembles a malignant tumor, feeding on all available resources until it kills the host. Many now-defunct dot.coms (and some extant ones) managed to attract funding even though they were designed to operate at a loss for quite a while. The results reminded investors and shareholders that profitability better suited their objectives, even if they had to wait a little longer for their return. Traditionally, one determinant of a business's profitability has been its ability to hold down costs - an area in which many failed dot.coms proved spectacularly incompetent. Take, for instance, the notion that in a knowledge economy, a company's primary assets are its “human capital.” True or not, that belief led to the erroneous assumption that any given worker should automatically be paid more for doing his or her job at a dot.com instead of at an old-economy company. The resulting nationwide talent grab drove up labor costs for both the dot.coms and U.S. companies at large.
E-business companies also paid exorbitant prices for new customers. According to the Yankee Group, the average e-tailer converts online shoppers to customers at a measly rate of one percent. Yet for many, sales and marketing expenditures amount to 50 percent or more of revenues. Those companies need to monitor these costs carefully and, in addition, to justify the dollars spent by improving the rate at which they convert prospects to customers and by building repeat or residual business from the customers they do acquire. Most surviving online retailers have already begun to make changes in how they service their customers, particularly in the area of shipping. From its inception, Outpost.com offered free overnight shipping on all orders, even small ones. That may have seemed like a great way to attract new customers, but delivery costs nearly killed the company financially.
Other e-tailers simply did not realize the infrastructure and experience that would be necessary for order fulfillment. Many of them are now outsourcing this function to companies that are already set up to handle it. Exceptions do exist, of course. Right here in New Haven, four-year-old Freshnex specializes in distributing foods straight from their source to restaurants and grocers.
This year, Freshnex has new e-commerce capabilities, thanks to NeuVis, another Connecticut firm. Freshnex's success however, to date was dampened by a restructuring this winter that cut a chunk of tis workforce. The NeuVis platform turns the Freshnex Web site into an even more sophisticated and high-powered marketplace, capable of running more than 400 transactional pages. Built to integrate tightly with such back-office functions as inventory and invoicing, the site also dovetails with a FedEx server to enable close, detailed tracking of individual shipments.
Rising from the Ashes
Despite the past year's mass dot.com die-off, some companies still cling to life. Newly humbled, a few are learning from their errors and trying to win back the confidence of investors and consumers alike. Priceline.com has retreated, at least temporarily, from its aggressive plans to have consumers name their own price on everything from cars to mortgages. In refocusing on its core business - travel - it was lucky enough to catch a big wave. Online travel companies are doing much better on average than dot.coms as a whole, and Jay Walker's dreamchild already owns about ten percent of the market.
Early this month, Priceline posted a first-quarter loss of just three cents a share, less than analysts had expected. On May 7 the company announced that it would replace its CEO with its Chairman Richard Braddock. Braddock had been CEO from Jul 1998 to May of 2000. Now the Internet travel retailer is predicting a second-quarter operating profit of one to two cents a share on sales of $297 million to $310 million and third-quarter earnings of two to three cents a share on sales of $320 million to $330 million. When Goldman Sachs greeted the news by upgrading the stock, buyers drove Priceline share prices up 36 percent in one day.
So there is hope for dot.coms, especially if CEOs remember to keep asking themselves the basic questions of business:
- What business are we really in? Do our goals extend beyond attracting capital to serving customers?
- What do our numbers mean? How much of our Web traffic translates into actual sales? Are we actually making a profit on those sales?
- How solid are our channel partners? If they hit a slump, will we go under?
- Could we survive if the Internet went down? Do we rely solely on e-commerce, or do we use the Internet as an additional sales channel? Why would customers bother to buy from us, rather than through traditional channels? (Hint: The answer had better not be price.)
- If the influx of outside capital stops, can we make it on sales revenues?
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