Dotcom downfalls: the lessons

As technology share prices start to fall and the first Internet casualties begin to emerge, is the future so bright for...

As technology share prices start to fall and the first Internet casualties begin to emerge, is the future so bright for e-commerce?

Things can change a great deal in the space of a few weeks. Just three months ago everything was rosy in the dotcom garden. Internet companies were the media darlings, every other advert on the television was for a new website or technology company, and the new economy had venture capital funding coming out of its ears. It didn't matter that very few of these new companies were breaking even, the old rules of business just didn't seem to apply anymore. "Get yourself established with a strong brand name first and worry about profits later" seemed to be the new mantra.

This situation, however, changed almost overnight. In March, technology stocks started to drop rapidly as many investors realised that not only were many of the new markets overcrowded, but it would be a long time, if ever, before they started to see a return for their outlay. Listings such as the Nasdaq started to tumble, taking established and profitable technology companies down as well as the newer dotcoms. Venture capital funding started to dry up, and many of the proposed IPOs by Internet companies were put on hold until market conditions improved. May saw the inevitable result of investor reluctance to continue funding these somewhat risky ventures, as many high profile websites closed their doors, most notably fashion retailer boo.com.

What we are seeing now, many believe, is a shakedown in the market. Too many companies have sprung up overnight and received massive backing without a concrete business plan or a time-scale to break even. Consolidation in certain sectors needs to happen before the market can reach its full potential. But what has happened for the market to suddenly turn sour, and why have some Internet companies failed while others survive? More importantly, when will things start to turn around again?

Almost since e-commerce was initially established as a concept, the Internet market has been riding on a wave of optimism and excitement. Many believed, as many still do, that soon enough the Web would be the only way to do business. Consumers were expected to flood onto the Internet to purchase the goods they would normally buy in shops, encouraged by the potentially large cost savings this could provide. Similarly, business-to-business e-commerce was expected to flourish due to the enormous reduction in administration costs that could be achieved.

Market investors were gripped by this fever and rushed headfirst into the market in order to get a piece of the action before it really exploded. Of course, this kind of action en masse caused the impending explosion in Internet stock value. While those companies that had floated were achieving incredibly high market values - sometimes much higher than comparable bricks-and-mortar companies turning in large profits - Internet start-ups were attracting huge interest from venture capital firms across the globe. Millions upon millions were pumped into these infant firms to help them gain a foothold in an increasingly competitive market. This money was spent at an extortionate rate, causing the companies to look for additional rounds of funding or perhaps an IPO if the time was right. All of this time, there were only a handful of dotcom companies that looked capable of making a profit in foreseeable future.

Almost every company that came under the bracket "dotcom" was caught up in this unprecedented move to invest. Investors' desperation not to be left out of the new markets, with a little help from those who knew there was a quick buck to be made from the dotcom phenomenon, drove share prices sky high. This, in turn, drove the stocks of established technology companies up too. Such was the desire to be involved in this market, it seemed to matter little what kind of company was involved, as long as it was Internet technology.

The "hysteria" that drove all tech stocks up almost unilaterally was reflected by the following crash, which hit almost every technology company listed and many that were planning to list. But while almost all were affected, the cause of the unbelievable highs and depressing lows can be traced back almost entirely to one particular segment, business-to-consumer e-commerce.

While the business-to-business sector is awash with potential customers keen on making savings and more willing to adapt to new technology to carry it out, the consumer sector is very different. Those entering the business-to-business area are often moving into a space between partners, enabling them to trade electronically. While many of these new companies will be in competition with each other, there is very little established competition already there. Online retailers, however, not only have to compete with a large number of new companies entering this market, but are also in direct competition with the vast ranks of established bricks-and-mortar firms. Many of these traditional companies, having seen the promise of the Internet themselves, are now carrying out their own web operations, leveraging their incredibly strong brand names to attract custom.

Further problems arose due to fact that consumers are also far more reluctant to use the Internet to do their purchasing due to fears regarding security and a wider ignorance on how to use the Web for shopping. Despite some significant cost savings at some sites, the benefits from shopping online were also perceived as marginal compared to just going to a store.

Building up a large and loyal customer base was always going to take a long time, but the costs involved in running such a business meant that online retailers were losing money, hand over fist, every day. Nevertheless, investors had been more than willing to pour money into these ventures, until recently. Finally, it clicked with investors than many of the dotcoms were never going to make the money originally expected of them, and that serious consolidation would have to take place before the market could get back on track.

Perhaps one of the best examples of the Internet boom and bust was Lastminute.com, which went public around the time that prices collapsed. Lastminute, which acts as a booking agent for holidays and other leisure activities, received huge publicity through co-founders Brent Hoberman and Martha Lane Fox. Demand for shares was so high that, at one stage, the company was valued at almost £900m and investors were severely restricted in the number of initial shares they could purchase. The story caught the attention of the media and with Fox and Hoberman happy to play the parts of media darlings, the company received an inordinate amount of attention.

Fairly soon, people began to question why the company was worth as much as it was estimated to be, a line which the media also took.

Sir Alan Sugar, chairman of Amstrad and Tottenham Hotspur, commenting in The Mirror at the time of the float said, "It doesn't take a brain surgeon to work out that if they book every single flight in and out of England for all of next year, the commission they would make would not generate profits worthy of the rating the stock market gave them."

When the company went public, shares skyrocketed in pre-market trading, but quickly fell soon afterwards. It is now trading well below its initial float price, but has at least managed to stay afloat, unlike some of its dotcom companions.

Not so lucky was boo.com, the fashion sportswear site, which was liquidated in May. Despite starting with a capital outlay of $125m, the company folded six months after launch with $25m worth of debts, mainly owed to advertising agencies and courier companies. The technology behind the website, which displayed items for sale in 3D, was sold to UK firm Bright Station for just £250,000. US Fashion portal, Fashionmail.com, bought the boo.com brand name in an attempt to enter the UK market. One criticism levied at the company was that its founders, who, like Lastminute, attracted a high profile, were not good businessmen yet both ran the company. Many analysts are advising dotcoms to get experienced chief executives in as soon as possible so that the business receives a proper structure that is capable of being sustained.

The Disney-owned Toysmart.com and upmarket shopping site Foofoo.com have also fallen victim to the markets new pessimism in recent weeks and shut up shop. Unfortunately, it is not just those companies that are perceived as badly run or unable to break even that are folding. Violet.com, a web boutique for unusual items in the US, was seen as having a promising future. Unfortunately, the downturn in the dotcom market happened just as the firm was looking for a new round of funding. Investors stepped back and allowed the company to fold.

Cash flow looks like being a big problem for Internet firms in the next few months. Companies such as CDNow and Peapod are predicted to be the next to fall due to lack of cash and unwillingness from investors to stump up what is needed. Several firms, such as Petstore.com, have seen the signs and are cutting staff in a desperate bid to reduce costs. Others, such as Letsbuyit.com, are delaying their IPO until market conditions improve, with investors unwilling to buy into new tech companies currently. Unfortunately, some analysts predict that the market conditions may not change until well into the New Year, which will surely see the collapse of many more dotcoms.

The next few months will sort the wheat from the chaff. Those that had a tenuous idea for a site and a shaky business plan are likely to disappear, while the more established companies, such as Amazon.com and those that are properly structured, should survive and go on to prosper.

Paul Grant

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