Investors in wonderland?

As’s share price dips below the offer price taking the shine off the gold rush, Alison Classe takes a look at the topsy-turvy world of e-commerce economics, and suggests they aren’t as unfamiliar as they look.

Investor wonderland A glance at the market for shares suggests the world of e-commerceis a topsy-turvy one., for example, is a giant among e-commerce ventures, with almost $700m sales in the last quarter of 1999.

Although it made an overall net loss of $323m in the same period, almost everyone seemed surprised and delighted with the news that Amazon’s US book business had showed a profit – the first time this had happened since Amazon began, five years before.

Again, look at Freeserve, the ISP and portal company whose IPO helped to precipitate dotcom investment fever. Shortly after becoming one of eight hi-tech companies that displaced the likes of Whitbread from the FTSE-100 in March, it announced third-quarter losses of $3.5m. But analysts and investors were delighted because revenues and user numbers had surpassed predictions.

On 8 March 2000, Howard Davies, chairman of the Financial Services Authority, was moved to warn prospective dotcom investors, via Radio 4’s Today programme: “These companies for the most part have never made a profit, have never paid a dividend, and have no intention of paying a dividend, so the normal basis on which you value a company is no longer relevant,” he said.

So let’s say you’re FD of a traditional company – a bricks-and-mortar company in Internet-speak – that’s thinking of dipping a toe or three into the waters of e-commerce. Faced with this confusing picture, how can you set about evaluating the proposition?

E-commerce is about business processes, not IT
It’s clear that you can’t expect to see a business case of the type traditionally associated with IT projects. In fact, you may not be looking at an IT project at all, but at a potential change to your whole way of doing business, as Richard Brown, senior manager, information systems assurance and advisory services, with Ernst & Young, points out. “First, you have to ask what exactly what it’s going to mean to your business. Designing the correct business process is the most important and difficult job. After that, using IT to make it happen is comparatively straightforward.” So e-commerce should be approached as business transformation with IT as the enabler.

Brown divides companies contemplating e-commerce into three categories. First, there are those that are out to maintain and nurture what they already have, using e-commerce to protect the core business: for example a supermarket setting up an Internet shopping service alongside its existing stores. (Though it might sound relatively simple, this could impact business processes extensively, for example because of the need to provide home delivery) Second, there are those who decide to change the game they’re in, like Encyclopedia Britannica which now offers its content free on the Web and aims to make money from its Web site rather than from selling encyclopedias. Third, there are those which create a separate dotcom business, as Prudential did with Egg. It’s important to be clearwhich of these things you’re considering doing, Brown says. Only then can you begin to form an idea of what it will cost and achieve – and how much the business will need to change.

What makes a sound e-business proposition?
Mass hysteria apart, what did the punters like so much about glamorous stockmarket entrant, which had never made a profit but was valued by the market at over three quarters of a million pounds on themorning it floated? A major consideration in assessing a dotcom is the uniqueness of the idea, but Brown reminds us it’s not enough to start out unique: “You also have to have some relationships or other advantages that make the idea difficult for others to copy.”

Often mentioned as a plus-point for was the fact that the 19-month-old company had registered 1.1 million potential shoppers. Italso pointed to established relationships with customers (i.e. those with commodities to sell on the site). The company had quickly managed toestablish a strong brand through a combination of advertising and copious media coverage. All these things were advanced in support of’s claim to a substantial headstart over any imitators. Time will tell how well-founded that claim is, and how realistic the valuation was.

The fundamental things apply
However bizarre the behaviour of the e-commerce world, and those who invest in it, may appear, the laws of economics still apply in the long run, points out John Gilligan, partner in charge of the e-Catalyst group at Deloitte & Touche. “A company is still worth the present value of its future cashflow. But in the case of dotcom startups, the statistics normally used in valuations don’t exist, and so the market tries to value them relative to other companies – one reason why the market is so unstable.”

Gilligan argues that to get a realistic view, the trick is to take a sensible view of risk. “There’s a systematic mis-estimation of risk in parts of the market: everyone thinks they’re buying a winner.” He also sees merit in an argument put forward by Harvard Business School and others that e-business enterprises are best spun off as separate enterprises in the way that Dixons has done with Freeserve. “That way you can float it separately and let the market decide what it’s worth.” Not every e-commerce activity may be as easy to spin off, but Gilligan claims it should usually be possible.

No half-measures
There’s no point in trying to do e-commerce on the cheap. If your e-commerce operation doesn’t please, your whole brand is liable to get tarred with the same brush. Recently, for example, was said to have failed to meet thousands of its US Christmas orders on time, and parent Toys’R’us now faces a lawsuit by disappointed customers, a form of publicity that it can probably do without.

Gilligan recommends that e-commerce projects be undertaken for positive rather than negative reasons. “Rather than regard e-commerce as a threat and adopting defensive strategies, it makes sense to try to be the best in your field.” Even though it may be a long time before some of these businesses become profitable, the best stand to make vast amounts of money eventually, he suggests. Having a strong vision and sticking to it could pay off handsomely.

Bricks-and-mortar companies have a ready-made advantage over startups in that they already have an established brand and customer base as a foundation for any e-commerce foray. However, if the e-commerce proposition doesn’t look strong enough to stand on its own, it doesn’t mean sitting back and doing nothing. Major automotive companies in the US, normally aggressive competitors, have set up a joint e-commerce venture to manage the supply chain electronically. Lateral thinking is the order of the day in e-commerce wonderland.

Deloitte & Touche on e-business:
Information on the class action against
Encyclopedia Britannica:
Financial Services Authority:

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