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BULLETIN
By: Walter Sabo
Did you hear about the industry that grosses $44,564,000,000 a year, $847,000,000 in just one week and grew 47% compared with same week last year. This business has such extraordinary public acceptance that almost every week delivers a new record high in usage. As recently as the week of March 19, 2001, 64 million people used it, up 20% in one year. You guest it, it’s that failure: The Internet. $44.5 Billion, that’s the minimum that will be spent by on-line shoppers in 2001. Federated department stores won’t come close.
* Source: The Industry Standard April 2, 2001
The Internet is the killer app that the personal computer industry has been waiting for since 1980. The Internet makes ownership of a computer compulsory for people who will never need to understand a cosign. The Internet is a great investment. Just look at those numbers. Get in now. Why is it suddenly perceived to be a financial risk? Because a large number of venture capitalists pulled out. They never had any business being there. Traditional VC’s have little experience funding start-ups and they do not understand where the money should flow in a start up.
Wise investors know that the Internet is a perfect investment. Internet acceptance by the public is so profound, that the ultimate mass appeal magazines have added Online sections. Entertainment Weekly, People and PARADE all have weekly features about the Internet. The VCR was the last piece of hardware/software to change the family culture. That was 20 years ago. Kids, the Internet is a hit.
SECRETS OF A START-UP.
To succeed with an Internet investment today, study the reality of start-up businesses.
Virtually every website is a successful start up. That is if you understand start-ups. 99% of venture capital firms don’t. A successful start-up on the Internet is one that continues to secure funding. That’s not a slight, that’s a fact. And it has always been a fact of all start-up businesses. The challenge for investors is to stick it out to profits. Venture Capitalists ran away too soon. If they had followed business start-up models, rather than internet start-up models, they would have understood that all new industries have surprisingly long gestation periods requiring extraordinary capital commitments. They would also realize that the greatest risk is pulling the money out before profits hit.
Let’s review a few old-economy start-ups.
ALERT THE MEDIA, NETWORK TV A FAILURE.
The economic “problem” with broadband is that as more people use a server, the more lines (streams) that are connected, the more money must be spent by the content provider. Naturally that causes skepticism about its financial viability. There is an excellent model suggesting that the ramp up is worth the wait: Network television.
Every time a network signed on a new affiliate, it paid that affiliate money. Money to clear the network commercials on its local airwaves. So with each new sign up, the network lost more money. Then, the gamble. The gamble was that the programming would attract an audience of significant value to advertisers. The price of advertising would outweigh the cost of paying affiliates for distribution and for the production of shows.
Good model. So, how long does something like take? That ramp-up time? When can investors see a return? Three years? Pant. Pant.
From its inception in 1956 until Fred Silverman took over the Entertainment Division in 1974, the ABC network division lost money. Certainly there was no problem with the public acceptance of the medium of network television. There was a problem with the content and distribution of the ABC network. Leonard Goldenson, the founder of ABC, was clever enough to maintain his network with a variety of revenue streams and investments. Through all the losses, there was no public perception that ABC was a bad business idea. Surely Mr. Goldenson had many sleepless nights and tough negotiating sessions.
THE HONEYMOONERS ALMOST GOT DIVORCED.
Some TV networks did not succeed, they ran out of money. You probably haven’t heard of the Dumont network. But you’ve heard of its product, The Honeymooners. Jackie Gleason’s perpetual syndication profit machine was launched on the Dumont network. Dumont’s failure established the myth that there was only space for three networks. Good thing Fox’s Rupert Murdoch never got that memo. Dumont didn’t make money in its start up years but it had excellent content. Their shows remain viable today. It just couldn’t maintain financing through a start up period. How many Dumont networks, creating hits like the Honeymooners, are winding up as Dead Dot Coms of the day because VC’s are pulling out too soon?
Here’s a quiz. Which of the six over-the-air television networks makes money in their prime time? Only one. It’s always been only one. The economics of television production and distribution demand a network be number 1 in prime time to make money in prime time. (Their steady profits come from daytime and late night.)
All-news radio is considered to be one of the great success stories of broadcasting. Every major city has a radio station devoted to all-news broadcasts. Fortunately they weren’t launched on the Internet in 1998, they’d all be closed. Almost every all-news station lost money for 10 years. While its owners covered the losses, the format was embraced by the community as a terrific service and its audience grew annually.
Website start-ups are following exactly the same pattern of all start-up industries. The fact that any site makes money so early in the history of the industry is remarkable. So why is the public perception that the Internet is a money toilet? Why doesn’t the public and investors realize that all industries had start-up losses? Blame Jeff Bezos.
HEY JERRY, SHUT UP.
Jeff Bezos really blew it. Not with Amazon. Amazon will be a big hit. (Thirty years from now people will realize that Amazon had an amazingly short start up time.) No, he blew it on the TONIGHT Show. Christmas 1999. Leno asked the best question:
“How come you’re a genius for losing more and more money. Each report comes out saying you’re losing more and more money.” People sat up. Yea! How come we catch hell if we overdraw but this guy is a hero? Jeff’s answer sucked. He laughed. He just laughed. Then he spewed the crap about claiming space and marketing and all sorts of things that an audience full of maxed out credit card holders just didn’t buy.
What he should have said was this:
“Jay, your television network took years to build. In fact, the NBC television network often lost money between 1948 and 1985. But its owners believed in television and that belief clearly paid off.” In two sentences he would have put investment spending in terms that made sense to us normal folk. Instead he extolled his industry’s arrogance. The devaluation of the NASDAQ started on the TONIGHT show.
VC’S GO BACK TO GE.
For years, Venture Capitalists wouldn’t touch a pure start-up. And they were smart. It’s bad for most VCs to invest in start-ups because their management tends to have little experience with start-ups. And---regardless of their claims--- their money is impatient.
To successfully invest in a start-up in a new industry, the money has to understand that there is no model. There is no model. To protect the investment and grow the business, two areas demand proper funding: Management. Research. Obvious, right? Didn’t happen.
• Management is not fungible. Management is everything. MBAs at VC firms are trained to look for patterns. They believe that patterns of the past will repeat. If the pattern is successful, do it again. That reasoning kills start-ups. It locks the CEO into explaining his future as it relates to another company’s past. But each start-up contends with different moving parts. Different consumers, markets, economies, competitors.
The past is a bad place to find management for a start-up in a new industry.
Winning start-ups break past patterns and enjoy new sources of profit.
DON’T CUT BACK, CLOSE IT.
As a member of the Board of Directors of a consumer electronics start-up, I’ve witnessed that VC’s specifically believe that a CEO who argues that lay-offs would be bad for morale is a bad CEO. The layoff of one employee starts a chain of events that will doom most start-ups. It would be wiser to just close a start-up than to cut back during the ramp-up. A clean kill rather than a coward kill. A layoff might save GE but it will permanently kill geewhiz.com.
When a CEO fights a board on cutbacks, he isn’t doing it to protect his buddies. He’s doing it because he knows that high morale is the fastest route to positive cash flow. Most VCs think morale is something cute. It’s not; it’s the most pragmatic factor in determining the potential success of a venture.
FREE FOOD CAN’T MAKE YOU HAPPY.
True entrepreneurs spend money only on what is needed to staff and tool the creation of the product. If the product is successful, they might turn some of the profits back into creature comforts. A coffee machine, better rug, better health plan. Over time, with cash in the bank, they’ll upgrade the physical plant. But they pay as they go. ABC did not consolidate its offices into its very own Manhattan building until 1987. Before that it rented what it needed at the best prices it could get. Morale comes from leadership not furniture.
AERON CHAIRS KILL
In the industrial section of Santa Monica, glowing in the night sky, you will see one of the wonders of modern architecture. A breathtaking brand new building. Stunning curves and shapes. Striking construction materials. Dramatic lighting that literally makes the 35,000 square foot building glow at night. Through the windows you’ll see brushed metallic walls, recessed panels and Aeron chairs. Room after room of Aeron chairs. Chairs that cost, at discount, $650 a piece.
If the building was the new centerpiece for KABC TV, a station returning profits of over $50,000,000 a year, well, they’ve earned it. The investment would make sense. It’s not. Sadly, it’s the home of E-Toys. What a great idea E-toys is. Terrific ad campaign. Spot- on service. But like most start up websites, instead of putting the money in product, staff and marketing, they wasted millions in cafeteria design.
Chelsea Markets is pricey Manhattan retail/office space. Cool as it comes. About $50 a square foot. On the second floor is Oxygen. Like any cable start up, it has trouble finding channel distribution in major cities. That’s not odd at all. It took the Disney Channel over 10 years to get a slot on cable in Manhattan. FX, produced in Manhattan, still isn’t available. There are dozens more. That’s normal. Yet, the wringing of hands in the press over the fact that Geraldine Labourne and her crew couldn’t get their very own channel in New York City is epic. Other brilliant TV executives such as Fred Silverman and Reese Schonfeld, founder of CNN, had similar, terrific ideas and are still waiting for a gate. This is normal for a startup. What’s not normal is that Oxygen has both traditional and VC money. VC money has no patience so they are making cuts before they can make a mark.
Fancy buildings? Aeron chairs? Original art in the lobby? At a start-up? A brand new company? It was backwards.
The employees that should be hired at a start up are those who derive their psychic rewards from a passion for the product. The right managers know how to spot and recruit people of passion. How many of those well funded websites would still be around if the CEO was compelled to motivate without the free massages and catered breakfasts?
Too many Internet start-ups were operated by former VC’s rather than true entrepreneurs, they wanted to build themselves a showcase to impress their buddies. They didn’t have a passion for the product, they have a passion for money. No start-up, in any industry succeeds with a leader whose only goal is money. Passion for the product is the mandatory management ingredient in a start up that ultimately becomes profitable.
VC’s, turned instant CEO’s, were schooled in modeling not management. They believed that the proper “internet start up model” was to secure “space”. That meant pouring money into advertising and building physical plants that would last for fifty years. They bought the lie that there actually was such a thing as an Internet start up model! There isn’t. Their sad obsession with business models kept them from finding true paths to profits. Just keep spending the money and claim the space! Through consumer research, successful companies discover that some great ideas turn bad when reviewed by the public. Failure to conduct on-going research is dangerous.
BEER BUZZ KILL.
• Have you heard of Maximus Super Beer? Oven bags? Master Blend coffee? Pringles. Aw, Pringles. Procter and Gamble, you know that pesky soap company that has never visited the cutting edge, they believe in two boring concepts: Research. Test markets.
Students at Syracuse University witnessed a remarkable event in the Spring of 1972. Beer buzz kill. Syracuse was a popular test market. Companies would test the viability of their product and advertising there. Maximus Super beer was special. It tasted like beer. Looked like beer. But had twice the alcohol content. Sure enough, students drank it like normal beer and were whacked out of their minds twice as fast. There weren’t enough ambulances.
Syracuse witnessed stoves blow up from oven bags. (Don’t ask). And they were treated to Master Blend coffee---half instant, half freeze dried.
Pringles was tested by P&G. It was in Syracuse that they learned that by putting them in a can rather than a bag, the value of their uniform shape could be appreciated and marketed. Left in a bag, no one would grasp the difference.
These lessons were learned in the field not in a meeting room. For a VC to successfully finance a start up they must fund a test period. A time when the product mix, advertising and packaging is perfected. No VC did that for any website. “Capture the space.” First in would, they believed, solve all future problems. Many failed websites tested the idea, but never tested the product. VC’s should have demanded and funded on-going research.
SHELL GAME.
The “dot com economy” as fueled by venture capital never existed. It was just the wrong guys investing in start ups. “Economy” implies profit and loss. There is no failure of the Internet. None. Look at the numbers at the beginning of the article. That’s success, a consumer success. The failure is found in the VC’s who demanded that their monies be thrown at buying future “space” and furniture rather than management, research and marketing. Then, instead of taking corrective action when that didn’t work, they pulled their money out. They pulled it out way too soon.
This is the best time to invest in the Internet. A young industry with extraordinary public acceptance. The investors who stick it out will find themselves enjoying their own version of the Honeymooners: Profits forever.
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