First Mover Disadvantage

The rules of Net investing are more art than science. The reason? There
are really no objective ways to value companies that are losing lots of
money, have limited operating histories and small revenue bases.

You need
to focus on subjective factors, such as management, positioning, branding
and so on.

One common factor is the famous “first mover advantage” (FMA for short).
There are many examples where this has worked wonderfully.
Yahoo! (YHOO)
had the advantage of being the first portal;
VeriSign (VRSN)
was the first in digital certificates;
RealNetworks (RNWK)
was a pioneer in online audio, which the company then leveraged into
online video.

The rates of return have been awesome. A ten-thousand investment in each
of these companies – since the IPO – would have yielded the following:

1. Yahoo: $331,136.

2. VeriSign: $123,382.

3. RealNetworks: $135,245.

But don’t be fooled. The FMA is no panacea. Truth is, a company may
have the FMA in a market that may amount to very little. Or a company may
be too early. As the old saying goes: “You can spot the pioneers.
They’re the ones with arrows in their back.”

This week, we got evidence where the FMA completely failed. The company is
Peapod (PPOD).

On paper, the company makes sense. First of all, the grocery market is
huge: $449 billion in 1998. Second, grocery shopping is unquestionably
boring. But there was a big problem: The grocery industry has slim
margins. To make money, a company needs to control distribution costs, which
Peapod’s model did not. Peapod’s plan was to be a reseller, not carrying
any inventory.

No surprise, Peapod’s stock has been a terrible performer. And this should
continue. This week, the company reported its results. In the last
quarter, sales posted an anemic increase to $16.5 million from $15.7
million while losses ballooned from $5.1 million to $9.4 million.

Then there is Webvan, which plans to go public today. This company
had the advantage of seeing the problems of Peapod and developing a model
that controls distribution costs. That is, Webvan is developing its own
system, with highly automated warehouses placed strategically across the

In fact, it is common that once an FMA company heads down the wrong path,
it is nearly impossible to reverse course. This is especially the case
with Net companies, which burn lots of cash quickly.

Peapod is now changing its model, developing its own warehouse system.
But it is crippled by a low stock price, which makes it difficult for the
company to aggressively compete against Webvan, which plans to raise more
than $375 million. Keep in mind that the market capitalization of Peapod
is $262 million.

Thus, at $15 per share, Peapod is no bargain. It could easily go lower and

The lesson from Peapod is that, as an investor, you really need to think
about the core of the business model when looking at an FMA company. Does
its system involve much labor? Are the margins slim? Do consumers really
demand the service? Trying to find answers to these types of questions can
save you major investment headaches.

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