The path to profitability for Internet companies is a rocky road, and Greg Kyle, president and chief executive officer of independent Internet research firm Pegasus Research International, said Monday that many companies are feeling the burn — burn rate that is.
According to the Pegasus Burn Rate Scorecard, Internet companies are burning substantial amounts of cash and a number of businesses are in danger of running out within 12 months. The Burn Rate Scorecard surveyed 339 Internet companies in the second quarter. Only 14 of the 339 — including DoubleClick, Prodigy, VeriSign and Xpedior — stopped burning cash in that time period.
To create the Burn Rate Scorecard, Pegasus calculated the burn rate of the 339 companies in the second quarter, and projected an estimate of when each company would consume the cash it had on hand as of June 30. The 273 companies with negative cash flow burned through an aggregate $1.8 billion, an increase from the $1.7 billion they went through in the first three months of 2000. Of those 273, 86, or about one-third, should run out of cash in 12 months. About 66 were in that situation in the first quarter.
But cash flow problems are not necessarily cropping up where one would think. For instance, e-tailers — long considered cash quicksand — performed very well in the second quarter, reducing their cash burn rate by nearly $100 million.
“What was surprising is that the e-tailing sector has really been the sector that’s shown the strongest improvement in cash flow,” Kyle said.
Kyle attributed the healthy state of the e-tailing sector to dramatic cost slashing, though he warned that probably won’t carry through the fourth quarter. “That’s typically a high spending season for e-tailers,” he said.
e-tailers may have curbed their spending, but the B2B sector — which Forrester Research, AMR Research and the Gartner Group have all projected will become a multi-trillion dollar market by 2004 — has not.
“We thought we would see better improvement in the B2B sector,” Kyle said. “They’re continuing to spend very aggressively.”
He noted that many of the companies on the list of firms at risk of running out of cash in the next 12 months are B2B companies. While he said there is a potential for very solid growth in the sector, that doesn’t necessarily translate into growth for everybody. “People are assuming that it will be a $1.3 trillion market, but you’ll only see a few winners emerge,” he said.
Much of that is due to slim profit margins, margins that Kyle said will grow ever tighter as greater transparency is brought to the market. But there is another problem as well: saturation. According to Deloitte Consulting, there are nearly 1,300 U.S. online marketplaces. Already, a number — including Efdex, Equipp.com, M-Xchange.com, Industrial Vortex and B2Beventures.com — have failed and more failures and mergers could be on the horizon. Still, the companies that survive could come out stronger than ever.
“There’s tremendous opportunity there, but it’s not all a bed of roses,” Kyle said.
On the other hand, some Internet companies are navigating the path to profitability. Bluefly, number 10 on Pegasus’ burn rate list, increased revenues in the second quarter to $4.3 million, up from $741,000 for the same period last year. At the same time, it cuts its customer acquisition costs from $239.46 per customer last year to $73.21. iGo Corp. cut its advertising costs from 53 percent of revenues in the first quarter to 30 percent in the second. And online insurance broker Quotesmith has reduced its expenditures as well.
“They have been able to scale back their expenses — not drastically but healthily,” Kyle said, contrasting their efforts with those of drkoop.com, which dramatically slashed its spending but also saw its revenue fall 50 percent in the quarter. drkoop.com was number two on the Burn Rate Scorecard.
The lesson of all this, Kyle
said, is that not only do old economy rules now apply to Internet companies, they always did.
“The valuations, the competitive forces, they’re the same [in the new economy as they were in the old],” he said. “I think too many people got caught up early on in the hype that it’s a new paradigm. It couldn’t be further from the truth.”
He added, “What we’re seeing is “digital Darwinism” at work. In this quarter we are starting to see the winners being separated from the losers very rapidly.”
So what should a new Internet company do?
“The most important factor that a new company can demonstrate is a very clear path to profitability while still showing solid growth,” Kyle said. “That’s what private equity investors and the public market are looking for now.”