Cutting costs is not helping Internet companies become profitable, according
to a study by Getzler & Co., Inc., a New
York-based turnaround firm, which found that cost cutting has resulted in
significantly lower growth rates, which could further undermine companies’
already depressed valuations.
The study examined 213 technology and dot-com firms, and identified 57
companies that had implemented cost cuts, particularly in the area of sales
and marketing. Getzler then studied the impact of these cost-cutting measures
on the companies’ financial performance.
“We’ve heard time and again how dot-coms are reducing costs in order to become
profitable,” said Brian Mittman, vice president, Getzler & Co. “But what we’ve
learned is that, rather than help the company, cost-cutting reduces sales
growth so drastically that profitability becomes nearly impossible.”
The study analyzed first- and second-quarter results of firms with more than
$1 million in quarterly sales. On average, the cost-cutting Internet firms
grew sales at an annual rate of only 19 percent, yet lost $1.20 for every
dollar of revenue.
“At that rate, even assuming certain costs remain constant, it will take many
years for these companies to become profitable,” Mittman said. “And investors
aren’t likely to wait that long.”
The average growth rate for cost-cutting dot-coms trailed the growth rate for
firms that increased spending — 19 percent annually vs. 149 percent annually.
“A 19-percent growth rate is typical of a healthy traditional firm, not a
dot-com, which is operating deeply in the red and whose stock price has
factored in expectations of several years of very high growth,” Mittman said.
Amazon.com was a prime example of the study’s conclusions. Amazon reduced
sales and marketing costs in the second quarter, but experienced virtually
stagnant growth, according to the study.
Nearly half of the cost-cutting firms examined in the study were e-tailers.
The e-tailing sector is facing particularly skeptical investor sentiment,
making it increasingly difficult for these firms to attract additional
funding. The result has been a wave of belt-tightening.
The study also corroborated analysts’ souring opinion of the loyalty of
dot-com customers. Dot-coms have spent vast sums of money on marketing,
reasoning that such expenditures were necessary to build a loyal customer
base.
“But if your revenue drops as soon as the dollars stop flowing into marketing
programs, you have to question customer loyalty and the wisdom of continuing
to invest blindly in extravagant marketing campaigns,” Mittman said.
Not surprisingly, the study suggests that dot-coms need to make better
decisions about their marketing expenditures. Mittman cited Internet firms
that spent millions on short ads during the Super Bowl. In certain cases,
firms spent a significant percentage of their entire annual budget on a single
advertisement that generated little customer follow-through or discernible
revenue.
The study did identify several exceptions, including e-tailers Pets.com and
PlanetRx.com, which have managed to increase sales at a healthy clip while
also reducing spending on marketing and sales.
“Clearly these companies are finding more efficient ways to spend their
marketing dollars,” Mittman said. Multex.com and Priceline.com, despite the
latter’s recent negative publicity, also proved to be exceptions. Both are
relatively close to profitability and both have maintained healthy growth
rates while reducing costs.
The news out of Europe is somewhat better, although marketing expenditures are
wreaking havoc there as well. Research by PricewaterhouseCoopers found that an
improvement in Internet company burn rates is heralding a healthier dot-com
market throughout Europe. Despite this improvement, however, the
20 most
vulnerable internet companies in Europe are at risk of running out of cash
within a year, unless they take direct measures to address the issue.
The PricewaterhouseCoopers’ study found that B2C companies are most
vulnerable, with an average burn rate of 15 months compared to 23 months for
B2B firms. The difference stems from continued high marketing expenditures by
the consumer-facing firms which, in some cases, account for more than 400
percent of gross profit. The service and e-commerce sectors are the strongest,
containing the most profitable companies with no burn rate; the content and
software sectors are the weakest, containing the highest number of “burning”
companies. German companies are somewhat more secure than their UK
counterparts, the study found.
“Against a couple of high-profile insolvencies, Internet companies are waking
up to the fact that the dot-com honeymoon is long over,” said Kevin Ellis, a
partner at PricewaterhouseCoopers. “What we’re witnessing is dot-coms
throughout Europe beginning to take proactive steps to consolidate their
position and regain the confidence of the market, including fundamental
business restructuring or seeking appropriate merger partners. On the whole,
the improving burn rates indicate that management teams are focusing not only
on cash management but also on bringing forward their breakeven points to take
control of their own destinies.”
Michael Pastore is the editor of CyberAtlas.
