Making Money On The Net
For something that was supposed to be the next gold rush, the Internet sure seems disappointing. True, companies such as Netscape Communications Corp. that sell the technology for setting up shop on the Internet's World Wide Web are doing a land-office business--and making immense paper fortunes in a bull market dazzled by the Web. But it's damned hard to find any of the prospectors who use those tools actually hitting pay dirt--by selling merchandise and information or running advertisements on the Internet.
The horror stories of money-losing Web ventures are everywhere--including high-profile fumbles by some of the biggest names in media and communications. Don Logan, CEO of Time Inc., last year complained publicly that Pathfinder, Time Warner's glitzy Web site, gives "new definition to the term black hole." Since then, Pathfinder has gotten new management, a facelift, and a plan to begin charging for some content. Now Time Warner executives say the site will generate profits ahead of schedule. Meanwhile, AT&T, as part of an overhaul of its Web strategy, ended up killing an ambitious "Health Site" before even finishing testing. MCI Communications Corp.'s Internet shopping mall failed to lure tenants and is shuttered.
No wonder the question being asked--ever more nervously--by bankers, entrepreneurs, investors, and corporate executives is: Can you make money on the Net?
Surprise. The answer is yes. Not a lot of money yet, mind you. And the number of losers still exceeds the number of moneymakers by more than 2 to 1. But it turns out that while the corporate giants have been thrashing around noisily in cyberspace, showing how not to make money on the Net, scores of entrepreneurs have been quietly tinkering--creating new business models for retailing, marketing, publishing, and advertising that work for them and could perhaps point the way to an Internet payoff. This first wave of profitable companies is proving that electronic commerce can work, that you can sell ads on the Web, and that--at least sometimes--people will pay for online information. "Companies that are offering a unique business proposition on the Web can and will be successful," says analyst Betty Lyter of Montgomery Securities.
Just ask Jason Olim. With twin brother Matthew, he founded Net startup CDnow Inc. from the basement of their parents' Ambler (Pa.) home. Jason Olim, a jazz fan frustrated by skimpy selections in music shops, came up with the idea of a cyberstore that could offer every jazz album made in the U.S. and 20,000 imports. The beauty of it: no brick-and-mortar costs and no inventory. Shoppers place their orders with CDnow (cdnow.com), which, in turn, contacts distributors. Most disks are delivered to the customer's door in 24 hours. Add in advertising revenues, and CDnow expects to hit $6 million in sales in 1996, triple last year's revenue, with 18% operating margins. Says Jason Olim: "We're dancing as fast as we can."
"THIS THING IS ON FIRE." In Corona Del Mar, Peter Ellis was nearly wiped out by the deep California recession of the early 1990s. He lost $15 million when he was forced to sell off or close 16 auto dealerships. But last January, he was back in business--on the Net. Auto-By-Tel, his new company, makes money by selling sales leads to auto dealers across the country. For a monthly subscription fee of $250 to $1,500, dealers get the names of Web surfers who have checked in at autobytel.com and decided to buy--at the listed "no-haggle" price. Some 1,400 dealers use the system, and at the current growth rate, Ellis says he'll turn a profit on $6.5 million in revenues this year. "This thing is on fire," he says.
In Silicon Valley, veteran entrepreneur Jerry Kaplan thinks he has the right formula this time. His previous startup, a maker of handwriting-recognition software called Go, went south in early 1994. In July, he launched ONSALE, an online computer auction. For a growing audience of computer-savvy consumers, bidding in the twice-weekly sale has become a ritual--part bargain hunting, part entertainment. By August, each auction was bringing in an average $445,000, putting the company on an annual run rate of $45 million. What's more, ONSALE (onsale.com), with 10% to 20% gross profit margins, has been profitable since January. Says Kaplan: "I'm becoming the P.T. Barnum of cyberspace."
Olim, Ellis, and Kaplan are not the only "Netrepreneurs" who are making it on the Web. In a June survey of 1,100 Web-based businesses conducted by market researcher ActivMedia, 31% claimed to be profitable, with 28% more saying that they will be in the next 12 to 24 months. Those surveyed accounted for $130 million in Web revenues in June alone. "This reflects the average company on the Net rather than the large companies you read about," says ActivMedia senior research analyst Harry Wolhandler.
And the ranks of profitable companies could soon swell dramatically as Web pioneers gain more experience. It's only about two years since companies began doing business on the Net at all, and the vast majority of the estimated 250,000 commercial Web sites now operating have less than a year's experience. "Step back," says Lyter of Montgomery Securities. "Most companies don't reach profitability in the first six months or even the first year."
So, what is the magic formula that the successful pioneers have discovered? In BUSINESS WEEK interviews with 35 operators of profitable Web sites and an additional 15 that expect to be in the black in the next 3 to 12 months, a surprising picture emerges. These companies haven't invented unique types of businesses--they're doing what everyone else on the Net is: selling products, selling advertising, and selling information.
But with a difference. For one, instead of plowing huge sums into their sites, most are operating on tiny budgets. That has forced them to focus on how to reach and serve their customers, rather than, say, pumping money into fancy graphics that look good in management meetings but wind up slowing down Web sites and turning off consumers. "We've had a focus on controlling costs, which others haven't had to do," says Jason Olim. "It's simply the discipline of having to be profitable to survive."
Even more important, the successful Web players are not simply replicating existing businesses in the new online medium but are taking full advantage of the unique, interactive nature of the Net. For example, the hottest stores on the Web don't just provide convenience and low prices--although those are essential ingredients, too. Across the board, successful Web merchants have created virtual "communities." At their sites, like-minded cybernauts congregate, swap information, buy something, and come back week after week. A flair for such community-building helped make bookseller Amazon.com Inc. a standout on the Web (box). Says founder Jeff Bezos: "This is the secret weapon of an electronic merchant."
Above all, the successful Web trailblazers share the ability to adapt--to scrap what's not working and improvise a new business plan on the fly. It is increasingly common, in fact, for Web businesses to wind up with hybrid strategies: Online stores end up taking ads; publishers go into retail sales and are looking for ways to get subscription revenue. InfoSeek, which is now the No.1 advertising venue on the Web, for example, set out to sell hard-to-find information across the Net.
GolfWeb is another example of how hybrid strategies are evolving. The site was started in 1994 by Ed Pattermann, former manager of Internet commerce at Sun Microsystems Inc. GolfWeb went after advertising first because, he says, "it was the easiest model to get to." It began posting everything anyone ever wanted to know about golf--35,000 Web pages, including reports on 19,000 courses at golfweb.com. GolfWeb has attracted advertisers such as Bank of America, Lexus, AT&T, Buick, and Callaway Golf. They pay $30 to $40 per 1,000 "impressions," counted as each time an ad is viewed. Pattermann is counting on ads to deliver about $400,000 in revenue this year.
Not satisfied with that, he's pushing hard into retailing and offering special services and content that consumers can buy a la carte or through monthly subscriptions. Pattermann's virtual ProShop, which opened two months ago, is already contributing 20% of revenues, a projected $100,000 a year. With "premier memberships," which will be added early in 1997, Pattermann will throw in services such as handicapping and golf eames. He expects service and subscription fees to generate some 40% of the $4 million he's anticipating next year. Ads will be 35% and retail 25%. "We really think we have the right formula," he says.
CHILI LOVERS. For now, at least, the most promising strategies seem to revolve around retailing. Net merchants will sell some $518 million worth of goods this year, and $6.6 billion by the year 2000, says Forrester Research. The best-sellers? Music CDs, airline tickets, books, and other known commodities that consumers don't need to sample before buying.
Not surprisingly, computers and related gear are huge sellers in cyberspace. This year, $140 million worth of computer products will be sold over the Net, according to Forrester. Dell Computer Corp., for example, just opened its Web store to consumers two months ago and expects it to sell $20 million to $30 million worth of PCs a quarter.
Going up against giant manufacturers in a commodity business like PCs can be a recipe for Web oblivion--which is why it's more common to find online stores in specialty areas. They profit by connecting enthusiasts with new or hard-to-find items: an out-of-print book or a rare Italian cheese.
There's Hot Hot Hot, for example. The tiny Pasadena (Calif.) shop was known locally for stocking all sorts of exotic hot sauces, but on the Web it has become a popular destination for chili lovers everywhere--all because one day Monica Lopez locked herself out. While Lopez waited for her husband to bring the keys, Thomas A. Soulanille, president of a Web-design company, arrived. The two started talking, and soon Hot Hot Hot was on the Web. Today, it offers some 150 different sauces to Web surfers, from Satan's Revenge to Scorned Woman. The site (hothothot.com) draws 1,500 visitors daily, and Lopez says the online outlet is profitable--and generates 25% of sales. "That many people wouldn't even fit in our shop," she notes.
It takes more than a specialty to keep the cybershoppers coming, though. It also takes cyber-merchandising. Online merchants are making sure their shops are cozy virtual hangouts for consumers, but they're finding that contests, giveaways, and "sweb-stakes" also keep the clientele coming back. Amazon.com, for example, has a quarterly drawing in which the winner gets a free book a week for a year. Smart Games Inc., a Marblehead (Mass.) startup, offers over $50,000 in cash prizes to customers who score well on its Smart Games Challenge CD-ROM game. Its web site, smartgames.com, attracts some 500 people a day who download a demo version of the game--helping to generate $1 million in sales of the CD.
Increasingly, however, online stores are counting on advertising, too. Traditionally, advertisers have looked for big audiences through newspapers, magazines, or television. On the Web, they're looking beyond such "content" providers to other places where they know they'll find consumers. That's why, for example, CDnow has begun running ads from Microsoft Corp. and Lands' End Inc., both of which saw how much traffic the record store was generating. CDnow says ads are coming in at the rate of $100,000 a year.
TV-SIZE AUDIENCES. At this point, however, Web advertising doesn't amount to much. In 1995, according to market researcher Jupiter Communications, ad revenues on the Internet totaled $42.9 million--a nit compared with the $32.4 billion spent on TV spots. And even the companies that are getting the most ad revenue (table) aren't necessarily moneymakers. InfoSeek, the popular "search engine" site, is not breaking even and is not expected to in 1997.
The ad picture could improve in short order, though. With the population of the Web swelling, ads are popping up everywhere, and revenue growth is accelerating. "There's been a real sea change over the last three months," says Daniel A. Stone, executive vice-president of Turner Broadcasting Sales Inc. Turner's CNN Interactive, one of three CNN Web sites, now gets 9 million page views a week, up from 3 million five months ago. "Revenues and the number of advertisers have been snowballing ever since," says Stone, who says that CNN Interactive will break even by yearend.
Market researcher Jupiter says that Web ad revenue will jump from $71.7 million in the first six months of 1996 to more than $240 million in the second half. The company predicts an explosion to $5 billion a year by 2000. Then, it figures, 50 million people will be connected to the Net, giving advertisers the chance to reach TV-size audiences.
But media giants may not get the biggest share of this pie. On the Web, advertisers have a much greater capacity to aim their messages at people they know are buying--those looking at car reviews, for example. That's why, for instance, sites such as ZDnet, a popular destination for computer shoppers, are commanding top dollar--upwards of $100 per 1,000 impressions, vs. $30 per 1,000 on more mass-market sites such as Pathfinder.
Happy Puppy, the Web's No.1 game site is a happy beneficiary of this trend. It got started 18 months ago, when three developers decided to market their games by putting demo versions on a Web site. It quickly mushroomed, and cybernauts visiting happypuppy.com can now sample all the popular games That makes the site a mecca for advertisers pushing everything from games to MTV to Sunny Delight juice. Happy Puppy's ad sales have been growing by 35% a month since May, and executives expect operating profits by October.
Tripod Inc. attracts advertisers by roping in GenXers at its tripod.com site. The Williamstown (Mass.) startup offers tips on everything from writing a resume to personal finance for members of the 18-to-34-year-old crowd, a group that includes an estimated 40% of Web surfers. Founder Bo Peabody, 25, says the precisely tailored "content" has attracted some 90,000 registered Tripod members--and a slew of advertisers. Ads account for 95% of revenues, which have reached $500,000 so far this year. In the last quarter of this year, Peabody expects ad revenues of $650,000, which will put him in the black. "Here we are out in the woods with a business model that's actually working," he marvels.
The promise of reaching hot prospects--not just consumers who might possibly be in the market--is persuading more and more major advertisers to put money into Web ads. Toyota Motor Corp. is one such company. It runs banner ads on sites ranging from Parent Soup (parentsoup.com) to ESPNet SportZone (espn.com). And when a consumer clicks on the ad and is sent to the carmaker's own Web site, Toyota wastes no time trying to turn inquiries into sales. "Advertising is going to become transactions," says Russell Collins, president of Fattal & Collins, a Marina del Rey (Calif.) unit of Grey Advertising Inc. "The lines between advertising and marketing and retail transactions are going to disappear. The Internet is going to become a channel of distribution."
Visitors to Toyota's site, for example, can order interactive CD-ROMs that show off the features of Toyota models, and before the CD-ROM arrives in the mail, a local Toyota dealer will call, inviting the Web surfer to come in for a test drive. Says James T. Pisz, national direct-response manager at Toyota Motor Sales USA Inc.: "We're done with research. We're done with experimenting. The Web is part of the mainstream at Toyota."
Not many big advertisers have reached that point, however, and that means few, if any, Web sites can get by on ads alone. To fill the gap, more and more online businesses are trying to get surfers to pay a subscription fee. Of all the business models for the Net, this is the least welldefined--and the one most fraught with risk. At the heart of the Internet culture has been the belief that "information wants to be free," and millions of Web surfers are used to pulling down everything from NASA weather maps to audio clips from Seinfeld. That's why few content providers have tried to collect fees, and the total revenue from Web-based subscription services will be just $120 million this year, according to Jupiter.
GROWING DEPENDENT. Still, a few pioneers have shown that if you have the right information, the customers will pay. Silicon Valley's Quote.com Inc., for example, charges subscription fees ranging from $9.95 to $42.50 a month for active investors who want instant access to financial analysis, news, and research. Like lots of Web sites, Quote.com gives away time-delayed quotes. But the additional research and other data create a compelling bundle. "People grow to depend on the service every day," says founder Chris Cooper. "That's ultimately how you get people to pay a subscription." In March, Quote.com was taking in $73,000 a month and turning a profit. Since then, Cooper has found advertisers who want to reach his 150,000 well-heeled customers, and the additional revenues are expected to boost sales to more than $4 million for the year.
Web companies moving the other way--from an advertising-supported model to a subscription/advertising mix--face a bigger hurdle. If consumers balk at paying, the audience will shrink and any gains from new subscription revenue may be wiped out by a possible falloff in ad sales.
But the pressure to turn Web sites from moneylosers to moneymakers is forcing more companies to take the chance. This fall, there will be a number of high-profile experiments. Time Warner plans to start charging for Pathfinder Personal Edition, a collection of Pathfinder material customized for each subscriber. And on Nov. 1, Microsoft will begin charging $19.95 for a yearly subscription to Slate, the online magazine created by Michael Kinsley. "Customers will pay for good content," argues Laura Jennings, vice-president of the Microsoft Network (MSN). "I do not think advertising is the whole answer, at least not in the next five years. So I'm a big believer in subscriptions."
While former New Republic editor Kinsley finds out if cybernauts will pay for his new publication, New Republic chairman and current editor Martin Peretz will be undertaking a similar experiment. Along with James Cramer, a hedge-fund manager and financial columnist, he's launching The Street.com, an online publication for investors that promises up-to-the-minute news and features--with a "slightly irreverent" tone. It's scheduled for a late-October debut, and the founders say they hope for 500,000 subscribers within two years. Fees have not been decided.
Microsoft will take another stab at subscription services in October, too. That's when MSN reemerges as a Web service. For programming that ranges from Star Trek and Entertainment Tonight to all sorts of online special-interest sections, the software giant plans to charge $6.95 a month to subscribers who have their own Internet access. But customers who buy Internet service through MSN will pay $19.95 a month for 20 hours of use--comparable to other Internet access services and, in effect, making the content free.
VIDEO-GAME EXPERIMENTS. The most widely watched test will be The Wall Street Journal's. On Sept. 21, the newspaper's Interactive Edition, which had been offered since April for free on the Web, will switch to subscription. "At this point, the subscription model is completely unproven," says Mark Mooradian, a senior analyst at Jupiter. But, he adds: "If anyone can do it, they can."
Meanwhile, away from the glare focused on Microsoft and the established media companies, there are lots of experiments in subscription Web services. Entertainment companies, including MPath and Total Entertainment Network (TEN), plan to start charging users of online games $2 or so for each hour of play--and will offer volume discounts for heavy users. 3DO, a maker of video games, will begin charging $9.95 a month in October for access to its Medieval game world, Meridian 59. Genie Interactive and Imagination Network, which was recently bought by America Online Inc., also will launch subscription-based entertainment sites this fall.
Little by little, consumers are expected to become more accustomed to paying subscription fees--just as they have made the move from free broadcast TV to cable service. Still, the Jupiter researchers figure that by 2000, only 40% of Web surfers will pay for such services. That will keep subscriptions the least likely source of revenue on the Net--reaching only $966 million at decade's end.
For now, however, all the multibillion-dollar markets in cyberspace are only a speculative gleam in forecasters' eyes. Before they become reality, the Net has to continue to evolve. The explosive growth of electronic commerce will depend on better payment systems. And a huge market for online content won't be practical until the Internet's pipes can efficiently deliver the sound, video, and animation that will appeal to a mass audience.
None of these obstacles, though, is likely to faze the clever entrepreneurs and businesspeople who already have found ways to make money on the Web. The returns may be meager, but these pioneers aren't a bit disappointed. Just ask CDnow's Jason Olim. "At 10%-to-15% growth a month?" he asks in exasperation. "It's easy for me to be tired. But it's hard to be disappointed."