The Case For Losing Money

Sure, high-flying dot.coms are dropping a bundle--but profits are on the horizon

It's a running joke among Net entrepreneurs. Venture capitalists won't fund you unless you can prove your company will lose $50 million in the first six months--otherwise they figure you're not ambitious enough. Profits? Oh, please. Tell them your business model is so extensible that you'll scale up first and monetize later. Don't laugh, it works. But maybe not for long. Now, investors and analysts who advise them are suddenly changing their minds about e-commerce company losses. In early January, for instance, dot.coms became dog.coms almost overnight when Web superstore Inc. announced that--despite beating fourth-quarter revenue estimates handily--it would still show significant losses. Momentum investors bailed out, and perennial naysayers crowed that e-tailers would never make money.

I think they're wrong--and those investors are wimps. Sure, there are way too many startups vying to become one of the two or three surviving online drugstores or toy emporiums. And I certainly can't devise a convincing defense of current stock premiums. But at least for now, the e-commerce leaders are right to keep spending--even if that means more losses.

For one thing, e-commerce is still in its infancy, showing little sign of slowing down. Companies that move first into a market, and spend enough to build it, capture the most customers at the lowest cost and tend to keep them. Just look at auctioneer eBay Inc. Despite site crashes, it continues to dominate person-to-person auctions.

Besides, it takes time to build real businesses online. For more than a decade, people thought America Online Inc. Chief Executive Stephen M. Case was nuts. From the time AOL started in 1985 until 1996, it didn't make a dime. Now, AOL is about to own the world's largest media company, Time Warner Inc. It's understandable why investors blanch when they see Amazon, eToys, and others spend millions on warehouses and customer service centers. But the recent holidays proved them right. They ended up pleasing customers--and that's the key to e-tailers ultimately turning profitable.

The big question is how long e-commerce companies should invest in expansion before producing profits. Answer: as long as opportunities keep popping up. "We think it would be a big mistake not to invest during this critical time," says Amazon CEO Jeffrey P. Bezos. Of course he'd say that, but others, such as Greg Kyle, president of Net market watcher Pegasus Research, agree: "There's so much opportunity that they shouldn't be managing for profits yet." That's even more true in emerging areas such as business-to-business e-commerce. Despite escalating net losses, for instance, investors value materials-procurement software maker Ariba Inc. at $16 billion. That's because its sales are more than tripling and it's expanding its market reach by creating online exchanges for buyers and sellers. Fact is, valuations such as Ariba's, or even Amazon's downsized $22 billion, prove most investors' thumbs are still way up.

Now, this can't go on forever. Already, Corp. and Inc. have lost their premiums by disappointing investors one too many times. Amazon and others may be in for the same unless they can show how and when they will turn the corner.

Still, the bottom line is this: Does anyone really think that only traditional companies will ever make money online? Some upstarts will prevail. They will be the very few who ignore the whiners, spend the bucks when it matters the most, and stay the course. Whom would you rather be: Steve Case or...uh, who's that guy who runs Prodigy Communications?