Way Down--in the Valley

Commerce One is working to escape from the ranks of the tech zombies

On a chilly, overcast autumn afternoon, Mark B. Hoffman, CEO of software maker Commerce One Inc. (CMRC ), is suffering through a quarterly conference call with stock analysts. The company has just reported a loss of $46.9 million--nearly twice the size of its $26.4 million in revenues. Sitting at a table at his suburban office in Pleasanton, Calif., he painstakingly details his recovery plan and waits for analysts to ask questions. And he waits. All he gets is awkward silence. "There may not be any," he says, finally, shrugging his shoulders.

"Let's move on," says his treasurer, John P. Biestman.

"Short and sweet," quips General Counsel Beth Frensilli.

Nothing sweet about it. Three years ago, at the height of the Net gold rush, dozens of analysts crowded into calls like this. Commerce One was one of the Net's highest fliers, with a market cap of $21.5 billion at its zenith. It was a leader in the burgeoning market for software to handle transactions between businesses over the Web. Its fast and furious pace left established rivals such as Oracle Corp. (ORCL ) and Germany's SAP (SAP ) in the dust.

Now, it's as if a hurricane had ripped through Commerce One's world. The company's market cap has shriveled to a measly $85 million. And, when fourth-quarter revenues come out on Jan. 30, they're expected to be just $19 million, down from a peak of $191 million in the boom times of 2000. CIBC World Markets forecasts the company will book $98 million in revenues this year and rack up an $85 million operating loss. Its stock trades at $3 a share, down from a split-adjusted high of $1,356, or $271 non-split-adjusted, on Mar. 9, 2000.

Commerce One is emblematic of a lost generation of tech companies created in the past decade. They're the Internet zombies--not quite dead, but with long-shot prospects of reviving. The unprecedented frenzy of cash, hype, and new technology produced nearly 6,000 tech startups. They were fueled with nearly $100 billion in venture capital. Yet only a handful--including Amazon.com, eBay, and software maker BEA Systems--have emerged as big-time successes. And nearly 4,000 remain. While tech busts before left hundreds of companies in deep trouble, this one left thousands. Never have so many been eyeball to eyeball with Darwin.

Drive south from San Francisco on Route 101 into Silicon Valley, and you enter a world Hoffman is trying desperately to escape. More than 100,000 tech jobs have been lost here. Some buildings are so empty they're called "see-throughs." In Foster City, 20 miles south of San Francisco, two towers that once housed 1,000 employees of Web-search startup Inktomi Corp. (INKT ) have barely 100 souls rattling around, awaiting completion of the company's sale to Yahoo! Inc. (YHOO )

The zombies stir up a certain resentment. Sure, they employ tens of thousands of people. And they did valuable work in their time. As they rocketed to fleeting fortunes just three years ago, they produced loads of crucial technology to power the Internet and e-commerce. That was then. Now, since many venture capital firms are still sinking money into their earlier bets, those dot-com-era outfits soak up capital and brainpower that could energize new companies--employing thousands and producing breakthrough technologies. Only 20% of the money VCs sank into info-tech startups in the third quarter of 2002 went to early rounds, compared with 38% in the more normal period of 1998, according to VentureOne Inc.

The Valley, say some, could get on with the tech recovery if most of these boom-time relics were quickly to go the way of the dodo bird. "Many of these companies should just liquidate or merge with somebody else," says Vinod Khosla, general partner at VC firm Kleiner Perkins Caufield & Byers.

A hardy few still have a shot at returning to glory. They can look for inspiration to Oracle Corp., now a $10 billion-a-year database-software giant, which nearly ran out of cash during the last tech downturn. These companies pioneered the Internet economy, and a handful of them remain leaders in key markets. Ariba Inc. (ARBA ) is still a force in e-procurement, and Juniper Networks Inc. (JNPR ) in Internet telecom equipment. The question is whether they can steer through this crisis and emerge strong again--and in the process help to shape tech's future. The answer for many should become clear in 2003, which looks like the make-or-break year for tech's zombies. With the industry still mired in its slump, they're burning through cash.

Hoffman desperately wants Commerce One to be among the survivors. "I would not count this company among the living dead," he says. The 56-year-old veteran manager is betting the company on a software program called Conductor, just now being installed by early-adopter customers. It's a software hub, the first of its kind. The idea is that instead of setting up separate links with all their suppliers, companies will be able to plug all sorts of e-commerce applications straight into Conductor. Analysts say it's smart and will help corporations as they struggle with the cost and complexity of integrating software from different sources. Says Laurie Orlov, an analyst at Forrester Research: "The question is: How soon will companies buy?"

And will they buy from a struggling near-zombie? Unlike many others in the dot-com era, Commerce One produced real products for more than 500 customers. While many of those customers remain loyal, it's difficult for the company to land new ones. It's tarred with the brush of dot-com failure--and burdened with a painful legacy of boom-era mistakes. As a result, it probably has less than a 50-50 chance of turning around. "They have the challenge of overcoming the heritage as a failed e-commerce player that's desperately trying to retool at the last minute," says John Hagel III, a San Francisco tech consultant.

Now, as Hoffman prepares to launch Conductor, the company's finances are dire. Commerce One has only $110 million in cash, and it's likely to burn $20 million in the first quarter. His plan is to cut more costs, in part by sending engineering work to India. He's hoping that a tech recovery will lift the company and fuel sales of its new product.

He knows it's a long shot. Walk into Commerce One's headquarters, 15 miles east of San Francisco, and the first thing you see in the lobby is Hoffman's 17th century tapestry depicting the Battle of Arbella in 331 B.C., when Alexander the Great led his underdog Macedonians to victory over the far larger army of Darius of Syria. The message to Hoffman's forces is clear: With hard work and a willingness to take chances, underdogs can overcome huge odds.

It will be a hard sell. Employees see the mistakes he has made, his delay in recognizing the crisis, and his failure to sell Commerce One when suitors were still around. Undermining Commerce One's prospects is a nagging doubt: Could it be that these startups, born and bred in the boom, were so warped by their upbringing--the easy money, the buggy products, the growth-at-any-cost mentality--that they're unfit to survive in normal times?

Hoffman insists this is not the case-- that he can revive Commerce One, just as he summoned it to life the first time. After all, it wasn't so long ago that it was sitting on top of the Net world.

Hoffman's breakthrough came in Detroit, in October, 1999. After running database-software maker Sybase for 18 years, he had joined a tiny electronic-catalog company in 1996, renamed it Commerce One, and redirected it to the Internet. By the fall of 1999, Net startups and giant corporations alike had fixed on the idea that electronic exchanges could be created on the Net, connecting hundreds of buyers with thousands of suppliers in a new form of nearly friction-free capitalism. General Motors Corp. was eager to link suppliers in a vast electronic marketplace.

The car company had plenty of leverage and was ready to use it: It wanted stock in its software supplier and wouldn't pay a cent for the software. Oracle, which was also vying for the business, refused to play by those rules. "I was thinking these guys were bullies," Hoffman recalls. Still, he agreed to their terms, suspecting that a GM deal would catapult Commerce One to the apex of the industry. And he was right.

Commerce One became a sensation. It signed up dozens of e-marketplaces, from aerospace to wood products. At the peak, customers even competed with one another to land it as their supplier. After landing just $33.6 million in sales in 1999, it racked up $401 million in 2000. But to keep up with growth, Commerce One skimped on quality. That has haunted Hoffman ever since.

Like many of its startup brethren, Commerce One didn't even have a testing program to make sure software really worked before it shipped to customers. Instead, a half-dozen engineers stood by at the end of each quarter, ready to fly anywhere to help install programs so Commerce One could book last-minute sales. The result was glitchy software and resentful customers.

This led to tension between engineers and the high-flying sales team. But who could argue with the sales team's Midas touch? Glenn Anderson, a senior sales account manager, recalls a ski vacation at Lake Tahoe after Christmas, 2000. During a lunch break on the mountain, he wrapped up eight deals worth $7 million--and pocketed $400,000 in commissions. "By the end of lunch, I was giggling like a little kid," he says.

Hoffman had been around enough to know that the boom would come to an end. Even as sales skyrocketed, he looked for a strong partner. The natural choice was SAP, the world leader in enterprise software. Commerce One had humiliated SAP by beating it to business-to-business e-commerce. In June, 2000, Hoffman and SAP co-CEO Hasso Plattner announced a bold partnership. SAP would invest $500 million in Commerce One, and the two companies would integrate their offerings--giving Commerce One a dose of blue-chip luster and SAP a much-needed dollop of e-business pizzazz.

These days, Mark Hoffman looks back on the market crash and kicks himself for responding to it in slow motion. A fast response could well have prevented Commerce One from falling so far. But it turns out that Hoffman's company, like many of its rivals, was not only engineered for a boom, its very psychology was molded by the giddy times. Hoffman remained optimistic in 2001, even as his industry cratered. Unlike his rival Ariba, which slashed its staff and offerings early in the year, Hoffman maintained 3,000 employees through much of 2001, building for a bright future that never arrived. "I wish I had cut sooner and harder," he says.

The paradox is that while Commerce One and many of its e-commerce brethren boasted of lightning-fast operations--living in so-called Internet time--many responded sluggishly to the crash. Most blew their best chances to be acquired by a white knight early on. Hoffman, for example, waited until August, 2001, to explore a merger with SAP's Plattner. It was too late. Commerce One's value was plummeting by the week. After the September 11 attacks, which shrouded the industry in gloom, the Germans pulled the plug.

Ever since, Hoffman has worked to rescue Commerce One, remaking it as a bare-bones startup. He has slashed staff three times and axed costs. He has even asked board members, who used to enjoy hot gourmet meals, to slap together their own sandwiches of cold cuts.

While Hoffman pared spending, debates within the company raged over the post-boom strategy. The common approach is to seek small niches--shelter from the raging storm. Many of Commerce One's veteran marketers favored whittling down to a couple of existing software products. But Hoffman insisted that he wanted to "go after an industry and create something big"--like Conductor. Executives who differed with his approach, including product marketing chief Mike Micucci, jumped ship. Finally, in April, 2002, at a staff meeting, the CEO said: "Either you believe in the strategy, or leave the company."

Still, Hoffman couldn't afford to put all of his resources behind the new strategy. To service customers, he had to keep most of his engineers adding improvements to older products. He started 2002 with only 10 engineers on Conductor, then gradually switched the other 400 over. That kept Commerce One's research and development costs high. And it means Conductor won't be ready until February--after 15 months of development.

The good news: Most customers appear to be sticking around. A dozen Commerce One clients interviewed by BusinessWeek are all keeping the company as a supplier. "Their responsiveness has very much improved," says Peter Rohrbach, general manager of procurement at Siemens. And 11 of them, including Eastman Chemical Co. (EMN ) and Siemens (SI ), are trying out test versions of Conductor. Yet even Rohrbach isn't buying yet. "The idea is good, but in the past, Internet technology promised a lot that didn't work out. We're going to see if it really works," he says.

A problem for struggling tech companies such as Commerce One is that, in these rough times, customers can command bargain-basement prices. Narry Singh, senior vice-president for marketing, says Conductor will start at about $300,000, a fraction of what it would have fetched during the boom. "It's a different world," he says. "We have to get in and prove some value."

Meanwhile, Hoffman keeps driving to pare back costs. Last September, while he was driving his Aston Martin through San Francisco, he admitted to himself that the company's spending was still way too high, even after repeated staff cuts. He dialed his CFO on the spot and ordered him to work up some business scenarios--including the worst case. Three weeks later, in October, he cut staff from 1,100 to 700.

While Hoffman struggles to reinvent his company, he must also battle burnout. After the October layoff, when 25 current and former marketing department employees gathered for a "pink slip" party at the nearby Hop Yard Alehouse & Grill, "there was a tiredness," recalls one employee. "It was like we were saying to the people who had lost their jobs: `You're the lucky ones."' Dennis H. Jones, a former president, likens his final days at Commerce One last spring to a hurricane he survived in Hawaii in 1992. His hotel was ripped out of the ground while guests huddled in the basement. "You feel totally helpless and overwhelmed," he says.

Somehow, Hoffman slogs on. "Mark is an optimist." says Alex S. Vieux, a member of Commerce One's board of directors. There's still hope among the industry's zombie companies. The question is whether they can overcome the heavy legacy that comes from being born and bred in the boom.

By Steve Hamm in San Francisco

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