You've Got to Spend Money to Make
Money
by Daniel Gross
Thursday, June 10, 1999
Comments: 16 posts
Internet Gorillas : Louis
Corrigan analyzes the
success of high-tech
companies like
Amazon.com.
The Portal Game : Dana
Blankenhorn examines
the risk behind the
strategies of Yahoo!,
Excite and Lycos.
Innovation Drives
E-commerce : As the
pace of change
accelerates, Diana Mayer
identifies the keys to
innovation.
Cyberboom: Making It
Last : Riel Miller
contemplates the Internet
stock bubble and how to
keep it from bursting.
With Friends Like These
… : Daniel Gross
analyzes divorce,
corporate style.
Search
Internet enthusiasts routinely proclaim that the explosion of the medium
betokens the advent of a new era and a new economy -- one in which sky-high
stock valuations are supported by rosy prospects, inflation is nonexistent, and
profits do not seem to matter.
Few of the dozens of Internet companies that have gone public in the last
several years have turned a profit. And few investors seem to care.
Amazon.com has racked up an $18 billion market capitalization despite a string
of losses that would make the hapless Los Angeles Clippers proud.
Cyber-entrepreneurs dismiss concerns about profits as fuddy-duddy, old-time
thinking. Indeed, analysts, investors and venture capitalists have embraced
losses and elevated them to a virtue. Companies operating in cyberspace do
not have to invest in bricks and mortar, or inventory, or vast work forces, or
raw materials, the reasoning goes. Instead, they should spend their dollars on
marketing: advertising, direct mail, sports sponsorships, etc.
The goal is to build market share, capture surfing eyeballs, and establish a firm
presence in the hearts and minds of consumers. Then, and only then, the
argument goes, can Internet firms generate enough business to gain scale,
attract advertisers and strategic partners, and, one far-off day in the 21st
century, turn a profit.
As Amazon.com Chief Executive Officer Jeff Bezos put it on CNBC on June 8:
"We believe it would be a terrible management mistake to be profitable now
during this critical category formation time."
Less bang for the buck
So far, Amazon.com has avoided this terrible mistake. Last year, it lost $125
million on revenue of $610 million. It also spent prodigiously on promotions.
Sales and marketing costs for 1998 were $133 million -- i.e. nearly the sum
total of its loss.
A check at a few other Internet high-fliers shows they are assiduously following
Amazon.com's example of avoiding profits and spending heavily on marketing.
Online financial magazine theStreet.com (1998 loss: $16 million), last year
spent twice its revenues on sales and marketing. iVillage, the women's content
site, spent $10.88 million last quarter on sales and marketing; its total
revenues were $6.4 million. In the fiscal year that ended last March, retailer
eToys had net sales of $30 million, of which it spent $20 million on marketing
and sales.
But that is just the beginning. "We anticipate our losses
will increase significantly from current levels because we
expect to incur additional costs and expenses related to
brand development, marketing and other promotional
activities," eToys' recent prospectus noted.
Investors seemingly have internalized the logic of
spending heavily on marketing to build name recognition
and attract customers. But there are ways of measuring
the effectiveness of marketing efforts. And a few years
into the boom, it is clear that not all Internet companies have been successful.
In its May 31 issue, Business Week gauged the marketing efficiency of 15
leading Internet firms by dividing their revenues by marketing expenses. It
found some winners. America Online reeled in $6.95 for every $1 it spent on
marketing, for example. But other Internet companies consumed marketing
fuel more like a Humvee than a Honda. TheGlobe.com brought in just 59 cents
for every dollar spent on marketing, iVillage raked in 53 cents, and
theStreet.com pulled in just 46 cents for every marketing dollar spent.
Worse, taken as a whole, the 15 companies surveyed proved less efficient in
1998 than in 1997; the average amount returned in sales per marketing dollar
fell 20%, from $3.37 to $2.70. In other words, in a year when e-commerce
caught on like wildfire, these 15 leading Internet firms got less bang for the
buck.
The old rules still apply
To a degree, such a result is not surprising. Each week, dozens of new
souped-up Web sites compete for the ultimately finite number of dollars
consumers and businesses spend in cyberspace each year. And therein lies
the rub. Marketing is not an activity companies undertake only when they are
in their start-up phase. Rather, it is as important for mature butterflies as it is
for larvae.
Advertising Age's list of the 100 top U.S. advertising spenders is
chock-a-block with household names whose products have long since entered
the commercial lingua franca. General Motors, the biggest spender, spent
$3.08 billion in advertising last year in the U.S. alone. Others spending more
than $1 billion on domestic advertising include such venerable brands as
Disney (No. 7); Sears (No. 6) and Pepsi (No. 8). Those figures do not even
include other sales, marketing and promotional expenses.
With each passing year, market leaders like GM, AT&T and IBM face pressure
to spend ever-greater sums on marketing. The only thing worse than not
having market share is losing market share. Analysts tally the quarterly case
shipments of Pepsi and Coke the way Rotisserie league managers obsessively
scan baseball box scores and are quick to highlight any slippage.
The difference between the old and the new companies is that dinosaurs like
Sears and Ford bring in enough revenue from operations to fuel their
marketing programs, to cover employee salaries and other costs -- and still
pay dividends to shareholders. Amazon.com, according to Business Week,
last year brought in $4.59 for every marketing dollar. But those impressive
revenues did not come close to meeting the company's costs. And its sales
and marketing expenses are unlikely to decline over time.
Once Amazon.com establishes itself as the dominant bookseller, CD store,
drugstore, auctioneer and toy seller in the Internet, will it suddenly stop
spending money on marketing and advertising? Now that would be a "terrible
management mistake."
Marketing is an essential vital function of any business, as crucial to a
commercial enterprise as breathing is to a human organism. To write such
spending off as an anomaly or a function of youth, as Internet companies do, is
disingenuous and self-deceiving. It is like a bankrupt person standing before a
group of his creditors and arguing that if he did not have to pay that $40,000 in
rent each year, he would subsist just fine on a $30,000 annual salary.
Daniel Gross is a freelance writer based in New York and the author of Forbes' Greatest Business
Stories (Wiley, 1996). He is a regular commentator for IntellectualCapital.com. He can be reached at
DGross6453@aol.com.
Related Links
It may be the end of the era when Internet stocks bring the promise of wild profits. The expense of
marketing for Internet companies may mean that many of them fail. Find out how one goes about
publicizing a new Web site. One online publication bills itself as “The Voice of E-Business and Internet
Technology.” Read the Internet Advertising Report. Learn more about a century of advertising.
Are e-commerce sites underestimating their future marketing and advertising
budgets? Does this exaggerate their worth? Is this bad news for potential
investors?
Below are the last ten comments in chronological order.
Click here to view the full comment history.
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6/11/99 1:02:41 PM Hal
One more thing: I applaud Mr Kling on his post. It represents the kind of thinking which needs to be done
in looking at this new business environment. He has analysed the situation in terms of the internet
environment itself and noted the differences in relative situations which depend upon the nature of the
use being made by the consumer. This kind of thinking is what is conspicuously absent from most
discussions of e-commerce.
6/13/99 9:45:18 AM KV
Most internet marketing companies without the product/service resources look like banana republics
with casinos and licence to print fake money (stock certificates). This is really a retail business on
borrowed money, except that money comes from gamblers, not banks, the traditional source. When the
gamblers have enough loss the tables would be empty.
6/13/99 7:16:17 PM Bernard D. Tremblay (Ben) ab006@chebucto.ns.ca
Business-to-business sales are huge, and those numbers are rarely if ever factored in. No, these
aren't retail, but they're real dollars swishing between real hands for real goods.
6/14/99 8:09:05 AM KV
Regarding Business-to-Business sales: It is really a different way to do the existing business with
normal growth expectations. That is, it is a shift in business conduct mechanism, not creation of new
products or services. Most businesses have special purchasing relationships with its key suppliers, it
now gets ecommerce-ed. EC does save money for the suppliers, and the savings will be passed on to
the purchasers, or the competitors will use the efficiency advantage in grabbing accounts. Mostly, it is
churning at lightspeed with potential for revenue reduction. Only comapnies that stand to gain are the
HW and SW makers, and connection providers...
6/14/99 5:24:02 PM Hungry Hunter
I think Cringley suggested it as a joke, but I'm ready to run the company. Sell 100 dollar bills for $95.
Anybody want in on the 'ground floor'. (I can guarantee great gross revenue growth, but I may be the
only customer). Seriously, when e-commerce takes over (it will), margins will be thin and markets
brutal. The only winners in a friction-less economy are consumers, the lossers (deservidly) high margin
retailors, commission sales people and the tax man.
6/14/99 10:02:02 PM victor chand preethi@netvigator.com
Guess what...the "Sell 100 USD bills for 95 dollars" model actually does work ! It is used by everyone
from old line media companies to free magazines, all of whom rely on paid advertising for their
revenues...So the joke is actually on the venerable "Economist" magazine, which was one of the fora
where the "One dollar for 95 cents" phenomenon was first pointed out...This is surely a case of the pot
calling the kettle black...the Economist would be unprofitable were it to rely on subscriptions alone...oh,
and by the way, unlike the Economist (or CBS, or the NY times, or just about any of the fuddy-duddies
who scream "The Internet is a Bubble"), Yahoo! has customized content for every single person who
accesses its page...Its as if you tune into CBS at 9:30 at night, and get your own personalized
program...Multiply this by 50 million and you get the picture (or maybe not...the internet is actually
underhyped, even by the optimists)...Actually, a dollar for 95 cents is a great deal...The internet will, in
the fullness of time, be profitable even if you offer a dollar for sixty cents...
6/15/99 12:05:13 AM KV
The concept of $100 for $95 is intellectually corrupt. We have needlessly believed that newspapers
and magazines loss money if they did not have the advertisement revenues. The reality is that they are
charging $2~$5 for may be 25 cents worth of paper and ink and another 5 cents for distribution cost,
while collecting the ad revenues. Actually, it is the ad revenue stream that attracts them to go into the
business. Most trade publications can be had for free, with more realistic and mostly truthful ads about
the products of some interest. This is the price of getting a targeted choiced group. Most professional
magazines come as part of joining an interest group, with minimal ads. By the way, trade magazine
publishers do make money. E-commerce is a cost effective and efficient business solution, and no
more. If Yahoo! did not provide custom pages, they would not get a choice group to advertise...Internet
hype of $100 for $95 is caused by a bubble that is only supported by the stock certificates of
questionable value and longevity, like the tulips.
6/15/99 5:07:02 AM victor chand preethi@netvigator.com
KV, while it is possible that your conclusions regarding the internet being a bubble may be true of
indvidual stocks, the broad thrust of your arguments is wrong. Among the factors you ignore are 1)
Scalability: Once an internet brand name (Yahoo, Amazon) becomes firmly entrenched in the public
psyche, the cost to them of going from 10 million customers to 50 million is zero..thus more dollars drop
to the bottom line. The argument that barriers to entry are nonexistent is incorrect. In fact, the fact that
there are no barriers is itself the greatest barrier.b) E-commerce does not result in new products or
services. This is wrong becuase the marginal buyer of the marginal product (like a Siberian buyer of an
obscure tome on Quantum Mechanics) is now brought into the commercial mainstream, when in the
past he would have been out of the loop because of the prohibitive costs of reaching him. Thus, reach
is expanded resulting in new business and profit opportunities on a vast global scale.c) I do not wish to
belabor the USD 1.00 for 95 cents point. There may be individual publications that are profitable even
without advertising, but that is not the point. The point is that this model has been used successfully in
the non-or-pre-internet era across a variety of enterprises, and it is hypocritical to start hyperventilating
on this subject when applied to the internet. (The NY Times on the web is free. This is a tacit
endorsement of the USD 1.00 for 95 cents model)
6/15/99 10:41:22 AM Allen Phelps
KV: "The reality is that they are charging $2~$5 for may be 25 cents worth of paper and ink and
another 5 cents for distribution cost, while collecting the ad revenues." While some publications may
sell for more than they cost to determine the reality of that assessment you need to add in the cost of
paying the writers, office rent, supplies, computers, printing equipment, etc.
6/15/99 1:06:41 PM Hungry Hunter
Yahoo and the like can only survive so long as advertisers support the bottom line. With the net
reducing economic friction, profit margins will drop and 'standard' products will all become commoditees
(the pricewatch.com effect). Net users on average have good disposable incomes, but if they cherry
pick every vendors loss leaders where is the profit? What is the value of reaching such net savy
customers? How many industrys could survive on the margins available for clone hardware today?
Anybody out there actually use Yahoo? (if you just got on the net you don't count, your a babe in the
woods) There is no brand loyalty in cyberspace. Admittedly the average IQ on the net has been
dropping quick (the AOL/WebTV affect) but I don't see many fools with money paying full retail++.
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