May 18, 1998

Netscape Playing Catch-Up
by Jim Surowiecki (TMF Cinder)

In their new book on the Digital Economy, Unleashing the Killer App, management consultants Larry Downes and Chunka Mui point to Netscape Communications' (Nasdaq: NSCP) introduction of its Navigator Web browser as a classic example of the way killer applications can transform entire industries and render old businesses instantly obsolete. Looking at the company today, though, one can be forgiven for wondering exactly who the victim of that killer app was. Distracted by its browser battle with Microsoft (Nasdaq: MSFT) and initially skeptical of the profit potential of Internet gateways, Netscape took a long time to recognize the power of its own brand and the reach offered by its installed Navigator base. As a result, the company finds itself playing catch-up in an economy that it helped create, and in the struggle for mindshare, catch-up is a difficult game at best.

That Netscape is in the game, though, was demonstrated by its recent announcement that it has signed a $70 million deal with Excite (Nasdaq: XCIT) to transform its Netcenter website into something resembling a portal site, with the centerpiece being a new Netscape search engine that will be powered by Excite search technology. Although Netcenter is one of the most popular sites on the Web by simple virtue of the fact that it is the default opening screen on the Navigator browser, Netscape has never really developed the site into a place that Web users would want to visit on a regular basis. The Excite deal represents an important step in Netscape's ongoing effort to cash in on its still-strong brand name and to take advantage of the fact that Navigator is still used by 60% of all Web users.

At the same time, the arrangement points up the still fluid nature of economics on the Web. Excite is paying Netscape $70 million and helping the company create a service that will make it more likely that Netcenter could evolve into a serious competitor to Excite, Infoseek (Nasdaq: SEEK), Lycos (Nasdaq: LCOS), and Yahoo! (Nasdaq: YHOO), all of which are attempting to evolve from search engines/directories into full-fledged portal sites. But Excite believes the deal is worth it because the new search engine will provide a direct link to Excite pages, and may very well direct traffic away from Excite's competitors. The company expects increases in ad revenues to pay for the deal, though there may be some wishful thinking built into that assumption. In any case, this curious alliance between competitors is emblematic of the confused nature of business on the Web, and of the overarching desire to gain more traffic at seemingly any cost. (Yahoo! has actually been singularly rigorous in resisting this desire.)

From Netscape's perspective, the deal is important from a number of angles other than simply the transformation of Netcenter. First, the $70 million is a welcome addition to the revenue stream of a company that has seen its expenses rise far out of proportion to its revenues. Second, the deal put the company back in the limelight again, stoking the ever-present takeover rumors and boosting the stock price. Finally, and most important, the Excite alliance makes clear the continued strength of the Netscape brand. What remains to be seen, though, is whether Netscape is equipped to capitalize on its most important asset.

Given the fact that Netscape actually is a technology company that has delivered a series of products of consistently high quality, terming the brand its most important asset may seem to be an exaggeration. That's especially true when you consider that although Navigator is the company's most recognizable product, it accounted for just 20% of Netscape's revenues last year, and will account for much less than that in 1998, now that the company is giving it away for free and has put the source code into the public domain. But the truth is that Netscape's business depends on its name in a fundamental way. Navigator may not be a real revenue driver, but it is, you might say, a loss leader. The browser is what got people to think about Netscape in the first place, and in some sense it's what continues to bring customers in today.

As Netscape CEO Jim Barksdale would be the first to point out, those customers are not fly-by-night operations, nor are the contracts that they've signed with Netscape small deals. Even as the company has slipped into the red, its annual revenues have risen (though in the fourth quarter of FY 1997 revenues dropped on a sequential basis). Its intranet software is used by companies like Morgan Stanley and BMW, and Netscape has done an excellent job of bringing the networking principles that made Navigator such a hit to internal corporate communications systems. In order to build on that success, though, Netscape needs to be able to convince its customers that it has a healthy future. And in order to do that, it almost certainly has to succeed on the Internet.

The great irony of Netscape's short history, after all, is that the company underestimated the potential for profits on the Net, and similarly failed to recognize early on that in an environment as chaotic as the Web, aggregating content was aggregating value. In a sense, Netscape thought it was in one market -- Web browsers -- when it needed to see that it was in another -- making the Web more accessible. That was an understandable mistake. When Navigator came out, it did seem to be the proverbial killer app, and Microsoft's cutthroat introduction of Explorer was hardly anticipatable in mid-1995. On the other hand, even then the example of America Online (NYSE: AOL) should have made it clear that owning the gateways people used to go online was more important than owning the tools. In the long run, Netcenter was more valuable than Navigator, even though Netcenter was only valuable because of Navigator.

What does all this mean for the company going forward? If Netscape does, as seems possible, concentrate more and more of its resources on the intranet/server market, then its margins will certainly drop (as they already have), and it will have to figure out how to hold off the eventual inroads of Windows NT. Certainly there are ways in which Netscape can design its corporate business in such a way that it's not a direct competitor with Microsoft, but that will be a constant struggle. In any case, the Excite venture suggests that Netscape now sees its Net presence and its corporate business as complementary, and that it grasps the degree to which branding has become important even in the high-tech world.

If Netscape wants Netcenter to become a genuine portal site, it has the proverbial long row to hoe, both because its brand is considerably weaker than Yahoo!'s and because content aggregation is not quite as easy as it looks. On the other hand, the Excite technology will give Netscape an easy route into the search market, which is still what most people go to the Web for, and it could provide the nucleus for a broader site. It also, of course, makes the site a more attractive candidate for a company like America Online to acquire. It's never a very good sign when a company gets most of its attention from takeover rumors. But Netscape is stronger than it was at the end of last year, and an independent future remains a viable alternative. Playing catch-up may not be the best game to play, but it's better than sitting on the bench.

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