July 28, 1998

Slippery When Online
by Nico Detourn (TMF Nico)

Companies are dynamic things; they change all the time. This is especially true of Internet and online companies and, indeed, the industry itself, which often seems to undergo a major shift with every passing quarter.

This industry is in constant transition. Business models evolve rapidly, often in ways not fully recognized until well after the fact. Whether through acquisitions, divestitures, reorganizations, or something as apparently simple as new services or partnerships, company prospects are altered. Yet our first impressions have a way of persisting, sometimes leading us to overlook or misread subsequent developments.

We tend to filter information through pre-existing notions, which can appear to confirm our initial impressions of a company, whether positive or negative. New information is sometimes ignored or hardly noticed, since we already "know" what we think. This is one of the pitfalls of adopting a static analysis of companies in an industry as dynamic as the Internet. A good example is provided by two of the original "search engine" companies.

It was easy enough to see last year's introduction of free e-mail by Excite (Nasdaq: XCIT) and Yahoo! (Nasdaq: YHOO) as fairly predictable additions to the services already available at their respective sites. Both had previously introduced a number of features more conventionally associated with online services such as America Online (NYSE: AOL.) The addition of e-mail as part of their ongoing "community strategies" was all but inevitable, and so was unlikely to influence an investor's basic assessment of the companies one way or another.

Less predictable and run of the mill, however, were more recent acquisitions by Excite and Yahoo!

In January 1998, Excite acquired MatchLogic, an online ad management services and direct marketing firm. Unlike free e-mail, which was an enhancement of existing consumer offerings, the MatchLogic acquisition represented a definite diversification and a broadening of Excite's operational range and business model, directly opening a new business-to-business revenue stream for the company. Last April, in a similarly diversifying move, Excite acquired Classifieds2000, an online classified advertising company, which counted among those using its services several of Excite's competitors, including Lycos (Nasdaq: LCOS), Infoseek (Nasdaq: SEEK), CNET's (Nasdaq: CNWK) Snap!, and CompuServe (now part of AOL).

Yahoo has likewise broadened its operational range with the June 1998 acquisition of Viaweb, an online commerce software developer. Through Viaweb, Yahoo will be able to provide small to mid-sized businesses the means of building and operating online stores within Yahoo-space, thus leveraging the traffic flowing through its eyeball-leading website to create an additional revenue stream which, knock on silicon, will flow to the company's much scrutinized bottom line.

Acquisitions such as these add new facets to a company's profile. They reposition and redefine a company, presumably for the better, though not necessarily. Importantly, these developments are not uncommon, and might reasonably prompt a review of the company's overall situation -- even if the final verdict remains unchanged in the end.

A divestiture can have a similar impact on a company and its business model, likewise calling for reassessment. An especially dramatic example of this is found in AOL's September 1997 decision to divest itself of ANS Communications, its network services division.

The details of this industry-shaping deal are too much to get into here, but the announcement came against a backdrop of America Online's abating "busy signal" crisis, following its late 1996 switch to flat rate pricing. That pricing plan was itself an abrupt, competition-countering move, which no doubt wreaked havoc on more than a few spreadsheets as number crunchers attempted to figure out just what AOL could be thinking.

With the stroke of a pen, America Online had once again re-created itself, throwing fundamental assumptions about its operations out the window. AOL would no longer be in the direct network-building business. In essence, it would swap ANS to WorldCom (Nasdaq: WCOM) for a multi-year sweetheart deal for network services, thus realizing the benefits of owning ANS without the associated cost and risk. Through the deal, AOL also acquired CompuServe's online service and subscriber base, which at the time was approximately 30% of AOL's total.

Of equal if not greater long-term strategic importance, this deal left AOL with its second new business model in under a year, and neatly positioned to concentrate on its core competencies of aggregating content, cutting merchandising deals, and growing its consumer online service.

Few companies are in a position to match America Online's continual self-recreation, which leaves its perpetual critics barely able to catch a breath before their target again morphs into something else entirely. The many fronts and huge scale on which AOL operates gives its management a unique field on which to play such a skillful game. Yet the game itself -- that is, the online industry -- calls for just such non-stop creativity on the part of company management. And so the best companies in this industry will, each in their own way, reveal the same "slipperiness" and non-stop evolution as does America Online.

Navigating the oncoming waters of the online industry is probably the single greatest challenge companies and managements face. But that same industry dynamism is a challenge also facing those who invest in the industry. That challenge calls for looking at company and industry developments creatively, from more than one angle, and being open to alternative, perhaps even previously rejected, analyses. It calls for adopting an occasionally "self-contrarian" perspective, rather than seeing only confirmation of our initial impressions, no matter how correct those might have been when first formed -- or how comfortable and taken for granted they've subsequently become.

It's earnings season again. How closely will you be looking at the results of the companies in which you've taken a position? Will you scan the announcements for quick confirmations? Or will you read them with a more critical eye?

Related Articles:
-- TMF Interview with Yahoo! President Tim Koogle
-- TMF Interview with Excite Co-founder Joe Kraus
-- Yahoo! Mocks the "Neigh"-Sayers, The Lunchtime News 07/09/98
-- Internet Stock Update 6/29/98