Friday, May 28, 1999
The following article originally ran as a Fool on the Hill investment opinion
in the Evening News report on February 10, 1998.
$1 for 90 Cents. Sounds Great!
by Louis Corrigan (TMFSeymour@aol.com)
Online business models have been under attack for a while. Every card-carrying curmudgeon has felt compelled to mock the major e-commerce players for sporting apparently lofty stock market valuations while still bleeding losses. Sure, they say, the revenue growth is impressive; Amazon (Nasdaq: AMZN) will soon be booking a billion bucks a year in sales. Yet, it's easy to grow revenue if you're selling stuff below cost. Then comes the yack-yack dismissive line, "Oh, but I guess they plan to make it up on volume," as if this old saw is such a hands-down truism that it sums up all the thinking one needs to do on the subject. I'm not exaggerating, either. As the "venerable" British weekly The Economist put it recently, "Amazon could yet become a $10 billion business with the profits of a corner shop."
Maybe so. But while the Web is still in a state of flux regarding which business models will ultimately work best, it is worth highlighting the fact that even supposedly freakish models aren't as ugly or bizarre as commentators seem to think. In fact, they're downright old-fashion if you get beyond the Web-worthy bells and whistles. Let's consider The Economist's ultimate putdown of the future of e-commerce: "Is it too implausible to imagine Dollar.com -- a company that sells dollar bills for 90 cents and makes money from advertising?"
Actually, no. Neither is that a necessarily stupid idea. In fact, that pretty much describes The Economist's own business model. Another way of saying you want to sell dollar bills at a discount, of course, is to say that you want to offer an attractive product to customers for less than it costs you to produce. And that's what most content providers do today. Subscriptions for magazines and newspapers typically cover just a fraction of the cost of paying writers, editors, and other personnel; maintaining office facilities; buying paper and ink; and distributing the product. Advertising pays for the vast majority of these expenses. No ads, no profits, no business. Period.
Indeed, many local newsweeklies made the rational business decision long ago that they can make more money giving their product away. That's because ad rates are based on circulation ("eyeballs" in Webspeak), and a free product usually attracts a larger circulation. The same is generally true of the television networks. Think about it. Everyday, your television carries hours upon hours of entertainment and news content -- for free. Sure, there's cable, which many of us can't live without. But over a quarter of American viewers watch good old free TV. These viewers have made an implicit deal with the networks and their local affiliates: Give us something worth watching, and we'll more or less let you assault us with advertising for 14 minutes every hour. Radio works with the same business model.
The Fool offers some for-pay items, like our excellent annual Industry Focus, which highlights 20 leading industries and 20 top investment ideas. But we've generally embraced this old-fashioned advertising-supported business model. And if you're reading this, so have you. In fact, you just sat through my ad for the Industry Focus. Now, back to the exciting conclusion to today's Fool on the Hill...
All of this would seem pretty elementary except that the Web has a way of confounding our perceptions even as it ought to be sharpening them. Trading the proverbial $1 for a customer's 90 cents -- or, maybe nothing but some required ad viewing -- may prove just as powerful with the Web as it has with other entertainment technologies.
Consider the offer made by Free PC, a California startup led by the venture capital firm Idealab. As the name suggests, Free PC will give away personal computers, beginning with 10,000 Compaq (NYSE: CPQ) Presarios with a 333MHz processor, 32MB of RAM, a 33.6kpm modem, Windows 98, CD-ROM and floppy drives, a 15-inch monitor, and a 4-gigabyte hard drive. Idealab's ultimate goal, assuming all goes as planned, is to give away millions of PCs. Interested? Go to www.free-pc.com and register by answering a list of questions. If you meet certain demographically attractive requirements, then you'll qualify. The main catch is that you must agree to be bombarded with ads (apparently for at least two years) every time you've got your PC on, whether you're online or not. About 2 gigabytes of the PC's hard drive will be reserved for storing ads (which will be updated each time you go online) and certain data gathered by Idealab.
The company's business model is based on the notion that your eyeballs are worth more than the $600 price of the PC. It's actually just a savvy twist on the patented concept launched long ago by Idealab's business partner Cybergold. This California company works up deals in which advertisers pay consumers for reading their ads. More recently, Cybergold has attained a business-method patent for the concept of a product that would store a consumer's demographic info (income, hobbies, and so on) and allow consumers to be compensated for giving this data to advertisers. This, too, sounds novel, but it's really little different than getting paid to answer a marketing survey.
Still, these developments suggest the obvious: Soap operas are designed to sell soap. If you can get customers to either sit through your ads or divulge information about themselves, then giving away financial commentary, entertainment programming, or even cash may make plenty of sense. The real value in this nexus may be your customer's time and personalized data. The Free PC initiative, however, reveals precisely how far e-commerce may go along these lines. It may end up being smart to give away merchandise (books, PCs, you name it) at or even below cost if you can make up the difference and salvage some profits on the ad front.
In light of Free PC, then, the move by online auction firm Onsale (Nasdaq: ONSL) that left The Economist in a tizzy may actually prove relatively conservative. In mid-January, Onsale (www.onsale.com) launched atCost, an e-commerce site that allows consumers and small businesses to buy any of some 35,000 PC-related items at wholesale prices. Customers also pay a fixed premium of $10 or less per item plus the costs of shipping, handling, and credit-card processing. As the company's press release reads, "This shift is reminiscent of the changes online brokerage firms brought to the securities industry with low- and fixed-price charges per transaction."
Of course, Onsale will supplement this modest markup with high-margin ad revenues. As company CEO Jerry Kaplan has said, the goal is to generate gross margins from atCost in the 7% to 9% range. While that's below Onsale's overall gross margin target of 9.7%, it could really help the bottom line since "the company expects only an incremental increase in related operating expenses" from this initiative since Onsale's already got the basic infrastructure in place. Assuming an efficient enough distribution operation, of course, it's not hard to imagine a world where e-commerce in general operates on even more of a magazine or newspaper model. Consumers may be asked to cover just a tad of an e-tailer's expenses, with profits coming all from advertising. In that world, volume -- or better said, eyeballs -- will mean everything.
Louis Corrigan wrote two additional articles in this series:
Onsale and the Future of E-Commerce
Amazon and the Future of E-Commerce