|traditional companies versus .com startups:
battle for internet consumers
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strategy one: transformation
Let's have a look at
what the traditional companies are doing. What are some of the successful models that
traditional companies have pursued to get into this space and compete against .coms?
The first one is a model that we call wholesale
transformation. This is when the traditional company says "Aha! I have to turn
into an Internet company because all or most of my business is going to be done on the
Internet in the future." They go through a transformative process and emerge as an
Internet company at the end of the day. [slide 18]
I'm going to argue that this is the process that Charles
Schwab has gone through to transform itself from a traditional discount broker into an
Internet company. If you look at the market, E*Trade, particularly, was early, but Schwab
is the biggest now. The reason is that when a traditional company is able to anticipate
the market in that way and pull off a wholesale transformation, they often are able to
eclipse new startup competitors in their sector. It's a very radical move for a
traditional company to make, and it requires enormous courage and leadership on the part
of the management, but it's a very successful strategy overall, one which really needs to
be done from strength.
The company I want to look at is Intuit and its TurboTax tax preparation product. Many
of you probably use TurboTax to create your tax return. Intuit had a tremendous market
share, over 75% in the tax preparation market. They aren't required to be on the Internet
since nobody was competing with them, but they see two things. First, it's expensive to
stamp out disks, print manuals and shrink wrap boxes. They can slash costs out of their
production if they can get people to do their work on the Internet instead. Second, they
see that the Internal Revenue Service
would like to have a huge portion of individual income tax returns filed electronically. I
think they have a stated long-term goal of 70% in 2007. If Intuit can put themselves as
the central processor and batch deliverer of individual income tax returns, making the IRS
dependent on that, how fantastic a business is that? So, they see these two things going
on and realize that they have to take a transformative approach to TurboTax.
When they began, the first thing that happened was that
they had to change technology. This happens to all traditional companies that go through a
transformation. In the case of Intuit, they had to move from a Windows platform to a UNIX
platform in order to handle millions of concurrent tax filers. They also had to develop a
new business model. TurboTax at retail sells for $35. On the Web it sells for $19.98. They
have done a big song and dance that each one of those shrink-wrapped TurboTaxes is used to
do two tax returns in order show their retailers that it isn't really a 50% price cut, but
this has been a fairly difficult thing for them to manage and people have been none too
happy, especially since those retailers often use TurboTax to draw people into the store
and sell other stuff. It drives foot traffic.
They also had to become a service provider. Let's open a
window into Intuit creating TurboTax in the past. They would have all these changes to the
tax code happening across the nation in all 50 states plus the federal tax codes. They
would run like mad to try to get all these changes into the TurboTax application and get
the thing stamped out on to the gold master disk by the end of December. They would run
like crazy, stamp that thing out and then the whole company would go collectively on
vacation. They would just relax because now the product is in the channel and it's not
their problem until next year. Intuit was incredibly good at it. They always hit their
deadline within five days which, if any of you have been in the software industry, you
know that's an incredible efficiency accomplishment. All of a sudden, however, Intuit
faces a situation where the work doesn't end in December, it begins. People file their
taxes all the way up through April, so they had to have a huge cultural change within the
company to adapt.
Finally, they have had to partner with other
companies. When it was a stand-alone application, TurboTax didn't connect to anything. As
soon as it was a network application, consumers naturally expected it to show bank
information, mutual fund information and so forth. They've had to commit to other things.
It's a brave move on their part in a market where they didn't strictly have to do it.
Here are some of their results. [slide 20] In the tax preparation market, you can see they
have 7 million returns filed. The 1999 date is actually their expectation for what they
are going to do for this tax year, so those numbers won't be final until the end of April,
but you see the kind of growth they are expecting. They already did very well in their
first year, 1998. In electronic filing, they are expecting an even more dramatic shift,
and part of that is due to the fact they are going to do a free 1040 EZ form. They decided
instead of trying to capture that as a revenue market, they would create the volume that
makes the IRS dependent upon them.
That's a successful strategy for traditional companies,
wholesale transformation. I think you see it at Schwab, and you see it going on right now
strategy two: risk balancing
Another strategy is
one that we call risk balancing. This is saying, "Okay, we're a big complex
organization and we can't possibly transform our whole company into an Internet business.
What we are going to do is take a unit and combine it with venture capital, and maybe an
Internet startup, and make a new business." Possibly some of you in this room are in
risk balancing ventures of traditional companies. It is becoming increasingly popular. If
you look at the venture capital market right now, this is the number one kind of deal they
are looking for, the spin-off from a traditional company.
These companies go through a similar kind of process to
become an Internet company, [slide 22] but rather than
anticipating changing the market they are looking simply to participate in it. It is a
fundamentally conservative strategy because it preserves the strength in their traditional
business and it's done from strength. It's not something they are doing because they are
Again I want to take a look at a traditional company that's
done something like thisDisney
and its path to the Go Network. Go
Network is one of the top five media properties on the Internet. It's the only top five
media property that's owned by a traditional company, so let's have a look at how it got
All the way back in 1996, Disney bought ABC [slide
23] and with it acquired the ESPN brand which had this funky little licensing
relationship with Starwave up in Seattle for ESPN
Sports Zone. Before Disney bought it, ESPN had thought so little about the Internet
that they just made this little licensing deal and said, "Sure, you use ESPN for the
Internet. That will be no problem." It was a great deal for Starwave, but then Disney
came in and realized that this is no joke. Disney is a company that really controls its
brands. They went in and strong-armed Starwave. They said, "Here are your choices,
boys. You are going to sell us half of this company with the right to take over the rest
of it, or we're going to pull the ESPN brand from Starwave." Starwave kind of wiggled
around. I know they went out and tried to get brands like Sports Illustrated and others, but they ended up selling just under
half the company to Disney with the right for Disney to take over Starwave if it ever
deemed that the ESPN brand was being badly used.
Now Disney looks around and says, "Okay, family.com, that's a pretty good family
property. We've got ESPN with sports, and that's a fairly good property. We've got
ABCnews.com; that's an okay property. But we don't have a Yahoo! here. We're not playing
in the big leagues." If you're Disney, you want to play in the big leagues; that's
just how it is.
So, now they realize that they need a search engine. They
combined Infoseek with Starwave, and here's how they did it. They bought all of Starwave
and gave it to Infoseek. Then they took a little under half ownership position in
Infoseek, again with the right to buy control. They created the Go Network and began to
market it through Disney properties. You see it marketed on television and in the theme
parks. Disney is just now in the process of taking control of Go. By the end of this year
it is going to be the only major media company to own a top five Internet property.
This strategy is interesting when you look at it
from Disney's point of view as a traditional company. What does it mean for them? The
first thing is that they avoided the startup coststens of millions of dollars in
losses in Starwave and again in Infoseek. They get to bring the company into the fold
after it's no longer generating those crippling losses. That is the source of the funding
advantage .coms have over traditional companies. The traditional companies can't incur
those kinds of losses. Disney has avoided that here, and they control the brands at every
point. That's been a very important part of their strategy as a traditional company. They
also have been able to support the Internet businesses fully. If you look at Disney
television, you see Go Network promoted on a regular basis. You can't buy that from
Disney. If you are not part of the Disney empire, you can't buy that kind of marketing.
You can't get marketing in the theme parks unless you are owned by Disney, so they have
been able to support their businesses without recognizing the losses in the near term.
the implications for netpreneurs
We have looked at the
consumers, the battle and how traditional companies are responding. Now, I'd like to look
at some of the implications for startup companies or .coms. What does this mean as you
begin to build a business and try to compete against these increasingly aware,
increasingly aggressive traditional companies?
The first challenge is offsetting IPO-mania. On the one
hand, it's a tremendous advantage to have the possibility of saying to people, "Look,
we are a startup company. We are looking to go public two years from now. You can join us,
and this is going to be great." You have to realize, however, that this IPO-mania has
created a kind of cancer and it mostly affects .coms. In the long run, it is a bad thing
for the startup company. It is very difficult, after you have gone public, to find that
your employee base has split between people who have won and made a lot of money, at least
on paperoh, by the way, they are still investing and it's tough to do all that work,
but they think they are richand the people who haven't. That's a very difficult
management divide for most startup companies.
There is also a tremendously difficult management challenge
when employees who have options see the company go public, particularly when the stock
runs up. Let's face it, it's really unsupportable. It's impossible to make an argument for
some of these Internet valuations, yet your employees watch that stock run up and they
calculate it. You can go out at $16, run up to $60, then fall back to $31. That's a pretty
darn good job at $31, but the employee feels like they are off from the $60. That stays
with people throughout the first two or three years after going public. It's an extremely
difficult period for the .coms. I actually know a guy who is president at a .com, and he
ended up leaving after going public because his investment bankers wouldn't allow him to
trade. He decided it was better to resign, and said to me, "I did the math. I figure
I have to be here six years to make this company worth what it's worth today. It's better
for me to just cash out and do something else with it." It's a very difficult
Creating multi-channel brands is an important thing for
.coms. You have seen this with some companies creating magazines. There needs to be a
physical presence for the .com on the newsstand, in the physical world and also on
television or radio. There needs to be a multi-channel sense of .com brands, particularly
in order to appeal to mainstream consumers.
Developing a physical presence is one of the big questions
that this world needs to be asking itself. It's extremely expensive to develop a physical
presence, but I don't think that we are going to be able to depend forever that
traditional companies won't figure out how to build Web sites. It's easier to build a Web
site than it is to build a chain of retail stores. Developing physical distribution
ability and also physical presence in the business is going to become one of the most
burning questions for .coms.
Finally, there is an enormous pressure to scale up fast. I
want to have a quick look at some of these economics. If you look at the startup company
getting going, what happens? You have this upward spiral and a lot of you are probably in
the spiral right now. [slide 27] The first thing you do
is go out and market. You try to get a world brand. You spend a lot of money on that, so
you have to upgrade your technology and infrastructure because now you have created some
traffic. You always upgrade your technology and infrastructure beyond what you need for
today's purposes, so now you are in a situation where you need to re-leverage that
technology infrastructure. You spend some more on marketing and therefore you have to
upgrade your technology again, and so it goes. There is a tremendous upward cost spiral
that exists, and you find that these marketing and technology costs exist almost as fixed
costs for startups. In a traditional company, you might see less than 5% spent on
technology. In a startup company, it's not at all uncommon to see 15%-20% of revenues
spent on technology; in many cases even more than that. In a traditional company, even the
biggest ones, Coca Cola is spending
20%-23% on marketing. In a startup company, it's not at all uncommon to see 35%, 40%, 50%
of revenues spent on marketing.
What does that mean? Startup companies that end up
forward-loading their costs, spending a lot up front in marketing and technology, end up
being able to build revenue momentum. You can see that in this model. [slide 28] There are two places to be profitable, one is
at sub-scale, and the other is at super-scale. The thing that nobody knows the answer to
is, how big is this scale?
Online (AOL) followed this model, and so did Yahoo!. Amazon, right now, is providing
us all an industry-wide test case on how far out the curve is. I don't think any of us
really knows the answer. I'm sure that Amazon doesn't, and I think they are taking a big
bet. I really do. They are taking a bet about whether they are going to win big or they're
going to lose big. They are basically betting that this curve is way further out, that
they can have way bigger losses and way more up front expenditures than anybody realizes.
Certainly that was AOL's market back in the time when they were checking out a lot of
losses. It came out for AOL, but it's not clear, yet, how big the scale really is.
What happens a lot in more cautious companies, and I think
this is the fault of traditional companies more than startups, is an insufficient early
investment in technology and marketing. That fails to create the kind of growth that's
required to ever get above the cost curve. That's one of the chief challenges for the
startup company, being able to get enough momentum going by spending enough in the early
What does this mean for industry structure? I would suggest
that in most Internet sectors you are going to see an industry structure that looks like
this. [slide 29] There are going to be a few very
dominant big players and they are going to be a whole lot of entrants. The price of
entering into Internet businesses is very low, and probably will continue to be fairly
low. I think of this as being a little bit like the software business. If you look at the
software industry, there are a few huge, super-dominant, powerful players, but there is
also an enormously busy, churning entrepreneurial group below them. The critical element
here is the transition point. Every couple of years, a big, dominant player loses control
of the brand and the technology because these are not fixed assets like railroad tracks or
telecommunications infrastructure. It's all intangible, so in these kind of industries the
major players fail on a fairly regular basis. Inside of two or three years you can see
somebody zoom from the entrance space up into the successful space, and you can see
somebody fall away as well. It's important for a startup company to get through that
transition point, and that's what leads to scale.
Startup .coms have taken the early lead on the Internet,
but traditional companies can still win. You definitely see this in the financial services
market, and certainly in the travel space. I would say that the airlines have been the
absolute biggest winners in the travel space. You definitely have to take into account
that the traditional companies will be among the top two or three players. In almost every
category, you will see at least one traditional company. Startups need to build
management, brand and presence to win, particularly with the consumer.
what do analysts want?
Before I wrap up, Mary asked me to speak briefly
about how to approach industry analysts.
There are a lot of startup groups being formed every day,
and the job of the analyst is to sort out which of them have a unique offering in the
marketplace and which of them are just me-too companies. Literally, as an industry analyst
right now, it's not at all uncommon to get invitations on the order of 10-12 a day from
companies that want to tell you about what they are doing. Since it's not humanly possible
to meet with every one of them personally, there has been a real push to understand,
up-front and fairly quickly, what they do that's different. What makes them not just
another kind of me-too company? That's particularly true in the E-commerce space, and
that's challenging because there are many ways in which to do it.
One of the things that analysts are definitely looking for
is a new kind of sales model. They are very much responding to a new idea in terms of how
the sales process is done. Something which gives insight into how consumers behave is
usually a very compelling and an interesting hook.
What's not so interesting is, "Oh, we are a .com
selling bags, clothing, whatever it is that ends up being sold." At this point, it's
a mistake to think that being a .com makes you inherently interesting. Now the onus is
being able to establish something unique beyond that.
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