Study Shows Dot-Coms Should Make Cuts in Operations, Not Marketing - Brief Article - Statistical Data Included

Information Superhighways Newsletter, March, 2001

Dot-coms seeking to become profitable should focus on cutting operating costs instead of sales and marketing costs, according to a new study released by Getzler &Company Inc., a New York-based firm specializing in turnarounds and corporate restructuring.

The study, which included 190 tech companies, compared the second and third quarter performance of 46 firms that cut marketing costs with 25 firms that cut operations costs. "While sales growth among the two groups remained approximately the same, there was a dramatic difference in profitability," said Brian Mittman, vice president at Getzler &Company. From the second to the third quarter, losses remained constant at firms that cut operations costs, but losses more than doubled at firms that cut marketing costs. "These results indicated that marketing costs remain a far greater driver of profitability for dot-coms than operations costs," said Mittman. Operations costs included general and administrative expenses, overhead, and the costs of technology, product and content development for Web sites.

The study also revealed some positive trends regarding restructuring in the dot-com sector. On the whole, more firms are restructuring. Roughly 40 percent of the tech firms in the study underwent restructuring during the third quarter, compared to only 27 percent during the second quarter. During the third quarter the industry maintained healthy revenue growth (more than 50 percent annually) while making some progress in reducing operating losses.

However, the study's results were not at all positive. "The bottom line is that virtually all dot-coms are still losing money. The ratio of their losses to sales remains high, and though losses are narrowing, it's not happening fast enough," said Mittman.

Of the 190 firms in the study, only three were profitable on a cash basis. The average firm lost $13.4 million on $22 million in sales during the second quarter, compared to the losses of $12.8 million on $25 million in sales during the third quarter. "At that rate of improvement, in the current market environment, most firms won't be around long enough to become profitable," said Mittman.

The study further identified three groups of firms according to their long-term prospects: those with little chance of becoming profitable, those that could become profitable but with severely reduced growth rates, and finally those that could become profitable and continue growing. Companies such as www.priceline.com or www.buy.com, for example, are relatively close to profitability but saw their sales decline in the third quarter.

More likely success stories, according to Mittman, are firms like financial information provider www.multex.com, on-line real estate broker www.homestore.com, and B2B community operator Vertical Net. Each firm had losses less than nine percent of revenue, reduced their loss during the third quarter, and increased their quarterly revenues by at least 20 percent.

The study also highlighted a number of firms whose financial performance was particularly poor, especially in contrast to traditional firms. "We saw certain firms which had, according to traditional metrics, absurd performance," according to Mittman. "Companies like estamp, and quepasa, whose marketing budget alone was as much as seven times their sales levels. Such firms ranked among the worst in their prospects for becoming profitable and for their proportion of expenses to sales."

The study also highlighted firms that, despite making significant increases in their sales and marketing efforts, still experienced significant declines in sales. Such companies included high-profile financial Web site www.thestreet.com, egreetings, and www.theglobe.com.