Valuation of the E-Commerce and Internet Services Industry

Weekly Corporate Growth Report, Oct 25, 2004 by Dolbeck, Andrew

The e-commerce and Internet services industry includes companies that sell goods or services online, including information products and information retrieval services. The industry also covers networking and other support services for companies that operate primarily on the Internet.

Industry Overview

Consumer online spending has become part of our society. eBay is posting record profits and Amazon.com is profitable for the first time in its eight-year history. But e-commerce growth rates in the United States are starting to slow. Major e-commerce sellers such as eBay currently expect to make greater profits outside the US this year.

Spending on information technologies rose in 2003 and early 2004 but declined in the second quarter of this year. As a result, many companies in the support services segment of the e-commerce industry have fallen short of their earning projections. A possible reason for the shortfall is that corporate buyers of Internet services have become more cautious, extending the time required for dealing with them. If this is the case, contract signings already in the works may be extended into the following quarters, causing an increase in sales for the second half of the year.

The fourth quarter is typically a strong one for the industry. Consumers increase spending for the winter holidays and corporations attempt to resolve service issues before the end of the fiscal year.

The selling of goods and services to individual consumers online, once a limited industry, has grown considerably since its formation. Internet savvy consumers are now purchasing big-ticket items online as well as smaller products. The online buyer's market for cars, for example, is a rapidly growing industry segment. About 20 percent of eBay clients now shop for autos and auto parts. eBay sold its millionth car in 2004. Other websites have developed to support online vehicle shoppers. Kelleybluebook.com provides data on prices for used cars by year, make and model, while sites like capitaloneautofinance.com and householdautofinance.com provide data on auto loans.

While sites that specialize in online sales dominate the e-commerce segment, traditional retailers are also entering the market. Stores that operate primarily as brick-and-mortar retailers are finding that they can profit from going online. Woodland Scenics, a provider of landscape products for the model railroad hobby, makes 95 percent of its sales through traditional channels. The five percent that it sells online is significant, however, because the company's profit margin for web sales is four times greater. The higher profit margin is due to the automation of order processing. Customer orders and records are created automatically, eliminating labor cost from that portion of the order fulfillment process.

Online sales are far from standard for most brick-and-mortar operations, however. Achieving the efficiency that makes online sales profitable is more complex than simply hosting a website. In response to the challenge of making online sales profitable, many Internet service industry companies are developing applications to help retailers automate their online retail systems. Online vendor NetSuite is providing Web-based applications for the development on online commerce, Syspro developed the e.Net architecture to create Web stores, and Best Software, the creator of the Peachtree line of accounting software, has also developed web store applications.

Playing the Online Middleman

Many e-commerce firms fill the traditional retail role, providing goods and services in exchange for cash. But the Internet has proven ideal for a different business model, that of the go-between who connects buyers to sellers for a small commission.

EBay, the famous online auction house, is the fastest growing company in history, beating the growth records of any other company during the first eight years of its existence. eBay's high profit margins can be attributed to the fact that the company has no factories or inventory and only a minimal staff - the company's customers provide the inventory and do much of the work of selling it. All eBay has to do (and the difficulty of this should not be underestimated,) is provide a stable and trusted online commerce center for goods to be exchanged.

LendingTree Inc. is another example of a profitable online middleman. The company provides an online exchange where more than 250 lenders compete for mortgage borrowers. LendingTree has branched out into other lending arenas such as auto financing, personal loans, and student loans. Lenders on the exchange have funded $74 billion in loans since 1997. LendingTree went public in January 2000 and was purchased in 2003 by lAC/InerActiveCorp., an e-commerce company that also owns Expédia and TicketMaster.

Branching Into Asia

With e-commerce growth rates in the United States starting to slow down, many e-commerce firms are expanding into foreign markets. The Asian market is particularly attractive. Market research firm IDC predicts that Asian e-commerce sales outside of Japan will increase about 38 percent per year through 2007. E-commerce giants such as Amazon, Yahoo, and eBay are moving rapidly into China and the rest of Asia.