Has judgement day really arrived?

 News Staff Writer seems as though over the last few years Silicon Valley venture capitalists and IPO-hungry investors were willing to throw their money at practically anyone with an idea for how to make a buck on the Internet.

The result: four online grocers, five online pet supply stores, seven online drug stores, eight online toy retailers and heaven-only-knows how many online electronics merchants and sites devoted to content for women, sports fanatics or people seeking health advice.
All of these new dot-coms bet they'd be the ``best-of-breed'' category killer, with ``zero gravity'' and unlimited upside potential.

A shakeout is well under way among online retailers and it is spreading to other dot-com sectors as Web companies burn through the cash they raised from investors.
Already, some online content companies, which make most of their money by selling advertising, are showing signs of strain. Even companies in the business-to-business e-commerce market -- the area with the biggest buzz at the moment -- have seen their stock prices plunge in recent weeks.
It's as if investors have suddenly woken up and started to actually look beyond the hype to see if there's any profits in sight. Their tolerance for a business model that promises continuing losses has largely evaporated, and they've knocked two-thirds or more off the market capitalizations of some companies in little more than a month.

``The Net doesn't change economics. Most businesses fail, and most Internet businesses will fail,'' said Kevin Werbach, managing editor of Release 1.0, a monthly report on trends in the technology industry published by Esther Dyson's Edventure Holdings Inc. ``The expectation that the rising tide of the Internet will lift all boats is not true.''

What's happening, explained W.R. Hambrecht analyst Derek Brown, is that sectors that have been around for some time -- like online retailing and content sites -- are farther along in the business cycle, and are therefore experiencing a normal shakeout. But as newer sectors mature, they, too, will face what Brown calls ``financial Darwinism.''

What's more, just as everything else taking place in Internet time gets speeded up, those shakeouts are likely to happen much quicker -- after months rather than years.
So far, attention has focused largely on the trouble involving last year's Wall Street darlings -- online merchants.

Santa Clara-based Beyond.com, which sells software, and Value America, which sells office supplies and computing products, have both announced layoffs and plans to refocus their businesses on corporate customers instead of consumers. Peapod, an online grocer that recently lost a $120 million funding commitment, and CDNow, a music retailer that is floundering after its planned merger with the Columbia House music club collapsed, are both actively seeking additional funding or companies that might buy them outright. Even shares of e-tailers that remain afloat, like eToys, Egghead and Cyberian Outpost, are trading in the single digits.

But the problems aren't limited to the Web commerce companies.

Drkoop.com, a health Web site founded by the former U.S. surgeon general, recently revealed that it is running out of cash. Many believe Drkoop could be the first in a string of Web content companies to confront the same kinds of troubles currently facing e-tailers.

Werbach said worries about online merchants center on one key question: How can they turn sales into profits when so many rivals are selling goods at a loss? The question for content companies like Drkoop.com: How can they turn visitors to their sites into revenue?

Yet many of these companies have been spending money hand over fist to market themselves and build up warehouses and distribution networks. As a result, quite a few of them -- notably many of the e-tailers that went public in 1998 and 1999 -- are rapidly depleting the piles of cash that they raised in their IPOs and secondary offerings.

Peapod, for one, revealed in mid-March that its cash reserves had fallen to about $3 million. The company is currently in negotiations with a potential investor. And CDNow has disclosed that even though it has a $51 million commitment from Time Warner and Sony, the joint owners of Columbia House, it may not have enough cash to carry it through the end of the year. CDNow is implementing a cost-reduction program to bring its quarterly spending down to less than $15 million.

As online retailers look to the stock market and private backers for more funding, however, they are getting a very different reception than they did the first time around. Investors are now asking whether some of these companies have viable business models.
``There are questions about whether there is a light at the end of the tunnel,'' Werbach said. ``At some point, you need to convince investors that profitability is coming.''

Compounding investors' doubts about the Internet retailing sector are concerns that there are too many merchants -- especially too many second- and third-tier merchants that have not built up real brand names -- vying for market share in product categories that can support perhaps up to three main players. And that's often before offline competitors, like Home Depot and Wal-Mart, ramp up their online offerings.
J.P. Morgan analyst Tom Wyman traces the roots of the current situation to the lack of discrimination by venture capitalists and other private investors in backing online retailers in their early stages. ``What happened in 1999 is that virtually anyone with a good e-tailing idea got funding,'' Wyman said. ``There were no barriers to entry. Everyone and their brother went into e-tailing.''

And that is the crux of the problem, said Steve Harmon, chief executive of eHarmon Zero Gravity, an Internet investment firm.
``Most of these companies that got funded weren't really companies,'' Harmon said, noting that many never had a real plan for making money. ``They were products, concepts, interesting ideas . . . But they weren't stand-alone companies.''

Looking ahead, Goldman Sachs analyst Anthony Noto expects to see a wave of mergers and acquisitions in the online retailing business. But while struggling merchants may have valuable assets to sell -- such as customer lists, technology, strategic alliances with manufacturers -- many deals won't be done at any type of premium.
``The question here is: at what price?'' Noto said. ``Companies could be acquired but at prices like $25 million.'' For a company that once had a market value of hundreds of millions, that isn't much better than going bankrupt.

For his part, Wyman predicts some Internet retailers will simply fail outright since they have little to offer a potential suitor -- no proprietary technology, no established brand and a management team that ``failed to execute the dream.''
Indeed, 1-800-Flowers.com doesn't see many attractive acquisition targets out there even though it has been approached by a number of struggling online retailers -- both public and private -- that are seeking white knights, said Jospeh Petitto, the company's vice president of investor relations.
Over the next two quarters, Wyman believes, some companies will run out of cash. ``They won't get refunded and the lights will simply be turned off,'' he said.

Shakeouts in the Internet industry are nothing new, and in fact play an important role in separating the winners from the losers. America Online, Mountain View-based Netscape and Lycos were among the market leaders that emerged from an industry meltdown that lasted from June 1996 through May 1997, noted William Blair analyst Abhishek Gami. But many other companies never really recovered from that period, and of those three, AOL has since acquired Netscape and Lycos trails other portals like Santa Clara-based Yahoo.

Gami expects a similar pattern this time around as industry leaders -- Amazon and eBay are repeatedly put in this category -- emerge from the rubble of this latest collapse. When it is all over, Wyman expects to see between 50 and 100 online retailers -- two-thirds of them arms of offline chains -- still standing.

And the shakeout will surely move to other sectors of the Web, many say.
Firms that sell software and information technology services to online retailers, for instance, will face pressure as their customer bases shrink, Wyman said. Content companies could also get hit hard as some Web sites struggle with how to make an offline business model -- advertising-supported publishing -- work online, Harmon believes.

Even in the high-flying realm of business-to-business e-commerce, competition is growing more intense as multiple players set up online marketplaces to allow companies in just about every industry imaginable to connect with suppliers and customers electronically.

Although Wall Street and the VC crowd are still pumping money into companies jumping onto the business-to-business bandwagon -- much as they did with the online retailers not so long ago -- Brown warned that there won't be much room for me-too players in many of these overcrowded markets.

That's because the goal of these marketplaces, by definition, is to bring together as many buyers and sellers as possible. ``The b-to-b marketplace is a winner-take-most environment,'' Brown said.

Source:  Joelle Tessler, San Jose Mercury, Saturday, April 15, 2000