"All they have to do to be profitable is cut back on marketing." That excuse for money-losing companies has been around forever. With Netcos, it's the motto that justifies headlong spending far beyond revenue.

CBS MarketWatch.com and TheStreet.com
Amazon.com and Barnesandnoble.com
The Ugly Truth

Of course, trimming marketing costs isn't that simple because it tends to slow revenue growth – the major measure of Net stock valuation. Moreover, the impact of cutting marketing varies widely among Netcos. And that reflects how well the entire business is managed.
The comparison of Internet companies in the table illustrates the point. Although the first column's figures for "Marketing Expense as Percentage of Revenue" are the most spectacular, the figures in the second column, "Marketing Expense as Percentage of Operating Loss" gives the essential perspective.

Here's the key principle: The higher the second-column figure, the more impact cutting marketing will have on the bottom line.

CBS MarketWatch.com and TheStreet.com

Let's look at two examples: CBS MarketWatch.com and TheStreet.com

In the third quarter, marketing expense was 118 percent of revenue at TheStreet and 107 percent of revenue at its direct competitor, CBS MarketWatch. Although that's nearly equal, marketing expense was 101 percent of MarketWatch's operating loss, but only 53 percent of TheStreet's. In other words, if MarketWatch and TheStreet stopped marketing, MarketWatch would (on paper) break even, but TheStreet would still be in a deep hole; it would be down $4 million.
Yet according to popular measures, TheStreet and MarketWatch are quite comparable. Third-quarter revenue versus the year-ago quarter was up 253 percent at TheStreet and 287 percent at MarketWatch; the stocks of both trade at about 24 times sales.

Obviously, eliminating marketing is unrealistic. So, by marketing measures alone, MarketWatch isn't better off than TheStreet. But the comparison does highlight the fact that other expenses need scrutiny.

Indeed, TheStreet's gross margins are almost half the 60 percent notched by MarketWatch. General and administrative expenses equal 95 percent of revenue at TheStreet, as against 34 percent at MarketWatch. The expense spreads imply shows that TheStreet needs to tighten cost controls more than it needs to manage marketing expense.

Amazon.com and Barnesandnoble.com

The battle between Amazon.com and Barnesandnoble.com provides another example. Each has gross margins of 20 percent. But revenue grew 214 percent at Barnesandnoble, while it went up 130 percent at Amazon. And Barnesandnoble spent 263 percent of its revenue on marketing, versus Amazon's 124 percent.

So it certainly appears that Barnesandnoble is in best position to improve performance by reducing marketing. Surprise: Actually, Amazon is. That's because Amazon's marketing expense is 110 percent of its operating loss, while Barnesandnoble 's marketing spending is only 88 percent of its loss.

What's more, Barnesandnoble's general and administrative spending as a percentage of its gross profit is more than three times that of Amazon. As with TheStreet, this suggests that Barnesandnoble has work to do in the areas of cost control and productivity.
Note the business-to-business companies in the table. The hoopla about B2B says that the Net enables better business models than are possible with retail. Still, as the table illustrates, the marketing spending of many B2B outfits is just as excessive.

The Ugly Truth

Regardless of the comparisons, no business that spends from 100 percent to 800 percent of its revenue on marketing can survive for long without generous investors.
Netcos and their investors expect seamless acceleration of revenue and profit past marketing expense. The same vision has seduced many startups and investors in the past, but history shows it's easier said than done. In the Net biz so far, only AOL, Yahoo and eBay have pulled it off over a long haul.

Brands and customers require perpetual nurturing. And, for many Netcos, achieving the levels of profit that entice investors will require the overall Internet audience to grow from today's 30 percent of households to upwards of 50 percent. Competing for the parade of newbies will require maintaining marketing at high levels.

Neither an increase nor a decrease in marketing can compensate for shortcomings in the management of other aspects of the business. However, marketing is the easiest expense to control. So companies that have control over other costs are in a better position to benefit from reductions.

David Simons is managing director of Digital Video Investments, an institutional research firm. Write to him at simonsd@digvid.com.
At the time of publication, he had positions in CNET, EarthWeb, and EFax. This column is solely for information purposes. Under no circumstances is it to be construed as a recommendation to buy or sell securities. Neither DVI nor the author can provide investment advice to individuals.
 

Source: Business Week, December 02, 1999