Financing the E-com Boom

If most of the visible (read business-to-consumer) e-com ventures are burning deep holes in their pockets, where does the money to keep them running and to start off new ones come from? The answer is slightly complex, so let me attempt a little bit of a backgrounder first.

The investment phase

The online world is currently considered by experts to be in the investment phase, and the Gartner Group predicts that paybacks will start only around 2003. So, everyone’s busy investing, without looking at current profitability.

What do you invest in? Basically, in building up the value of your e-com venture. In traditional business, you do this by building capital infrastructure, building up your brands, and of course, by increasing profitability. As we saw above, profitability is not the current top concern of e-businesses. So, you’re left with infrastructure and brand-building. 

The stated infrastructure for an e-business is its servers and software. The other logistics, such as distribution infrastructure, is kept carefully hidden (lest the marcap goes down, I guess). But there’s only so much you can invest in buying servers and software and in other infrastructure. So, e-com ventures invest in brand-building. In the short term, success of the brand–the e-com site in this case–seems to be measured by the number of people who come to the site. For the Web, this started off as hits, then moved on to page views and to unique visitors. For e-com sites, the measure of site success seems to be number of visitors or members, and the total value of goods sold from the site. 

So, e-ventures invest heavily in getting more and more customers to their site, and in taking over other e-com ventures. The first of these is akin to the brand-building exercises that traditional businesses undertake. This includes massive advertising, both in print and on other Websites, partner programs, and customer loyalty programs, mostly in the form of huge discounts, free shipping, etc. In partner programs, e-com ventures tie up with other Websites to direct their traffic to the e-com site. The partner sites are paid either a flat click-through fee or a percentage of what the person clicking through spent at the e-com site.

By taking over other sites, they get to add to their own site the visitors and sales of the other site. In the process, they may even acquire some good technology, or ward off potential future competition. All these together add considerably to the visible value of the company. Big players like Yahoo, Amazon, and Microsoft follow aggressive acquisition strategies to enhance their e-com portfolio and market value.

Where does the money come from?

All this is fine. But where does the money come from? The single-sentence answer is “The strong US economy”. For quite some time now, the US economy has been in a growth phase. The Asian financial crisis has strengthened it further. So, both individuals and companies have substantial investible
surpluses. With the Internet poised to become the next high-growth area, it is but natural that many would want to invest in this potential goldmine of the future. First, it was the software companies that made it good–Oracle, Microsoft, Infosys, et al–and then came e-com, with the promise of being able to go where no other business has gone before–right into the customer’s bedroom.

In a sellers market, with too few Internet stocks being chased by too many investors, the stocks of these companies have ballooned into the stratosphere. With stock prices rising like nobody’s business, more and more investors got attracted to them and the cycle repeated itself with fresh entrants in the market.

So to finance your e-com venture, you take your idea to a venture capitalist for funding, and once your company gets going, you take it public with an IPO. With Internet companies, today you have the enviable situation of venture capitalists chasing around for ideas. At PC Quest, we’ve actually fielded calls from people who already have venture funding, but are looking around for a workable idea.

Valuing a Net business

At this point, it’s interesting to note that the traditional parameters of valuing a company go for a toss when it comes to e-com ventures. How do you value companies that don’t have too much of infrastructure, but still draw huge volumes of business? How do you value companies that even state upfront that they have no intention of paying dividends at present
(Amazon.com), but could well be the ones to ride the wave of the future?

It is in answer to this that things like unique page views become overriding factors in determining value. The more the number of people visiting your site, the more its value. Thus you have Indiaworld getting valued at a cool Rs 499 crore. The more you advertise, the more the value of your business, seems to be the e-paradigm today. 

More Madness?

In the ensuing frenzy, you see many things that could otherwise be termed as absolute madness. Consider the Internet gurus and analysts who proclaim that if you aren’t investing, you’re dead. Seems reasonable, right? But what do you do when they extend the logic to conclude that you aren’t investing enough if you’re still making profits? And what do you do when businesses, analysts, and investors actually follow this advice, and keep making investments (and losses) like there’s no tomorrow?

For the so-called Internet businesses, the rules of marcap–that ultimate measure of success–seem to have changed drastically from being based on current profits and dividends to future potential.

The future is anybody’s guess, and companies are investing madly without looking at current returns. So in the short term, the rule of the game seems to be that the more the losses you make, the more are your investments for the future, and hence the more should be your share price and market
capitalization.

Will the bubble burst?

It’s common knowledge that stock markets go through cycles. Upswings are inevitably followed by downswings. Everyone I spoke to–IT industry insiders, investors, stock analysts–admitted in their moments of candor that what goes up will have to come down. Hopefully, it won’t come all the way down, but will stabilize at some higher level.

So, when will the bubble burst?

How I wish I had a crystal ball to predict that one. Don’t you too?