Outlook 2011: The new dot-com boom

Twitter, Netflix, Zynga, Groupon and Foursquare have sparked a new web frenzy on Wall Street. And this time, it’s not just hype.

 

Not long after the last champagne bottle had emptied and most of the world was still wrestling with the consequences that come with ringing in a New Year, Facebook raised $500 million from Goldman Sachs and Russia’s Digital Sky Technologies in a deal that values the social network at $50 billion.

The significant boost in monetary muscle placed Facebook’s value higher than companies like Time Warner, News Corp. and eBay. Skeptics wondered aloud how such a young company with an unproven business model can possibly be worth more than established media giants, conjuring chilling visions of a dot–com bubble déjà vu.

Facebook and a new wave of Internet firms are increasingly catching the eye of Wall Street. But today’s web business leaders are a breed apart from the e–flops that plagued investors at the dawn of the decade. Companies like Zynga, Twitter and Groupon didn’t race to stage massive IPOs mere months after their inception, avoiding the skyrocketing stock prices and spectacular crashes that doomed so many 10 years ago. Nor are they following the mid–decade stars of Web 2.0 such as MySpace, Flickr, Bebo and Delicious, selling out relatively quickly to be absorbed into larger entities like Yahoo and News Corp. Instead, the web’s newest players have built their billion–dollar businesses, demonstrating both audience growth and functional revenue models over years. Even after they’re established, they continue to search for new and better ways to monetize.

Just a few short years after the Internet was a twinkle in Al Gore’s eye, the web was big business. By the mid– to late–1990s, web companies were misguided, over–valuated and horribly, horribly unstable — but still big business. Everyone wanted a piece of it, and web startups were all too eager to grab and spend every dollar thrown their way by both venture capitalists and Wall Street.

One sad sack e–poster child for the dot–com crash was Webvan.com, an online grocery outlet founded in 1999. In November of that same year, the company raised $370 million in an IPO and was worth $1.2 billion. But by July 2001, a mere 18 months after it launched, consumer demand drastically lagged Wall Street’s interest in returns, and Webvan declared bankruptcy, putting 2,000 people out of work.

You know the rest. The Nasdaq hit a record high of 5,048.62 on March 10, 2000, then promptly tumbled 78% by mid–2002. With millions casually burned on ill–conceived or ill–timed ventures, the web business in general started to look decidedly distasteful. Spooked investors stayed away for years.

In the cool, clearheaded view of hindsight, many of the early dot–com era’s duds appear as ideas simply ahead of their time. Some of the most flamboyant failures were e–commerce sites. Thankfully, technology and consumer behaviour have caught up to many of these previously pie–in–the–sky ideas, and both investors and entrepreneurs are taking advantage, using past experiences to make better decisions. This year, sales in U.S. online retail are projected to hit $191.7 billion, compared with just $19.5 billion in 2000. And while early dot–coms spent hundreds of millions on infrastructure, advertising and fleets of Herman Miller office chairs, today’s companies simply aren’t spending so much on starting and establishing their business.

“One of the big lessons learned is, in the old days you had to throw tons of money and a ton of people at a lot of problems to try and create a business,” says Rob Solomon, president and chief operating officer of online discounter Groupon. In 2007, Solomon sold travel search engine Sidestep to Kayak for $200 million. “Nowadays, it’s a little bit easier. You can get pretty far without hiring a ton of people in certain categories or spending tens of millions of dollars. So you see startups scraping by and extending their life by not having to expend that much capital.”

There are a handful of companies right now that, instead of selling out, are betting on their own versions of what tech blog All Things Digital dubs “The Zuckerberg Gambit” — a nod to Facebook CEO Mark Zuckerberg’s repeated rejection of big–name buyers like Viacom, Yahoo and Microsoft to go it on his own. Groupon, for one, just turned down a $6–billion offer from Google in December, while Twitter has successfully staved off acquisition as well. For some, Web 2.0 provides its own cautionary tales, both on the fickle nature of consumers and the downside of joining a much larger corporation. Last summer, AOL sold its social network, Bebo, which has seen traffic steadily decline, for $2 million after acquiring it for $850 million in 2008. In December, news leaked Yahoo was looking to offload Delicious, thanks in no small part to dropping user numbers. Meanwhile, MySpace visitors are down 20% over the past two years, after consistently ceding ground to Facebook on every front except music. This month The Wall Street Journal reported MySpace was preparing to lay off between a third and half of its estimated 1,100 employees.

The advantages to staying independent and private for companies like Facebook, Twitter, Groupon and Zynga is the ability to innovate, execute and experiment without the scrutiny of shareholders or corporate owner. A number of analysts have pegged this year as the return of the Internet IPO, earmarking a number of these companies and others to go public in the next 12 to 24 months. LinkedIn, a social networking site for business people, is reportedly planning an IPO for the first quarter of the year. The reasons for 2011 to be tipped as the start of a new run on tech stocks vary from citing the sheer amount of venture capital invested and activity on the secondary market, to simply that the products and revenue models have matured sufficiently to survive and thrive on the public market.

Not every new Internet idea can afford to spurn all suitors. Everyone can’t be Google, Amazon, Facebook or, despite all the imitators, Groupon. But whether poised for acquisition, staying independent or going IPO in 2011, a new excitement surrounds this next generation of web business. Hard lessons have been learned from the past, and technological development and capability are no longer such imposing barriers to executing creative ideas and innovation. It’s all contributing to increased confidence in a sector not too long ago many on Wall Street wouldn’t go near — save for the free porn and classified ads. What follows is a look at five companies that embody this new Internet business ideal and their plan for the future.

 

Groupon
Location: Chicago • Founded: 2008 • Worth: $6.4 billion • CEO: Andrew Mason

Both Forbes and The Wall Street Journal have dubbed Groupon the fastest–growing company ever. This sounds like hyperbole, until you consider estimates peg the two–year–old online discounter Groupon’s gross sales at $800 million.

Still, the Chicago–based company shocked onlookers when it turned down a $6–billion offer from Google in December. That followed a reported rejection of Yahoo earlier this year for an estimated $3 billion. In April, Groupon was valued at $1.35 billion after raising $135 million in funding, second only to YouTube in its pace to reach the billion–dollar plateau. And Groupon’s business model is miles ahead of where the video site was at the same age. YouTube was acquired by Google in 2006 for the comparatively paltry sum of $1.65 billion and still awaits a trip to the black. Groupon counted itself profitable in just seven months. Last month, the company’s board approved a push for up to $950 million in new funding, which could boost Groupon’s value to a reported $6.4 billion.

“I think what we’ve tapped into is one of the larger spaces addressed by the Internet,” says Groupon’s president and chief operating officer Rob Solomon. “Internet business has typically been advertising– or e–commerce–based. And e–commerce is a gigantic category, however it’s only about 6% or 7% of all commerce.”

The brilliance of Groupon is positioning itself as a bridge between the online and physical world, e–commerce and in person. “We think it’s a trillion–dollar–plus market, if you think about all the local goods and services that are addressable by the Groupon model,” says Solomon.

The site e–mails out one deal every day to subscribers in each of its markets. Every deal requires a certain number of people to sign up, and Groupon integrates social networks like Facebook and Twitter, allowing consumers to spread the hype quickly and easily. If the minimum number of sign–ups is met, the deal opens up to everyone. If it doesn’t, the deal’s off. By setting a buy–in minimum, Groupon increases the likelihood interested subscribers will spread word of the deal, as well as guaranteeing merchants a certain number of customers. From discounted yoga sessions to pepperoni pizzas to helicopter flying lessons, Groupon’s had it. In August, the Gap had a national deal offering $50 worth of merchandise for $25, selling 441,000 Groupons and raking in $11 million. The site reportedly pockets 30% to 50% of deal revenues. Big national deals can be good PR, but it’s small business that really benefits from Groupon’s services, which promotes the companies to far more customers than they could otherwise reach.

There is skepticism about the model’s slim profit margins and retailers’ ability to meet demand, but that hasn’t slowed the herds of merchants and consumers flocking to Groupon and its imitators, like the Amazon–funded Living Social, hipster iteration Keynoir, and Torstar–owned Wagjag.

The company expanded from the U.S. to 34 other countries in 2010, first to Canada, then locales in Latin America, Asia, Europe and Russia. The world tour was largely fostered through acquisition of much smaller local services, and Solomon says international expansion will be a key focus in 2011.

“The biggest lesson we’ve learned is that this model is universal, ” he says. “The subscribers, whether they’re in Chicago or Edmonton or Tokyo, are very much interested in the same things like restaurants, health and beauty services…it’s been staggering how common the appeal is for these types of deals across the globe.”

Twitter
Location: San Francisco • Founded: 2006 • Worth: $3.7 billion • CEO: Dick Costolo

Hard to believe this summer will mark five years of tweeting, hash tags and the Fail Whale, but on July 15 Twitter will celebrate a half–decade in existence. While it’s added a whole new verb to the English language — tweet! — the 140–character micro–blogging service still faces skepticism about its economic viability. The company recently raised $200 million in new funding, significantly boosting its valuation to $3.7 billion. Some observers question how a company can be worth so much without an established revenue model. However, it’s hard not to see the possibilities inherent in having upwards of 200 million users — up from 58 million in 2009 and 503,000 in 2007. And Twitter is taking deliberate steps to improve its platform in a way that will satisfy both its millions of users and its bottom line.

The company hasn’t rushed to find revenue, instead taking a measured approach to integrating advertising gradually, pacing these efforts in order not to disturb what users find most valuable. “You don’t want to kill the goose that laid the golden egg,” says Forrester Research senior social media analyst Augie Ray. “Twitter is building an ad platform that encourages advertisers to do things that people will want to engage with and actively discourages treating it like just another platform, which is one of the reasons for optimism in thinking Twitter could succeed quite well.”

CEO (then–COO) Dick Costolo addressed the issue of meaningful monetization in April by announcing a promoted tweets service to marketers, putting ads first in users’ search results and later embedding the ads in users’ feeds both on Twitter.com and the gaggle of third–party access clients such as TweetDeck and TwitterBerry. In addition to advertising, data is another revenue stream for Twitter. Content–search deals struck with Bing and Google in late 2009, for Twitter updates to appear in search results, put an estimated $25 million into Twitter’s pocket and pushed the company to profitability for that year.

“We are not in a rush to make a certain amount of money this year,” Costolo, one of Twitter’s earliest investors, told Advertising Age. “We want to get this right. We don’t want to force a model on people that is based on incorrect hypotheses.”

In October, Costolo said the company had worked with more than 40 advertisers and expected that number to be in the low hundreds by the end of the year. On top of promoted tweets, Twitter is also offering marketers promoted accounts, where brand accounts can be included in Twitter’s “Who to Follow” feature. The Twitter CEO expects to expand from there until there is a robust enough infrastructure to offer brands a self–serve platform for a variety of ad types, including tailoring ad content to users’ location.

Despite its impressive numbers all around, perhaps Twitter’s biggest impact has been less about the quantity of users as it is about the quality. It’s become a direct line of communication between public figures — President Obama, Paris Hilton, Steve Nash, Stephen Harper, Margaret Atwood — and their fans. The connection is immediate and its presence is growing.

While Twitter can’t boast the same explosive growth enjoyed by Facebook, it has emerged as a valuable platform in its own right. “For people who want to share thoughts, information, promote their products and services, engage with celebrities and others,” says Ray, “Twitter has proven to be a very rich and active network.”

 

Zynga
Location: San Franciso • Founded: 2007 • Worth: $5.51 billion • CEO: Mark Pincus

You may not recognize the name, but chances are more than a handful of your Facebook friends are addicted to one of its games. Between FarmVille, CityVille, Texas Hold’Em Poker, Mafia Wars and others, Zynga titles boast upwards of 215 million monthly active players, and estimates peg the company’s annual revenue at $600 million. The company also raised $300 million in combined funding from Google and Softbank this past June. That’s a whole lot of virtual tractors, sheep, poker chips and firearms.

This past fall, the company’s estimated worth was $5.51 billion, more than traditional gaming powerhouse Electronic Arts’ stock value of $5.22 billion, illustrating the rapid rise of both Zynga and social gaming. Social games can be added to users’ social network profile pages and played with friends online, while traditional gaming is most associated with consoles like the Playstation3, Xbox 360 and Wii.

Existing largely within the fabric of Facebook, Zynga’s roster of games also has apps for the iPad, iPhone, and other mobile devices. The games are free to play, but users are offered a plethora of items to help boost their progress. In FarmVille, for example, which had 60 million players within six months of its 2009 debut, players plant, tend and harvest virtual crops, as well as raise virtual livestock. “Farm coins” and “Farm cash” are the game’s currency, earned by successfully completing levels, viewing ads and through payments of real money.

This all might sound like child’s play, but a 2010 study said the average social gamer is a 43–year–old woman. The company has deftly combined the communication and interaction that’s made Facebook so popular, with the broad appeal of board games, tapping a very large, lucrative nerve among online users. Brands like McDonald’s, Kia, 7–Eleven, MillerCoors and Visa have signed up in the past year as advertisers, looking to attract some of Zynga’s more than 50 million global daily players, helping the company’s games serve up a billion ad impressions every day.

Zynga also goes beyond the traditional model of developing a game then releasing it out to the world as is. The company is constantly changing and experimenting with its active games, to better engage and attract consumers. “Our games are not static. They change every week,” says chief technology officer Cadir Lee. “At any given time, we’re running hundreds of experiments on how people respond to different parts of our games.”

Even with its astounding success, Zynga does face some difficult challenges. Two of the company’s rivals, Playfish and Playdom, were purchased by Electronic Arts and Walt Disney Co., respectively. Zynga must now compete against major properties like Monopoly and Marvel superheroes. Also, in October Zynga (along with Facebook and Google) was named in several class–action suits over revealing users’ private information to advertisers. The company maintains the sharing of info was unintentional, but the court cases will continue into this year.

A major focus for the company in 2011 is increased expansion to global markets. In July, the company launched Zynga Japan with investor Softbank. Zynga also marked its first multilingual launch in November with CityVille available in English, French, Italian, German, and Spanish which attracted 290,000 players in its first 24 hours.

“We’re definitely focused on how to become a more global web player, with translated versions in a variety of countries,” he says. “We planted some of the seeds for that in 2010, particularly in Japan, but a big challenge for us is figuring out how to transition into a truly global company.”

 

Netflix
Location: Los Gatos, Calif. • Founded: 1997 • Worth: $10.5 billion • CEO: Reed Hastings

It’s a word that strikes fear into the hearts of cable companies and gives studio execs the flop sweats. Netflix.

Forget no late fees and cash lineups, the Los Gatos, Calif.–based company allows TV and movie lovers to do it all from the couch. Founded in 1997 as a DVD rental–by–mail service, the company has defied predictions of its demise at the hands of now–bankrupt Blockbuster or Amazon. Instead, the publicly traded company’s stock has skyrocketed thanks to nimbly navigating a major shift in audience behaviour.

As consumer appetite for DVDs slows and interest in on–demand, online viewing increases by leaps and bounds, Netflix has managed to go from streaming fewer than 2,000 titles on PC’s only in 2007, to having its service on more than 200 devices, including virtually every Blu–ray disc player, Internet–enabled TV, gaming console and mobile phone. The company begins 2011 with more than 16 million subscribers, $2 billion in sales, and stock growth at 200% in the past year.

Sure, many point to how quickly the company changed the focus of its core business model — from DVD mailings to online streaming — as the key to its success. But even in 1997, they called it Netflix for a reason. Company spokesperson Steve Swasey says CEO Reed Hastings envisioned web delivery from the start. “It just took this long to have all the content rights and devices available,” he says.

In the past, streaming rights were viewed as an afterthought, allowing Netflix to lock in content cheaply. As the potential for streaming becomes increasingly clear, those deals have given Netflix a significant head start on the competition. Time Warner CEO Jeffrey Bewkes mocked the Netflix threat to traditional media companies, comparing it to the Albanian army taking over the world. But this past summer, Netflix signed content deals with MGM, Paramount and Lionsgate. A recent J.P. Morgan research survey that says 47% of all active U.S. users of Netflix’s streaming service would consider dropping pay TV or have already. Albania? More like Attila.

The launch of its streaming–only service in Canada has so far exceeded company expectations, prompting officials to predict Netflix.ca profitable by September. The move has been a significant boost in confidence for further international expansion, now slated for late 2011.

The company’s agility in reacting to consumer behaviour is nowhere more prevalent than its response to mobile last year. In his January 2010 earnings call, Hastings told investors Netflix wouldn’t focus too much on mobile, and most of the company’s energy would be spent on TV. By spring, Apple approached, asking if Netflix was interested in the iPad. Six weeks later, a deal was done and soon expanded to other mobile devices. Where the company’s shift from DVDs to online streaming has played a major part in its meteoric rise, it’s this proven ability to recognize opportunity and make it happen quickly that will play a key role in Netflix’ future success.

Foursquare
Location: New York • Founded: 2009 • Worth: $95 million • CEO: Dennis Crowley

Over the past year, more and more marketers, tech wizards and startups have adopted a new mantra from their brethren in real estate: “Location, location, location.”

While not the first to engage users with geo–location services, social networking site Foursquare quickly became the highest–profile name in the space upon its launch at the South By Southwest Interactive festival in 2009.

The startup encourages users to connect with friends and “check in” to specific locations in order to earn points using its mobile app. The check–in not only marks the user’s presence at a particular bar, restaurant or store, but also alerts that user’s network of friends so they can meet up. The company has struggled at times to avoid a hype hangover after strong initial buzz, but has so far outpaced competition like Facebook Places and Gowalla. Foursquare says it has five million users and adds 25,000 new users every day, which contributes to more than two million check–ins per day. The 40–employee company has raised more than $21 million in funding.

The business model behind Foursquare so far involves partnerships with companies in a variety of ways, such as rewarding Foursquare “mayors” (users who check in most often at a specific location) with deals, to running user contests, to tips from companies on a user’s surroundings after they check in.

But despite a plethora of press coverage, a recent Forrester report pegged American awareness of location–based services at 4%. The app has also seen traffic dip from about 1.8 million unique visitors to less than one million between August and November. But Foursquare can take heart, remembering Twitter’s 27.8% decline between September and October 2009, before growing 76% between August 2009 and August 2010.

Invariably, Foursquare’s potential is hitched to the continued rise of smartphones In 2010, co–founder Naveen Selvadurai says the company focused on building its internal team to better handle technological, creative and business challenges. Crucial this year is finding new ways to effectively integrate marketers, media and local businesses into its user engagement.

“We want to give them great data on who’s coming in, who their loyal customers are and the different ways to reach out to them. We were partnering with about 30 businesses at the start of 2010, and now it’s in the tens of thousands,” says Selvadurai.

There have been both encouraging baby steps and deflating hiccups. One growing pain was a Starbucks promotion that fell flat after employees weren’t adequately informed about the free coffee giveaway users had “earned,” disappointing both caffeine–starved “mayors” and cheerleaders of location–based marketing. On the plus side, Foursquare in September introduced a button, much like Facebook’s now–ubiquitous Like, to place on third–party sites, enabling users to add locations gleaned from restaurant reviews and other content to their Foursquare “to–do” lists from media partners like The New York Times, Zagat and the National Post.

In December, the company announced some important new pieces, including a new version of its iPhone app and the debut of its Android app. Then they announced users could now attach photos to venues and comment on friends’ activities. It was a productive month. But Selvadurai says they’re far from finished.

“We need to redesign a lot of the features and game mechanics, which have gone a long way in comparison to a lot of our competitors,” says Selvadurai. “It’s almost two years old, we’ve made a few tweaks here and there, but it’s largely stood still. So we’ve been thinking about different ways to make it much more engaging and valuable this year.”

The next wave?
More web companies to watch

Spotify: This Europe–based music streaming site has an estimated 10 million subscribers, and is much lauded for its ease of use, content choice and (surprise!) legality. Draws its revenue from advertising and subscription fees. Not yet available in North America, and dubbed by Wired magazine “The Coolest Music Service You Can’t Use.”

Quora: Social Q&A collects, edits and organizes questions and answers, allowing users to collaborate on both. Pros? Popular with the tech crowd, has attracted knowledgeable high–profile users such as Facebook, Twitter and VC execs, as well as a reported $86–million valuation. Cons? No clear business model, not accepting advertising yet and quick growth risks diluting the quality of content.

Gilt Groupe: The invitation–only shopping site launched in 2007 and built a cult–like following among shoppers lured by cut–rate discounts on designer goods. In past two years, Gilt expanded to menswear, home goods and luxury travel. Revenue estimated at about $500 million for 2010. Has been stalked by imminent IPO rumours since 2009.

Boxee: This magic little box can transmit movies, TV shows and other videos from the web to your TV, and lets you tag any video link to watch later on your TV. Boxee debuted its hardware in November and, with content partners like Major League Baseball, the NHL and Netflix, wants its software on as many game consoles, TVs and Blu–ray players as possible.

 

 

 

 

 

 

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