Nakato Hirakubo
Assistant Professor of Business and International Marketing
Department of Economics
Brooklyn College of the City University of New York
e-mail: nhirakubo@msn.com

Hershey H. Friedman
Professor of Business and Marketing
Department of Economics
Brooklyn College of the City University of New York
e-mail: x.friedman@att.net

While a great deal can be learned from examining dot-com successes, even more can be learned from studying dot-com failures. The number of failures, unfortunately, is in the many hundreds and has resulted in the loss of billions of dollars and thousands of jobs. The authors describe the major reasons so many firms failed and offer advice for future dot-coms on how to succeed.

Peter Drucker said he was surprised that the dot-com bubble did not burst two years earlier (Shoenfeld 2001). Drucker believes that the cultural impact of the Internet is unbelievably great. It has been profoundly changing consumer values, consumer behavior, job market, and industry structures. The magnitude of the changes is equivalent to those brought on by Gutenberg’s printing revolution or James Watt’s steam engine (Drucker 1999). However, according to Drucker, the economic impact is only marginal. The Internet is just another distribution channel so far (Shoenfeld 2001). Consumers place their orders with keyboards instead of going to stores or calling toll-free numbers. Michael Porter said, "The Internet didn't invalidate the importance of the product, the brand, the distribution system, or even physical locations like stores and warehouses. The Internet affected discrete parts of the value chain, but other parts of the value chain remained important." (Byrne 2001)

It seems that the consumers, investors, managers, and mass media all overreacted to the Internet hype. Toffler and Toffler (2001), however, claim that stock prices do not reflect the actual underlying economic activities. The bubble burst because too many firms tried to jump on the wagon, and too much money was invested in the unknown field. During the early stage of industrial revolution, thousands of startup companies failed. In the U.S. alone, over 3,000 automobile manufacturers were established between 1900 and 1920 (Lohr 2001). Both dot-com and old-economy failures lacked know-how, capital, business model, infrastructure and other key assets.

Nevertheless, electronic commerce is having a dramatic impact on the way business is being conducted all over the world. In fact, within a few years it is expected that sales over the Web will be several trillion dollars. E-companies such as America Online, eBay, Amazon.com, Yahoo, MSN, and others have enjoyed phenomenal growth.

While a great deal can be learned from examining the dot-com successes, even more can be learned from studying the dot-com collapse, which resulted in the loss of billions of dollars and thousands of jobs. More than 210 Internet companies failed in the year 2000 and many more folded in 2001. Webmergers.com estimates that at least 555 Internet companies failed between January 2000 and June 2001. What can be learned from this debacle? This paper will attempt to examine the reasons that so many dot-coms went belly up.

Some of the major dot-com failures include: Auctions.com, Boo.com, Carclub.com, Cyberrebate.com, Etoys.com, Eve.com, Furniture.com, Go.com, Govworks.com, Jewelry.com, Kozmo.com, Living.com, Mercata.com, Pandesic.com, Planetrx.com, Reel.com, Rx.com, Theglobe.com, Toysmart.com, Value America, and Webvan.com. Those interested in seeing the home pages of failed dot-coms, can go to Steve Baldwin’s Museum of E-Failures at http://www.disobey.com/ghostsites/. As of September 27, 2001, the number of failures at the museum was 845. UpsideToday’s Dotcom graveyard at http://www.upside.com/graveyard/ and DotComDoom’s website at http://www.dotcomdoom.com are additional resources for studying dot-coms that bit the dust. The reason for the failure of numerous European dot-coms can be found at the whytheyfailed.com website at http://www.whytheyfailed.com/ from Bathwick Research.

It is important to study the failures so that history will not repeat itself. Many of the mistakes made by the dot-coms can be avoided by firms that examine both the online success stories and failures.

Because it was so easy to enter many e-industries — some software and a good website is all that was needed — there were too many firms going after the same customers. Freedom of firms to enter and exit an industry is one of the necessary conditions for pure competition. The Web certainly made it easy for firms to enter most industries. There is however a limit to how many firms within one industry can survive, even online. Wolverton (2000) notes that there were just too many online pet stores, and to add to the confusion the names of many were very similar (e.g., Pets.com, Petstore.com, Petopia). It is apparent that oversaturation was a problem in many other industries. For example, a Yahoo.com search with the search terms "online bookstore", results in 481 listings from Barnesandnoble.com to Ridgebacks Online Dog Bookstore. Similarly, Yahoo searches yield 386 online drugstores and 173 online travel agents.

Dreier (2001) claims that oversaturation was a problem even for the pornography sites and Reilly (2000) states that oversaturation was a problem in the business-to-consumer (B2C) auction markets. There are hundreds of online auction sites, but only a handful of B2C sites (e.g., eBay, Yahoo, and Amazon) are well-known. The same problem occurred in the business-to-business (B2B) marketplace or exchange which brings purchasing agents and suppliers together electronically. There was a great deal of competition and many exchanges, e.g., Chemdex and Dell Marketplace, did not survive. In fact, of the more than 1,000 marketplaces, predictions are that fewer than 200 would survive by the conclusion of year 2003 (Tedeschi, 2001).

The oversaturation has been partially caused by venture capitalists who were willing to invest in almost any business plan if it ended with the dot-com suffix. They did not even look seriously at those plans, said Caroline Plumb, a recruitment consultant (Hayward 2001). Banks should also be blamed for irresponsibly offering loans to dot-com startups that had not even made a single sale (Hayward 2001). This is similar to the late 1980s when Japanese banks fueled the real estate bubble. Even in a rapidly growing market, a firm cannot survive with a mediocre business plan.

Oversaturation can be also caused by too small a market. A number of dot-com startups such as Pets.com and Stamps.com failed because they overestimated the size of the market (Bates et al. 2001). There was no real need for their services. They squandered their resources where there was little possibility of a payoff. While commodities such as airline tickets, books, and CDs have been moving quickly on the Internet, the sales of higher-margin, high-risk products such as cars, pharmaceuticals, and mortgages remain complicated by law, customer habits, and longstanding supplier relationships. Consumers prefer face-to-face contacts when purchasing complicated, high-risk products like life insurance (Wecker 2001). One must also realize that the Internet markets have not yet been fully developed and may never be developed for some products.

A large number of dot-coms failed because they simply ran out of money. When the Nasdaq began to drop precipitously, investors became reluctant to invest in unproven dot-coms. For instance, at one point, Kozmo, the online delivery company, was expanding into many markets and was spending more than $30 million a month. When the firm could not raise money by selling stock because of the weak market, the firm was forced to restructure. Employees were laid off, delivery fees were added, and the company started selling merchandise with higher profit margins than videotapes and soft drinks. The company went from 3,300 employees down to 1,100 employees and was spending $2 million per month. At this point, the company did begin to make some profits in some of their markets, but it was too little and too late. Had the firm been more prudent with its spending in the early years — the firm was founded in 1998 — there might have been sufficient financing for them to survive. In fact, Gerry Burdo, President and Chief Executive of Kozmo made the following statement regarding the failure of Kozmo: "Some decisions made early in the company's development, combined with current market conditions, prevented Kozmo from overcoming the challenges associated with conquering the last mile." When Kozmo went bankrupt, not only had firm gone through about $280 million invested in it, but 1,100 employees lost their jobs (Blair, 2001a).

David Scult, CEO of Radnet.com, provided on the company’s website the following reason for his firm’s failure: "As with many other technology and Internet businesses in the current market environment, we have been unable to secure the funding needed to execute our business plan or to find an acquirer." This is quite similar to the reason provided by David MacSwain, CEO of Spaceworks: "We simply ran out of cash and couldn't make the next round of funding. This is a tough place to be in right now." The carclub.com website also attributes its failure to financing problems: "It is with deep regret that carclub.com has closed its doors and joins those companies that have fallen casualty to the diminished availability of investment capital in this constrained economy."

At the Whytheyfailed.com website, 54 European dot-com failures are listed. Reasons for failures are provided for most of the firms. Approximately 60% of reasons have to do with "funding," "spending cuts," "failed to secure additional funding," and "running out of money." Boo.com, the European high-fashion e-tailer, burnt through $120 million in just 16 months. Boo.com and most others relied far too heavily on outside capital, as the revenue wasn't forthcoming.

It is clear that many dot-coms failed because they spent far too much when the company was founded and then ran out of money. The dot-coms raised funds through venture capital firms and IPOs and were too aggressive with other people’s money. There were few cost controls since no one believed that they would ever run out of money. The reluctance of investors to invest in dot-coms when the stock market began to take a dive contributed greatly to the downfall of many of them. A prudent firm should be careful with other people’s money and not assume that they will always be able to easily raise money from outside investors.

Ellis of PriceWaterhouseCoopers says that, despite the increase in dot-com crashes, most are still spending too much and further failures are inevitable. The typical dot-coms increased marketing spending and overhead by 11 percent in the third quarter of 2000, which is over 150 percent of gross profit (Hayward 2001). It is estimated that two-thirds of small dot-com startups will go under by 2003 due to lack of cash (Hayward 2001).

The managers of pure-player dot-com startups failed to realize that a huge up-front investment was necessary in developing infrastructure and promotional activities. While the costs of building warehouses, developing a website, and building brand recognition were unjustifiably high, gross profit margins were small due to intense price competition in the oversaturated market. The dot-coms that have succeeded tend to be the click-and-mortar variety (Hayward 2001). They already possess products to sell, infrastructure, brand name, and loyal customers.

Many of the dot-coms invested more time and resources in pumping up the value of their stock than in developing a healthy business. This is why many of the standard rules for running a business were ignored. The market capitalization of Etoys was once a ridiculously high $10 billion; PlanetRX.com, an online pharmacy, was valued at $10.8 billion. It is difficult to act rationally when firms with a few million dollars in assets and no profits could command such high market caps.

Webvan was one of the largest dot-com bankruptcies; it spent almost $1.2 billion put up by investors. The market capitalization of the firm at its peak was $7.5 billion. According to Levitan, an analyst at Robertson Stephens, Webvan’s major mistake was expanding too rapidly all over the country rather than simply testing their business model in one market at a time. Webvan expanded to 26 cities nationally at a cost of $35 million each. This was necessary since they could not raise money from investors unless they could promise them super-fast growth. Unfortunately, they were having difficulty learning how to make a profit in the low-margin, extremely competitive grocery business. In addition, they had to use their own fleet of trucks, rather than relying on UPS or Fedex, for home delivery of groceries since many groceries are perishable. Not surprising, they never did become profitable in any market (Hansell 2001a). They might have had a chance had they focused on one market and learned how to make a profit in the business of online home delivery of groceries. Levitan’s conclusion from the Webvan failure was that: "it’s a small niche business, not a mass market business like Webvan thought."

The dot-com failures were trapped by their obsession to gain market share. Their philosophy was "go big or go home." As Bob Metcalfe, founder of 3Com, pointed out, the more people that are connected to a network, the more valuable that network is. The first company that reaches a critical mass tends to sweep the market. A large auction site, for example, can provide better selection and better bids than smaller ones. Thus, people have no reason to visit any site other than eBay. Dot-com managers feared that if they did not move first and fast enough, competitors would outrun them (Hansell 2001c).

While it is true that market share is important, being obsessed with it and totally ignoring profits does not make business sense, especially for firms that do not possess deep pockets. In fact, the strategy of many of the dot-coms was to gain market share and worry about profits later. Unfortunately for them, there was no later: they ran out of money before ever making a profit.

Tesco, a British online grocer, on the other hand, did not have state-of-the-art $35 million warehouses, $54 million computer systems, or $1.2 billion in cash. The company started an online grocery venture in 1996 with a crude web site and their own stores where goods are selected. After making sure there was sufficient demand, the firm expanded the service to 100 stores in 1999. Today, groceries are shipped from the company’s 250 stores. The online venture generated $450 million and the net operating margin is $22 million or 5% or the sales (Reinhardt 2001).

In some cases, failure was due to a flawed business model. They simply failed to create value for their customers. For instance, Neuborne (2000) believed that the target audience of Boo, women under the age of 30 interested in trendy clothing, preferred shopping with friends in stores. To them, shopping is also a social experience and they do not prefer the convenience of the Web for fashionable clothes. Wolverton (2000) claims that one of the reasons that Pets.com failed is that it did not offer any important benefits to consumers. While it is true that the home delivery of pet supplies is convenient, this advantage is more than offset by having to wait for several days for the product to be delivered. Most grocery stores carry pet food so that it is much easier to pick it up when shopping for other convenience goods. A niche online company such as Waggin’ Tails selling specialized pet foods (e.g., Vital Nutrients Certified Organic Flax Oil, Wild Salmon Dog Treats, etc.) with very high profit margins could make a profit; Pets.com could not make a profit selling bags of pet food with their low profit margins.

Blair (2001b) claims that the Kozmo business model was flawed from the outset. He cites Michael Drapkin who believed: "The whole thing about same-day delivery is that they run ultra-efficient operations on paper-thin margins. Even if you could corner the entire market, you could never get enough to be able to get a return on an investment of $280 million."

The products that large numbers of consumers purchase on the Web include books, music, software, and DVDs. These are products that are not always easily available and consumers are willing to wait a few days for them. For those who want the product immediately, software and music (even, in some cases, books and films) can be downloaded directly into the customer’s computer. The basic rules of marketing apply to products sold on the Internet. You have to offer some advantage to the consumer: either convenience, better quality, wider selection, or lower prices to succeed. To the consumer, the Internet is just another channel of distribution. Since most consumers tend to avoid uncertainty, one would not switch to another vendor unless the benefit is visible and meaningful.

Content providers on the Web have not in general been successful at getting consumers to pay for on-line material. People are quite willing to pay several dollars for a magazine, but few are willing to pay for the same information if it is online. This is not surprising given the culture of the Web, i.e., obtaining free information. Thus, most businesses that planned on relying on subscription revenues for online information have had to change their approach. One of the few exceptions is Consumer Reports Online. For an annual fee of about $24 per year, you get access to their archives of product reviews. What is quite fascinating is that Consumer Reports, a nonprofit organization, is one of the few online sites actually making a profit from selling content.

It is becoming apparent that dot-coms will have to start charging for services they used to offer for free. This is due to the fact that Web advertising that was supposed to pay for so many free services is just not that lucrative anymore. As Jakob Nielsen, a Web consultant, notes: "The free Web was a temporary aberration. It is just not sustainable" (Borrus 2001). You can no longer get a free computer from free-pc.com or a phone call at callfreeway.com. Free picture developing at Snapfish.com now costs $1.99 a roll (Hansell 2001b). Free Internet access providers such as Netzero and Kmart’s Bluelight.com now only offer a limited number of hours for free; users are encouraged to switch to a pay service. Companies such as Outpost.com that offered free shipping are now charging for it and prices for products are being raised. Even Yahoo charges fees for auctioning, receiving stock quotes, paying bills and so on (Hansell 2001b).

Borrus (2001) believes that consumers will have to pay for such services as high-speed broadband access, technical support, stock market predictions, lists of the best doctors, music on the Web, video on demand, and online personal shoppers. Smart dot-coms are learning to modify their business models and try to find new ways of making money. They might offer some basic services for free to attract clients, but will start to charge for more and more services. The New York Times, for example, provides a free subscription online, but one has to pay a fee for downloading an article from its archive. It is free to create your own homepage at Homestead.com unless it exceeds three pages.

Agrawal, Arjona, and Lemmens (2001) examined the behavior of thousands of visitors to the websites of several hundred firms and came to the following conclusions. A large number of e-commerce companies were very successful at attracting visitors to their sites, but were not effective at getting visitors to buy (conversion). Even those customers that did buy, rarely came back to buy again (customer retention). In a number of cases, the more visitors a site attracted, the more money it lost. They note that the "foundation of long-term profitability is lifetime customer value: the revenue customers generate over their lives, less the cost of acquiring, converting, and retaining them." They found that during the first half of 1999, fewer than 4.5% of visitors to a website actually bought anything and fewer than 10% of those who did buy came back to make additional purchases. It cost more than $1,100, on average, to acquire a customer who would spend about $400. Things did get better during the second half of 1999, but not by very much. It still cost on average $800 to acquire a customer who would spend only about $400.

Agrawal, Arjona, and Lemmens (2001) contend that to be successful in e-commerce a firm must focus on the costs of attracting, converting and retaining customers. Firms should not go spending crazy in the hope of attracting visitors to a website. Many of the deals involving placing banner ads on portal sites such as Yahoo made no economic sense. The cost per customer (and even the cost per visitor) was just too high. According to the authors, e-mail campaigns targeted to segments with known online purchase patterns are far more likely to produce profitable customers than banner advertisements on portals. In addition, paying other websites a fixed amount, say $5 or $10 per individual who clicks through an advertisement and makes a purchase make much more sense than costly advertising campaigns.

Conversion rates range from .4% to 12% and it is crucial to do everything to ensure that a visitor will be converted from a viewer to a buyer. This requires making the purchase process user-friendly, providing "call me now" buttons and live on-line customer support, assuring customers of the safety of their online transactions by using independent watchdogs (e.g., TRUSTe), and contacting customers who abandon their shopping carts before concluding their purchase. A simple method for improving retention is to deliver orders on time and to promptly answer any customer queries.

One of the most important and widely accepted marketing concepts is relationship marketing. It considers buyers and sellers as partners, and the relationship promotes long-term growth for the company and maximum satisfaction for the customer. Thus, many customer-oriented firms place a higher priority on building relationships with current customers than on developing new markets. Loyal customers tend to spend more when shopping, bring in new customers, provide information to the firm, and provide assistance to other customers with regard to installation, use, repair and maintenance of the product. Loyal customers also become an entry barrier against startup dot-coms. Flourishing sites such as AOL, iVillage, MSN, Yahoo, and Amazon.com have successfully developed web communities. They try to enhance their relationship with customers and those between customers using personalized homepages, chat rooms, instant message boards, contests and sweepstakes, and other activities. In fact, more than 70% of Amazon.com sales is generated by repeat customers.

Green, Sharpe, and Weintraub (2001) write that one important lesson that can be learned from the dot-com fiasco was not to rely on a single-revenue source. For instance, dot-coms that relied solely on advertising for their revenues were hit hard when this source of revenue shrank dramatically. In 1999, companies spent $4.6 billion on online advertising (Levins 2000). However, a huge number of sites all competing for the same advertising dollars diluted each one’s advertising revenue. In addition, advertisements are concentrated on well-known sites. Go and Excite went out of business because the top three portals AOL, MSN, and Yahoo dominate both traffic and advertising revenue. Smaller dot-coms that relied too heavily on selling advertising space were destined to go bust (Hayward 2001).

There are four ways to generate income: selling products/services, selling advertising, selling information about customers, and through subscriptions. The way to succeed on the Web is to diversify and have several revenue sources. Homestore.com, for example, which provides lists of available homes and rental apartments, makes money from advertising, listing fees charged to real estate agents, and from selling software to realtors. The comparison shopping sites such as MySimon generate revenues from selling banner advertisements, charging for prominent placement, and from sales commissions.

Agrawal, Arjona, and Lemmens (2001) note that the successful dot-coms had good websites, i.e., sites that were easy to use and encouraged customers to come back. The key to successful e-commerce is customer retention and this requires a reliable, trustworthy, and helpful site. Successful sites encourage retention and conversion by personalization. Intelligent agents such as collaborative filtering are employed to promote additional products that customers might be interested in based on past purchases, or purchases of customers with similar preferences. Needless to say, sites that retained customers responded quickly and competently to customer queries and delivered more than 95% of orders on time. These companies also made it easy for customers to return products if they were not satisfied.

The Vividence (2001) study entitled "Tangled Web 2001" demonstrated that the websites of 69 major companies had problems. Key problems to avoid are the following:

(1) Poorly organized search results including erroneous results or too many results.

(2) Shoddy information architecture such as poor grouping of information and inconsistent elements within a group.

(3) Slow performance

(4) Cluttered home pages

(5) Confusing labels and terminology

(6) Invasive registration procedure including asking for too much information.

(7) Inconsistent navigation

Ubid, a consumer electronics auction site, increased sales from $48 million in 1998 to $313 million in 2000 (Tillett 2001). One of the reasons for success is a constant upgrading of their website. The company is enhancing it with more product information, product comparison tools, and educational videos. They will spend $5 million to add the personalized features (Tillett 2001). They also know performance is critical. Greg Jones, CEO of Ubid, says customers want the site to be fast, focused, and easy to find what they need.

To succeed on the Web, a firm should do the following:

• Spend money carefully. Every penny is valuable. Even if funds were provided by a venture capital firm or by IPO, they should not be treated like "other people’s money." Expect the unexpected. Any startup business is vulnerable, and management should put aside some cash in order to be able to sustain losses for the first few years.
• Test its business model as it expands slowly and carefully; not expand to numerous markets simultaneously with an untested business model. In general, successful dot-coms are niche businesses. Tesco.com started with a small territory. Ubid.com handles only consumer electronics. iVillage.com targets only women. Amazon.com and eBay are rather exceptions. Do not try to mimic them. A firm should expand only after proving there is enough demand and its business model works flawlessly.
• Diversify and have several revenue sources. A firm cannot solely depend on advertising revenue. It is also very difficult to survive without charging for services such as shipping and handling. Establish a solid revenue base.
• Make sure there is something unique about its product/service — either in terms of price, quality, or convenience. A firm should find out why customers visit its site. Does it sell something others do not? Is it cheaper than anyone else’s? Does it provide valuable information? Is it fun to browse the homepage? Ideally, a site needs to have something distinctive.
• Focus on the costs of attracting, converting, and retaining customers. The main measure to be considered is lifetime customer value. Relationship, relationship, relationship. A firm should develop a community and always give its customers a reason to come back.
• Be customer-oriented. Have a website that downloads efficiently and is frequently updated. Ordered products should be delivered quickly. Customer complaints should be taken seriously and dealt with sincerely and honestly. Make it easy for customers to return products with which they are not satisfied. Serve customers the way you would like to be treated.

There are no guarantees in business but the dot-coms made numerous mistakes that guaranteed that they were heading down a very dangerous path. Avoiding the mistakes made by the dot-bombs should at least give a firm a fighting chance of becoming an e-commerce success rather than another dot-com disaster story.