At Idealab, Rewards Outweigh the Risks

Internet start-up factory Idealab is celebrated for turning inspirations into corporations, sometimes in mere weeks. In the four years since entrepreneur Bill Gross founded Idealab in a Pasadena warehouse, five of its offspring have become national symbols of sudden Internet stock wealth.

The success of online retailer EToys, Web search engine firm GoTo.com, free Internet service provider NetZero, Ticketmaster Online-CitySearch and Tickets.com, have pushed Gross and Idealab into celebrity status. Even after some recent declines, the combined stock of this quintet of Idealab businesses is worth more than $10 billion.

But Idealab has created nearly 30 companies--and some of its ideas have completely failed. Idealab quietly pulled the plug on four companies, IdeaMarket, Answers.com, FeatureCast and EntertainNet, and a handful of others have struggled for years to stay alive.

“Even though [Idealab] has a lot of smart people there and potentially a lot of good ideas, they’re never going to have a 100% success rate--or even 50%,” said Tim Bajarin, an industry analyst with Creative Strategies in Campbell, Calif. “They only have two or three companies at any given time that are going to make it out the door” and into a successful public stock offering.

A closer look at three of Idealab’s earliest ventures--kids’ bartering site Swap.com, online communications software maker PeopleLink, and free intranet firm Intranets.com--reveals much about the perils of trying to create a hot Internet company. Each firm has spent years searching for a successful formula to follow its siblings to big wealth on Wall Street.

None has suffered more than Swap.com, which has gone through four different business plans, layoffs, executive turnover and three name changes.

The company began as Learning.Net, founded by Gross along with movie mogul and early Idealab investor, Steven Spielberg. Their plan was to create an educational Web site with reading and math exercises. By early 1998, the company planned to merge with a Philadelphia firm called Electric Schoolhouse, which had a similar Web site for use in schools. Getting schools to buy their product proved difficult, however, so the deal fell through and Learning.Net’s staff was reduced to one.

But Gross, who became rich by founding educational software maker Knowledge Adventure, was determined to harness the Net for the good of education. Learning.Net then metamorphosed into Kids Online, a subscription Internet service patterned after America Online with special youth-oriented content and safety features to prevent children from viewing pornographic and other Web sites. With financial backing from Gross, the staff climbed back to 10 and within four months the company was testing prototypes of its subscription service.

“We found out that [although] parents are concerned about their children’s safety on the Internet, they’re not really willing to pay for it,” said Steve Damron, who was Kids Online’s chief executive.

In search of a new business idea, Damron and his colleagues visited chat rooms and talked to kids about what they liked to do online. Shopping was the answer, but kids had no way to pay for goods they wanted to buy. So Kids Online retooled itself again as a site for kids to keep track of their allowance, convert it into e-cash, and spend it online with their parents’ permission.

Though Gross backed the switch, many Kids Online employees didn’t. Some of them were used to working in big companies, and they were jarred by the sudden change in strategy. Those who signed on with the company because of its educational mission couldn’t stomach the shift to naked commerce.

With the help of Idealab’s engineering staff, the remaining Kids Online employees launched a prototype for the allowance Web site. It showed potential, but it also faced competition from three more established sites. So Kids Online decided it was time for a change--again.

The company would still run an e-commerce site for kids. But this time the currency on their site would be toys, CDs, video games, Pokemon cards, anything that kids would be willing to trade. In October, Kids Online turned down money from venture capitalists who were interested in the allowance business, changed its name to Swap.com, and began building a new Web site.

Every one of the remaining 15 employees stayed on through the transition. Several new people were hired, including former E! Entertainment Television Chief Financial Officer Bill Keenan, who took over as CEO. Keenan expects Swap.com to finally move its operation out of the Idealab incubator and into its own offices by summer, with an IPO further down the road.

If so, that will make up for feelings of resentment among Swap.com employees who watched other Idealab companies leave the nest quickly and go public.

“There’s some jealousy,” said Damron, who now vets new business ideas as an Idealab executive producer. “You love to see other companies be successful, but there’s also a little bit of rivalry about ‘My company got bigger faster.’ I had people [at Kids Online] in their 20s and 30s who were wondering why they’re not millionaires yet.”

Another idea that began with great expectations was PeopleLink.

The Santa Monica company was launched in 1996 by Steve Glenn with backing from Gross. Glenn, who previously worked on virtual reality projects at Walt Disney Imagineering, wanted PeopleLink to create a suite of services such as online chat, instant messaging and bulletin board discussion groups. Glenn planned to market the services to community-oriented Web sites run by groups such as the Sierra Club and college alumni associations. PeopleLink even developed a service to allow online correspondents to talk on the phone without revealing their phone numbers.

But customers were slow to buy the services, and PeopleLink and its nine employees were living on corporate loans. Glenn even missed payroll once. Then AT&T; offered to invest $2 million in the company on the condition that it focus exclusively on instant messaging on the Internet, Glenn said. PeopleLink took the money.

Unfortunately, America Online made its instant messaging service--already hugely popular on its proprietary AOL system--available on the Net. So PeopleLink abandoned the instant messaging software it was developing and bought other technology to get its own instant messaging service to market faster.

But it was no use. For the next year and a half, PeopleLink was stuck in third place behind America Online and ICQ, an Israeli company that AOL later acquired. “AOL and ICQ were on the market eight months before us, and we couldn’t catch up,” Glenn said.

In the meantime, Glenn began to lose some workers who jumped to more promising firms. “It became difficult to run this business when it was clear we were getting killed in the marketplace,” Glenn said.

By 1998, Glenn convinced his board of directors that PeopleLink had to return to its original business plan of producing online communications software that could be sold to Web sites.

So PeopleLink introduced its new e-mail discussion group service in 1998. Other services followed throughout 1999. The company has signed up clients such as IVillage.com, MTV Online and StarMedia. Now PeopleLink has 62 employees and monthly revenue has climbed above $100,000. This week, PeopleLink expects to close a $30-million-plus round of financing and Glenn thinks the company can finally go public in the next year.

Intranets.com, a Woburn, Mass., Idealab firm run by Steve Crummey, also took a long time to settle on the right product.

Crummey, a software veteran from Lotus Development, met Gross in 1986 when Lotus bought GNP Development, an accounting software company that Gross and his brother Larry created. A decade later, Gross called Crummey and asked him to lead a new firm called Intranetics to create software for running intranets, the internal corporate computer networks that operate like the Web.

Like Crummey, much of Intranetics’ management team came from Lotus, a traditional software developer. So Intranetics spent a year developing its first software product and sold it on CD-ROMs in retail stores. The company released a second version a year later, but it took two years for Intranetics’ to land 500 corporate customers. Crummey was frustrated.

In retrospect, Intranetics acted too much like an old-style company that spent too long developing products and sold them in conventional retail stores, instead of offering them as a service on the Web.

“The greatest gold rush in [American] history was happening, and we weren’t playing in it,” Crummey said. “I went to Bill [Gross] on Memorial Day last year and said, ‘What we’re doing isn’t working.’ ”

So Gross flew the entire Intranetics management team to Pasadena, where for two long days they and Idealab’s staff worked on a different plan to make its software available for free on the Web. That meant the company could offer a service instead of just a product. The re-christened Intranets.com would try to make its money through advertisements placed on its customers’ intranets.

When he returned to the company with this new plan, Crummey instantly killed a third version of the Intranetics software.

He also laid off 15 of 40 employees who didn’t fit with the company’s new mission. Many who stayed were also suspicious of the new plan to create an Internet service. But the entire technical staff stayed on, and the service was ready in two months.

By then, Intranets.com had 10,000 customers who preregistered on its Web site. Six months later, the company has more than 100,000 customers, and the intranets hosted by Intranets.com are viewed for 3 million minutes each week.

Crummey won’t discuss ad revenue, but he says the firm’s losses are narrowing. After 2 1/2 years of struggling, Intranets recently raised $20 million in another round of private financing and is looking to go public by year-end.

“If we had stayed with the old model, there was bankruptcy in our future,” Crummey said.

“We’re going to have failures,” said Idealab Vice Chairman Bob Kavner. “Otherwise, we’re probably not taking enough risk.”