Small Dot-Coms Thrive While Industry Giants Melt Down

Beneath the chaotic dot-com busts of the last half-year, an overlooked breed of Internet companies--mostly small and nimble--is thriving.

They have no public stock, no Super Bowl commercials, no million-dollar product-launch parties, and no naming contracts with professional sports stadiums. Their small size has allowed many to weather a storm that has quickly taken down hugely stupid, profligate and unlucky Internet firms.

This year’s grim portrait of the Internet economy has largely been painted by big-money Wall Street nose dives, such as those by Priceline.com, Drkoop.com and EToys.

By contrast, the mundane dot-com survivors are small operations with few employees that have trudged along, slowly but steadily, in a parallel universe that more closely resembles the so-called Old Economy.

While the destruction of companies is undeniably commonplace, the creation and re-creation of companies is even more common, fueling a kind of roiling mix that is building the foundation of the Internet economy.

A survey this month by Challenger, Gray & Christmas Inc., a Chicago outplacement consulting firm, found that more than 16,000 dot-com workers have been laid off since December. But the U.S. Bureau of Labor Statistics estimates that the job category largely made up of Internet positions grew by nearly 11,000 jobs over the same period.

Signs of Experimentation

While dozens of dot-coms have gone under in the past six months, they represent a mere fraction of the nearly 3,000 Internet companies created so far this year, according to government estimates.

Hal Varian, the dean of UC Berkeley’s School of Information Management, said these are not signs of disaster but of experimentation. They mirror the tumultuous era of a century ago, when the auto industry was made up of hundreds of start-ups eager to capitalize on the new technology of the car. Only a few of them survive today.

“This is the dot-com primordial soup,” Varian said.

Even if eight out of 10 dot-coms failed, that simply would mirror the failure rate for traditional brick-and-mortar companies, Varian said.

Signs of continued growth abound. Venture capital is pouring into dot-coms about twice as fast as it did last year. Spending on Internet advertising is up, revenues are up industrywide, and the productivity of online workers is soaring, according to recent economic studies.

One dot-com chief executive said prospective employees are just as arrogant as ever, demanding exorbitant pay and even stock options for internships. And in Los Angeles, the local dot-com baseball league has been bursting with new teams.

Companies such as Theglobe.com--a Web portal that gives away free home pages and saw its stock jump 606% in a record-breaking IPO--and Drkoop.com--which had a market capitalization of more than $1.5 billion last year, despite waves of red ink--came to symbolize dot-com mania at the height of last year’s frenzy.

The high fliers were driven by a risky strategy fueled by record amounts of venture capital and the widely accepted belief that it was critical to grab as big a share of the market as possible, no matter what the cost.

That approach normally would bring a quick death to any business. But the tens of billions of dollars that poured in from venture capitalists created a sense that there was always more money available. According to the National Venture Capital Assn., nearly $40 billion was invested last year in just 2,318 Internet companies--an average of $17 million each.

In reality, the vast majority of Internet companies have never seen a drop of venture capital or had a public stock offering. Of the about 10,000 dot-coms in the United States, fewer than 500 have publicly traded stock. Only a quarter have received venture-capital money, depending instead on money from more patient private investors, their own checkbooks and credit cards or--remarkably--company revenues.

Many companies, such as NewsFactor Network in Sherman Oaks, turned down offers from venture capitalists who favored free-spending business plans over good old-fashioned money-making.

“Some said, ‘We need to see red ink,’ ” said Richard Kern, NewsFactors co-founder. “I told them, ‘We’re just not comfortable writing a business plan like that.’ Rule No. 1 around here is that revenues must exceed expenses.”

His company publishes trade magazines on the Web, such as E-Commerce and Linux Insider.

In many ways, these dot-coms resemble the endless array of small shops that cover Los Angeles, selling fast-food chicken, cheap jewelry and cut-rate shoes. The shops have managed to survive defense-spending cutbacks, recessions and riots that easily took down some of the giants of Southern California industry. Their dot-com brethren aim to do the same thing.

Jamie Korody turned her idea for a coupon-clipping Web site into a profitable business by keeping expenses low. Korody is the only full-time employee of Eclip.com, which operates out of her Santa Monica garage.

Her husband’s company, which specializes in planning meetings, paid for Eclip.com’s Internet service and some outside Web design work when she started her venture in 1997. But the total expenses for the company were small, only about $800 a month. It took her 1 1/2 years to make a profit, but Eclip.com hasn’t lost money since.

This year, Korody figures that beyond her own salary, which varies between $75,000 and $125,000 a year, she will make a few tens of thousands of dollars on sales of about $300,000. While it is a small enterprise, the bottom-line results shame the likes of Steven Spielberg’s Pop.com, a high-profile Web entertainment venture that lost $9 million in a year.

Revenues Are Growing

Very few dot-coms are making money, but they are increasing their sales at a pace that belies the apocalyptic predictions from Wall Street.

A University of Texas study released this summer found that revenue at Internet-related companies in the United States jumped 62% last year, to $524 billion. Researchers Anitesh Barua and Andrew Whinston estimated that total revenue will surpass $850 billion this year, more than in the auto and truck industry ($728 billion) and the life insurance industry ($724 billion).

That’s not to say that dot-coms have been unaffected by the downturn in technology markets that began this spring. But in some cases, the result has actually been quite positive.

Bluefire Systems founder Kevin Katari said that while the rest of the world was writing off the Internet economy, his San Francisco-based start-up, which makes Internet-based inventory management software, was on its way to generating millions in sales and breaking even in its first year.

“We saw it as an opportunity,” said Katari, Bluefire’s chief operating officer. “The rent in San Francisco is ridiculous. . . . If a little bit of a slowdown could make some of those problems better, that’s a good deal for us.”

Even small dot-coms, however, are not immune to trouble. Because online businesses are easy to start, bad ideas are rampant and good ideas often face numerous competitors.

“We now know we don’t need 10 pet stores on the Net,” said Robert F. Foster, executive director of the Center for Management in the Information Economy at UCLA’s Anderson graduate school of management.

As in the early days of the auto industry, the Internet is ripe for a weeding out of weak dot-coms.

But many executives at small dot-coms say the weeding process ultimately favors the small and self-reliant--those that can survive on revenue and profits instead of outside investment dollars.

“Lots of Internet companies live hooked up to respirators--if they weren’t hooked up to the respirator, they’d die,” said Katari of Bluefire Systems. “But we’re not hooked up to a respirator. If someone switches off the electricity, that doesn’t bother me.”