Idealab Rethinks Its Formula in Wake of ‘Dot-Com’ Downturn

Pasadena-based Idealab built itself into one of the major hubs of Internet entrepreneurship by churning out companies such as online toy retailer EToys, Internet search firm Goto.com and online city guide and local services provider Ticketmaster Online-CitySearch.

But now the original Net business incubator has become a victim of the industrywide downturn that has sent stock prices crashing and made the public leery of anything that ends in “dot-com.”

Last month, 4 1/2-year-old Idealab was forced to withdraw a plan to raise as much as $300 million in an initial public stock offering and shut down two of its offspring companies. None of the approximately 50 companies in its portfolio will turn a profit until next year at the earliest.

Now Idealab, along with most other players in the Net economy, is fighting a difficult battle to win back credibility with the business community.

In his glass-walled office inside a brightly painted converted warehouse, Idealab Chairman Bill Gross, 42, discussed the road ahead with The Cutting Edge.

Q: Your IPO is off the table for now, the stock market is turning its back on most Internet companies and people are getting sick of incubators. Is Idealab back at square one?

A: I don’t feel this is a period of starting over for Idealab. It’s an evolution to more quickly profitable companies. That’s what the market is demanding, and those are the kinds of companies that we have to make.

Q: There are all kinds of rumors swirling about Idealab right now. There’s one rumor that you’re scaling back to only five companies and that Idealab could run out of money as early as February. I’m sure the decision to pull the IPO made some people believe it could be true. Is it?

A: We come up with approximately 10 to 20 new ideas a month, of which we’ll fund four or five, of which we’ll take one or two to outside investors. We plan to continue to make at least one company a month probably for at least the next five years. We have $330 million, and our burn rate is about $6.5 million a month. So we have enough money to continue building new companies for a very long time.

Q: Does the way the market is behaving suggest to you that the whole concept of an Internet business incubator is a proven failure?

A: Probably 80% of new businesses fail. Probably that same percentage will apply to incubators because they’re just businesses. Our business is building companies, and our success at doing that is solely based on the strength of our ideas and the quality of talent we have to help make those companies successful.

Q: But it sounds like you’re backing away from the word “incubator” the way the Democrats have retreated from the word “liberal.”

A: The only reason I would back away from the word “incubator” is because other people are calling themselves incubators, and they’re not doing what we do. I feel it’s overly simplistic to ascribe one word to the whole process of what we do to build companies.

Q: What kind of revisions are going on with business plans at Idealab companies? Is it just a matter of slashing costs?

A: Cutting costs is one part of it. Another part is slowing growth. The market was previously saying, “Grow as fast as you can, I don’t care if it takes longer [to turn a profit].” Now the market is telling companies, “I care more about profits, so slow your growth to get profitable sooner.” Slowing your growth sometimes means just changing your marketing budget. Sometimes it means changing your whole cost structure--employees and everything.

Q: Can you give me an example of an Idealab company that is in the process of adjusting so that it can become profitable?

A: Yes. When Z.com was started as a company to make original programming to be viewed on the Web, the goal was to grow as fast as possible. That meant growing the amount of production capability, the number of shows, the amount of traffic and the revenues. We wanted them all to grow as fast as possible. But the funding realities of the marketplace have changed to say, “Prove that you can become profitable first and then grow.” So we changed the order of our priorities. Z.com scaled back the amount of shows and scaled back the amount of people by approximately a factor of two. We’re giving the company a chance to build to profitability in 2001, as contrasted with building a larger company that wouldn’t be profitable until 2002. That’s the trade-off that businesses have to make.

Q: Some of the Idealab companies have not been able to make that transition. For instance, online cosmetics store Eve.com closed down, as did Scout Electromedia.

A: Eve’s closing is a very interesting story. It’s about how much cash is required to get to profitability and what the trade-offs are. We set out to build a business in the beauty area, and our goal was to make it the No. 1 company in that space. We succeeded in doing that, and the site was doing about $1 million a month. It’s not that the company has fundamentals that don’t allow it to get profitable. This was a case where the company clearly could get profitable. The problem in this climate is that no one is willing to fund the company. The return on investment is not as good as with other alternatives.

Q: Was Scout the same kind of situation? They had already built Modo, a wireless device with local entertainment listings.

A: Scout is a situation where the company did not have any proof of profitability. It was too early in the company’s history, and the money-raising climate for a company that didn’t have proof of profitability yet was impossible.

Q: Do you think there will be more closures?

A: We feel that all the companies in our portfolio now are in a very strong position. Either they have enough cash to get to profitability, or they are just about to close financing to get to profitability. I don’t see any closures right now.

Q: Let’s talk about some of the new ideas that Idealab has in the works. What are some of your favorites?

A: We have a new company called Mybiz which is building out a Web-based solution for small-to-medium businesses to improve their customer relationships. It allows them to track who their customers are, build mailing lists with them, communicate with them and transact with them.

Another company we’re making is called DesktopTV. This is a new business that allows us to deliver a small television player on your computer screen that uses a peer-to-peer technology like Napster to solve the problem of getting multiple channels over a limited bandwidth connection.

Q: Are any of your companies going to be profitable soon?

A: Yes.

Q: How soon?

A: I believe we’ll have about five Idealab companies that are profitable in early to mid-2001.

Q: Which ones?

A: We’re not at liberty to detail that information. The companies make their own announcements about profitability projections.

Q: Will you have to raise more money from private investors before you try again for an IPO?

A: I don’t believe so.

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Times staff writer Karen Kaplan can be reached at karen.kaplan@latimes.com.