Special Report: The powers that be: VC's new marching orders

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Dot-coms are reeling, but VCs are still dealing. Venture capitalists--who financed dot-coms' ill-fated marketing free-for-all--are plowing record amounts of cash into Internet start-ups. Most of the money is going into focused business-to-business plays, with VCs in triage mode on last year's marauding but now maimed b-to-cs. VCs still will pay for marketing, but the overlords are scrutinizing plans, demanding results and not thinking twice about stepping in with advice. It doesn't take a flashy Boo.com blowup for dot-coms and their sponsors to get spooked by the skittish yet hard-charging Internet economy. Apparel e-tailer Boo.com gave up the ghost in May, shutting down after burning through $135 million in capital--all before its first birthday.


Across the board, all dot-coms--business-to-consumer and business-to-business--are under increasing pressure to boost revenue, turn a profit and kick their lavish spending habits. The Internet tsunami that catapulted tech-heads into the multimillionaire ranks the day of a start-up's stock sale has since swept many under water. As dot-coms march toward the all-important fourth quarter and hunker down to focus on financials, ad and marketing spending is being scrutinized more than ever by VCs and other investors, as well as by chastened dot-com executives. Analysts, VCs and dot-com CEOs agree traditional ad spending will decrease as start-ups look to get more bang for their buck with interactive advertising and promotions, along with viral or word-of-mouth, direct and e-mail marketing. All are less costly and perceived as being more targeted. "Last fourth quarter was insane," says Felicia Lindau, founder and chairman of Sparks.com, a greeting card e-tailer and gift certificate site. "Every single start-up that barely had any money spent a lot of money." Outright landgrabs by dot-com start-ups are just about over, VCs say, thanks to the stock market shakeout that started in March, culminating April 4 with a 575-point drop of the Nasdaq Composite Index. The dot-com graveyard is littered with the remains of ventures such as Toysmart.com, the Walt Disney Co.-controlled e-tailer; APBNews.com, the crime news service; and Petstore.com, acquired by rival Pets.com last month. Dozens more have crashed and more flameouts are to come. Even so, record dollars are pouring into VC coffers to fund Internet start-ups and give established Net companies additional capital.


For the first quarter, VCs raised $9.8 billion--double what was raised during the same period last year, according to VentureOne, a San Francisco-based market researcher. VCs and Wall Street analysts estimated that number could grow to $20 billion by year's end. While that would be a record, the reality is money flowing into VCs has slowed significantly since the spring stock slump. With that, the landscape is forever changed for Internet start-ups. "Regardless of whether a company is pre- or post-IPO, there are two catchphrases: `path-to-profitability' and `cash conservation.' These are the new mantras of the dot-com CEO," says Rich LeFurgy, general partner of WaldenVC and chairman of the Internet Advertising Bureau. Just months ago, he notes, it was " `get as big as fast as you can,' both in employees and in terms of registered users." The profound shift is not lost on Sparks.com's Ms. Lindau. "The market got smarter," she says. "Now `get big fast' means [generating] revenue. . . . The time horizon is based on what the market is valuing' and now it's based on profitability."


Today, start-ups are expected to reach profitability within two to four years, some VCs say. Sparks.com this summer completed its fourth round of funding, an undisclosed amount said to be in the double-digit millions, from four VCs including Benchmark Capital and Venture Strategy Partners. Sparks will focus marketing dollars on e-mail and affiliate marketing to support a recently launched partnership with AmericanGreetings.com, American Greetings Corp.'s online arm. "That deal probably drives more impression levels than we would have gotten out of a media buy," says Lizzie Nichols, VP-marketing. In 1999, Ms. Nichols made targeted interactive buys on prominent women's sites and search engines, and tested TV just prior to the fourth quarter. "The prices of media went up because of the demand, and we actually didn't have a budget that would break through the clutter," she says. Sparks.com spent $306,000 last year on offline ads, Competitive Media Reporting estimates.


Ms. Nichols declined to specify Sparks.com's marketing budget, but projects the company will spend 50% less on marketing this year than last. In a cost-cutting move, Sparks.com earlier this year laid off 14 people; it now has about 50 employees. Even before the dot-com meltdown, Ms. Nichols and Ms. Lindau received plenty of advice from at least one of their VCs, Joanna Rees Gallanter, founder and managing partner of Venture Strategy. Ms. Rees Gallanter, who sits on the Sparks.com board, voiced caution before last year's dot-com advertising frenzy took off. "She told us it was coming and that we're very shortly going to see a return to traditional fundamentals," Ms. Lindau says. "We were able to sharpen our strategies for last fourth quarter so that we did not do what most companies did . . . shoot a wad of money." Hundreds of dot-coms last year threw newly minted VC money at ad agencies to create instant campaigns that would presumably create brand awareness overnight. "The VCs were driving expenditures. Now they're driving to cut them off," says Ms. Rees Gallanter.


Not only are VCs more cautious about start-ups' marketing expenditures, they also are more interested in funding b-to-b companies that create technologies to enable the Internet. Such investments include software, services and hardware related to Internet security, customer support and Web-site management. These b-to-b companies spend money on marketing, but not with the out-of-sight budgets of last year's consumer plays. "[VCs] are saying, `No longer are we giving money to the gold miners, but to the picks and shovels. . . . Let's create the tools that these companies (on the Internet) will need to sustain and build the customer base,' " says Ms. Rees Gallanter. Venture Strategy's last b-to-c investment was eStyle.com in May 1999, she says. "We're open to great b-to-c opportunities, but the business has to have underlying fundamentals and economics that work and that scale."


Venture Strategy's earlier b-to-c investments include Flooz.com. "Our companies, in general, have not spent a significant amount on mass advertising," Ms. Rees Gallanter says. "We back businesses where the teams have a good basic understanding of how to build value without a lot of advertising." Flooz, an online gift-certificate service, spent $3.5 million last year and $2.7 million in the first quarter of this year on offline ads, CMR estimates. Ms. Rees Gallanter maintains dot-coms will look for more targeted, one-to-one and personalized methods of permission marketing to reach their audiences more efficiently. That could be "any closed-loop way of understanding the impact of a marketing campaign," allowing dot-coms to closely track the effectiveness of a marketing effort. Snowball.com, a network of online communities such as ChickClick (www.chickclick.com), a site for 13-to-30-year-old women, and ign.com, a male-targeted amalgamation of entertainment content, is an example of a dot-com that's harnessed its business model to decrease dependence on traditional advertising.


Essentially a network of networks, Snowball doesn't have enormous costs to acquire customers and to lure new eyeballs to its site because every new content partner that joins one of its networks brings new customers and page views. "Our challenge is to do cross-network marketing," says Teresa Crummett, VP-marketing. Snowball went public March 20: "We were considered the last b-to-c to get out in the marketplace. . . . Many [IPOs] were canceled," Ms. Crummett recalls. So far, however, the stock has been an avalanche: Snowball last week traded below $3 a share, 86% off its post-IPO peak. Snowball ran a spring cable TV and radio campaign via Stein Rogan & Partners, New York, and has done online ads with in-house creative placed by Avenue A, Seattle. Ms. Crummett says Snowball--with a $15 million to $20 million marketing budget, the majority of that for online advertising--will get back to print advertising and e-mail newsletters. "We're a content company. Year-round we have interest." Ms. Crummett adds: "The fourth quarter is going to be a make-or-break (period) for many companies, and I think there'll be somewhat of a pullback" in dot-com advertising. Of course, more than a few pundits have predicted Christmas is make-or-break time, at least for e-tailers. It is difficult to pinpoint how much VC money will find its way into marketing on a line-item budget, say VCs and the executives whose start-ups they help fund. To begin with, each dot-com start-up has different needs and target audiences.


"For many of these companies, the marketing budget is a huge part of their total spend, and they are strategizing more now about how they spend their money," says Steve Jurvetson, managing director and partner of VC firm Draper Fisher Jurvetson. "There are some companies for which brand awareness is very important. For others, it's evangelizing a category." B-to-c dot-coms' quarterly spending on sales and marketing as a percentage of revenue has averaged 73.5% this year, according to data from a study done by Pegasus Research International for Advertising Age (see story, Page s-4). That's down from 87.8% last year, but that's still a big number. "There's been so much spent on marketing," says Murray Alter, a partner with Pricewaterhouse-Coopers. "It's an issue for all start-ups--consumer and b-to-b. . . . It's a dark hole, sort of a money pit. VCs want to see how the money is spent." B-to-c companies are adapting to a tougher capital market by cutting back. BizRate.com, for example, spent $10 million on advertising as a start-up last year and intended to spend $40 million this year--until the stock market pullback. The privately owned company now is making do with money raised before the market drop and has slashed its planned 2000 ad budget to $20 million. VCs are trying to advise their start-ups and many times leading them to consultants and experts who can help them creatively conserve cash. "We have had conversations with [our start-ups] about what to expect going forward and how to stretch out their cash position," Mr. Jurvetson says. Since the market pullback, "We've been having sit-down sessions to brainstorm alternative marketing techniques, such as investing on the development side rather than turning on the marketing dollars . . . and on doing more viral marketing."


Mr. Jurvetson cited InfoRocket.com, a question-and-answer site, and NetZero, a free ISP, as two start-ups that Draper is advising on "ways to be creative about their media, to go where others aren't, look for interesting opportunities." For example, he says, the two companies found the student population and its media were neglected. Another VC firm, El Dorado Ventures, was the first investor in Women.com Networks. The female-oriented property is not profitable--with a net loss of $16.6 million on revenue of $12.3 million in the second quarter--but its backer contends the start-up is moving in the right direction. "They've grown the business successfully. They have enough users and they're generating significant revenues off their users," says Charles Beeler, El Dorado's general partner. Wall Street is less enamored; the stock last week traded at $4.50, down 81% from its post-IPO fall '99 peak. El Dorado, like most VCs, is investing the bulk of its money in b-to-b Internet infrastructure deals, around 50% to 60%. About 30% goes to communications start-ups and 10% to 20% to b-to-c and "other." "When we fund a company, we expect that they'll lose money for two to three years," Mr. Beeler says. "We hope the losses will be containable, but (in) most of the business models that you see on the b-to-c side, there's no point in time when the switch flips. "We're continuing to look at b-to-c opportunities if they're interesting, but there is a level of triage here," he adds.


The bottom line? There's money out there. Just don't count on it being plowed into big-bucks consumer ad campaigns. "Any b-to-c company will be hard-pressed to get an infusion of new capital through the balance of this year," says Ms. Rees Gallanter. "Money will be thrown into marketing vehicles where there'll be tangible results."1

Copyright August 2000, Crain Communications Inc.

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