Winners and lots of losers

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REPORTS that Spotify’s CEO Daniel Ek is attempting to get a valuation of around £200 million in order to attract investment of between £20 and £30 million once again raises questions about online profitability.

Some 10 years since the internet began coming into our homes in earnest, and there is still something of the Yukon gold rush about online business, with otherwise sensible individuals still willing to invest substantial proportions of their fortunes on ventures that rarely if ever have to submit to the kind of strict due diligence and risk assessments that investors would otherwise ask for.

Despite the spectacular collapse of the dotcom bubble some eight years ago, the list of investors who have lost money in similar ways is long and distinguished, and features some of the UK’s best known and most respected entrepreneurs, including members of Dragon’s Den.

There have been success stories, too. Along with Google (which requires no fleshing out of its historical background), various Stanford and Harvard alumni have gone on to become richer than Croesus, predominantly through the development of search engine software or through the creation of social media and other, associated Web 2.0 applications.

It’s perhaps the scent of possibility that causes investors to abandon their usual cautious procedures and produce a cheque on the spot. There is good precedent for this, not least Michael Moritz, the Cardiff-born venture capitalist based in California and reported by The Sunday Times to be worth £558 million. His investments read like a what’s-what of IT giants: Google, Yahoo!, PayPal, Apple Computer, Cisco, and YouTube. He is rightly regarded as the sector’s Warren Buffett, a bellwether whose nod can take an individual business’ share prices into the atmosphere.

But he is the first to admit that he has invested in some disasters, too. Some big disasters, including eToys.com and Webvan. eToys, an e-commerce site that allowed users to buy toys and have them delivered, went from a high of $76 a share in 1999, when the company was valued at $8 billion, to chapter 11 bankruptcy just two years later. If anything, Webvan was worse, and was hailed last year by CNET as one of the greatest dotcom disasters in history. An online grocery delivery service started up by Borders bookstore founder Louis Borders, it operated in 10 US cities at its peak. However, it was its investors’ advice that did for the venture. They advised the company to spend heavily in infrastructure in order to maximise on the kind of first-mover advantage pioneered by Amazon.com. It over-stretched itself and ran out of money.

While it’s unlikely (particularly in light of the near-Galaxian collapses of motor companies and major financial institutions) that we will see online bankruptcies of such scale again, the old saying that investing and running a business is like walking backwards into a storm in the dark describes almost perfectly the world of online venture. Comparing like-for-like and looking for trends is often close to impossible because it remains – still – such new territory.

Where the best businesses have succeeded, such as eBay, they have changed the way we live. But even Facebook, the very modern description of an internet success story, is not believed to be the cash cow that Google is. Founder Mark Zuckerberg won’t be drawn on its turnover, and has only sold very small parcels of shares despite repeated approaches from the goliaths (Microsoft bought 1.6% of the business at a cost of $240 million, suggesting the site is valued at $15 billion). He has also said: “I don’t think social networks can be monetized in the same way that search did. In three years from now we have to figure out what the optimum model is.”

There are other issues. Since Microsoft, the big players base part of their strategy on crowding everyone else out of the market. So, for example, Google spends huge amounts of money in developing open source software, which it is able to give away as part of its search engine package. This has the dual benefit of providing added value to its advertisers (who now spend more with it in the UK than ITV receives in revenue) while ensuring that innovative but smaller businesses find it far harder to market similar, sometimes superior, products that they cannot afford to give away for free.

The march of the goliaths has also impacted on the way people search. It has been possible to buy all your Christmas presents online for some time. But now it can be done easily at one site. Take Amazon, which sells sat navs, garden furniture, Versace shirts and cordless drills. Never mind the high street – what incentivises a browser to search for a specific site that deals only in DIY tools when Amazon’s reputation for value is taken into account?

And value has become incredibly important in this recession for consumers. However, for online businesses, it has only served to further muddy the waters. There seems little doubt that many industrial sectors will come out of the downturn looking nothing like they did when they entered it. Chief among these must be auto manufacturers and newspaper publishers. Both have been subject to shifts in attitudes and taste in the past decade, and recession has hastened change.

But where there is like-for-like, it doesn’t mean that online is ready to pick up the baton and run quite as fast and purposefully. Spotify is a good case in point. For over 10 years, the music business has buried its head in the sand and used issues of copyright as an excuse for doing nothing in the teeth of the iPod revolution. Finally, it has woken up, and now faces a huge uphill battle to contain piracy on a level never previously experienced by a performing industry. It could have all been so different. The selling-out in seconds of recent big tours, including Take That and, sadly, Michael Jackson’s 50 O2 dates, proves that live music is as popular as ever. Instead of focusing on adding value to downloads though sophisticated marketing and augmenting it with high-grossing concerts, most record companies have clung on to traditonal and more expensive means of selling their wares. The result is the worst of all worlds, because Spotify and iTunes face similar problems with piracy.

But elsewhere the internet is suffering from the recession. IMRG/Capgemini has found that e-commerce growth has dropped dramatically in the last 18 months, from 58% year-on-year in the fourth quarter of 2007, to just 11% in April and May this year. Most of this has come from falls in advertising, a revenue stream that many sites have become reliant upon – overly so, perhaps, with the benefit of hindsight.

Observers believe that Spotify is trying to find breathing space through investment, allowing it to attract subscription customers before it has to pick up the heavy tab for music royalties, as well as further expansion, particularly in Europe. But the question marks that it raises proves that we are still some way from an online sure thing.