Cost cutting doesn't add up for dotcoms

The dotcom burn rate currently only appears to be surpassed by the speed at which such companies change their business strategies.

But this week's wisdom, that cutting costs will help online firms to make a profit, isn't actually born out by the facts. According to a survey by Getzler, which specialises in helping to turn around ailing companies, reducing expenditure is a recipe for slowing growth rates.

The study of 213 US technology and dotcom organisations showed that those implementing cost reduction measures, particularly in the area of sales and marketing, had not boosted their financial performance.

"We've heard time and again how dotcom companies are reducing costs to become profitable," said Brian Mittman, a vice president at Getzler. "But we've learnt that, rather than help the company, cost cutting reduces sales growth so drastically that profitability becomes almost impossible."

So as far as dotcoms are concerned, it seems that reducing expenditure does not work.

Egg.com, for one, announced its fiscal third quarter results earlier this month. The online bank saw its losses fall by 10 per cent, but witnessed a slowdown in the number of new customers signing up to its site. While some 197,000 customers joined in the first quarter of this year, the figure had dropped to 107,000 by the third.

But Egg seems unconcerned by this development, pointing to increased sales from existing customers. It also said it expects customer growth to pick up again after it launches a credit card joint venture with Boots.

Roulette wheel stock
Mike Harris, Egg's chief executive, claimed that 84 per cent of UK citizens were aware of its brand. "Our brand goes from strength to strength and we are pleased with the early results of our new brand advertising, which is having a noticeable effect in increasing traffic to our website," he said.

But this argument failed to convince some financial experts, who are concerned about slowing growth rates and as a result, have described the firm's stock as being a gamble. They believe that whoever buys Egg's shares is simply betting on the theory that it can boost the revenues generated by its profitable units, but that there is no evidence one way or the other to prove this is true.

The Getzler study also indicates that the average annual growth rate for dotcom companies involved in cost cutting is 19 per cent compared with an average of 149 per cent for firms that boost their spending.

"Nineteen per cent is typical of a traditional firm. But not of a dotcom operating deeply in the red with a stock price based on a very high growth expectation," said Mittman. "Amazon.com was a prime example. It reduced sales and marketing costs in the second quarter, and experienced virtually stagnant growth."

The report also confirmed analysts' opinion about dotcom customers' lack of loyalty. Dotcoms have spent vast sums of money on marketing, reasoning that such expenditure is necessary to build a loyal customer base.

"But if your revenue drops as soon as the pounds stop flowing into marketing programmes, you have to question customer loyalty and the wisdom of continuing to invest blindly in extravagant marketing campaigns," Mittman said.

Not surprisingly, the study advises dotcoms to spend their marketing money well. It cited US internet firms that spent millions of dollars on short adverts during the Super Bowl, pointing to some that spent a significant percentage of their entire annual budget on a single slot that generated little customer follow-through or discernible revenue.

Keeping out of trouble
Stephen Houston, partner at solicitor Addleshaw Booth, said: "Investors won't put money into a company that will only spend it on branding."

As a solicitor focusing on ebusiness enterprises, Houston has been working with many dotcoms to help them keep out of financial trouble and has represented those that didn't make it in court.

"While dotcoms must keep an eye on their cash flow to be successful, drastically cutting costs is not the answer. Instead, they need to become more clever about how they spend their money and how they operate," he explained.

"Smaller companies have a better chance of survival in B2B [business to business] than in B2C [business to consumer]. The latter is dominated by existing brands."

His comments were mirrored by a recent study from PricewaterhouseCoopers' (PwC') of European internet firms, which concluded that B2C companies are currently the most vulnerable of the dotcom players.

The average burn-out rate for such organisations is 15 months compared with 23 months for B2B companies due to high marketing costs, which can amount to as much as four times gross profits.

But the research also found that the overall burn rate of internet firms had improved by seven months to an average of 20 months as a result of fundraising efforts and business restructuring measures. According to PwC, this is likely to herald a healthier dotcom market throughout Europe.

Despite this improvement, however, the 20 most vulnerable European online organisations are at risk of running out of cash within a year unless they take steps to address the issue.

Kevin Ellis, a partner at PwC, said that, although investors' current views about the dotcom sector seem to have been influenced by a couple of high-profile insolvencies, in fact, sub-sectors such as software and infrastructure are producing strong returns.

"Dotcoms throughout Europe are taking proactive steps to regain the confidence of the market, including fundamental business restructuring or seeking appropriate merger partners," he said. "On the whole, improving burn rates indicates that management teams are focusing not only on cash management, but are also taking control of their own destinies."

Like this story? Spread the news by clicking below:

 del.icio.us     Digg this     reddit!