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					NET PROFIT
How to Invest and Compete in the Real World of Internet Business PETER S. COHAN

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MAIN IDEA Thousands of businesses are in the process of migrating to the Internet because the entry barriers are so low at the present time. The leading Web players, however, are those companies that have shaped their business strategy so as to gain control of the choke points and economic levers within their respective industries. While there is a lot of hype about Internet businesses and everyone is struggling to decide precisely how to value such a business, the Internet actually follows the same patterns that have marked the introduction of other significant technologies throughout history. On that basis, the most valuable Internet companies of the future will: 1. Enjoy economic leverage -- that is, provide a rare product or service that is highly valued by the customer. 2. Offer complete or closed-loop solutions, providing everything required to add value and realize the potential benefits. 3. Be guided by an experienced management team who can change business strategies rapidly as the Internet evolves. Over the longer term, the Internet business world will ultimately become subject to the same fundamental rules of economics that apply everywhere else in the world of commerce. That means there are some outstanding bargains available at this stage of the Internet’s growth -- stock in today’s start-ups that will generate significant capital gains in the future as the real value of these companies becomes more definitively established. Sifting through the barrage of hype and frenzy that currently cloud the world of the Internet is the major challenge of the present time. However, investors and managers who are aware of important changes occurring in technology, customer needs and Internet business strategies will be well positioned to generate the high investment and stockholder returns of the future.

Section 1 -- A Framework for Assessing the Value of Internet Based Business Models . . . . . . . . . . . . . . . . . . . Page 2 To make business sense of the Internet and the valuation given Internet based businesses, three frameworks can be used: 1. Net Profit Evaluation -- for investors 2. Net Business Phases -- for Internet business managers 3. Net Application Phases -- for non-Internet managers Section 2 -- The Profit Potential of Nine Internet Business Segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 3 A successful and profitable Internet company will generally satisfy three basic criteria: 1. It will be positioned in an industry that has economic leverage. 2. It will exploit a strategy by which it offers a closed-loop solution. 3. It will have an adaptive, fast moving management team. The nine Internet business segments are: 1. Net Infrastructure 2. Web Consulting 3. Internet Venture Capital 4. Internet Security 5. Web Portals 6. Electronic Commerce 7. Web Content 8. Internet Service Providers 9. Web Commerce Tools Section 3 -- How to Evaluate an Internet Investment Opportunity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 8 From an investor’s perspective, the key task is to screen any potential Internet business opportunity for: 1. Economic leverage 2. Closed-loop solutions 3. Adaptive management teams. For companies that pass that screening test, there are presently six key rules of Internet business investing: 1. The market values top-line growth more highly than profits. 2. There will be significant private-public market arbitrage. 3. Volatility increases with the amount of private ownership. 4. Internet stocks appreciate quickly and depreciate slowly. 5. Growth rates will vary among Internet industry segments. 6. The market and investors reward market leadership.

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Section 1 A Framework for Assessing the Value of Internet Based Business Models Main Idea To make business sense of the Internet and the valuation given Internet based businesses, three frameworks can be used: 1. Net Profit Evaluation -- for investors 2. Net Business Phases -- for Internet business managers 3. Net Application Phases -- for non-Internet managers Supporting Ideas These frameworks are useful in: 1. Evaluating Internet investment opportunities. 2. Analyzing Internet business strategies. 3. Deciding how to use the Web to improve businesses. 1. Net Profit Evaluator An Internet based business is most likely to generate profits if it: 1. Has economic leverage -- that is, sells a product that is important to its customers and is in such short supply the company can charge a high price for it. 2. Offers a closed-loop solution -- that is, a total solution that generates economic value for customers. 3. Has a management team that can adapt well to the rapid changes that are occurring. Those companies which offer products and services embodying these three characteristics will be the most likely to generate profits and should, therefore, attract the highest market valuations. 2. Net Business Phases 3. Powerware

3. Net Application Phases Business managers who have no Internet experience need to quantify what the incremental costs and benefits of moving their business to the Internet will be. In essence, businesses moving to the Internet go through three distinct phases: Phase 3 Integrated Operations & Transactions Phase 2 Front-End Transactions Phase 1 On-Line Brochures

Phase 1 -- Online Brochures These companies put product literature, annual reports and other information on their Web site. Phase 2 -- Front-End Transactions These companies use their Web site to gather order forms for their products. The orders are then handled by the company’s normal order fulfillment process. Phase 3 -- Integrated Operations & Transactions These companies use the Internet to exchange information with customers, to link with the internal operations of the company and in some cases to deliver products and services. Most companies start out at Phase 1. Some companies then move to Phase 2 and still fewer commercial entities then move to Phase 3. Key Thoughts

2. Brandware

1. Lossware

Most Internet business go through three distinct phases: 1. Lossware -- companies that lose money because of low entry barriers, low or no switching costs for customers and loads of competition. Lossware companies spend the bulk of their revenues on marketing. 2. Brandware -- companies that have established a brand name consumers become familiar with -- which saves customers the trouble of comparing offerings from numerous vendors. Brandware companies still spend quite a lot on marketing in the expectation of surviving industry consolidations. 3. Powerware -- companies that have a product which is in short supply (because competitors have been squeezed out) and which has high switching costs. Powerware companies generate consistently high returns. Many companies start out as Lossware in the expectation they will evolve to Brandware and ultimately to Powerware at later stages. Few companies ever make it all the way to Powerware, however.

‘‘The Internet has proven itself to be the most significant economic and social phenomenon of the latter half of the 1990s. The financial markets have been replete with tales of investment killings made in a day, simply because a company appended .com to its business model. To managers and investors schooled in the notion that the value of a company is related to its future profits, the Internet is a perplexing phenomenon. So many of the publicly traded Internet companies have scant revenues and substantial net revenue losses: Why then are these companies worth so much more than many other companies that are much larger and earn substantial profits? And in asking this question, managers and investors are struck with two conflicting emotions. One is the desire to get a piece of the Internet action. The other is a nagging fear that the whole thing is a house of cards that is doomed to unravel at some unspecified point in the near future. This is an attempt to understand the underlying dynamics of the industry segments in which Internet companies compete. And it is about a search for the business strategies that distinguish the market leaders from their peers.’’ -- Peter Cohan

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Section 2 The Profit Potential of Nine Internet Business Segments Main Idea A successful and profitable Internet company will generally satisfy three basic criteria: 1. It will be positioned in an industry that has economic leverage. 2. It will exploit a strategy by which it offers a closed-loop solution. 3. It will have an adaptive, fast moving management team. Supporting Ideas The profit drivers for creating economic leverage in an Internet based business are: 1. The Internet is a participatory medium -- not broadcast. 2. Internet buyers use information to be self-directed. 3. Internet purchasers are prepared to switch vendors quickly. 4. Low entry barriers means there are multiple vendors. 5. Internet vendors can quickly match a competitor’s offerings. 6. There are more profits in selling to companies than individuals. 7. Building market share by giving away product is common. The strategies by which an Internet based business can create a closed-loop business solution are: 1. Focus on the size of the market and whether it can justify the investment rather than falling in love with a technology. 2. Use the Internet to improve the way the business creates customer value, not merely automating existing processes. 3. Raise the costs to switch to another vendor by creating as reasons for customers to keep coming back. 4. Build barriers to entry -- competitive advantages nobody else will be able to match. 5. Build partnerships with others who can provide the technical capabilities required to create added customer value. The essential characteristics of an adaptive and flexible management team are: 1. A healthy paranoia about competitors, and total absence of complacency. 2. A total focus on maintaining and expanding contact with the customer and understanding of their needs. 3. An ability to attract, retain and productively utilize sizable numbers of smart and capable people. 4. The absence of any bias towards technologies developed in-house, and a willingness to offer whatever technologies customers want -- before competitors do so. 5. A willingness to reinvent the company and go in an entirely new direction if necessary. That is, an ability to develop and execute contingency plans.

1. Network Infrastructure (Powerware) Description The network infrastructure industry designs, manufactures, develops and distributes the routers, central control devices and edge connectors that form the backbone of the communications capacity of the Internet. Due to the ongoing growth of the Internet, this is the most profitable Internet business segment, with a growth rate of 30- to 50-percent per year over the past 10 years. Market Size The network infrastructure industry had revenues of $30.8 billion in 1998. Growth is forecast to remain at 30-percent or more per year over the next 10 years. Major Participants Cisco Systems, 3Com, Nortel, Cabletron and Nexabit Key Profit Drivers 1. A proprietary technology which is aimed at the large and growing mass consumer market. 2. Positive reviews from independent third parties or product analysts. 3. A strong management team who have a demonstrated ability to attract and motivate sales and engineering staff. 4. Technologies and products which complement products offered by the large companies already in the field -- leaving the possibility of acquisition as an exit strategy. Three Basic Criteria Evaluation From the three basic criteria perspective, Cisco Systems has several competitive advantages over all other companies within this sector. Cisco’s competitive advantage is derived from: 1. The economic leverage that comes from having an 80-percent market share of the technology which lies at the heart of the growth of the Internet. 2. Offering a closed loop solution in association with partners in which an assurance is given that all components will work together effectively when purchased, and be upgradable to meet future demand. 3. An effective management team who are growing Cisco through strategic acquisitions and a staff performance-based compensation scheme: 1. Providing the highest commissions in the industry. 2. Includes stock options. 3. Pays bonuses based on quarterly customer survey results.

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2. Web Consulting (Powerware) Description Web systems integrators are business consultants who provide advice on how to change a business’s processes so as to be able to use the Internet to improve economic performance. They work with clients to build new systems and processes, and then to fine-tune those systems in the real world. Market Size $4 billion in 1997, projected $33 billion by 2002. 60-percent annual growth rate. Major Participants Electronic Data Systems, Computer Sciences Corporation, Andersen Consulting, American Management Systems, International Business Machines, Diamond Technology Partners, Keane, Sapient Key Profit Drivers 1. The ability to offer strategic advice to CEOs, support to company information technology staff and sales to technology vendors. 2. An ability to offer a fixed time/price solution rather than a time-and-materials based charging plan other business consultants prefer to use. (This also acts as a barrier to entry for companies inexperienced in delivering fixed time/price services. 3. Sufficient insight and experience to be able to assist companies to develop new business processes that take full advantage of the capabilities of the Internet. 4. The formation and cultivation of virtuous cycles -- as the company delivers added value to clients, it attracts more business. This, in turn, increases its stock price. Therefore, it becomes easier to attract, motivate and compensate new staff, which in turn allows the company to deliver more added value to clients, expanding its base of satisfied clients. 5. The creation of switching costs by becoming so familiar with the client’s business using another consultant would require the application of significant resources. 6. A young management team (less than 35-years old) who are prepared to allocate the majority of their time to building the business rather than to balancing personal- and professional-lives. Three Basic Criteria Evaluation Sapient is a web consulting company which passes the Net profit criteria by: 1. Delivering services on a fixed price / time basis -- thereby creating economic leverage over time-and-materials style consultants. 2. Providing a closed loop solution by: 1. Suggesting new Web business systems that add value. 2. Having the creativity and expertise to develop systems. 3. Having the technical and change management skills. 4. Delivering the systems on-time and within-budget. 3. Having an adaptive management style that: 1. Adds expertise by strategic acquisitions. 2. Hires and expands staff aggressively -- 60-percent per year. 3. Uses an active learning system to spread insights.

3. Internet Venture Capital (Powerware) Description Venture capital firms are usually partnerships with the limited partners (who invest capital) getting 80-percent of the return generated and the general partners (who identify opportunities) getting 20-percent and a fixed management fee. Venture capitalists invest in new companies and liquidate their investment when an IPO or acquisition occurs. Market Size In 1998, $14 billion of capital was invested in 2,850 companies by venture capitalists. Of that, $3.3 billion went into Internet-related companies. This is a highly cyclical industry, but Internet related venture capital investment has doubled each year for the past three years. Major Participants Kleiner Perkins Caufield & Byers, Sculley Brothers Key Profit Drivers 1. Venture capital investors are finding increasing competition from angel investors and corporations funding new technologies. Therefore, the ability to find great deals (by networking) is vital. 2. A realization that a good product or technology won’t make its own way to success combined with a willingness to help assemble a quality management team that can build the business. 3. The ability to identify new businesses which are using innovation to create a compelling customer value proposition for consumers in huge and well established markets. 4. A systematic due diligence process that identifies and manages risk before the investment is made, rather than attempting to offset weaknesses at later stages. 5. A network of resources that add value to the investment -directors, managers, investment bankers, analysts, corporate partners, journalists, etc. Three Basic Criteria Evaluation Kleiner Perkins is currently the leading Internet venture capital firm. It passes all three of the Net profit criteria through: 1. Having significant economic leverage. Venture capital companies invest in only 1-percent of the deals offered to them. On average, their return will be around 10-times of the amount invested. That creates a huge leverage factor, and considerable wealth. 2. Venture capital companies offer a closed loop solution by: 1. Building strong and capable management teams. 2. Providing access to important business partners. 3. Introducing investment bankers and analysts. 4. Creating profitable follow-on business opportunities. 3. Enjoying a management style that: 1. Stays at the cutting edge of new technologies. 2. Identifies companies that are developing viable products. 3. Builds on a strong track record of success. 4. Has taken a leadership role within the industry.

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4. Internet Security (Brandware) Description Internet security companies develop firewalls (which prevent access to data by unauthorized computer users), develop authentication processes enabling companies to identify who it is conducting a transaction with, provide encryption products to allow sensitive data to be protected and provide other professional services. This industry also includes ethical computer hackers -- who attempt to break into a computer system with the owner’s permission to find potential security problems. Market Size Approx. $2.4 billion in 1998, after three years of growth at rates greater than 100-percent per year. Major Participants VeriSign, Internet Security Systems, Network Associates, CheckPoint Software Technologies Key Profit Drivers The industry is currently unprofitable. Therefore, to identify the most likely generators of future profits: 1. Watch for the emergence of market leadership. The Internet security industry currently lacks standards. Therefore, whichever company moves to establish a common platform will ultimately generate the greatest profits. 2. The industry is highly fragmented. Companies that can offer closed-loop solutions will enjoy a significant competitive advantage. 3. Internet security is currently less acknowledged than issues such as year 2000. Therefore, those companies that educate the market on the need for their product should succeed. 4. Sales and marketing costs are high since none of the companies in this industry have achieved the critical mass necessary to start a virtuous cycle to reduce costs. Whichever company is the first to achieve critical mass will move ahead quickly. Three Basic Criteria Evaluation The Internet security industry does not currently meet any of the three Net profit criteria, specifically: 1. The industry lacks economic leverage. It appears quite likely Internet security will become absorbed into the operating system industry, controlled by Microsoft and others. 2. There is not presently any closed-loop Internet security solutions being offered to consumers. No company has managed to establish itself as the industry standard -consequently, the market is highly fragmented. 3. While the current industry participants do appear to have management teams that adapt well to change, the lack of an industry leader creates a disjointed market.

5. Web Portals (Brandware) Description Web portals offer Internet users a starting point from which they can search and link outwards to other Web sites. Most Web portals started out as search engines and evolved further by offering advertisements, personalization capabilities and other virtual community offerings. Web portals essentially work on a broadcast industry style business model, and are actively exploring various ways to derive future revenues from advertising and e-commerce activities. Market Size 1998 revenues of $464 million, losses of $114 million. Collective market capitalization: $25 billion Major Participants Yahoo, Lycos, Excite, Infoseek Key Profit Drivers In the Web portal field, losses outweigh profits at present. Future profits will depend on: 1. Maintaining a healthy sense of vigilance against new entrants (who often enter the industry through a partnership arrangement) and current participants. 2. Being able to influence the future growth of the industry in a way that matches a company’s strengths. 3. Making it easy for Web portal visitors to derive added value by visiting. 4. Creating a closed loop business solution for advertisers, so they get value for their advertising investment. 5. Matching outgoings with income through financial discipline and focus. 6. Hiring smart people and letting them grow into the managers of the future. 7. Retaining cash reserves for the inevitable industry consolidation which is coming. 8. Resisting the temptation to get swept up into portal euphoria. Three Basic Criteria Evaluation The Web Portal Industry currently fails to meet the Net profit criteria, with only Yahoo coming close. More particularly: 1. Until consolidation occurs, none of the existing portals has any economic leverage. In addition, TV networks, Internet Service providers and others can enter the industry easily. 2. Yahoo and Excite are attempting to create a closed-loop solution from Web advertisement to product purchase, but this is still under development. 3. The management teams at the major Web portals have shown a willingness to bring in experienced management as market conditions have changed over the life of the Internet. If this adaptability continues into the future, the Web portals will continue to be well placed.

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6. E-Commerce (Brandware) Description Electronic commerce is simply Internet based business transactions. It attracts a huge amount of consumer interest and conjecture. E-Commerce is split into business-to-consumer transactions ($20 billion by 2000) and business-to-business transactions ($175 billion by 2000). Market Size $2.7 billion in 1996, $21.8 billion in 1997 and a projected $1.2 trillion by 2002 according to the U.S. Department of Commerce. Participants Thousands of companies at present, potentially hundreds of thousands more in the future. Key Profit Drivers Current levels of profitability vary widely. Future profits by any e-commerce company will be determined by: 1. How the business creates added value for the customer, and where it fits on the value creation chain between suppliers and customers. The more a company focuses on where it creates value and outsources other activities, the better. 2. The viability and cost of building a market leadership position, and having access to the resources required to sustain that position. 3. Whether or not it is possible to build switching costs -- so customers have an economic incentive to remain loyal. 4. The amount of rivalry between existing market participants and potential new entrants. The greater the competition, the lower the profit expectations should be. 5. How creative the company is in developing newer and more cost effective ways to derive future e-commerce revenues from diversified sources. 6. How well the company understands its customers and their expectations for delivering added value. 7. Whether the company can take advantage of its competitive strengths intelligently and cost effectively. 8. Whether the company will be able to partner effectively with other companies in the future -- even some of its present entrenched competitors. Three Basic Criteria Evaluation At present, the e-commerce industry as a whole meets only two of the three criteria: 1. No e-commerce companies have any sustainable economic leverage, because barrier entries are so low new market entrants can emerge overnight. To offset this, many Internet e-commerce companies are attempting a branding strategy. The ease with which Internet consumers can change to competing companies suggests e-commerce profitability levels will remain low for the foreseeable future. 2. Many e-commerce companies offer high quality closed loop solutions. This quality is the foundation of the growth of e-commerce transactions to date. 3. Many e-commerce companies have excellent management teams that are highly adaptable and effective at managing change.

7. Web Content (Brandware) Description This is the industry that collects and analyzes information about the Internet. It includes companies in the general media, Internet-only media, general technology consulting and Internet-only consulting fields. Market Size Unknown Participants Industry Standard, Network World, CNET, Forrester Research, Gartner Group, Ziff-Davis, International Data Corporation, Giga Information, CMP Media Key Profit Drivers 1. The Internet can help build on a business model that works elsewhere. It can be a complementary force to existing operations, and not solely a revolutionary force. 2. Web culture dictates content should be free. Web technology enables that to happen. That makes sense if the government pays the bills. In the business environment, however, subscriptions, advertising or both are needed to produce information that adds value. 3. The key to creating long-term added value is superior content -- not the ability to deliver information through a variety of distribution channels. The more insightful and well researched the content is, the better the prospects for long-term survivability and profitability. 4. The content needs to be positioned precisely at the intersection of consumer interests and technological advances. As technology moves or consumer preferences change, the content should mirror that change. 5. The greatest value is created when the content is useful to managers or executives who are required to make large, high risk investment decisions. If the content provides factual information to decision makers, it will be valuable. 6. Ultimately, the content must provide a return on investment. The best way to achieve this is by providing a closed-loop solution that helps customers trace the flow of value from the decision to spend money on the product or service through to the incremental revenue these services have generated for them. Three Basic Criteria Evaluation Taking into account the fact the web content business is split into four types -- general media, Internet-only media, general technology consulting and Internet-only consulting: 1. Only general technology consulting enjoys economic leverage by virtue of their reputation for excellent work and their influence on decision makers. General media and Internet-only media do have some economic leverage, but not a substantial amount. 2. Again, general technology consultants offer closed loop solutions while the other three types offer little or no closed-loop solutions. 3. Similarly, general technology consultants tend to adapt quickly. General media, Internet-only media and Internet-only consultants are usually slower to adapt. Clearly, only general technology consulting meets the Net profit criteria.

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8. Internet Service Providers (Lossware) Description An Internet Service Provider (ISP) connects individuals and organizations to the Internet. Around one-half of all ISPs are local operations, one-quarter regional operations and one-quarter are national. More than 60-percent of ISPs employ fewer than 10 people. Market Size $3.1 billion in 1996, projected to grow to $13.3 billion in 2001. Participants Approx. 4,500 ISPs in the United States at present. Better known ISPs include America Online, MindSpring, EarthLink, UUNET Technologies, PSINet Key Profit Drivers 1. Internet access is a commodity which has low barriers to entry and intense rivalry, combined with consumer resistance to price rises beyond $20 a month. The only way to differentiate is by providing better service or greater convenience. 2. Since many ISPs are currently at a marginal level of profitability, consolidation within the industry is likely to occur. Investors in ISPs to be acquired could do quite well. 3. Marketing costs are a huge drain on cashflows for ISPs. Therefore, managing costs effectively will become a critical skill in this industry. 4. Companies that are pursuing the goal of market share in the expectation of future revenues are exploiting an unproven business model. Whether that greater market share will ultimately offset the capital required to expand quickly remains to be seen. 5. ISPs that tailor service packages to the needs of different customers create switching costs -- providing a disincentive for customers to switch to other ISPs. Whichever company is best at tailoring services has a sustainable competitive advantage. 6. ISPs that pursue strategic alliances to generate new customers will only succeed if there is compatibility between the cultures of both companies. If this blend is right, cross-selling by ISPs could bring in significant numbers of additional subscribers. 7. ISPs that are attempting to evolve into Web portals will only succeed if they have strong consumer marketing skills and capabilities. They also risk losing focus. Three Basic Criteria Evaluation The ISP Internet business segment fails to meet any of the three Net profit criteria: 1. The industry lacks economic leverage, or even the ability to raise prices. In addition, the threat of other substitute services always hovers over the entire industry. 2. No ISPs currently offer a closed-loop solution, particularly to companies in the e-commerce or advertising industries. 3. The ability of ISPs to respond aggressively and in a timely manner remains unclear at best. Several of the larger ISPs have been very slow to adapt to change in the past. How they will adapt to future developments is unclear.

9. Web Commerce Tools (Lossware) Description These companies supply the complex, behind-the-scenes tools that enable e-commerce to work effectively -- search engines, browsers, Internet advertising management software and e-commerce specific software for credit card processing, etc. Market Size Unable to be determined accurately Participants Microsoft, Netscape, RealNetworks, Spyglass, Inktomi, Alta Vista, DoubleClick, NetGravity, 24/7, Open Market, Macromedia Key Profit Drivers 1. All of these companies see Microsoft as their greatest threat. If Microsoft assimilates their area of specialization into its operating system or replicates the company’s strategy, they are out of business. 2. These companies need back-up business models in place -so if the current model doesn’t pan out, they have a back-up strategy ready to work immediately. Otherwise, they might get left behind. The next business might be in media or another tightly focused technology field. 3. Any company that fails to achieve critical mass before its resources are exhausted should attempt to be acquired. 4. Any company that cannot demonstrate where and precisely how it creates measurable added value for its customers will have a hard time staying competitive in the Internet business field. 5. Only those companies that demonstrate they can outperform their peers will attract the fuel for future growth -- additional investment capital. A premium will always be paid for those companies with clear product leadership. 6. Even if the company has a good product and an excellent management team, those assets will only generate revenues if it is able to price its products or services at a consumer price which leaves room for profits to be realized. Whether or not the dynamics of the industry will allow that should be examined carefully. Three Basic Criteria Evaluation Broadly speaking, the Web Commerce Tools segment fails two of the three Net profit criteria: 1. Although there are a number of separate and distinct industries within this segment, none of them have any degree of economic leverage. Generally speaking, marketing costs are so high as to place substantial burdens on the prospect of profitability. 2. As a general rule, web commerce tools tend to be open ended -- they solve just one part of the customer’s problem, and must be combined with other products by systems integrators. Some companies are now attempting to evolve into closed-loop solution providers, but none have yet made the transition. 3. There is a varying track record of adaptability within the Web commerce tools industry. This criteria is indecisive at best based on performance to date.

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Section 3 How to Evaluate an Internet Investment Opportunity Main Idea From an investor’s perspective, the key task is to screen any potential Internet business opportunity for: 1. Economic leverage 2. Closed-loop solutions 3. Adaptive management teams. For companies that pass that screening test, there are presently six key rules of Internet business investing: 1. The market values top-line growth more highly than profits. 2. There will be significant private-public market arbitrage. 3. Volatility increases with the amount of private ownership. 4. Internet stocks appreciate quickly and depreciate slowly. 5. Growth rates will vary among Internet industry segments. 6. The market and investors reward market leadership. Supporting Ideas The Screening Test Whenever an Internet investment opportunity is presented, begin by running it through the following checklist as a screening test: Economic Leverage: Is there currently a large and identifiable market for the product or service? Is there sufficient perceived value that prices can be charged which will exceed costs by a substantial margin? Can switching costs be introduced to discourage movement to an alternative vendor? Do any barriers to entry exist within this industry? Closed-Loop Solutions: Do customers in this field prefer to deal with one vendor that offers a comprehensive solution? Does the company appear to understand the specific needs and requirements of its core customers? Is there any evidence the company can form effective alliances and partnerships in order to offer comprehensive closed-loop solutions? Adaptive Management: Does the CEO communicate frequently with customers and stay abreast of their evolving needs and requirements? Does the CEO have a clear vision of what the company needs to do to achieve leadership in its industry? Has the CEO demonstrated a willingness to make acquisitions and form partnerships that create added value for customers? Can the CEO attract and retain the number of smart people the company will need to grow? Has the CEO created a compensation system which encourages employees to watch expenditure carefully and be responsive to customer needs?

Six Key Rules of Internet Business Investing 1. The market values top-line growth more highly than profits. Everyone figures the Internet is going to be big -- but nobody is very certain just how big it will grow. Therefore, at the present time, those companies that achieve rapid top-line growth (in revenues) are valued much higher than companies that show predictable growth in their bottom-line (or profits). 2. There will be significant private-public market arbitrage. Publicly traded Internet business companies are currently attracting exceptional market valuations. This places them in a strong position to add value by acquiring private Internet businesses at much lower valuations. 3. Volatility increases with the amount of private ownership. The smaller the percentage of shares in the public float, the greater the amount of volatility. As a rule of thumb, Internet based companies tend to have high levels of stock owned by insiders -- and consequently greater volatility than normal. 4. Internet stocks appreciate quickly and depreciate slowly. When the NASDAQ market turns upwards, Internet stocks appreciate at a faster rate than non-Internet stocks (on average). Conversely, in a market downturn, Internet stocks decline at about the same rate as the overall market. 5. Growth rates will vary among Internet industry segments. In other words, not all Internet stocks will perform at the same rate. Potential investors should therefore become educated in the differences and nuances of each Internet industry segment rather than anticipating every Internet stock will perform as well as any other. 6. The market and investors reward market leadership. Disproportionately in fact. Therefore, whichever company ultimately achieves leadership in its market will appreciate in value at a faster rate than any other company. Key Thoughts ‘‘Although the real world of Internet business has many unique characteristics, it is still subject to certain fundamental rules of economics. For the manager or investor, the most important of these rules is that economic leverage goes to the firm that can deliver a product or service that is in short supply and critically important to a powerful decision maker. If the manager can build a company that supplies this commodity, that manager will sustain high Net profits. The investor who buys shares in that company’s history will be amply rewarded.’’ -- Peter Cohan ‘‘Web investors need to understand the challenges that Internet business managers face and must be equipped to evaluate how well the Internet business managers are addressing those challenges. Similarly, many Internet business managers own big chunks of equity in their companies. To paraphrase Warren Buffet, stock is an ownership stake in a business. To evaluate whether or not to buy stock, the investor must understand the business.’’ -- Peter Cohan

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