First-Mover Advantage: What's It Really Worth?

When you're building a business on the Internet, what's it worth to be first? Maybe not as much as you think.

That may be a problem for Internet investors, because many assume that the first company to set up shop, whether it's a bookstore, auction house or Net broadcaster, will benefit hugely. The notion of "first-mover advantage" is gaining currency quickly and, in turn, influencing companies' chances for success.

The idea of first-mover advantage seems to have become fashionable only recently. In a Dow Jones database search, the term appears 156 times in publications since the beginning of 1998, but only 28 times in the six years from 1988 through 1993. Much of its usage, before the rise of the Internet, was in overseas business publications and academic journals.

No question, first-mover advantage is becoming a routine part of Internet-company analysis. Earlier this month, Merrill Lynch analyst Jonathan Cohen wrote that Internet search-and-network-efficiency company Inktomi (INKT) "can benefit substantially from its first-mover advantage." In December, Business Week's glowing profile of Amazon.com (AMZN) mentions the company's "crucial first-mover advantage" in bookselling. And DoubleClick (DCLK) CEO Kevin O'Connor, in an interview with the Wall Street Corporate Reporter, called first-mover advantage one of the company's "three huge advantages over the competition."

Phil Leigh, vice president at Raymond James, says first-mover advantage is worth a 100% to 150% premium over how a stock might be valued by other measures -- for example, as a multiple of revenue. In a recent report on Internet webcaster broadcast.com (BCST), Leigh wrote that broadcast.com "has the 'first-mover' advantage since there are few other companies, and none of them any large size, focused on multimedia Internet broadcasts per se." But though Leigh says this premium is consistent with his valuation of broadcast.com, he says he hasn't used the formula to determine the value of that stock or any other. (His firm hasn't done any underwriting for broadcast.com.)

What's so great about being first, anyway? Publicity, for one. "If you are the first company out there, you become associated with the business that you're in, and people know your name," says Sara Zeilstra, e-commerce analyst at Warburg Dillon Read. First-mover advantage is "a head start," Zeilstra adds. "Almost anyone would be crazy not to have a head start."

But it's more than that. You can also set the terms of the business you're creating, says Wit Capital's Francine Sommer, managing partner of the Multimedia Angel Partners venture capital fund. "You create the paradigm," Sommer says. "You're setting the tone. You can define the space you're in, which is very important."

Being first, and thus having the longest track record, also helps attract customers. In business software, providing a new product before competitors is tremendously valuable when companies are shifting the platforms on which they compute, says Eric Upin, software analyst at BancBoston Robertson Stephens. "Whoever gets in first and gets big," Upin says, "has a real advantage." In a report earlier this month on Concur Technologies (CNQR), a company that has developed travel and entertainment expense management software, Upin cited first-mover advantage as a leading strength of the company. (BBRS was lead underwriter of Concur's December IPO.)

But just like other rarefied qualities that Internet companies strive for --like buzz and momentum -- first-mover advantage isn't necessarily something you can take to the bank. And like so many other terms used to explain the Internet, the closer you look at the concept of first-mover advantage, the less tangible it becomes. "I don't pay an extra dollar a share because someone has first-mover advantage," says Robert Mohn, portfolio manager of the Acorn USA fund. And first-mover advantage may be no prediction of future success on the Net.

"In large parts of the real world, there is not a first-mover advantage," Mohn adds. "Wal-Mart (WMT) was not the first discount store. There was something called Korvette's." That's true in other markets, such as film. In 1998, two movies about the earth getting smashed by a meteor went head-to-head; Armageddon did much better at the box office than Deep Impact, which came out two months earlier and had a stronger start. And what about Sharp? Despite years of selling personal organizers, the Japanese electronics giant could do little to slow the rapid acceptance of the handheld Palm Pilot, now a 3Com (COMS) product . Even Netscape's (NSCP) head start against Microsoft (MSFT) in the Web browser market didn't help the company. Spyglass (SPYG) also began selling Web browsers at roughly the same time Netscape did without gaining a long-term advantage.

For many Internet companies, being first may boost their stock price but has yet to help the bottom line. If there are profits to be made, other companies may come after the same market. If an internet company is successful, says Kevin Landis, portfolio manager of the (TFLQX)Technology Leaders Fund, you're going to draw competitors "like shark to blood," he says. "You have to have a way to hold onto what you've got."

Landis believes Netscape did have a first-mover advantage over Microsoft. "But Microsoft has its own set of advantages," he says, such as brand name, size and operating systems. The value of first-mover advantage, he says, "depends on the entry barriers and customer loyalties you're able to establish."

So even if there is a first-mover advantage, it's a qualified advantage. "It's really the first-mover that gets a critical mass,'" says Mohn, noting that "critical mass" is "another nebulous term that's not going to help you." In other words, being first is great -- as long as a company has all the qualities that would make it successful even if it didn't have first-mover advantage.

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