Money in E-Commerce Sites Starting to Dry Up

Analysts suggest that the business-to-business sector may begin to grow at the expense of e-commerce.
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Less than six months ago, Scott Segal thought he was sitting atop the next e-commerce gold mine. He had just raised $1 million for his venture,

ijewelry.com

, and expected another couple of rounds of financing to generate up to $40 million in the run up to an initial public offering in 2001.

But then came the explosive growth in business-to-business Web sites, and the money for other electronic commerce sites started to dry up.

"We got caught in a downturn in the cycle," said Segal, 29, who is now looking to sell the assets of ijewelry.com, an Internet site that sells jewelry at discount prices. "We missed our window by about three months."

After an astonishing bull run, marked by a seemingly endless flow of venture capital and sharp increases in e-commerce stock prices, the online retailing sector got a jolt last week when

Peapod.com

(PPOD)

and

CDNow

(CDNW)

separately disclosed that they were both faced with liquidity problems as well as concerns as whether they would ultimately survive.

As investors tried to decipher whether the news meant correction or shakeout, market watchers warned that the rumblings signify a deeper rift along the business-to-commerce fault line.

Not only are investors growing tired of companies that do not post profits, venture capitalists and the investment banks that take nascent companies public are starting to rethink the Internet as a more effective tool for business-to-business commerce than it is for selling goods to individual consumers.

"If you do a reasonable amount of due diligence, the risks are lower on a B2B play," said Hadar Pedhazur, founder of venture capital firm

Opticality Ventures

. "Predicting consumer behavior is not an art and it is certainly not a science."

While money has tended to pour into the e-commerce sector at a faster rate, analysts suggest that the business-to-business sector may begin to grow at the expense of e-commerce.

"Venture capitalists may perceive the business-to-consumer model as being less complex to bring to market than the business-to-business model,"

PriceWaterhouseCoopers

wrote in a recent

MoneyTree

report. "However, given that the business-to-business market in general is so vast, it is entirely possible that this segment of the Internet will charge ahead in the year 2000."

According to

MoneyTree

, venture capitalists directed $4.46 billion, or 22% of the $19.9 billion invested in Internet-related businesses in 1999 to business-to-consumer e-commerce, while they put $2.64 billion, or 13%, in business-to-business ventures.

A survey conducted by

vFinance.com

, a portal that monitors the venture capital industry, went even further to state that investments in the business-to-business sector were already outpacing those in e-commerce by a rate of nearly two to one. (The vFinance.com survey categorized all Internet-related investments as either business-to-business or business-to-commerce, whereas the

MoneyTree

survey had more sub-categories.)

"We haven't seen a trend like this since the ASP (application service provider) craze of a year ago," according to Tim Mahoney, chairman of vFinance.com, noting that business-to-business activity increased 30% over the last 12 months while business-to-consumer activity expanded by a lower 20%.

"Entrepreneurs and their investors are finding deep market niches in B2B," Mahoney said.

The e-tailing sector's problems, however, run deeper than the growing allure of business-to-business on-line commerce. Many analysts who once thought on-line shopping posed the biggest threat to brick-and-mortar retail outlets are now beginning to alter their thinking as they realize that conventional retailers have more to gain than they have to lose from the Internet.

Not only do stores benefit from having a physical presence, where shoppers can go and sample the goods, brick-and-mortar companies already have the distribution networks in place to maximize any business they may derive from setting up an Internet site. Conversely, Internet-based businesses, such as bellwether e-tailer

Amazon.com

(AMZN) - Get Report

have had to revert to establishing more conventional distribution channels in order to maximize their margins.

"It is easier for

Wal-Mart

(WMT) - Get Report

with good distribution and order fulfillment to create an electronic storefront than it is for a company with no brick and mortar to create distribution channels and fulfill orders," said Charles Scavone, a portfolio manager at

AIM Management

, who has never invested heavily in business-to-commerce companies. "The cost of acquiring and servicing a customer are far greater than the revenue and profits you will ever derive from a customer over time."

Arvind Bhatia, an analyst at

Southwest Securities

, estimated that a few dozen e-commerce companies now stood on the brink of extinction should the markets grow even less forgiving of on-line retailers' slowness in achieving profitability.

Companies such as online grocer Peapod.com and CDNow are already on the brink after auditors separately questioned each company's ability to continue as a "going concern" after the companies' backers pulled their support.

"B2C has been cold for quite a while now," Bhatia said. "A lot of guys who went public during the last few months are trading below their IPO price," he added, citing

Ashford.com

(ASFD)

,

Streamline.com

(SLNE)

and

1 800-Flowers

(FLWS) - Get Report

, which are all trading in single digits.

As the shakeout takes hold, analysts said they expect to see overloaded segments of the e-commerce sector -- including home furnishings, pet supplies and groceries -- thin out, with only the top one to two players in each group remaining. They also expect to see more partnerships between online and off-line retailers as well as more service-oriented Web sites sprouting up.

"To realize the full potential and efficiencies of the Internet, companies that do more consumer services will tend to benefit," Bhatia said. "Companies that do travel services and billing services -- that's the beauty of their models."