Lessons of history learnt seven years ago

If experts are to be believed, the Indian economy is entering a phase where money will be slightly tighter than a year ago, growth slightly slower, margins lower and valuations somewhat more modest. While I do not anticipate a meltdown anything like the one in 2000, it is important to learn the lessons of history. On Dec 24, 2000 I wrote the following article in The Pioneer newspaper.


The Story of the Year - The Dotcom Bust

Dec 24, 2000

A little over a year ago, I met a well-known NRI who was visiting India from Silicon Valley.

He asked me how the dotcom I worked for was doing. I proudly told him that we were making a profit, that we weren't running a dotcom but a business, that we actually charged people for our services, that when we had started out three years earlier, dotcoms hadn't been fashionable and that we also intended to be around when dotcoms were no longer fashionable. He told me with a straight face that I had a vision- problem and that I wasn't thinking big enough. If we were making a profit then we couldn't be investing enough in the business. I was crestfallen, for many regarded this luminary as some sort of guru.

A little over a year ago, I thought the world had suddenly gone mad. You could get really serious money on just an idea and a presentation if you told your story well enough, that is. You couldn't throw a brick in this city without hitting someone who had either started a dotcom or wanted to start one or worked for one or wanted to work for one or was funding one or wanted to fund one.

All you needed to talk "millions of dollars" was an expense plan that was outrageous (the higher the expenses, the bigger your vision) and revenue projections that were mostly fiction. The latter were supposed to be worked backwards after seeing which numbers would justify your target-valuation. Valuation was the instrument you measured your manhood with the "mine is bigger than yours" syndrome never mind that the valuation was notional and you could never hope to get that kind of hard cash in your `personal' pocket. All the time of course, you looked people in the eye and said that you weren't in it for the money it was the opportunity to change the world that excited you.

Many wannabe entrepreneurs and their backers failed to understand that there is one set of competencies needed to build a website and another quite different set to run a web-based business. It was assumed that if you could build a good site you would have a successful web business. Frankly, there were too many people chasing valuations and too few actually trying to service customers. Most dotcoms did not have a long- term outlook to their business. Almost all promoters wanted to cash out within a year or two. Fuelling this charge were media reports of Indiaworld selling out to Satyam for Rs 500 crore in cash. That no other entrepreneur in India was able to cash out of his dotcom for a large sum of money, is another matter altogether.

As lakhs of people jumped onto the Great-Indian-Dotcom-Bandwagon in the hope of making millions overnight (not entirely unlike the KBC craze today), I slowly began to come around to the view that perhaps it was I who was old fashioned and the world reasonably sane. Sadly, before I could be completely converted, the Great Dotcom Boom of 1999 had metamorphosed into the Great Dotcom Bust of 2000. The transformation was so sudden that most people went into a state of denial for the first few months "It's a temporary correction, we expect valuations to recover in a few months," went the refrain. As reality begins to sink in and the corpses of once trendy dotcoms begin to wash up on the beach, it is useful for us to collectively contemplate on our respective navels and ruminate on why the dream went so horribly wrong.

The most fundamental lesson from the dotcom fiasco is that, for most of us, there is still no quick and easy way to get rich. Most instantly successful companies take over 10 years in the making. Sadly, even in cyberspace, there is no free lunch. In order to realise value, you have to first create it. You need customers and you need to offer them a value-proposition. You need to sell them something that they want and you need to charge them an economic price for it. You need to provide quality service to customers and you need to focus on terribly unsexy things like the backroom, logistics, fulfilment and customer complaints. You don't need to run an idea, you need to create a business. Most of this stuff is pretty boring and old-economyish – far removed from the dreams of the starry-eyed 20-something MBAs, who were
funded by other 20-something MBAs who worked at the VC firms.

One of the major reasons why the dream went sour is that most dotcoms grossly overestimated the impact the Net would have on India. It was believed that what the Net did in the US, it would do in India. However, the reality check is revealing. The Net has a penetration of 40 per cent in the US and less than 0.2 per cent in India. In other words, 99.8 per cent of India does not have Net access. That is to say, even with a 500 per cent growth in Net penetration, 99 per cent of the population in this country would not have Net access. This would seem to seriously limit the market for products and services offered by dotcoms in India. Of course the Net has not lived up to expectations in the US, even with a 40 per cent penetration.

But then overestimation of market size is not new to India. Remember the myth of the 200 million-strong Indian middle class with the alleged purchasing power of a European country. This myth drew many an MNC to launch luxury products in India, only to learn the hard way that the market size was a fraction of what was believed earlier. Executives in many companies manufacturing breakfast foods, luxury cars, scotch whisky and expensive sneakers will privately testify to this.

Coupled with the overestimation of market size was a rapid overcrowding of the dotcom space without any anticipation of competitor moves. This sort of herd mentality led to a bizarre situation where within three months, the number of women's portals went from zero to fourteen, none of which had a viable revenue model. At least one CEO of a woman's portal has told me that had he known, prior to launch, that competition would intensify so rapidly, he would have shelved his project.

This herd mentality among entrepreneurs was fuelled by competition among VCs to fund dotcoms. There was far too much money and too few good investment opportunities. Purely to get market share, many VCs made sub optimal investments. For a while it looked as if VC grew on trees. Valuations were unreal but the VCs didn't mind, as long as there was someone ready to give an even higher valuation in the next round of funding. It was like a high-stakes game of passing the parcel where as long as the music was playing, nobody got hurt. But then valuations could not stay divorced from intrinsic value for very long and the music stopped, very suddenly.

A problem that industry pundits did not recognise as one, till it was too late was the use of proxies as evidence of success. Hits, page views and visitors were parameters used to value businesses. Whereas conventional logic would suggest that the real health of a business should be measured by revenues, costs and profits. Beyond a point, dotcoms and their cheerleaders were unable to sustain the myth of the validity of such proxies.

Another myth which was perpetuated was that if you spent a lot of money on advertising, you built up brand equity and barriers to entry, which in turn built up your valuation. The net result was that many dotcoms that got funding, spent recklessly on advertising without sufficient scrutiny of how this spending was going to build the business. But that's easy to do with a clear conscience if you are spending someone else's money.

Even companies which had funding, which had built a good site and had in theory at least a viable revenue model, discovered that it takes time to get people to change habits. E-commerce sites quickly discovered that getting visibility and traffic is only part of the story. The reluctance of customers to order on the net without touching and feeling the product limits the potential of e-commerce in this country, at least in the near term.

Yet, there is a silver lining even in this cloud. The dotcoms that survive the shakeout and do not lose sight of their fundamental business objectives, will emerge stronger and thrive. To do that, they will have to understand a few ground realities: They are not running a dotcom but a web-enabled business. The Net is not a business but a channel of communication. That they need to build a business first and build the dotcom around it, and not the other way around. That they need to chase the right metrics - customer satisfaction, revenue and profits are in and page views are out.

That overheads should chase turnover and not the other way around. That a brand is not built by advertising but by customer experience. And that they cannot spend money that they cannot hope to earn.

The dotcom is dead. Long live the dotcom.