Follow the Money

Who in the hell's going to pay for that?" asks venture capitalist Larry Coleman. He's just been approached by a company that's losing $10 million a month, a "humongous burn rate" by any measure. Unless a B2B company has a sustainable financial model, Coleman and his partners won't touch it.

As managing partner of Coleman Swenson Hoffman Booth, a Franklin, Tenn., venture capital firm specializing in health care and life sciences, Coleman has seen the biotech fever come and go. Like biotech, the Internet, he says, "is a breakthrough technology that will change the way a lot of things are done. But if you look at how many biotech companies were financed in their heyday, there were thousands, and if you look at how many are profitable today, it's a relative handful."

To be among the handful of companies to flourish in the B2B marketplace, a business needs to guard its fiscal health carefully by growing wisely, managing debt, choosing customers carefully, building strategic partnerships and ensuring that profits come in before all the capital goes out the door.

Companies that succumb to the "grow now, pay later" mentality of today's B2B marketplace are playing a high-stakes, high-risk game. But the potential rewards and, thus, the allure, are enormous: A survey by Forrester Research Inc., Cambridge, Mass., of 80 Fortune 1000 executives shows that by 2002, 93 percent of all companies expect to transact business over the Internet. B2B companies that grow fast enough to dominate their markets can expect healthy shares of that business explosion.

Optimizing On Growth
Growth is essential. "Showing an early profit doesn't demonstrate long-term success in this economy," says Theo Forbath, formerly a consultant with Northeast Consulting Resources. "The new company does not optimize around revenue,the new company optimizes around growth and reach."

Forbath himself is an example of the new economy he describes. To optimize its reach, a Needham, Mass.-based high-tech B2B start-up, NerveWire, bought Northeast Consulting,including Forbath's and 27 other consultants' services,to jump-start its staffing late last year.

"There's a landgrab under way," agrees Dean Dorman, vice president of business development for Internet market-maker Ventro Corp., Mountain View, Calif., which is grabbing vertical market territory hand over fist.

Ventro started life as Chemdex, a market-making company in the life sciences industry, but changed its name in February to "reflect unlimited opportunity in an exploding marketplace," according to the press release announcing the new corporation. In addition to Chemdex, Ventro now includes Promedix (specialty medical products), Broadlane (hospital and medical supplies), Industria Solutions (process plant equipment) and Amphire (food service industry). By the end of the year, it hopes to double the verticals it targets to 10. Founded three years ago with $50,000 from angel investors, Chemdex posted gross revenue of $30.84 million in 1999, and analysts predict Ventro will reach $145 million in 2000.

"There's still an enormous opportunity and will be for a couple of years," says Dorman. He predicts another year of "good, fresh possibilities," followed by a year of opportunities generated by the aftermath of the collapse of many of today's existing markets and coalitions. "We'll be in a real good position to participate in the aftermath," he says.

During the landgrab stage of B2B's evolution, numbers of customers and "liquidity" (transaction volumes) matter more than profits, says Tim Clark, a Jupiter Communications Inc. analyst in New York who follows B2B marketplaces.

In addition to the fact that market-making companies such as Ventro collect transaction fees, liquidity is crucial because the more volume a B2B company has, the more reliability it has in terms of a customer being able to find something on its site. "If you only have a transaction every other week, you don't become a very reliable place to go," Clark says.

"The big thing is momentum," adds Lynda Partner, co-founder of Internet start-up GotMarketing.com, Saratoga, Calif. "That's what drives an Internet company,the ability to demonstrate we're ramping up quickly. Everything from strategic partners to customers to revenue to just traffic on our Web site to amount of buzz we're able to create in the industry."

First-mover advantage is critical, agrees Stan Lepeak, vice president of the Electronic Business Strategies Service and an analyst with Meta Group Inc., Stamford, Conn. "You only need so many B2B players in any space." A B2B company must quickly dominate market share in its space or face extinction.

Managing Debt
The delicate balancing act between spending money fast enough to grow and managing debt long enough to stay alive is a key element of fiscal health. "If you're losing money, you'd better be able to raise it somewhere," warns Coleman. But the venture capital community is starting to question whether it should throw good money after bad. As Coleman says, "there's a lot of setting in of reality here."

When companies such as AltaVista and Zefer Corp., a Boston-based Internet consulting firm, postpone their IPOs in the wake of recent market corrections, it's a reminder that the pot of IPO gold at the end of the start-up rainbow may not be as rich as the companies' backers envisioned. A lot of dot-com stock is now worth less than its initial offering price.

Fortunately, most professional services companies seem to be resisting the temptation to take on a crippling debt load to finance their expansion into e-business. Only 15 percent of the respondents to VARBusiness' survey of professional services organizations, conducted for this B2B Strategy Guide, say they're planning to sell assets or increase debt to fuel the growth of their e-business sales.

Choosing Customer Targets Wisely
Ventro offers a useful lesson to any business seeking to expand in the B2B space: Cover your bets and leverage your strengths by targeting more than one vertical. "I personally feel that single net markets have very little chance of survival," says Ventro's Dorman. "The reason vertical markets are so powerful is that enormous pieces of running a market can be leveraged."

Architecture, product development and customer service are among Ventro's offerings that can be leveraged across multiple verticals. For example, by the end of the year, Dorman promises that a single Ventro customer service operation will provide customer service for 10 different verticals. And covering multiple groups of customers means that if a single vertical turns sour or decides to squeeze out market-makers such as Ventro by running its B2B operations as a consortium, rather than turning to a third party, the company can turn to its other customers to survive.

Another consideration is to target old-economy clients rather than rely exclusively on the dot-com world for growth. And consider the fact that big businesses are potentially attractive and lucrative sales targets.

Although two-thirds of the solution providers who responded to VARBusiness' survey of professional services organizations typically work with small to midsize customers, big businesses are starting to flex their muscles in the e-business world.

"The Fortune 100 companies are very different now from the deer-in-the-headlights look they had some months ago," says Kathy Biro, president and vice chairwoman of Boston-based Digitas, an Internet professional services company that focuses on big business clients. "You're starting to see some really bold moves."

Lepeak agrees that you need to be aware of the strengths of the old brick-and-mortar organizations: "The old players have the customers, money and products. How you integrate rather than exclude them [should be the question]."

Hybrid bricks-and-clicks businesses are gaining strength as well, says Coleman. A company that already operates at a profit but uses the Internet as a tool to expand and become even more profitable, he says, makes sense. His company is exploring the possibility of investing in a pharmaceutical company that owns pharmacies, already has a good distribution network, and is using the Internet to order and track drugs and perform a host of other applications.

Biro subscribes to the same philosophy as Coleman: "We focus on bricks-and-clicks business integration," she says. She believes the "big guys" are asserting their rightful place in the world. As a result, Digitas focuses on helping "Goliath smite David," she says, "by winning the battle for the consumer over the next decade." Biro says Digitas works in partnership with a limited number of clients on a category-exclusive basis, forming big-scale relationships.

Building Partnerships
As Biro suggests, building partnerships is another key element of a financial strategy that minimizes risk and maximizes growth and profits. "You need to recognize gaps and provide a new and different service, but more important than that, ask, 'Who are your friends?'" adds Lepeak. "Even if you have the best idea and good vision, if you don't have friends, including the right type of support from the investment community, you'll fail."

Although partnerships begin with investors including venture capitalists, they should also extend to customers, who can be a source not just of immediate revenue but of the kind of credibility money can't buy. A long-term relationship with a major industry player helps convince other customers to come on board. Customers can even become board members, contributing invaluable advice and even investment capital. A customer who owns a piece of a service provider is predisposed to selecting that provider when it comes time to award a significant contract.

In this era of the B2B expansion, another kind of key partnership is a merger with the competition. Take a look at MarchFirst Inc., for example, the new company formed out of the merger of Whittman-Hart and USWeb/CKS, itself the product of a merger of two Internet service companies. The new company brings 8,500 employees into the competition for B2B territory,formidable economic clout against young start-ups struggling for employees and market share.

Keeping An Eye On Profits
Although the importance of growing quickly has meant sacrificing short-term profits for the sake of market share, recent market corrections have B2B companies pledging allegiance to traditional measures of financial health. "Everybody realizes that, at some point, profitability matters,it's just a question of when," says Jupiter's Clark.

Sooner rather than later, says Coleman, successful new companies must make money the old-fashioned way, even though their short-term goal may be to grab territory.

In the wake of a dizzying swoop downward from a stock high of $243 less than a month ago to less than $27 on April 14, Ventro's Dorman insists the new economy is just Business 101 with a different twist: "It's ultimately based on profitability and cash flow. That's why we are so [intent] here, and have been since early last year, on building a business model that is razor-focused on profitability."

Biro is of a different mind-set. When the dust settles and there's a flight to quality, she says it's going to come down to such things as earnings and track records and long-term sustainable relationships with clients to make a difference. Unlike market-making firms, such as Ventro, which count on transaction fees for most of their revenue, Digitas is a professional service company that relies on service contracts for its income. "Our relationships are very, very big in scale," explains Biro. The company's smallest relationship is worth a couple of million dollars, while its average is $10 million annually, and it has three large relationships in the $40 million range.

Findings in VARBusiness' survey of professional services organizations suggest the wisdom of a professional services strategy in the B2B marketplace: Gross profit margins averaged 32 percent among surveyed solution providers with a professional service focus.

A more risky source of revenue for a professional service company is to invest in its customers, taking a piece of the action in exchange for its services. NerveWire, for example, has a venture capital arm, NerveWire Ventures, which allows the organization to take an equity stake in the B2B clients it thinks will be true e-commerce leaders, explains Mike Leeman, principal of the company. "This may turn into an additional source of profits, which will be shared with employees," he says. "We see this as a way to attract and retain top talent, and it paves the way for stronger relationships with clients due to shared incentives."

MarchFirst, too, recently announced the formation of Bluevector LLC, a venture capital organization that will serve as its platform for evaluating possible investments in emerging e-business and technologies.

But even while B2B companies consider the potential of big payoffs from buying a piece of the action in some of their customers, recent market corrections have them also considering the wisdom of people like Coleman. "Just because you have a B2B interaction, that isn't enough," he says. "The question is whether you can make money at it. The Internet is a tool that can make business more efficient, but there has to be a sustainable financial model or it's going to fail."

Clearly, you need more than a slick PowerPoint presentation to attract venture capitalists such as Coleman these days, but the potential offered by the new B2B business territory is too vast to ignore.