2B or not to B2B

A funny thing happened last April. Wall Street remembered what capitalism is all about,profits. In a matter of days, the Street lost its patience with B2C e-commerce companies that thought operating in the black was a distant, low-priority goal, not a near-term necessity. Once the financial market's stars, B2C companies turned into pariahs. The effects of Wall Street's disdain rippled through professional service organizations (PSOs) and software companies that were keeping the consumer-focused dot coms running.

And when Web integrator Scient was downgraded by a Wall Street analyst because of excessive dot-com exposure and a large unpaid bill from a client, other e-commerce integrators took a look at their own operations.

Did Wall Street overreact, or is B2C commerce really dead? Depends who you ask. At one end of the spectrum is the positive take of Jerry Colonna, managing partner at Flatiron Partners in New York, a venture capital firm that never had a heavy investment in B2C. "I think there remain some relatively interesting opportunities in that area, especially for businesses that can really provide a unique advantage--wireless shopping, for example," he says. "Regardless of where these companies' stock prices are, do you think people will stop shopping online? I know the answer is no."

At the other extreme is Menlo Ventures in Menlo Park, Calif., which stayed away from B2C projects even when other venture capitalists were pumping huge sums of money into them. "For a while, we felt pretty stupid; now we're feeling smart," says Sonja Hoel, general partner and managing director. "There's just no barrier to entry."

For its part, Austin Ventures has decided to put the brakes on B2C. "Our standards are higher post-Nasdaq crash. That applies to all categories, but particularly to B2C," says Brian Goffman, general partner of the Austin, Texas-based VC. "We prefer later-stage companies that already have a track record. We will support existing portfolios, not new ventures."

Many PSOs are also taking a more selective approach, scrutinizing B2C projects more closely.

"We're not moving away from our B2C competency, but we have tightened up our criteria," says Martin Wright, president of Emerald Solutions, Portland, Ore. "Before, our due diligence was primarily focused around [companies'] financial capability to pay their bills at the end of the month. Our philosophy was, 'Who are we to judge who the market is going to reward?'"

But that's changed, Wright says. "Now, we don't want to be associated with failed dot-com enterprises," he says. "So, we have extended our due diligence to include analysis of the business plan and strategies. If we can't make sense out of it, we don't want to be associated with the endeavor. We have a brand and a reputation to protect, too."

Experienced Retailers Rebound
While some PSOs are seeing fewer requests for B2C projects, others are encountering an upturn in brick-and-mortar projects, as once-timid traditional retailers take advantage of the weakness in strictly dot-com e-commerce.

"I think people in the professional world are viewing the pure dot-com opportunities with some caution, but there aren't that many opportunities because the funding for them is a challenge," says David Fry, CEO of Fry Multimedia, Detroit. "There's a distinction to be made between retail e-commerce and pure dot-com commerce. Our clients are much more in the click-and-brick category--Eddie Bauer and Crate and Barrel, for instance. They are moving along very aggressively with B2C plans because they are able to leverage existing business infrastructures. Our experience is that those companies are growing, and they typically take advantage of more of our services than pure-play firms."

Chris Markesky, managing director of the retail and consumer products business unit at Sapient, shares Fry's view: "What the established retailers are coming to us for is much more strategic than it was 12 months ago. Customer demands increasingly involve the back office. Did it ship on time? Was the return process easy? All that is behind the scenes; you need to revolutionize the back-end processes to support the online channel. A lot of companies fell down because they thought it could be separate."

Markesky believes the market correction was justified and that many companies were doomed from the start. "A lot of companies were founded in the B2C pure-play space that had no right being there," he says. "They were run by people who were not retailers and did not understand basic functions such as merchandising. Too many pure-plays were founded by technologists."

Sapient, based in Cambridge, Mass., and recently ranked as the top e-commerce integrator by Cambridge, Mass.-based consultancy Forrester Research, has always taken equity in start-ups in addition to standard fees--not in lieu of them, as some integrators did. It plans to continue with that policy. As for accepting new clients, "Our criteria are the same as they've always been," Markesky says. "Is it the right value proposition? Do they have the management team to pull it off? That applies to brick and mortars, too."

Emerald Solutions applies similar criteria to all B2C clients, but is looking more favorably on traditional players. "Our brick and mortars have not been quite as innovative or quick to make decisions," Wright says. "But, for the most part, they haven't made the fundamental business mistakes that some of the pure dot coms have made."

Adds Jamie Lerner, CTO and co-founder of San Francisco-based XUMA, which bills itself as a build-to-order e-business solution provider and ASP: "We've certainly seen a decrease in demand for B2C sites, and that is a direct reflection of the market." Lerner, however, believes there is a good deal of vitality in the traditional retailer arena. "We're seeing the brick and mortars showing a lot more Internet courage than they did a year ago,"

Lerner says. "Plus, they've got the funding staying power."

Like other e-commerce integrators and ASPs, XUMA had already turned to the B2B market when B2C start-up funds became scarce. It's adapting its services as more companies combine B2C and B2B commerce on the same Web site.

E-Merging Market
Lerner sees B2C and B2B merging and is responding by adapting his company's products. In its CommerceX application, XUMA offers reusable components such as tax calculations and credit-card processing. "The reusable components for B2C are very similar to the ones we use for B2B. When two businesses are transacting, they still need to calculate shipping and have a catalog," he says. "Many of the software components we've written have been repurposed for our B2B customers. For example, for Maxim Integrated Circuits, we provide B2B functionality such as value discounts and custom quotes. If you are a home enthusiast, you can hook right into the same catalog and order using a credit card. I just look at B2C as a feature of an e-commerce site."

Emerald Solutions' Wright agrees that the distinctions between B2C and B2B are diminishing because of what's going on behind the scenes at sophisticated B2C sites. "There's a B2B component to business-to-consumer companies," he says. "For instance, for Handyman.com we are linking to contractors from the consumer site. That's a B2B component. At some point, we expect the market to say, 'B2B, B2C, we don't really care. Is this a good business model?'"

While integrators receive payment for services at the commencement and completion of a project, other service organizations rely more on continuing revenue than up-front fees. But even those service providers run into trouble if they tie themselves too closely to their customers' revenue.

In August, for example, Sunnyvale, Calif.-based ASP Pandesic, which specialized in B2C e-commerce solutions, announced it was shutting down. Pandesic had worked out a payment plan in which it received 2 percent of customers' revenue in addition to the monthly fees it charged. The revenue stream, however, never amounted to much, and Pandesic was pessimistic about achieving profitability.

ABCs of Fees
Other ASPs, nevertheless, are thriving. George Kurian, vice president of content delivery services at Akamai Technologies, Cambridge, Mass., says that selling services on a pay-as-you-go usage basis limits his company's liabilities and provides some breathing room for customers. "Cash-strapped B2Cs don't have to go out and buy large amounts of infrastructure to get the capabilities of a high-performing Web site," he says. "Instead of deploying thousands of dollars of equipment, they can literally buy a service for $19.95 per month. It's a pay-as-you-go model. We don't finance our customers," he says.

That monthly fee covers a set amount of traffic that can be upgraded to a higher flat fee as the customer's site gets more hits. "Our applications are applicable to anyone who has a Web presence, whether they are B2C or B2B, corporate enterprise or small business," Kurian says. "We have 2,100 customers. And we continue to see e-retailers sign on; it's still a healthy market."

Despite the financial community's snubbing of consumer-oriented e-commerce, PSOs remain upbeat. Industry analysts are still predicting huge increases in Web purchases of consumer goods during the next few years, though the rate of growth is slowing and the average value of each transaction is decreasing. The consensus, however, is that there will be fewer dot-com players as bankruptcies and mergers take their toll. PSOs are adapting by turning to brick-and-mortar retailers with cushy balance sheets and lots of tangible assets. And, after their initial trepidation, traditional retailers are turning to PSOs for full-fledged solutions that tie the front ends and back ends of their businesses.

Meanwhile, pure-play dot coms that survive will be stronger and will continue to need integrators and strategic consultants as they tweak their business models. Sapient's Markesky is already seeing leaner, meaner, profit-driven companies. "Every change we are asked to make to a Web site is business-case driven. That's a big shift. Now people are thinking about the bottom line."

Web integrators that previously took equity in lieu of fees or a percentage of client revenue have discarded those models. Most are thinking like VCs instead of just taking on any client. "When projects are presented to us, I put myself in the shoes of someone on Wall Street and wonder what they would think of that project; would an investor be excited about it?" says Fry Multimedia's Fry, who never took an equity position.

XUMA, too, performs extensive financial background checks to make sure that potential clients can cover the fees. "If they are going to sign a long-term contract, we want to make sure that they have the financial depth to commit to that," Lerner says. "Over the past few months, we've tightened up the due diligence."

Menlo Ventures' criteria for funding a Web company works just as well for PSOs wondering whether to take on a new client. To determine whether a company is likely to be a worthwhile client, Hoel recommends asking, "Can a company be No. 1 in its market space? Can it solve a real problem? Is there a unique customer set?"

Another VC's perspective is also worth remembering. "Simple characterizations like B2C or B2B don't do anyone justice," says Ray Rothrock, general partner at the Menlo Park, Calif., office of Venrock Associates. "What's hot today or cold today can turn around quickly, as we all have witnessed in recent months. The IPO bubble in which all venture groups have been living is just not indicative of the long-term characteristics of this business."

Despite the turmoil in the market, it's unlikely that businesses and consumers will go back to shopping the old-fashioned way. So, with a bit of intensive care, B2C looks like a survivor.