Getting Stiffed

There's a whole new kind of partner that today's Web integrators may want to consider joining forces with once their work is done. They're called collection agencies. Although analysts say the market for e-business solutions is still hot--and they predict that will continue for at least the next few years--for many solution providers, getting stiffed is becoming a bigger part of doing business in the new economy.

One of the first high-profile cases of an integrator being burned by a delinquent client came in April when AppNet revealed that dot-com customer eOutlets.com was going out of business and couldn't pay its bills. For the integrator, eOutlets' demise was a major hit to its first quarter 2000 earnings. (AppNet has since been acquired by Bethesda, Md.-based Commerce One Global Services.)

But the industry really took notice when Scient told analysts in June that Verde Media, a dot com that still owed $2 million for services rendered by the San Francisco Web integrator, filed for Chapter 11. The announcement came only weeks after another Scient client, brick-and-mortar reseller Inacom, also filed for bankruptcy.

As a result, Scient's stock plummeted--down from a high of more than $130 a share in March to just below $40 following the announcements--as analysts turned a keen eye to the integrator's customer base and concluded that it was too reliant on shaky dot coms, which made up about one-third of Scient's fourth quarter 1999 revenue. The integrator's stock rebounded somewhat in July, but then dropped again with the overall decline in Internet services companies, despite posting strong revenue and earnings for the first three quarters of 2000. (As of Nov. 8, it was selling for just over $16 a share.)

For many in the industry, Scient's wild ride moved what were once only back-burner concerns over the shakiness of dot-com clients into stark reality. And the company is certainly not alone. Chicago-based e-integrator Lante reported that $1.7 million in bad-debt expenses related to some of its struggling dot-com clients contributed heavily to its third quarter loss. The company says it has been taking steps to minimize that risk moving forward. And last quarter, Internet engineering firm Cysive reported holding a bad-debt reserve of 8 percent of its revenue to offset the risk of getting stiffed.

Half the Story
With such a strong focus of late from investors and Wall Street on revenue growth and bottom lines, it's easy to see how a Web integrator's getting stiffed by just one large client can send its quarterly revenue--not to mention stock price--tanking.

The truth is, when it comes to bill collecting, the problems plaguing e-business solution providers are no different from those that have vexed vendors in any other client-serving industry. What is different, however, is that up until recently, funding for

e-business projects was relatively easy to find, with most VCs willing to throw a few million dollars at any company with a business plan and a URL.

Well, it's no secret that things have changed dramatically over the past year, with investors taking a more serious look at e-businesses' profitability and business results--or lack thereof. And while a traditional reseller may have had the ability to repossess property from a delinquent client, what recourse does a service-based company such as a Web integrator have once the work is done and the bills go unpaid?

According to some executives in the industry, the accounts-payable problems affecting many of those e-business solutions providers are much worse than reported.

"Those numbers usually under-report by half what really went on," says Michael Treacy, co-founder and chief strategy officer of Boston-based Gen3 Partners. "In every one of those deals where a company had a dot com that owed them cash, part of the deal was a series of warrants, options or stock on that dot com, as well. That doesn't go reported. It's a lot worse than they are talking about."

With so many dot coms struggling to make a profit and others folding up entirely, many in the industry are expecting to see more cases of delinquent clients moving forward.

"Whenever you hear a story like that, my first comment is that it's not unexpected," says Ralph Armijo, president and CEO of Web integrator Navidec, which also has a subsidiary, NaviNet, for incubating start-up companies. "There are a lot of companies that have gone public and have gotten early funding that probably never should have, but because of the hype at the time, they were able to do it."

For every incident making headlines, there are countless others flying under the industry's radar, insiders say.

"If you look at some of the other '-iants' of the world, you'll see that they have two or three companies that they have invested in," says William Ames, CEO of Web integrator Gobosh. "What that means is those companies didn't pay their bills, so they take stock. It wasn't like they're out being a VC."

Taking Responsibility
When analyzing fast-moving dot coms, you can point to a variety of problems that might cause them to crash and burn. Industry watchers say the prime reason is that they have historically structured their business models around buying Web traffic rather than making direct profits. "Ultimately, you can't afford to buy traffic long-term," Armijo says.

As a solution provider serving those dot-com clients, Armijo says it's his company's responsibility to make sure they will be able to pay--before they start an engagement. "That's why most of our business is not dot coms but rather B2B applications," he says. "With the dot coms we are involved in, we have scrutinized them very closely, from a financial point of view as well as their business models. I think every company still has some amount of risk, but we hope and believe that we have minimized ours."

Hank Satterthwaite, CEO of New York-based Internet services company Snickelways Interactive, says the easiest way to avoid delinquent clients is to act like a venture capitalist and do your homework up front. Much like a VC would do, Snickelways looks at the prospective customer's financial plans and makes sure it is a viable business with sufficient funding to be taking on a complex

e-business initiative.

"If we have the fear, we just don't take the business," says Satterthwaite, noting Snickelways has yet to work with a client that couldn't pay its bills.

But it's not always client bankruptcy that keeps an integrator from seeing a paycheck. In August, Web integrator Cysive made a drastic move to cut ties with CorPay Solutions, its largest client, after losing confidence that CorPay would come through on money it owed for services. But CorPay claims Cysive was months behind schedule and could not deliver the functionality that was promised in the contract.

While major cases of a Web integrator getting stiffed appear to be few and far between, smaller incidents are just as common as in other industries, say executives at San Jose, Calif.-based Gobosh.

"We haven't had it happen to a large extent yet, but we have some small ones, like in the $10,000 or $12,000 range," Gobosh's Ames says. "It's been nothing too big, but of course that is always a concern in our marketplace."

That's why the company makes an effort to stay on top of client accounts in danger of becoming delinquent. The idea is to head off small problems before they snowball.

"Typically, we really try to keep our finger on the pulse and not let them get out of sorts and use us as a credit card and then say, 'Oh well, I've got to file bankruptcy, so you're not going to get paid,'" says Eric Hughes, Gobosh's executive vice president. "It's just really a matter of being very aggressive."

It's also a good idea to have clients pay bills on an installment, says Snickelways' Satterthwaite, whose company generally avoids what he considers the "all-or-nothing" payment plans.

"We ask our clients to pay up front a certain percentage of what they are doing," he says. "It's a phased activity. If you have any sense in the first part of the engagement that the dot com is on shaky financial terms, then you don't go any further and you collect a smaller amount."

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