Reality douses dotcom delirium

Retrenchment hits an industry that now makes up 10 percent of US economy and is the fastest-growing sector.

America's New Economy is facing some jolting truths from the old one: Profits, hard-nosed business plans, and experienced management count.

Those truths are behind the swooning dotcom world of the past several months, say economists and Internet experts. And they expect to see dotcoms and Internet start-ups experience more layoffs, meandering stock prices, and headline-making turmoil through the summer and fall.

But those gyrations are only tempering the spectacular rise of the Internet industry, which promises to remain a leader in overall economic growth.

"This is not like the auto or steel industry downturns of the past, which slowed the economy," says economist Stephen Levy of the Center for Continuing Study of the California economy. "This is an industry slowing down while still growing way ahead of the economy as a whole."

Viewed from the inside, though, the dotcom shakeout has been traumatic, changing both its culture and economics.

"The Internet has created the most Darwinian environment in business history," says Jay Whitehead, CEO of EmployeeService.com in San Francisco. "You can now fail faster in the dotcom world than ever before."

Many have in recent weeks. The crime and justice site APBnews.com, retailer Boo.com, and HealthShop have all been shuttered. Pink slips have fallen on a host of other dotcoms, ranging from AltaVista, an online search engine, to the CBS Internet news division. "It's all just a sign that we're moving into the next stage of the dotcom revolution," says John Challenger of Challenger, Gray & Christmas, whichtracks layoffs nationally. In fact, dotcom layoffs are so new that the Chicago firm only began monitoring them in May.

But Mr. Challenger predicts layoffs will accelerate this month and into the summer, even though that doesn't necessarily portend a retrenchment for the industry. "It's not shrinking, just growing more slowly," he says of the dotcom job base.

The Internet economy barreled into 2000, accounting for close to 10 percent of the US economy and nearly one-third of its current growth. A study this month by the University of Texas and sponsored by Cisco, an Internet hardwaremaker, found that the Internet sector of the economy directly employs nearly 2.5 million people.

While that represents a small share of the total workforce - about 2 percent - it's growing far faster than the economy as a whole. Internet jobs grew 36 percent in 1999, the study found. And, says coauthor Andrew Whinston, dotcome employment will "continue to grow and ... the overall employment opportunities will be tremendous."

Still, turmoil in the dotcom world is reflected in falling stock prices. The technology-laden Nasdaq index remains about 1,200 points below its peak in March. One of the latest victims: Amazon.com., whose stock plummeted Friday in the wake of a gloomy brokerage house report about its credit.

The market decline is seen as a leading cause of dotcom failures. With less-spectacular gains, investors have grown more selective in who they fund, demanding clearer projections of revenues and profits and more-experienced managers. And when capital is invested, venture companies today are more apt to lower their valuation of the start up, meaning they get a share of the company for fewer dollars.

"The stutter in the market causes everyone to slow down," explains Kirk Walden, director of venture-capital research for PricewaterhouseCoopers.

Venture capital, a primary source of funding for dotcoms, has been pouring in over the past two years. In the first quarter of 2000, venture capital to Internet-related firms totaled more than $10 billion, a record, and more than twice the amount of a year ago.

But many expect the second quarter of this year to show a flattening, or even possibly a slight decline, in venture-capital investments. "The old rules of business are beginning to apply," says Mr. Walden. By that he means that venture capital increasingly flows to dotcoms that are already up and running and that have a clear plan for revenues and, ultimately, profits.

That means harder times for start-ups, particularly those not founded by entrepreneurs with a track record. When it comes to raising money in the technology world, it is no sin to have failed previously. In fact, many funders prefer entrepreneurs who have learned lessons the hard way.

But what venture capital firms are increasingly repelled by are start-ups headed by novices, however appealing their ideas. That likely means fewer newly minted MBAs striking instant riches, say analysts.

Still, churn within the dotcom workforce hasn't changed the shortage of skilled technology workers, and most employees that are laid off quickly find new jobs.

Tech employers' unrelenting demand for skilled workers has led to legendary perks, ranging from free rent for a couple of years to some companies offering top executives BMW Z3 sports cars.

While some firms have noted a shift in applicants wanting more of their pay in salary rather han stock options, other dotcom recruiters say most workers are still willing to take the higher risk and reward inherent in the option approach. Notes one marketing executive with an 11-month-old dotcom: "The 'I'm going to win the lottery' mentality is still strong."

Using his own informal measure, Mr. Whitehead says the coming-out announcements and new-product parties are growing less ostentatious: The average size of shrimp and stature of bands is shrinking.

(c) Copyright 2000. The Christian Science Publishing Society