*Michael Cox, Andrew Larson, Brian Long, Jarrod Carlson
January 26, 2005
Acct 7630 - Unit 2 Group Assignment
http://www.fool.com/portfolios/rulebreaker/2000/rulebreaker001114.htm
http://www.ecommercetimes.com/story/19024.html
Hundreds of companies in the mid to late 1990’s were formed based on an idea, financed with venture capital money and brought public by overzealous investment bankers. Few of these companies posted profits prior to their IPO, and only a few have been posting profits since then. These companies, better known as Dotcoms, remain notorious for sending the stock market plummeting and dissolving many people’s nest eggs. Not only did investors pay dearly for their investments, but underwriters like Merrill Lynch were forced to settle due to their part in inflating buy ratings for companies like Buy.com, eToys.com & Pets.com.
Pets.com is a perfect example of a failed Dotcom. Their management team had absolutely no experience being in charge of a business. These people had excellent technology skills but little if any business sense. Any due diligence that venture capitalism firms usually do would have picked up major discrepancies with the basic business plan that Pets.com submitted, but the whole Dotcom boom effectively pulled the wool over the VC’s eyes, and they, along with many other companies, fell through the cracks.
The problems that plagued the company from the beginning were hidden due to the greed of investment bankers and venture capitalists. Pets.com went through an IPO and additional rounds of financing before creating any value. Amazon.com bought into the idea and became one of the biggest shareholders, owning as much as 30% at one point. Pets.com’s management team proved their level of incompetence by spending most of their money on advertising instead of operation improvement. They should have used this money to build a successful business model and become profitable, and then moved forward to expand the business. In fact, they did the exact opposite.
Pets.com did not develop a core competency and tried to counteract this by spending millions of dollars on advertising. They thought that the key to success would be to sell low margin goods to millions of customers. With this in mind, they put a full scale operation in place and set their sites on expansion. One small problem though, they were not profitable. Their growth was based exclusively on capitalization. Most of the items they sold had razor-thin to zero margins, and nearly 80% of the items they sold online were sold at a loss. The products they offered had low price-to-weight ratios that could usually be found in local brick & mortal stores at a much cheaper price.
Before their very first round of financing, they failed to ask themselves and their target market some very simple questions to see if they could be profitable. Are consumers who own pets a likely group to be early adopters of the Internet? Will pet owners buy online? Will it be a convenience they will pay a premium for? In the end, it turned out that the premium cost did not out-weigh the convenience, and customers simply did not buy items that could easily be purchased at a pet store or regular grocery store.
Eventually, the venture capital firms realized that Pets.com was nothing more than a money pit, and they pulled their investments out, leaving the general public to take the financial hit that ultimately ensued. Once the company realized how broken their system was, and that they could no longer sustain their business model, they were forced to declare bankruptcy and pay off as much of their debt as they could.
There were numerous other examples of Dotcoms that had the same result. These bankruptcies were caused by the free flow of money from venture capitalists to people that were not in good positions to run a corporations. A lot of people got on the Dotcom train, but few got off before the crash.