Internet Strategies That Work (Maybe)

Thanks to the carnage of the past 10 months, we have a pretty good idea of which business strategies don't work on the Web. But what does work?

The thrill is gone. Sure, some great Internet companies will be built over the next 10 years, and the power of digital technologies to reshape companies and industries is going to grow. But the strategies that are required to build those companies and the leadership skills that are necessary to achieve deep-seated change (rather than merely talking about it) are just now being devised and identified.

Thanks to the carnage of the past 10 months, we have a pretty good idea of which business strategies don't work anymore. But what will work in the future? Which strategies will help big companies make the necessary adjustments so that they can become players in the fast-moving Internet economy? Are there better ways for startups to challenge conventional wisdom, make big bets on new markets, and stay in the game long enough to become profitable?

The case studies that follow address these and other questions. Consider them to be examples of next-generation Internet strategies. The game has changed: It's more exacting, less exuberant. But the opportunities are still enormous. Here's how a collection of smart executives from London to Silicon Valley are working to realize those opportunities.

The Empire Strikes Back

The ocean-shipping business has been conducted the same way for centuries: Brokers match shipowners with cargo merchants and take a percentage of the transaction.

But earlier this year, an old-line industry entered a new era. In January, a cargo of oil that was bound from Singapore to Rotterdam was matched up with a tanker and secured by contract. This time, the parties conducted their business entirely online. It was the first official transaction for LevelSeas Ltd., a London-headquartered Internet exchange that handles bulk-cargo transport on ocean freighters.

More than two dozen online shipping exchanges have been vying for business, many of them classic Web-based startups, a few with the backing of giants like Texaco. But when BP Amoco, Cargill Inc., and Shell combined forces to form LevelSeas, they brought with them 10% of the bulk-cargo chartering business. That's 10% of about $70 billion, which is the annual value of seaborne bulk freight (mostly oil, coal, and grains). On January 7, some of the world's largest shipowners and cargo brokers also invested in LevelSeas, making it the closest thing to an industry-wide platform. What's left for competing exchanges? "Not much," boasts Richard Hext, CEO of LevelSeas. "Our strategy from the outset has been to come to market with so much scale that we could overwhelm anyone else attempting to do this, or we could come bloody close." The race to reinvent the shipping business is underway — and the winner may well have been determined on the very day that LevelSeas entered the contest.

This is the new look of the Internet economy. The first round of innovation was powered by venturesome entrepreneurs who were starting from scratch — young companies that brought energy, enthusiasm, and a we-can-change-the-world zeal to their startups. The second round has more of a sober quality to it. Big, established companies are discovering that their advantages of scale, their established brands, their loyal customers, and their long-standing relationships with suppliers are just as valuable online as they are offline. That doesn't mean that the force of their innovations is any less dramatic — or that the challenges to success are any less real. It turns out that history, experience, and wisdom have their virtues — but only if established companies can forget many of their old ideas about the logic of strategy and about the best ways to make decisions.

All of which make LevelSeas instructive, particularly since it is the first Net company built by eVolution Global Partners. EVolution itself is a novel creation of the Internet economy. Its financial backers are a trio of powerful business mercenaries: consultancy Bain & Co., venture-capital firm Kleiner Perkins Caufield & Byers, and private-equity specialists Texas Pacific Group. These players saw an opportunity to carve out the assets of established companies and combine them to form new Internet companies that would have the instant advantage of scale. It's not a repudiation of the Internet business model, but a culling of its most-effective attributes: the speed of flat organizations, the power of networks to rewire big business problems, and a slate of financial incentives for everyone involved that still assumes that the venture will pay off handsomely.

"We are a venture-capital company," says Stan Miranda, 45, a managing director of eVolution's European corporate development and the chairman of LevelSeas. "But we only help the empire strike back." Indeed, eVolution's partners see themselves as a new type of general contractor that oversees the construction of Internet companies with staying power. "In all cases, we're leveraging some big-company assets to give these new businesses a head start," says Kleiner Perkins partner Ted Schlein, 36, a director of eVolution. "If we're doing our job right, then these companies are starting out with a huge unfair advantage."

That doesn't mean that all big companies are eager to get with the program. For one thing, many CEOs are a lot less worried today about being blindsided by a gutsy new Net competitor. "The heat is off these guys now, and it's leading them to make some bad decisions," says James Allen, 40, eVolution's CEO. "When we talk to corporate executives, we tell them, 'Don't get smug, because the real lesson of the new economy is that talent will flow where there is equity and empowerment. Don't presume that you can build these businesses within the old corporate structures now, because it won't work.' "

Governance Matters

From the beginning, eVolution's role at LevelSeas was to ensure the independence of the venture. BP Amoco, Cargill, and Shell had already joined forces in February 2000, but until they brought in eVolution as an investor and partner the following June, LevelSeas was regarded with suspicion by many in the shipping industry. That's because part of LevelSeas's promise is good, old-fashioned disintermediation. Shipowners and brokers have profited from a lack of visibility about where in the world to find ships that are available for cargo — which amplifies the normal swings in supply and demand. The same ship carrying the same cargo along the same route can jump five or six times in price over the course of a few months, because the charterer doesn't know where else to find an empty ship. "Brokers that continue to provide good advice and good reads on the market will continue to get business," Hext predicts. "But the more liquid and open the market becomes, the less the nudge-nudge, wink-wink world of brokers operates."

Even after LevelSeas assumed a lead role with Miranda as chairman and Hext as CEO, the company had to work hard to counteract the perception that it was designed to serve the interests of its founders first. That's why eVolution worked with Kleiner Perkins and Texas Pacific Group to develop a distinctive blueprint for corporate governance. It calls for granting the management team 20% of the equity, with provisions for a hefty payout if the shareholder companies fail to pull the trigger on an IPO. A contingent of independent directors (including eVolution's representatives), and bylaws that require a two-thirds majority to make binding rules, mean that there is "enough independence on the board to block anything silly," Miranda says.

But there's more to the structure of LevelSeas than blocking bad ideas. There is also a set of incentives in place to build the business intelligently and quickly. An exchange like LevelSeas lives or dies by how liquid it is — that is, by how large and numerous the transactions are that pass through the exchange. LevelSeas needed a mechanism to reward the partners who channel more of their business into the system, while discouraging free riders. To hardwire the commitment of its corporate partners, eVolution came up with a novel way to tie the equity of its shareholders to the volume of their transactions with the new company. The board would set targets for each strategic investor: either a dollar amount or a percentage of the volume of business that is passing through the operation. Every time shareholders hit a target, another chunk of their equity vests. This way, heavy users can quickly build their stakes.

Ultimately, however, LevelSeas adopted a more modest scheme, which allocates equity on top of each company's original stake when it brings more of its business to the new venture. Because eVolution arrived after LevelSeas had been established, it was unable to push through the higher-octane plan. "That proves how difficult it is," says Miranda. "Sometimes when we're called in, the company is already in motion. Then we have to use the carrot instead of the stick."

Fast, Yes — First, No

LevelSeas may be the most-powerful player aiming to bring ocean shipping to the Internet, but it wasn't the first such operation to launch. A U.S.-based company called

SeaLogistics Inc. actually completed an Internet-based charter transaction on November 1, 2000. A year ago, that difference in timing would have been a big deal — the most powerful advantage, after all, was first-mover advantage. No more. When your partners and your customers are among the biggest players in an industry, time to market isn't the only priority. What really matters is being best to market. "It's all about integration," says Miranda. "Big companies in particular don't want to have to reintegrate their computer systems and redo all of their procedures. You can be the first out there, but if your customers take a look and say, 'That's only 10% of what I need,' then you haven't helped yourself in this arena."

By Miranda's reckoning, corporate ventures have three to six months to get their act together after the first entrants announce that they are up and running. That's hardly a lot of breathing room. At LevelSeas, eVolution sought input from BP Amoco, Cargill, and Shell along the way, but it established ground rules for the interactions. Every week or two, parts of LevelSeas's operating system would be kicked back to the shareholder companies for feedback. The short cycles of building and learning helped LevelSeas to incorporate winning features without falling behind schedule.

More than once, the process threatened to spin out of control. But eVolution anticipated a tug-of-war among shareholders over LevelSeas's capabilities and created a powerful central figure — the design director — who is responsible for brokering all of the competing claims on the evolving system. "We've become religious about the design director," says Miranda. "Every startup we're involved in has to have one. If he's not a very strong character, he will get ripped in different directions by the shareholders."

Miranda has come to think of the design director as an Internet counterpart to the chief designer for a new automobile. It's an analogy that springs partly from his consultant's admiration for the focus and clarity of the design team at Ford's Jaguar unit, which fought off the many committees that were attempting to water down the design of the popular XK8 and make it cheaper to build. Thanks to their perseverance, Jaguar wound up with a winner. "The design directors at LevelSeas and at the other companies that we're involved in have the same authority," Miranda says. "That person makes the final calls after taking input from all directions. It sounds far-fetched, but these are complicated technologies to build. Like an automobile, they have so many pieces that have to work together."

Strategy on a Whiteboard

There's another benefit to clear lines of authority: They make it easier for a complex venture to change direction. Originally, LevelSeas envisioned that it would make its money from commissions it earned by matching cargoes with ships and setting prices on a Web-based exchange. But with the arrival of eVolution and its focus on aiming at the most-profitable opportunities, LevelSeas shifted its strategy. "Very soon into the first demos," Miranda says, "people started saying to us, 'The matching capability is interesting, but when will I be able to track all of the events and documents that occur after the ship has been chartered?' If we hadn't been listening carefully, we would have had the best matching engine out there that people weren't waiting for."

So LevelSeas changed course to become an online platform where many different parties can convene to manage the entire life of the voyage, from contracting with a shipowner to determining who pays if the cargo is late. It developed a system for managing the wave of documents that a charter generates and provided tools such as an online voyage calculator. "A lot of the benefit comes from creating a collaborative environment where lots of people can work together in one place," says Stuart Gent, 29, an eVolution partner who was design director at LevelSeas until Hext came aboard.

At the same time, eVolution was pushing to make the shareholders of LevelSeas more representative of the shipping industry, with a balance of big charterers, brokers, and shipowners, from the "dry" side (grain and coal) as well as the "wet" side (oil). The all-important strategy for building the technology also shifted from outside contractors to internal resources as the founders' names and eVolution's backing helped the company to attract top developers.

It is, all told, a blue-chip way to build an Internet company. But James Allen argues that few of these innovations could have happened if LevelSeas had been trapped inside the big companies that sponsored it. "Not only do you lose the ability to recruit great partners, but corporate decision making doesn't create enough good, strategic, out-of-the-box opportunities," he says. "The independent approach lets us make strategy on a whiteboard — and in the Internet environment, that's the best way to make strategy."

Startups For Grown-Ups

Nothing about Richard Wilkes suggests that he has a romantic view of business. He has built his professional life around hard, rational financial analysis. Wilkes, 54, has worked in the mortgage industry for nearly three decades, including six years running North American Mortgage Co., when it was growing into one of the largest mortgage lenders in the country. More to the point, Wilkes sharpened his edge by combing through the wreckage of the savings-and-loan debacle in the late 1980s, buying up gutted thrifts from government regulators, and turning their operations around. His partner and backer in that enterprise was Ronald Perelman, one of Wall Street's toughest speculators.

Yet even a gimlet-eyed rationalist like Wilkes lost his bearings during the Internet boom. His love affair with the dotcom world started like that of so many others. In Spring 1999, lured out of a comfortable consultant's life by John Hummer, founder and chairman of Hummer Winblad Venture Partners, Wilkes sold his home in Houston and moved to the San Francisco Bay area to run IMX Exchange Inc., a B2B Internet company that connects lending banks with mortgage brokers.

At first, the deal maker in him rebelled at the out-of-this-world financial logic of Silicon Valley. "When I saw how companies were valued, I thought that it was ludicrous," says Wilkes, who looks like he could be Oliver North's beefy older brother. "But it's easy to get seduced. You listen to the bankers who say, 'You're going to have a market cap of a billion dollars, maybe two billion.' And then this gorgeous woman comes in, and her name is IPO."

What happened next brought everyone back to earth. As Wilkes's company was preparing to go public, the bottom fell out of the NASDAQ. Wilkes says that he came as close as he's ever come in business to feeling heartbreak. "I had forgotten one of the lessons that I'd learned from Ron Perelman," he recalls. "Never fall in love with a deal. Be ready to walk away just before you sign the last document."

But Wilkes chose not to walk away. Hired for his industry smarts, his knowledge of mortgage lenders and brokers, and his operational experience, he decided to prove to himself and to his colleagues that a solid idea for an Internet startup can survive even the harshest market turmoil. Wilkes is trying to pull off a strategic trifecta that faces so many dotcom companies today: land new customers, find new capital, and generate a new business strategy, all at the same time.

"We're trying to beat a horse that's barely alive," Wilkes admits. "We've had four quarterly increases in a row in our lender and broker members, bids for mortgages, and revenues. Everyone who saw it said, 'We like your model.' But I've learned not to confuse a favorable comment with a 'yes.' In situations like this, you've got to change your business model and conserve cash."

Cash Is the Gas

The turnaround at IMX has been neither pretty nor easy. It has cut employees from its payroll three times since June 2000. The company probably would have become a casualty already if Wilkes had not been able to raise an additional $18 million from its existing investors, led by ABN Amro, Hummer Winblad, and Lehman Brothers. Pulling down more money for an Internet startup in the summer of 2000 was a minor miracle. "It was like pulling back teeth," he says.

Still, having real money makes all the difference these days. "It's like the movie The Road Warrior, where gasoline was everything and the guy who could find the gas was king," he says. "In this case, cash is the gas." Like Mad Max, the movie's self-reliant protagonist, Wilkes has become obsessive about hoarding the one commodity that stands between him and oblivion. Each week, he sends an email around to IMX's four senior managers, informing them how much cash the company has spent in the past week and how much is left. "I have to let them know that cash is a scarce resource now," he says. "It makes them think, 'What can we do to raise more revenue or to reduce the suction of cash out of the company?' Our assumption is that the $18 million we raised is the last chunk of money we will ever get from private investors."

Even with the world collapsing around it, IMX is steadily adding customers, and with the slowing of its burn rate, Wilkes says that the company could be profitable in under a year. The pool of customers is relatively small: The top 25 lenders account for roughly half of the total volume of mortgage loans made in the United States, and IMX is attracting business from big mortgage lenders like Bank of America Mortgage, First Nationwide Mortgage Corp., and Wells Fargo. On the other side of the market are about 2,300 mortgage brokers who act as the shock absorber for the large lenders, taking the bumps out of the loan-origination process by finding qualified borrowers and bundling them together.

The arguments for swapping mortgages on a Web-based exchange instead of via paper and fax are as compelling as ever, Wilkes claims. Fortified with fresh capital, he sees IMX as a likely survivor in a rapid roll up of dotcom mortgage companies that spent too much to acquire customers and now need to be rescued. Indeed, figuring out how to navigate the consolidation phase of an infant industry has become Wilkes's most-pressing strategic concern. His approach is a mixture of optimism and ruthless tough-mindedness. "This industry will consolidate almost by definition, and someone is going to make this work," he says. "The question is, Do we want to be a catalyst or a bone picker? We wrestle with it, because prices for the companies that we would consider buying will be lower at the boneyard than they are now. But others may be waiting at the Chapter 11 courthouse too."

As much as anything, the deal making that Wilkes is engaged in is emblematic of the next phase of the Internet industry. "We're not going to merge with five companies in the next 90 days. It would blow us apart," he says. "But I like the idea of putting companies together, eliminating redundancies, and getting the benefits of consolidating staff. To me, that strikes a big chord."

Anatomy of a Dotcom Deal

On a recent afternoon, Richard Wilkes sat in his office on the second floor of a featureless building in San Ramon, California and fielded telephone calls. The first person was a longtime acquaintance of Wilkes's in the mortgage industry who was calling to propose a merger between IMX and the subsidiary of a new, Web-based financial-services exchange. Wilkes had just hung up when the phone rang again. This time, it was a competitor with an offer to sell his company. Wilkes listened patiently, taking notes and asking questions. He was under no illusions about the motives behind the calls, he said later: "We've got cash, and they don't."

It was getting dark outside when Wilkes gathered four members of his management team to brief them on the calls that he had received that afternoon. Glancing at the legal pad in his left hand, Wilkes began to sketch out the offers on his office whiteboard. Before he had finished explaining the offer, the team had started breaking it down, weighing what they would get that they didn't have, and what they might be saddled with. The discussion was fast paced and jocular, with nearly all of the jokes at the expense of IMX's desperate competitors.

As the meeting broke up, Wilkes said that he thought the best course was to watch and wait. On his way to dinner at a nearby restaurant, where the team would reconvene, Wilkes talked about his savvy old boss, Ronald Perelman. "When you've done this in the past, you get a feel for who's desperate and who's not, who's bluffing and who's not," he said. "It's different from the skills that used to be required to build an Internet company, but it has become critical."

Grow to Be Great

Wilkes is not his usual ebullient self when he walks into the sales meeting the next morning. He's quiet and unsmiling. Dressed in a black turtleneck sweater, houndstooth pants, and black loafers, he fills a styrofoam cup with coffee and walks to the head of the long conference table. He stands there with his mouth fixed in a small, straight line, waiting for the nine people in the room to quiet down. When they do, he gets to the point quickly. After a record month in September, October is off, and Wilkes wants to send the message that it's not business as usual. "We're spending more money than we're taking in," he says. It's the beginning of a 20-minute harangue, by turns sharply critical and rousing, that is intended to light a fire under IMX's sales team. "We've got 12 months, people."

Wilkes tells the sales team about the calls he has received from competitors who are interested in a sale or in a merger. "Why are they talking to us?" he asks. "Because unless they raise more cash, they are going to run out of money and die." Wilkes says that IMX was able to pull in another round from investors because they liked the company's strategic position at the point where the price of mortgages is established between lenders and brokers. But there's no mistaking the real point: "The only way we're going to survive is to produce more revenue, and the only way to produce more revenue is for the people around this table to go out and sell the product."

The sales team listens in silence. But there's resentment building. Some of the sales managers chafe at the new direction set by Wilkes, who is pushing an expansion into private-label software that lenders can use to suck up mortgages from brokers, as well as other products that are adapted from the pricing engine that lies at the core of IMX. That strategy takes the company down a different path than the Internet-based mortgage exchange.

The sales team pushes back at Wilkes, arguing that the new products undercut their efforts to sell brokers and lenders on the exchange. "How should we sell both products without cannibalizing the exchange?" asks one of the senior sales managers. "How should we do that?" Wilkes is quick with his rejoinder. "If someone at McDonald's went to Ray Kroc and said, 'I've got a good idea. I think we should sell chicken sandwiches,' do you think he would say, 'Hell no, it would cut into our hamburger business?' Well guess what? It turns out that McDonald's got more customers because they sell both beef and chicken."

A few minutes later, Wilkes signals that the discussion is over. "The investors gave us $18 million, and we have to use it to increase revenue," he says. "You're where the rubber meets the road. Be creative. As long as you come close to dying trying, that's good enough for me."

It's the kind of scene that's being played out at so many surviving Internet companies these days. The romance of the startup life is long gone. What's replacing it is the tough logic of veteran business leaders like Richard Wilkes. "I learned long ago that you should operate, structure, and finance a company as if you could sell it tomorrow," he says. "Call it mercenary, but it's a discipline that forces you to build economic value." In the end, Wilkes has done what turnaround specialists instinctively do: Having stripped away the soft coating around IMX, he has uncovered the hard, shiny seed of an opportunity.

The company's offices in San Ramon are not far from one of Chevron Corp.'s office towers. After the layoffs last summer, Wilkes gathered the remaining employees and gave what he calls his "Chevron speech." He told them that they still had a chance to build a great company, that IMX is stronger for its layoffs, and that if they don't want to stay for the turmoil of a dotcom, then they can always go get a safe job at Chevron. Nearly all of them have stayed.

Paul C. Judge (pjudge@fastcompany.com) is a Fast Company senior editor. Contact Richard Wilkes by email (rwilkes@imx.com).

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