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internet business models

text and cases

tom eisenmann

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© 2002 The McGraw-Hill Companies, Inc., All Rights Reserved.

Access Provider Lecture

Chapter One

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Get Big Fast

• Accelerated investment in customer acquisition

• Premise: first-mover advantage

• Tactics– Massive marketing campaigns– Giveaways, subsidies, deep discounts– Mergers

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Get Big Fast When...

1. Businesses exhibit “Winner-Take-All” structural characteristics

– Strong network effects, scale economies, and customer retention rates

– In Netspeak: viral, scalable, sticky!2. Competitive risks are “reasonable”

– Avoid full-frontal assault on entrenched leader– Avoid wars of escalation and attrition

3. Lifetime value of a customer is positive4. Capital markets reward first movers (or you have cash on

hand)– Euphoria, overtrading, revulsion

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Get It Right First When...

1. Ensuring reliability is crucial to customers

2. Learning-by-doing is important

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GBF Payoff for Access Providers

• TCI• Teledesic• Geocast• EarthLink

– 48% of 2000 revenue on sales and marketing– 1.7 million subs B.O.Y. ‘99 4.8 million B.O.Y. ‘01– Stock price down 91%

• NetZero stock price down 96% from 52-week high

• AOL stock price down 10%

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Network Effects

• Connectivity-related– Communications: chat, IM, videoconference, IP phone

– Collaboration: document sharing, calendars

– Community-generated: multi-player games, photos, message boards

– Commerce: auctions, exchanges, classifieds, bill payment, wallets, loyalty programs

• Software-supply related

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Strength of Network Effect

• Proprietary networks (walled gardens)– Joint: boost industry demand– Risk: stall

• Sensitivity to aggregate participation rates

Probability of P

rospect Joining N

etwork

Probability of P

rospect Joining N

etwork

% of Prospect’s Existing Offline Partners Already Active in Online Network

% of Prospect’s Existing Offline Partners Already Active in Online Network

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CaseStrength of

Network EffectsComments

TCI Weak?

Repurposed content for ITV Proprietary communications (chat,

IM, videophone)

Teledesic ? Hard to predict

Geocast Strong Strong software-supply effect

EarthLink None None apparent

AOL Very strong IM, chat

ComparisonScale Economies

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Scale Economies

• Variable contribution margin– 80% of revenue for content provider, portal, market

maker

– 20% of revenue for online retailer

– 34% of revenue for ISP

• ISP Economics– Revenue $20.00

– Variable costs 13.20• customer support 5.80• network (½ POPs; ½ leased lines) 7.40

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• Network effects• Differentiation (sustainable??)

– Skills/execution– Different tastes

• Switching costs

• ISP churn: 4% per month, so keep 61.3% of customers after one year

– Average life of customer relationship = where x = annual

retention rate

– For ISPs, = 2.6 years

Retention

x1

1

– Reintegration of information systems– Forfeiture on transaction profile– Risk of disruption

– Hassles opening/closing accounts– Retraining– Cost of data re-entry

61.1

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Lifetime Value of ISP Customer

• Variable contribution margin = [($20-13.20) per month 12] = $81.60/year

• 2.6 years @ 10% NPV is $134

• For EarthLink, average customer acquisition cost for 2001 projected to be $168 (down from $200 in late 2000!)

• So, LVC is negative!