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Great Opportunities, No Bull

by Arnold Kling

March 9, 2001

One of my favorite movie scenes is near the end of "Apollo 13." An official grumbles that this could be the worst disaster in NASA history. Hearing this, Gene Kranz (played by Ed Harris) tugs at his vest, straightens his tie, sticks out his chin and says, "With all due respect, sir, I believe this is going to be our finest hour."

In that spirit, I am going to make a bullish case for the Internet. No, I am not recommending that you rush out and by Yahoo, Amazon, and, which closed yesterday at $17.70, $11.70, and $0.25, respectively. My feelings about the Internet high-flyers always have been--er, how shall I put it?--mixed.

The bullish case that I am going to make is for opportunities that are, to use the title of my forthcoming book, Under the Radar. That is, they are not large markets in which companies can hope for billion-dollar valuations. They are for the quaint souls who believe that $10 million or $20 million is still real money.

I will describe a number of categories of Internet businesses that seem promising. Within these categories, there are businesses that are being pursued successfully by entrepreneurs now. However, there are many more opportunities for people who want to take the start-up route.

  1. Vertical IT Shops

    A vertical IT shop is a company that offers computer services in a particular industry segment. The offering may combine hardware, software, services, and support.

    Many small businesses suffer from IT headaches. Law firms have a hard time retaining network administrators, for example. Mental health practices have difficulty with tracking billing and collections.

    For small businesses, it is very difficult to deal with maintaining a computer network, upgrading software, and keeping up with changes imposed by trading partners (such as standards imposed by insurance companies on mental health care providers). For entrepreneurs, the Internet represents an opportunity to solve these problems inexpensively. In effect, you can become the IT shop for many small businesses of a given type.

    The vertical IT shop tries to give the small business a targeted, complete outsource solution. Examples include Don Britton's Network Alliance and Bernard Brookes' Actualize, Inc..

    However, becoming a vertical Application Service Provider requires more than just writing generic software code. You need to understand the peculiar features of the industry. You need to wrestle with the issue of customization--doing enough to satisfy your customers but not so much that your cost structure blows up. And you need to develop a rapport with the typical owner or manager, so that you develop a successful sales pitch.

    The adoption hurdle can be very difficult to overcome. These IT hassles have existed for so long that many small businesses believe that they have adapted to them. As Michael O'Horo has pointed out, once people have learned to live with pain, it becomes harder to convince them to buy a solution.

    On the other hand, this inertia works both ways. Once you have customers on board and satisfied, the renewal rate tends to be very high. Once you have your service model operating efficiently, phrases like "free trial period" and "money back guarantee" can be used to grow your market.

  2. Defraggers

    Defraggers take fragmented industries and give customers a rational interface. My favorite example of this is Trevor Cornwell's, which transformed about 1,000 independent charter aircraft operators into a single virtual airline.

    A less successful example (so far) is Dan Cunningham's 507media, which built a system to facilitate online booking of bands for music gigs. Another interesting attempt is Therese Haar's Farmerlink, which aggregates local produce farmers who sell to consumers.

    To make the Defragger model work, you need more than just a fragmented market. Some other conditions that are important include:

  3. Niche Newsies

    Email newsletters are the secret weapon of Internet marketing. Advertising in email newsletters gets very little publicity, but it gets much better ROI than web advertising.

    In my opinion, advertising on web sites should not exist. Web sites should drive you either to transactions or to newsletters. Banner ads are the road to ruin.

    Niche newsletters are terrific because they provide targeted opportunities for advertising. For example, consider Paul Sherman's Potomac Techwire, a newsletter about high-tech firms in the Washington, DC area. It has a very effective classified advertising section, because advertisers know that the newsletter is eagerly absorbed by its target audience.

    In general, newsletters are not as demanding to develop and maintain as web sites. Consumers expect little in the way of graphics. There are no interface design issues. Link structures are simple.

    The combination of solid revenue potential and low cost makes the niche newsie business the best model for the journalistically-oriented Internet entrepreneur. The challenge is to build up a loyal base of regular readers before you try to bring in too much advertising.

  4. Virtual Immigration

    The cost of labor is very high in places like San Francisco and New York. However, for executives, it may be necessary to locate in an expensive area in order to stay in contact with critical business partners.

    The Internet makes it possible for a firm with a high-cost headquarters location to reduce the cost of its routine labor. You can have clerical work, software development, or customer service done remotely, with no loss in turnaround time.

    Some of the most striking reductions in cost come from moving work overseas, to countries like Ireland and India. Because immigration is restricted, both by cultural and legal factors, wages are much lower overseas for workers with comparable skills. The Internet makes possible "virtual immigration," in which workers effectively join American firms without leaving their home country.

    Many opportunities exist to facilitate and profit from virtual immigration. You need to have contacts with companies in the United States that have outsourcing opportunities as well as contacts with people overseas who can organize pools of workers.

Characteristics of Good Opportunities

In the current environment, good opportunities are characterized by the following: