FOOL ON THE HILL
An Investment Opinion

Shop Online, But Beware of Inflated Revenues

By Yi-Hsin Chang (TMF Puck)
November 29, 1999

Now that the holiday shopping season has kicked off, I'll risk being called the grinch that stole Christmas by being the first to say that online shopping ain't all it's cracked up to be.

Don't get me wrong, shopping online can be easy and convenient, especially if you abhor shopping in crowded stores or dealing with potentially rude sales clerks, and you can shop 24 hours a day. It can offer you more variety than what's available at your local mall or shopping center. It can also save you money, though not always. The Internet allows you to compare prices to your heart's content -- there are even websites dedicated to the task -- but things aren't always cheaper, especially when you include shipping costs and "added services" like gift wrapping.

Despite the Web's interactive nature, online shopping has its limitations. When you shop online, you can't taste that fruitcake before ordering it. You can't smell different types of perfume. You can't feel the texture of that scarf or hold up that sweater in front of a store mirror. In short, the virtual shopping experience isn't quite a reality -- at least not yet. What's more, the Internet will never beat real world stores when it comes to last-minute or spur-of-the-moment buying, nor for diehard shoppers who love trying on clothes, digging through racks of discounted merchandise, and people-watching.

But my beef with online shopping is more as an investor and analyst than as a shopper. I am amazed by the endless proliferation of websites offering online shopping. While competition and expanding choices are a boon to consumers, I can't help but wonder how the heck these ever-emerging websites will actually make money.

Oops. I'm not supposed to mention the p-word (profit) when it comes to Internet companies. We should just pay attention to "revenue growth" and throw caution to the wind. We're supposed to be enthralled by any business plan that involves doing business online. We're supposed to claw our way to get in on any Internet IPO, any dot-com. Never mind that the company is projecting losses for the foreseeable future.

I can't help but be skeptical of so-called "explosive revenue growth" when some Internet companies are wrongfully booking bartered advertising as revenue and a marketing expense. This simply means that xyz.com and zyx.com exchange ad space. No money is exchanged, but each company books the ad as revenue, like a sale, and then turns around and expenses the same amount as a marketing cost. While this doesn't affect the bottom line -- the p-word -- it does inflate revenues, which is what all too many analysts and investors look at.

Internet companies have found other ways to pump up revenue figures, if not the revenue themselves. Some book revenue for the "free" services they offer. Some include as revenue the total price of the product even when they are merely distributing the product on behalf of another company. They should really only be booking the distribution fee, not the actual price of the product. Voila! Phantom revenue, if not phantom profits.

That's why the U.S. Securities and Exchange Commission (SEC) recently asked the Financial Accounting Standards Board, commonly known as FASB (pronounced "fas-B") to impose stricter standards governing the way Internet companies report their revenue. In the meantime, investors should become more aware of the tricks of the trade and less enamored by dot-coms simply for dot-com sake.

To dispel more myths about Internet companies, I'd like to point out that no dot-com has no overhead. These are businesses that require computers and servers, not to mention people to run them. Contrary to popular belief, most Internet companies are run like most businesses -- out of an office, with real world rent, utilities, and parking bills. Don't believe every garage story you hear, and don't forget warehousing and fulfillment costs.

What's more, Internet companies have much higher customer acquisition costs than your typical physical store. Living in New York, I'm bombarded by ads for websites -- on the sides of buildings, on billboards, on buses, in the subway, on TV, in magazines and newspapers, and, of course, online. It seems to me that some of the companies benefiting the most from the Internet economy are traditional media companies and outdoor advertising firms.

It costs money for Internet companies to make themselves known. Sadly, this is another cost that is all too often downplayed. Instead of booking ad costs as a straight marketing expense, some companies have been known to expense costs over time by claiming that the positive effects from an ad are felt over time.

I don't mean to come off as an Ebenezer Scrooge here. I am just tired of all the hype surrounding Internet companies. Are there great Internet companies out there? Yes. But there are a lot of crappy ones, too, so buyer beware.