THE PROFIT SHORTFALL.

Okay, let's stop picking on foolish dot-com entrepreneurs who "forgot" they were supposed to earn a profit. The folks who started and funded Web businesses screwed up in a lot of interesting ways, but losing money--lots of money--certainly isn't what collapsed the bubble.

In fact, we all know that most new ventures (even those run by mature companies) lose money during their startup phase; some indulge in orgies of deficit spending that make the dot-coms look like penny- pinchers. The folks at Microsoft, for instance, were certainly not irrational when they chose to give away Internet Explorer as a way to dominate the browser market, and even more red ink is already flowing in Redmond from projects like MSN and the X-box.

It's also not important that many startups spent their seed capital lavishly and often stupidly. True, a lot of money was wasted on fancy offices and SuperBowl ads and wildly excessive headcount. But cost overruns are among the easiest (though perhaps not the most painless) problems to solve: Get rid of non-essential people and focus on the most productive part of the business.

No, the fundamental problem with most of the startups we've seen (and a lot of business plans that are still looking for funding) is that they fail a simple test: They can't show a way to generate really outrageous, knock-your-socks-off profits.

That's an important shortcoming: Athough most business plans do project some beyond-the-rainbow profitability, it's almost always modest-- typically, a few points over breakeven. Presumably, ultra-conservative projections help make a plan look more credible. But in reality they send an opposite message: Strip away the cool technology and the creative business models, and what's left is usually a business with an rather underwhelming value proposition. Either there's no way the business can operate more cheaply than the competition, or there's no way to charge premium prices. Bottom line: The profit potential stinks.

By contrast, true breakthrough concepts radically change the value proposition, usually by supporting much higher prices or by carving away hefty chunks of operating costs. And this breakthrough value proposition--at least in theory--is reflected in huge operating profit margins. The marketplace has always rewarded inventors and entrepreneurs who figured out "faster, better, cheaper" solutions. It happened in the early days of the PC software business, and it's happening again on the Internet.

Sadly, though, fat margins seem to be less than fashionable on the Web these days. Much as we admire Amazon.com, for example, it's hard to see how Jeff Bezos can ever escape the inherent boundaries of being a commodity reseller: Amazon clearly can't charge extra for selling a book online, and the company hasn't found a way to buy or ship products for much less than the rest of the bookstore world. In terms of profit potential, Amazon has spent tons of money to achieve the same skimpy margins as any other big bookstore.

(As a side note, the Book-of-the-Month Club and publishers like Time- Life Books did change the model for selling books in an important way, by bypassing the retail channel and targeting what we'd now call an "opt-in list" of frequent buyers.)

Of course, figuring out how to change the value proposition for a whole business is tough; it's much easier to throw programmers and technology at a problem, and to hope that when the dust settles the margins will be good enough to keep the company alive. But that's ultimately a lazy answer. If entrepreneurs and investors spent more time trying to build outrageously profitable companies, we suspect they wouldn't be pulling the plug on so many losers.