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Performance 101. (Cover Story: Redefining Leadership).

The crash of the dot-coms gets the media ink, but some tech-based start-ups are surviving and thriving. These four young companies' leaders could teach a course in start-up success.

OK so selling a 30-pound bag of dog food online -- charging $20 for the product and another $15 to ship it -- doesn't make a lot of sense. But not every dot-corn is built on a bad idea. And not every tech-based start-up failed when the bubble burst.

In fact, a number of companies are defying the new conventional wisdom and succeeding. How? By combining time-tested business fundamentals with hard-won lessons of the New Economy.

"Dot-coms that were concerned only about aggregating eyeballs or disintermediation or other so-called business strategies are in deep trouble or no longer standing," says Geoffrey Bock, a senior analyst for the Patricia Seybold Group, a market research firm in Cambridge, Mass. "But if it enables you to reach new customers at a lower cost or deliver goods and services that you couldn't otherwise, then starting an internet-based company or investing in Internet technology still makes a lot of sense.

"Don't write off the internet," agrees Frances Cairncross, author of the just-released The Company of the Future (Harvard Business School Press). "That game isn't over; it's just beginning. A lot of silly things happened over the past few years. But internet technology -- and companies built around that technology -- will have a profound effect for a long time."

To understand just how profound that effect can be, we examined four successful startups -- two of which are pure-play dot-coms, and all of which have information technology at their core. What they reveal are four key lessons for any company, at any point in its development: Start by identifying customer needs, gain a foothold in a specific market segment, adapt to changing market demands, and maintain your focus for the long haul.

Eyes on the Prize

While adapting to market changes, a company must maintain its focus to succeed long term. That seeming contradiction can be the biggest challenge for a start-up. "The fundamentals of starting a new business have never changed," says Michael Wood, president and vice chairman of LeapFrog Enterprises, based in Emeryville, Calif., a maker of interactive learning books and toys. "You need to understand your market, make sure you have the right resources, make sure you respond to needs, do it at the right price point [and] ... assemble a management team with the skills to execute."

Wood founded LeapFrog in 1995, when he couldn't find a product to help his son learn phonics. Working with experts in early-childhood learning, he developed the patented Phonics Learning System to teach kids to sound out letters and words.

In 1997, his company merged with Knowledge Universe, a Menlo Park, Calif.-based VC firm. Knowledge Universe made a $50 million investment in LeapFrog and installed Thomas Kalinske as its chairman and CEO. (Kalinske's career includes stints as head of Mattel and Sega of America.) Since then, LeapFrog's revenues have grown at a 118 percent annual clip. The company expected to record $300 million in net sales in 2001, and is profitable, according to Wood.

"Mike is the creative genius and inspirational soul of the company," says Kalinske. "But the goal was always to grow the company rapidly. I knew the pitfalls and things to watch out for when you move from being a specialty retailer into the mass market."

"We've never changed our core strategy," Wood says. "From the beginning, we spent a lot of time playing with kids, talking to experts and talking to parents to identify developmental skills or concepts kids are having trouble with ... [and] find really engaging ways to impart that information."

LeapFrog is among the fastest growing firms in the toy industry, with more than 50 interactive learning products and 37 interactive books covering phonics, reading, math, music, geography and science. Its most successful product is the LeapPad platform, which looks like a laptop computer and holds interactive books that teach spelling, reading and phonics.

Early on, LeapFrog's management team decided against becoming an online retailer, primarily so that it wouldn't compete with sites such as Walmart.com and ToysRUs.com, both of which sell LeapFrog products. Still, the company provides an innovative online service that allows kids to download content for LeapFrog platforms. Membership is free for six months, after which there is a subscription fee ranging from $20 to $60, depending on the content. Kids specify which textbook they're using, and LeapFrog delivers content in sync with what they're learning at school.

Despite the success of LeapFrog's core strategy, Wood admits to mistakes. "There are things I would have done differently, but that's as it should be," he says. "I tell our design people that if 10 percent of our products don't fall, we aren't being creative enough. When we fail, though, it shouldn't be because the product doesn't engage kids and teach them something. We can do both and still have a product that isn't commercially successful, because the packaging was wrong or the message was wrong."

The solution involves recognizing customer needs. "You need to really understand your customer, as well as any customers in the chain that get you to your ultimate customer," Wood emphasizes. For LeapFrog, that meant understanding not just kids but also what teachers believe should be taught, what parents will spend and what retailers will promote. "You have to understand the entire chain, and every link of the chain has to buy into your concept," he adds.

Message in a Bottle

"There has to be customer value to what you're creating," insists Michael Osborn, founder and vice president of Portland, Ore.-based eVineyard. "It can't just be another channel for the same problem. It has to solve the problem."

Solving a problem is exactly what the entrepreneur did in 1998, when he launched what is now the largest online retailer of wine in the United States. "The consumer experience of buying wine can be very intimidating," Osborn observes. "Many people aren't comfortable going to a liquor store and trying to understand what's available." What's more, there are tens of thousands of wine brands. No store could possibly carry every variety and maker, and no customer could be expected to sort through them all.

Selling wine online is an ideal solution. eVineyard carries some 5,000 wines, plus accessories. It augments its huge catalog with a broad range of content, including reviews, recommendations and tutorials. Even more helpful, the site allows customers to search for wines by price, type, region and more -- an impossible proposition in a bricks-and-mortar store.

Of course, solving the wine-buying challenge meant changing consumer behavior. "Even though many consumers don't like the experience of buying wine, it's a $20 billion industry," notes Osborn. "So we had a lot of behavior to change." eVineyard focuses on customer service, aiming to ensure that the buying experience is easy and that orders are delivered promptly and accurately. That's important when selling relatively low-ticket items, to keep customers coming back for more. "Customers typically place a small order the first time," explains Osborn. "As they come back, their orders get larger."

A strong customer focus isn't Osborn's only strategy. In fact, his approach to starting a company has been decidedly traditional, flying in the face of most dot-coin wisdom. For starters, he quickly brought in experienced executive leadership. "I never wanted to do everything," he says. "I wanted to build a strong management team and surround myself with folks who had a lot of experience."

Osborn also strove to control costs. "We have a lot of used office furniture," he says. "We didn't spend money like drunken sailors. We're a retailer. Fundamental business principles apply."

That measured approach helped eVineyard outlast two well-funded competitors, Wine.com and Wineshopper.com. "They focused on brand awareness and advertising," Osborn explains, "while we focused on the customer experience. Wine.com had over 400 employees, while we have 60 employees. They raised $200 million in venture capital, while we raised $35 million."

eVineyard's strategy paid off. Wine.com and Wineshopper.com first merged, and then went under. In April 2001, eVineyard acquired various assets of the merged business -- including the highly valuable wine.com Web address -- for a mere $10 million. Osborn reports that eVineyard expected a profitable fourth-quarter 2001 and is "very close to being profitable as an organization."

Still, selling online is uncharted territory that demands experimentation, Osborn says. "Just don't experiment in a way that would negatively affect the customer experience," he advises. "The hype will come and go, but fundamentally your business needs to add customer value."

Image Is Everything

As a provider of medical imaging solutions, Stentor, Inc., based in South San Francisco, has to worry about more than just customers: It's up against heavyweight competitors like General Electric, Eastman Kodak and Siemens. But that has been little worry to Oran Muduroglu, Stentor's co-founder, president and CEO. "Our competitors didn't see us as a threat, and that enabled us to establish mind share and equity," he says.

It's a classic start-up strategy: First establish a beachhead in a narrow market segment, and then work to progressively win competitive battles and enter new markets. It's a lesson many dot-coms learned the hard way as they burned through cash in an attempt to quickly gain market share.

"Your first go-live plan should identify the middle hurdles to establishing a value proposition and getting to a business that actually is a business," suggests Muduroglu. "The idea of being able to continuously raise funding doesn't exist anymore."

Muduroglu launched the company in 1998, to solve a vexing problem in the medical cammunity: low-bandwidth hospital networks that can't efficiently transmit large digital images such as X-rays and MRI scans. With the cost to replace existing networks prohibitively high, many hospitals still rely on film, which is costly and time-consuming to print and transport.

Stentor's solution is iSite Enterprise, a technology that delivers diagnostic-quality images over existing networks. Instead of sending an entire 50 MB image, the software captures the resolution coordinates for the portion of the image the physician wants to view, then delivers only that data. To the user, it's no different than if he or she had real-time access to the entire file. Even better, multiple physicians can view the image simultaneously in different locations.

Stentor uses a delivery model similar to that of an application service provider. The company installs the solution at the hospital, but it owns and manages the equipment and charges on a per-study basis. "For half the cost of using film, we do it electronically," says Muduroglu. "We handle the entire infrastructure, and the hospital doesn't ... have to spend capital dollars to solve an operational problem."

Although Internet technology is at the core of Stentor's business, Muduroglu decided early on that he would not position the company as a dot-com. "One struggle we had was that the investor community wanted to know what our Internet strategy was, whether we could name the company Stentor.com," he recalls. "But this made no sense for us. Our value proposition was based on solving a problem for hospitals."

The company raised $25 million in two rounds of venture funding and is now growing the business by gaining new customers; more than 100 hospitals use the technology already. Although the privately held firm doesn't disclose financial information, the Wall Street Journal estimated its revenue at about $1.5 million between September 2000 and September 2001 -- a number the company doesn't dispute.

Stentor is developing additional products, but Muduroglu emphasizes the need to win battles in a targeted market before attacking new ones. "Our technology can be used for sending images over the Internet, for satellite imaging, for computer graphics," he says. "But we understand the health care market, and we know we can solve a problem for that market. You have to avoid the temptation of pursuing every opportunity too early in the process."

Adapting to Change

Understanding a market can be more than a little challenging when the rules of engagement change constantly -- a fact that spelled the downfall of many a dot-com. But Brad Greenspan, chairman and CEO of Los Angeles-based eUniverse, Inc., has learned how to adapt quickly to changing market conditions.

Greenspan founded eUniverse in April 1999, and brought it to Nasdaq a year later. The company offers online games, contests and greeting cards via nearly 20 Web sites, including Flowgo.com, JustSayWow.com, FunOne.com and Send4Fun.com. It consistently ranks among the 25 most-visited Internet properties; its e-mail content reaches 40 million subscribers a day.

But eUniverse's revenues have been derived largely from advertisers, a model that has proved unsuccessful for many dot-coms, particularly in a harsh economic climate. "Business strategies have had to change since the economic downturn," says Greenspan. "There's now a much smaller window to prove a concept. That reins in what you can do. But it also makes you more focused."

What eUniverse is focused on today is adapting its strategy in two ways. The first is a "cost-per-click" model, whereby advertisers pay for each user that responds to an ad either by visiting a site or buying a product. Because the company captures detailed subscriber information and generates real-time reports, it can work closely with advertisers -- which include Microsoft, Sears and Sony -- to constantly fine-tune ad content and placement.

The second change is to decrease its reliance on advertising through e-commerce sites such as CupidJunction.com, an online dating service. The site has attracted 800,000 users and is profitable, Greenspan says. Developing paid subscriber bases is essential. eUniverse plans to launch enhanced content on some of its now-free sites for a fee. "Our model is to attract people to the site with entertainment content and then offer them products and services that they pay for," he explains. "Essentially, we're combining two business models," free content and e-commerce.

eUniverse generated $15.7 million in revenues in fiscal 2001, becoming profitable in the quarter ending June 2001. More important, it expects to remain profitable for the foreseeable future, growing primarily through acquisitions (it has bought 15 Internet companies in the past 18 months). In October, 550 Digital Media Ventures, a Sony company, invested $17 million in eUniverse, representing a 20 percent stake.

But key to the company's success has been its ability to adapt, maintains Greenspan. "You have to be willing to change directions quickly," he says. "You have to be able to admit that the strategy everyone was rolling forward may not be working."

Choose Your Strategy

Getting people to buy into your concept can be a lot harder in the post-dot-com era. And that places new pressure on start-ups of all kinds.

"Going forward, you have to differentiate between a dot-com strategy and a product-oriented strategy," says Geoffrey Moore, a partner in Mohr, Davidow Ventures, in Menlo Park, Calif., and author of Crossing the Chasm (HarperBusiness, 1991). "The dot-com strategy is to keep your burn rate low and get to breakeven quickly. The product-oriented strategy goes back to the venture capital days of five years ago. You raise the first round [of funding] to prove the technology works, the second round to prove there's a market, the third round to grow, and then you go public. That's a process that takes five to seven years."

But going forward, there may be less distinction between dot-com and bricks-and-mortar. "We won't be talking about differences between dot-coms and other companies for much longer," predicts Jim Collins, co-author of Built to Last (HarperCollins, 1994). "The same fundamentals apply. And increasingly, the Internet will be one aspect of a company's business, not its core."

Contact

LeapFron Engerprises www.leapfrog.com

eVineyard www.evineyard.com

Stentor www.stentor.com

eUniverse www.euniverse.com

Eric Schoeniger. ("Performance 101" and "Running a Lean Machine")

Eric Schoeniger is an award-winning freelance writer specializing in business and technology, based in Lower Gwynedd, Pa.
COPYRIGHT 2002 Chief Executive Publishing
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2002, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Schoeniger, Eric
Publication:Chief Executive (U.S.)
Article Type:Company Profile
Geographic Code:1USA
Date:Mar 1, 2002
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