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The second shoe to drop

Times are tough for Internet companies, but the problem may be worse than the well-documented online ad weakness suggests.

Times are tough for Internet companies, but the problem may be worse than the well-documented online ad weakness suggests.

International, wireless, and the migration of traditional advertisers online--often discussed as key sources of new revenue--will not be the silver lining many had hoped.

International revenue growth has not kept pace with traffic growth. Yahoo, for example, gets 40 percent of traffic from outside the United States but only 16 percent of revenue from abroad. This gap, common to many U.S. Internet companies, could widen over the next few years--not shrink as many have expected.

Why? Because European and Asian advertisers are more conservative than their U.S. peers, and the value of online advertising is not clear enough to command a significant investment. In addition, PC penetration rates in many countries are low, hovering in the 10 percent to 15 percent range, so the PC-based Internet audience is relatively less important.

Wireless, the second great hope, gets significant in 2002 but will be difficult for generating revenues. In 2003, the number of mobile phones will eclipse PCs worldwide. The low cost of these devices will help spur the next wave of growth on the Web as more new consumers are introduced to interactive services.

Within five years, 40 percent of all traffic over the Net is expected to come from mobile devices, and within key markets in Europe and Asia, mobile phones will be the primary access vehicle. But Internet companies will have to fight the carriers for ownership of the customers, and making money off the mobile Internet will prove particularly challenging.

The wireless carriers hope to dominate mobile devices as Yahoo and America Online have dominated the PC. Consumers have decreased the number of sites they visit per day to six to eight from 15 in early 1999, with Yahoo and AOL being primary beneficiaries.

On mobile devices, the number of sites visited may drop to one, which is why the wireless carriers will battle fiercely for the portal role or at least for some portal revenue. In the United States, we expect Yahoo and AOL to retain their stature and customer relationships across the mobile arena. But in Europe and Asia, where PC penetration rates are low and mobile penetration rates are high, the big portals will have more formidable competition.

In addition to fighting over the role of gatekeeper, Internet companies need to find a way to turn wireless into money. Advertising, which has fueled some of the most successful Internet companies to date, will be a virtual non-event for wireless, totaling less than $1 billion in 2005. Commerce will be the dominant revenue stream, projected to reach more than $200 billion worldwide by 2005.

Finally, traditional advertisers continue to come online, but not at a sufficient pace to compensate for the loss of dot-com advertisers or to provide the growth expected of an Internet company. With click-through rates plummeting to below 1 percent and increasing pressure from advertisers for performance-based deals vs. impression-based deals, many traditional advertisers are taking a more measured approach toward the online market.

Importantly, a new sales approach and perhaps new salespeople are needed to get the Fords and PepsiCos of the world to make significant investments online. A 25-year-old sales executive may lead the charge in negotiations with other Internet companies but is not likely to have the experience, speak the talk, or command as much respect among the Fortune 500.

It is these issues that are driving many Internet companies into the arms of offline partners. A strong offline partner can provide a source of traffic and revenue growth from cross-promotion. The Internet opportunity remains incredibly alluring, but unless dramatic steps are taken, long-term growth will be tempered by the challenges of making money from international traffic and wireless, and by the pace of traditional advertisers' movement online.

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