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internet business models

Online BrokersIntroduction

Tony Gauvin

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Overview

• Definition of the Online Broker Business Model• How online brokers create value• Economic model for online brokers• GBF Strategies• Choices

– Online Broker vs. Online Retailer or Online Market Maker

• Challenges to going online

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Definitions

• Broker– A person hired to act as an agent or intermediary in

making Contracts or sales– Help clients by identifying potential transactions

partners and sometimes help negotiate the transaction

• Client– Person or entity that engages a broker

• Broker examples– Real estate agents, independent insurance agents, talent

agents, stock brokers, travel agents

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Categories of Brokers

• Ongoing relationship with clients

• One time transactions

• Representing sellers or buyers – Representing both can lead to conflicts of

interest – Conflicts of interest existed in travel agencies,

stock brokerage and real estate

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Determining Business Models

• Realtor.com– Provides home sales listing

• Content provider or broker• The Key is intent; since the intent is facilitating the sale >> Realtor.com is a

broker• CNET?

– Provide editorial content that facilities a purchase • Market Maker vs. Broker

– Market maker organize and manage a marketplace– Brokers represent clients– Some market makers have a brokerage role– Some brokerages have a market maker role– Priceline.com is a Market Maker…Why?

• Travelocity is a broker– Carpoint.com is a Broker … Why?

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Creating Value

• Reduction of search cost for clients– 24/7 Database Access– Parameterized searches

• Personalization of transactional media– Remembers

• Facilitate communications

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Online brokerages Success factors

• Industries that Have– Information-Rich, complex products and

services– Inventory is perishable, Supply and demand

conditions are highly dynamic– High Search Costs

• Proprietary information– Real estate listing– Airline reservations

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Revenue Streams

• Commissions and other transactions related fees• Subscriptions fees• Advertising• System integration fees• Three Big questions

– Who pays who?

– Where does the revenue come from?

– Where do loyalties lie?

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Cost Categories

• Cost of Revenue– Vary directly with transactional volume

• Product development– Website development tends to be fixed

• Sales and Marketing– Heavy spending– Large customer acquisition costs

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LTV of Broker Customers

• Discounted present value of the variable contribution generated by the customer minus the cost of acquiring the customer

• E*Trade– $263 AC – $600 revenue per year– LTV of $1,843

• Autobytel– Negative value due to large acquisition costs

• InsWeb– Same dilemma as Autobytel

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Economics1st 3 quarters of 2000

Autobytel Homestore InsWeb Travelocity E*trade

$ in millions

Revenue 49.7 151 18.8 127.2 1122.3

Cost of Revenue 0 40.0 0 51.5 408.5

Gross profit 49.7 110.9 18.8 75.7 713.8

Sales amd marketing 50.4 90.4 31.0 80.8 402.0

Product Development 18.1 9.8 7.2 13.8 106.6

G& A 10.0 39.5 15.8 12.4 171.0

Operating Income (28.8) (28.8) (35.2) (31.3) 34.2

% of Revenue

Cost of revenue 0 26.5 0 40.5 36.4

Gross profit 100 73.4 100 59.5 63.6

Sales and marketing 101.4 59.9 164.9 63.5 35.8

Product Development 36.4 6.5 38.3 10.8 9.5

G&A 20.1 26.2 84.0 9.7 15.2

Operating income -57.9 -19.1 -187.2 -24.6 3.0

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GBF??

• Network effects– More clients >> more trading partners?– Depends on

• Buyer and Seller Heterogeneity– Idiosyncratic preferences vs. Commoditization

• Client Exclusivity– Sole representation of a group

– Not strong for same brokers• Scale economies

– Large fixed costs• Customer retention

– Depends on Brokerage type– Website usability & stickiness

• GBF for online brokers– ??

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Referral, Retailing and Reverse Auctions

• Competitors are often not other brokerages but alternative business models– Online retailers (disintermediation)– Online market makers (reverse auctions)– Referral agencies

• 3 factors– Expected price realizations

• Level of Consumer • Convenience• Referrals are two step

– Need for Consultative selling• Complexity of transactions

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Challenges facing incumbents

• Self-Cannibalization– Stock brokerage

• Efficiency gains challenge cost structures– Online MLIS for Real-estate

• Intermediation by Clients – Why pay brokers at all– Orbitz

• Joint effort by American, United, Delta, Continental and Northwest

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TRACKING STOCKS, SPINOFFS, AND CARVEOUTS

• Advantages to a separate security for Internet unit– Capital to fund growth– Options to attract/retain employees– Currency for acquisitions– Separate metrics, so easier to invest in growth without fear of stock price penalty– Valuation boost

• Different investors with risk preferences that match risk profile of Internet unit• Better disclosure; reduced agency costs; focused incentive plans

• Tracking stock – Shareholders have a limited claim on future dividends and distributions from a line of

business; they have no claim on assets– Advantages of tracking stock vs. carveouts or spinoffs

• Tax efficient: can offset parent profits with losses of Internet unit• Maintain control of unit: governed by a single board• Can unwind security

– Disadvantages of tracking stock• Shareholders have few rights: must accept "trust me" promise with respect to potential conflicts of

interest over transfer pricing, proceeds of liquidation, etc.• Complex security may deter some investors• Control by parent eliminates takeover premium