Has Netscape Hit The ‘Innovation Ceiling’?

Netscape Communications Corp. was supposed
to be the next Microsoft. Its trailblazing web browser and lightning pace of development
helped reset the thinking of the entire computer industry-and earned it an overwhelming 85
percent share of the web browser market, to boot. It was Netscape that pioneered the
Internet business model of giving software away to build up marketshare and then sell
related products. The company even posed the first serious threat to Microsoft in
years-and forced the software giant to double-time its Net efforts.
Oops. On January 5, Netscape shocked Wall Street by disclosing that it expects to post a
loss of up to $ 18 million in the fourth quarter because of a steep drop in web browser
sales and fierce price competition for server software sales from Microsoft Corp. and IBM.
The Mountain View (California) company says it expects revenue of $ 125 million to $ 130
million-far below earlier expectations of $ 165 million. That’s because Netscape’s browser
sales fell 37 percent, to $ 17 million, in the fourth quarter, vs $ 27 million in the
previous quarter. A key reason: Microsoft copied Netscape’s plan, giving away its Internet
Explorer while the startup began charging a few dollars. And now, Netscape is down to a 60
percent share.

Line Of Fire
Where does this leave Netscape? In a jam. While the company still has promising
technology, it may not have the financial might to go up against rivals that can afford to
heavily discount products without a blink. If giveaways persist, Netscape’s best chance
may be to either focus on a niche or sell out to a company that can afford these
high-stake Web tactics. "You don’t want to invest in the line of Microsoft’s
fire," says Analyst David Readerman of NationsBanc Montgomery Securities.

That’s chilling news for Netscape, but it
could be even more so for the industry. Netscape’s fourth-quarter loss raises the specter
that startups, no matter how innovative or pioneering, can’t cut it in these digital
times. Today, all tech companies are Web-obsessed, especially the deep-pocketed titans
such as Microsoft, IBM, Oracle, and Sun Microsystems.

Microsoft Chairman Bill Gates may be right
when he says that innovation in the computer industry has not been stifled. But Netscape
shows there is an innovation ceiling. Tech startups can thrive if they pick a lucrative
niche. Venture into a potential megamarket, however, and bigger competitors will stomp on
you but fast. Thus, the chances of a young company growing into a multibillion-dollar
giant such as Compaq Computer Corp. or Cisco Systems Inc. are becoming rare. Instead, hot
cyberstartups such as WebTV, Hotmail, and Diba Systems are selling out to the big guys,
Microsoft and Sun.

In the digital age, volume equals power.
The captains of today’s technology heavyweights-Gates, Oracle’s Larry Ellison, Sun’s Scott
McNealy, and IBM’s Lou Gerstner-are great believers in the power of PC economics; that
higher volumes enable them to spread costs over a larger base and therefore charge less
for their products. "Competition has heated up in terms of intensity and on the price
side," says Analyst Alan Braverman of Credit Suisse First Boston. "Gates has
been in the industry for a while, and he has ratcheted up the intensity, cut prices,
thrown more bodies at it, and done more marketing."

Netscape CEO James L Barksdale understands
PC economics, too. He brought the ultimate version of it to the Internet-giving away
Netscape’s Web browser to capture marketshare. But he abandoned that strategy to shore up
short-term revenue. Netscape may thrive as a niche company that sells complex Internet
setups to large corporations, but the company will have trouble keeping up with Microsoft
and IBM without big browser volumes. "If you don’t own [browser] marketshare, you
don’t sell servers or get the benefits of traffic from the web site," says Merrill
Lynch & Co. Analyst Bruce Smith.

Barksdale doesn’t agree, although he says
he is considering going back to giving the browser away to stem the drop in Netscape’s
marketshare. He says the company is now focusing on server software for electronic
commerce and building computer networks that let companies share information with clients
and partners. "We don’t see that as nearly as competitive a marketplace as the others
we’re in," he says. Barksdale keeps trying to move Netscape to higher ground, but he
keeps bumping up against the innovation ceiling.

A commentary by

Copyright BsuinessWeek
January 19, 1998.

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