1. © 2003 UMFK. 1-1 internet business models Online Brokers Introduction Tony Gauvin

2. © 2003 UMFK. 1-2 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

3. © 2003 UMFK. 1-3 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

4. © 2003 UMFK. 1-4 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

5. © 2003 UMFK. 1-5 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?

6. © 2003 UMFK. 1-6 Creating Value Reduction of search cost for clients –24/7 Database Access –Parameterized searches Personalization of transactional media –Remembers Facilitate communications

7. © 2003 UMFK. 1-7 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

8. © 2003 UMFK. 1-8 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?

9. © 2003 UMFK. 1-9 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

10. © 2003 UMFK. 1-10 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

11. © 2003 UMFK. 1-11 Economics 1 st 3 quarters of 2000 AutobytelHomestoreInsWebTravelocityE*trade $ in millions Revenue49.715118.8127.21122.3 Cost of Revenue040.0051.5408.5 Gross profit49.7110.918.875.7713.8 Sales amd marketing50.490.431.080.8402.0 Product Development18.19.87.213.8106.6 G& A10.039.515.812.4171.0 Operating Income(28.8) (35.2)(31.3)34.2 % of Revenue Cost of revenue026.5040.536.4 Gross profit10073.410059.563.6 Sales and marketing101.459.9164.963.535.8 Product Development36.46.538.310.89.5 G&A20.126.284.09.715.2 Operating income-57.9-19.1-187.2-24.63.0

12. © 2003 UMFK. 1-12 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 –??

13. © 2003 UMFK. 1-13 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

14. © 2003 UMFK. 1-14 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

15. © 2003 UMFK. 1-15 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