Internet leaders to remain strong in downturn

The recession is creating a golden opportunity for some Internet industry leaders to solidify and expand their already-dominant positions.

Companies like search giant Google Inc. (GOOG), Web-based movie service Netflix Inc. (NFLX), Internet retailer Amazon.com Inc. (AMZN) and online jeweler Blue Nile Inc. (NILE) can take advantage of the downturn to reinforce customer relationships, develop new products and services, and take share from weaker competitors that are simply trying to survive.

But to come out of the recession stronger, these companies will need to continue investing in new technologies and capacity while keeping an ever tighter lid on costs. They will also have to negotiate market shifts that will inevitably occur as the economy goes through one of its worst recessions since the Great Depression.

"We have to keep coming in every day and making the right decisions," said Blue Nile CEO Diane Irvine, "but this our time to shine."

The companies most likely emerge stronger from this downturn will be those that provide the best value to customers and have strong track records of innovation and operational excellence, Barclays Capital analyst Doug Anmuth wrote in a recent note. He likes Google, Netflix, Amazon and Blue Nile because they spit off strong free cash flow that can be reinvested, giving the companies an opportunity to further distance themselves from their competitors.

"We believe certain segments within e-commerce and online advertising may actually be widening the gap with their competition more during this recession than even if we were in a more favorable overall economic environment," he wrote.

Despite the opportunities, none of the companies are expected to come through the recession unscathed. Amazon and Netflix have already lowered fourth-quarter revenue guidance, while Wall Street has been ratcheting down fourth-quarter revenue and earnings expectations for both Google and Blue Nile.

Shares of all four have tumbled in recent months as the economy slowed, squeezing their growth rates. Google is off 55% for the year, closing Thursday at $310.28; Amazon is down 44% at $52.08; Blue Nile has fallen 61% to 26.22; and Netflix is up 6% for the year but has slid 31% since April to $28.24.

Netflix and Amazon said they're confident in their strategies and continue to invest in new opportunities. Google declined to comment for this story.

The leading companies face challenges similar to those that stymied earlier Internet leaders, like Yahoo Inc. (YHOO), eBay Inc. (EBAY) and then-named AOL Time Warner Inc. (TWX). Those companies were dominant going into the last downturn but were dislodged by a series of managerial mistakes and under-appreciated competition.

Analysts say the three former leaders made common mistakes: They all failed to prepare for marketplace changes and new competition that ultimately undermined their business models.

Yahoo was forced to play catch-up after Google redefined Web advertising. Time Warner's plan to converge content and distribution was a strategic and costly misstep that weakened the company's ability to compete. EBay was slow to adapt to competition from Amazon's Marketplace service, which provided an attractive alternative for third-party sellers.

"Companies tend to get surpassed by others that essentially redefine their markets and the value proposition around them," said Patrick Viguerie, a consultant at McKinsey & Co.

Industry leaders face challenges not only from the economy, but also changes in the way business is conducted. New technology, the spread of information and globalization of commerce have led to a quicker changing of the guards in all sectors, according to a recent study by McKinsey.

The consultancy said that between 1972 and 1977 market leaders had a 9% chance of being knocked off the top rung within a five-year period. The effects of globalization, emerging technologies and the availability of information pushed that rate to 30% in the period from 1997 to 2002. Viguerie says the trend will only grow in the future.

Still, the current crop of Internet leaders have a better chance of retaining their perches because of their strong leads. Google has 64% of the global search market, while Blue Nile commands 50% of U.S. online market for engagement diamond sales. Netflix is even more dominant, controlling more than 70% of the U.S. online movie rental market, and Amazon has more than twice the revenues of Staples Inc. (SPLS), its nearest online retail rival.

Their businesses have been bolstered by the widespread adoption of the Internet since the last downturn. They have also refined their business models and picked up market share from rivals. Importantly, all have been profitable since at least 2003.

To stay on top, each will have to address weaknesses specific to their business. For example, Google has invested billions of dollars in new products but has not been able to diversify its revenue base beyond search advertising. Amazon and Netflix rely heavily revenue from physical media, but those products are increasingly being digitized and streamed over the Internet. Blue Nile will need to fend off challengers from outside its core diamonds business.

Already, each of the companies has developed strategies to address those weaknesses and appear committed to investing in them even if it causes short-term hiccups in their profits.

Google has prioritized investments in display advertising, online business software and mobile phone ads. Amazon is building a cloud computing business and is ramping up its digital music, movies and books business. Netflix spent an estimated $75 million this year to build out its digital streaming service, and Blue Nile is pushing its high-end diamond products into dozens of international markets.

But weighing investment priorities against slowing growth is a critical challenge, says David Yoffie, a professor at Harvard Business School who focuses on competitive strategy, technology and international competition.

Yoffie says companies must take advantage of the downturn to eliminate truly unneeded legacy costs so they can invest in new products and infrastructure that position them for a resumption of growth. So far, only Google has announced it is cutting workers and reducing other expenses.

"If they don't find ways to drive excess costs out of their system, their ability to fund innovation will be curtailed," says Yoffie.

Nike Air Power

Nike's Second Coming

When Nike set out to market its Air Force 25 basketball shoe in January 2007 (which also celebrated the 25th anniversary of the seminal Air Force 1), the Beaverton, Ore.-based athletic apparel giant, along with longtime agency Wieden + Kennedy, did what you might expect: They went big, creating an epic 60-second commercial, grandly titled, "The Second Coming," featuring 10 of the biggest names in the NBA, including Kobe Bryant, LeBron James and Tony Parker.

They commissioned two young hip-hop hotshots - Juelz Santana and Just Blaze - to create what a Nike press release referred to as not merely a song but "an exclusive track for the AF25 movement." The commercial was shot by music video director David Meyers. The campaign also wove its way into programming (with a special show, 
"1 Night Only" on MTV and MTV2), featuring a joint performance by Nas, Kanye West, KRS-One and Rakim performing a Grammy-nominated track produced by Rick Rubin - and a display of some 1,700 Air Force 1's in every color and style under the swoosh. (The Rubin-produced song, "Better Than I Ever Been" - which contained several references to the Air Force 1 - and "The Second Coming" anthem were both sold on iTunes.)

In short, the AF25 launch was done in classic Nike style. Or was it?

In some ways, the shoe's debut illustrated how much things have stayed the same in terms of Nike's relationship to b-ball royalty and its ability to attract an audience. In 1982, when the Air Force 1 had its launch, the shoe, the first to use Nike Air cushioning, surrounded itself with NBA stars such as Moses Malone and Jamaal Wilkes. 

But the AF25 launch also demonstrated how much Nike, as a marketer, has changed. As a lyric from the commercial's soundtrack says: "Let's say good-bye to the past - the future's here at last."

Aim High

Of course, the shoe's launch featured online integration deals, such as a Nike Air Force Channel on mtv.com. But the stars of the digital aspects of the campaign were consumers, who, through a special Web site, nikemashup.com, were able to edit their own spot. Using some 70 frames from the commercial, and a variety of musical tracks, the site gave basketball fans a particularly diverse array of content from which to roll their own spot. Organized into categories such as dunks and close-ups, the site (which is no longer live) made becoming your own commercial editor easy. Using a simple drag-and-drop interface, users could create a timeline of the action, play it, and send it on to friends, achieving something all advertisers seem to aspire to these days, but few actually achieve: the viral effect. Not surprisingly, some of the re-edits consisted of footage solely of one favorite player, such as Bryant or Steve Nash, and made their way to YouTube; some received tens of thousands of views. (Nike didn't return e-mails seeking more information about nikemashup.com's results or other aspects of the campaign.) 

Yes, you could argue that, even at the time, there wasn't all that much new there; in February of 2007, as aficionados of consumer-generated commercials might recall, Frito-Lay's Doritos brand aired two consumer-created ads on the Super Bowl. Still, the Nike mashup illustrated how far fans can take a passion when you give them the tools with which to indulge it. According to Sarkissian Mason, the New York-based, digital-focused shop which worked with Wieden on the campaign's interactive efforts, some 1.5 million people visited nikemashup.com. More impressive, in a world where click-through rates are notoriously low, 65 percent of visitors created a personal version of the commercial. The average time spent on the site was six minutes, the equivalent of watching the commercial 12 times.

Sky Pager

But what truly separated the mashup effort from its predecessors was that it contained a mobile component - those who had the technology could mash, mix and share their Nike commercials via their mobile devices and register for behind-the-scenes clips of the shoot to be sent to their handsets. 

This was particularly out of the traditional advertising box when you consider the context - the campaign launched some six months before the debut of the iPhone, which jump-started the cell phone as a true multimedia device in the United States. Even today, according to Forrester Research's "Benchmark 2008" study, only 4 percent of the U.S. market uses an iPhone, a Treo or a BlackBerry. Meanwhile, of those 1.5 million nikemashup.com visitors, 100,000 experienced it through their mobile devices, indicating that, these days, when it comes to knowing your demographic, you'd better know which media platforms they use. 

The Nike mashup mobile effort extended what could be called a tradition at Nike, at least in the fledgling world of mobile advertising. At least as far back as 2005, Nike has employed some form of mobile in its efforts - a Nike ID billboard in Times Square that year allowed passers-by to "dial up" the billboard and, in 60 seconds, design their own shoe, which would then be displayed on the billboard. It could also be downloaded as wallpaper by its creator and even ordered. 

As would no doubt be the case with the Nike ID billboard, which these days seems relatively static, if Nike were to launch the shoe today - or debut the Air Force 26 - it would do so with an additional flourish or two. Asked how he would alter the campaign for today's mobile consumer, Patrick Sarkissian, president of Sarkissian Mason, said: "I would make everything higher resolution because broadband has increased to such a high rate now. The output would benefit by being much larger on screen and also something that users would want to play with more because it would be more broadcast-oriented." He added, "We would also make this into an iPhone app." 

With that in mind, digital-advertising enthusiasts are probably anxiously awaiting Nike's launch of the AF50, undoubtedly coming in 2033.