USWEB Weaves Great Quarter, turns up the heat in the Market Place

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USWEB Weaves Great Quarter, turns up the heat in the Market Place
D. Geller - February 4th, 2000

Event Summary

USWEB/CKS (NASDAQ USWB) announced its fourth quarter results for 1999 on January 25, 2000. The results show strong growth and closely predicted performance, including a clear net profit. As well, USWEB/CKS reports changes in the market place that place it in a position of strength as the market moves from the mid- toward high-end.

Market Impact

USWEB/CKS is an end-to-end Internet services provider that provides Intranet, Extranet and Web site solutions and services to medium-sized and large companies. The company has brought in a stronger than expected quarter, making total revenues for the year of $511M, and $47M (9.2%)after-tax profit excluding non-cash charges.

However, the red ink is still there, since when operational expenses and non-cash charges are included, the company lost $175M for the year, comparing favorably with a loss of $188M on $229M in revenues in 1998 (for comparison, much smaller rival Proxicom returned $4M in after tax profits on $82M revenue including operational expenses - or +4.9% - for 1999 compared to a 1998 loss of $21M on $44M revenue).

Q4 was 10% in sequential growth from Q3, matching Q3's sequential percentage increase despite the fact the fourth quarter was expected to be slower due to the holiday season. The revenue growth year-to-year amounts to 124%, far exceeding the anticipated market growth of about 60%. USWEB/CKS clearly has a formula that is working.

It is also significant that the company is expanding rapidly and extending its services through its merger with enterprise-wide e-Business solutions provider Whittman-Hart, who has close cultural and complementary business capabilities to USWEB/CKS. The merger should be completed by the end of February. USWEB/CKS also recently acquired Mitchell Madison Group, a world-class strategy and management/change management consulting company.

Also interesting in this announcement is that the average engagement size has practically doubled over the past year - from $1.7M to $3M to $4M. According to IDC the market growth rate is about 60%, but it is in our opinion (60-70% probability) they missed the point that engagement sizes would increase. This would not be the first time IDC missed the mark - it predicted in 1996 a market of $13.8B for 2000, but this figure is (80%-90%) likely to be at least $20B and possibly as high as $30B. This is a possible indication the market is larger than anticipated in dollar terms.

USWEB/CKS sees the trend of larger engagements continuing over the next year, with the size of engagements reaching $15M in phased projects, and requiring a full spectrum of services. Providing full spectrum services gives USWEB/CKS a much more highly leveragable business model, providing end-to-end services and continued support to the client, while cross- and up/down-selling services.

There are several other factors leading to USWEB/CKS's success. Sales have been positively impacted by its drive at technology partnerships with the likes of EXODUS, where it has first dibs at developing new sites, and 3COM, which has put $100M into the USWEB/CKS pot to assist USWEB/CKS in developing its broadband business.

However, there are a number of issues it must tackle if it is to continue being successful. Foremost of these is staff retention. Current turnover is close to a quarter of the staff per annum, with key areas such as business strategy, architecture and technology being most affected - the very areas that create leverage for the value added services. Smaller companies offer share options and challenge, often a potent mix for ambitious employees. Despite the attrition, USWEB/CKS has, however, been winning the battle through recruiting drives, increasing its payroll by 3,500 this year - a well over 30% increase from its former size a year ago. Its main attraction to new hires is its internal training capabilities and career path offerings smaller companies cannot match. Most of this growth has been organic, and USWEB/CKS sees few new acquisitions on its horizon. In the battle for bodies, USWEB/CKS looks as if it is winning.

On the client side, the revenue per client has increased dramatically, while the acquisition of new clients has not been as significant.

USWEB/CKS has been able to retain and even grow its client base in spite of its large turnover rate. USWEB/CKS is also moving cautiously toward fixed price engagement models for the higher end client where projects are in appropriately phased portions. Currently, about 30% of engagements use this model, while the rest is T&M. Fixed price is a practice that is prevalent in the pricing models of some smaller players such as Xcerlerate, who are largely in the small to mid-size engagement business.

USWEB/CKS's cautious approach could relate to a lack of confidence in delivering as fast and within the cost margins of competitors like Razorfish, or an attempt to force its equal-sized competitors into the domain where it may have a cost advantage. In doing so, it has to live up to its "time-to-value" philosophy.

Taking the above together, USWEB/CKS is attempting to lead the market place, and is acquiring skills organically or by acquisition. These acquisitions add pressure to other vendors to consolidate so they remain competitive. Larger companies, such as USWEB/CKS, are able to deal with larger engagements covering the full-spectrum of services, and to retain employees by offering rewarding careers and opportunities.

User Recommendations

As a user of SP services, it is wise to consider the size and capabilities of the company you are about to partner in your e-business. Service providers with inadequate strategic front-ends may not be able to deliver services that you can quickly need as the e-business world changes, or you realize that you need to change your business model. However, the user should be aware of the attrition rate of the partner, in what areas, capabilities of the replacements and training provided by the SP. The size of the company will obviously matter - 25% of a small company, where the attrition is among senior and experienced personnel would be especially painful, is far more significant than 25% of a large company.

Quality of delivery can be impacted depending on whether the vendor is technology agnostic, such as USWEB/CKS, or not. Technology agnosticism is a term that indicates the vendor is willing to determine the technologies that best meet the needs of the client - and has the resources to implement those technologies - rather than use a limited set of technologies and products governed by supply agreements, direct profit motives, or limited capabilities and resources.

As a trend, however, many companies such as USWEB/CKS are forming relationships with product-centric companies like IBM, Novell, and Microsoft. While this does not necessarily mean a loss in the agnostic trait, the user should be aware of the degree of immersion of the company with any particular technology. This can prove to be an advantage or disadvantage depending on specific user requirements.

Fixed price contracts, if reasonable, also provide a degree of comfort that the vendor has confidence in delivery on time and in budget. USWEB/CKS is learning to play the game, while others have started at an earlier stage. If possible, the user should consider fixed price engagements as a leverage point in negotiations against T&M arrangements as a litmus test of the SP's confidence.

Consolidation of the market will likely accelerate through the year (a 90% probability). Small to mid-size companies may be tempted to merge or position themselves to be acquired by larger players. Small companies will continue to serve the low-end market, but market hopefuls from the small end will have a lot of work to do to attract talent if they want to climb into the big leagues.

As a user, consider the corporate goals and long-term support capabilities of the company if going for a low to mid-end project in the $50K-$500K engagement regime.

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