The Knowledge Web: People Power – Fuel for the New Economy pot

United States
Education & Training Services
Knowledge Enterprises
23 May 2000
Michael T. Moe, CFA
Director of Global Growth Research
(1) 415 676-3570

Henry Blodget
Senior Internet Analyst, Global Coordinator
(1) 212 449-0773


The Knowledge Web
Part 1: People Power – Fuel for the New Economy

Highlights:

Technology is the Driver of the New
Economy and Human Capital is its Fuel
The Internet’s Capability to Deliver a Total
Human Capital Solution Creates a Powerful
Investment Opportunity

Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
RC#60214529


The Knowledge Web – 23 May 2000

Knowledge Enterprises Group
Michael T. Moe, CFA
Director of Global Growth Research
(1) 415 676-3570


Education Services

Global Internet Research

Kathleen Bailey
Vice President
(1) 415 676-3572


Henry Blodget
Senior Internet Analyst, Global Coordinator
(1) 212 449-0773


Neil Godsey
Assistant Vice President
(1) 415 676-3574


Kirsten Campbell
Assistant Vice President
(1) 212 449-3113

Michael B. Armstrong
Industry Analyst
(1) 415 676-3585


Business & Employee Services
Thatcher Thompson
Director
(1) 212 449-8787

Chandy Smith
Assistant Vice President
(1) 212 449-0841


"Albert Einstein"™ Licensed by the Hebrew University of Jerusalem,
Represented by the Roger Richman Agency, Inc., Beverly Hills, CA 90212 www.albert-einstein.net"

2


The Knowledge Web – 23 May 2000

Introduction to the e-Knowledge Industry
The new economy moves at a pace never seen before. The new
economy is a knowledge economy based on brainpower, ideas
and entrepreneurism. Technology is the driver of the new
economy, and human capital is its fuel. The knowledge
economy is people-centric. Our economy has evolved from

manufacturing-intensive to labor-extensive. Fundamental to
success in the new economy is how companies obtain, train and
retain knowledge workers. The knowledge enterprise industry
is over $2.2 trillion. We expect the online component to grow
from $9.4 billion to $53.3 billion by 2003, a 54% CAGR.
Ubiquitous PCs and high-speed bandwidth will facilitate access
to knowledge anytime, anywhere. The Internet democratizes
knowledge, increasing access to it, lowering its cost and
ultimately improving its quality. We believe combining the
“richness” of an offline experience and the “reach” that only the
Internet provides creates a network effect that allows scale
knowledge enterprises to be born. Moreover, we see significant
potential advantages that offline operators can achieve by
leveraging their experience and brand online.
e-Commerce has forced all traditional businesses to
compete at Internet speed. In a 4% unemployment
economy with 65% of all the new jobs created requiring
skills, 70% of Fortune 1000 CEOs are saying that finding
qualified workers is a major issue for growth. “Time-tocompetency” is a bottleneck or a strategic advantage
depending on how effective an organization is at finding
and training knowledge workers. Domestic online
corporate learning is expected to grow from $1.1 billion in
1999 to $11.4 billion in 2003, a 79% CAGR, and online
staffing and recruiting, critical functions of human capital
management, is projected to grow from $5.8 billion in
1999 to $28 billion in 2003, a 48% CAGR.
The information revolution that began with the birth of the
PC is really the knowledge revolution. e-Commerce is to
the knowledge revolution what the railroads were to the
industrial revolution. We think enterprises building

“knowledge tracks,” or infrastructure, into the corporate
market, K-12 community, and higher education spaces are
poised to enjoy explosive growth.
Integrating quality educational content with
testing/assessment and certification programs is the new
education paradigm for the 21st century. In the knowledge
economy, assessment is the currency with which all skills
are valued. The four engines of the new economy –
computers, telecommunications, healthcare and
instrumentation – employ approximately 50 knowledge
workers per 100 employees and are growing. These
technology-intensive industries are growing 3-6 times as
fast as economy-wide job growth. Career vortals,

providing continuing education, employment opportunities
and relevant information, will be knowledge nerve centers
for vertical knowledge communities.
Colleges and universities are the most wired community
on the Web, with over 90% of college students accessing
the Internet, 52% of them daily. Students spend nearly 19
hours per week on the Internet, 84% of the time pursuing
academic activities. College students currently spend $105
billion annually, with $1.5 billion of that online. Higher ed
hubs provide educators and e-commerce companies access
to this very compelling demographic.
The Internet creates one economy and one market. As
large as the online higher education market is in the U.S.,
the global opportunity is significantly greater. Unlike the
U.S. where post-secondary education is relatively
available, access to world-class post-secondary institutions

in many parts of the world is limited. Currently, there are
84 million students enrolled in higher education
worldwide. Global demand for higher education is
forecasted to reach 160 million by 2025 − if online
learning captures even half of this growth, there would be
40 million students for online education. We predict that
in the next five years, there will be global virtual
universities with potentially millions of students enrolled.
We project that the online higher education market will
grow to $7 billion by 2003 in the U.S. alone.
The number of K-12 schools connected to the Internet has
climbed from 35% in 1994 to 96% today. Today’s kids are
the Internet Generation − Generation i − and are as
comfortable on a computer as on a bicycle. With 53 million
schoolchildren, three million teachers and 23 million
families, the K-12 marketplace encompasses a huge number
of potential users. The Internet is the world’s greatest
library and gives a student in Minot the same access to
knowledge as a student in Manhattan. Key for improvement
in learner outcome is getting parents involved − the homeschool connection − and email has already proven to be an
effective communication tool between parents and teachers.
The Internet is all about disproportionate gains to the
leaders of a category. The gigantic opportunity has not
been lost on investors, with over $3 billion in venture
capital funds flowing into knowledge enterprises in the
past fifteen months alone. By focusing on knowledge
enterprises that contain the 4 P’s (People, Product,
Potential and Predictability) and other key differentiating
factors, notably the network effect outlined in this report,
we hope to identify the Yahoo!s from the yahoos and

provide outsized investment returns for what we see as an
outsized opportunity.

3


The Knowledge Web – 23 May 2000

Fast Facts: The New Economy
•

•

The pay gap separating a high school graduate from a
college graduate was 50% in 1980. Today, it has
reached 111%. Looked at another way, a 30-year-old
male with a high school diploma earns just two-thirds
of what he earned 25 years ago. Even so, only 21% of
American adults over the age of 25 have a bachelor’s
degree or better.
In 1980, the price-to-book ratio of the ten largest
publicly traded companies in the U.S. was 1.2x.
Today, the price-to-book is 12.1x, or ten times greater.
This multiple expansion correlates directly with the
increased productivity of a company’s intangible
assets – its human capital.

•

On average, each employee at the leading “New

Economy” companies is “worth” $38 million based on
market cap-per-employee. In contrast, each employee
at the leading “Old Economy” companies is worth
about $689,000, or less than 2% of employee value at
the New Economy companies.

•

Venture capital funding in knowledge enterprises
amounted to over $3 billion since January 1999, or
about triple the total invested in the previous 9 years.

•

•

•

•

At the end of 1999, more than 196 million people
were using the Internet worldwide. The number of
global Internet users is expected to more than triple to
638 million by 2004, a 27% CAGR.
The “free agent” mindset of today’s knowledge worker
is evidenced by the fact that the average person entering
the workforce today will work for between 8 and 10
different employers versus 4 to 6 a decade ago. Only
15,000 businesses currently recruit online, but this
figure is expected to increase to 124,000 by 2003.

Worldwide, the Internet economy is expected to
mushroom from $361 billion in 1998 to more than
$2.8 trillion in 2003.
In 1999, nearly 720,000 IT positions went unfilled.
Today, one of every five IT jobs remains unfilled, and
nearly 75% of new openings fail to receive interested
and qualified candidates.

•

Worldwide business-to-business (B2B) commerce
dwarfs B2C commerce in both size and growth. Total
B2B Internet revenue is expected to top $2 trillion in
2004, up from $80 billion in 1999, a 91% CAGR.

•

Firms are stepping up their e-commerce outsourcing
initiatives as they move from building stand-alone
sites to Internet-enabled supply chains and customer
service systems. The result is a rising median
outsourcing budget, from $750,000 in 1999 to a
projected $1.5 million in 2001.

•

4

The amount spent on online advertising is expected to
increase tenfold from $3.3 billion in 1999 to $33

billion in 2004, a 58% CAGR.

•

At the end of 1998 there were approximately 88
Internet stocks. Currently, there are approximately
400 with nearly a half trillion dollars of market cap.

•

Approximately 50% of the total Internet market cap is
accounted for by the five largest Internet companies,
providing evidence for the belief that, on the Internet,
the winners “take all.”

•

Studies have shown that effective management of
human capital can improve shareholder value by up to
30%.

•

By our estimates, the e-knowledge market will reach
$53.3 billion by 2003 from $9.4 billion in 1999,
growing at a CAGR of 54%.

•

Reflecting the transformation of technology in our

economy, in 2000, skilled jobs will represent 65% of
all jobs. This is expected to expand to 85% by 2005,
up from just 20% in 1950.

•

Knowledge Services – education and corporate
learning for the new economy – is a $740 billion
industry in the U.S. and a $2-trillion industry globally.

•

Web-based corporate learning should enjoy explosive
growth, measuring $11.4 billion by 2003, up from
$550 million in 1998, an 83% CAGR.

•

By 2002, technology-based training will capture the
majority of dollars for IT training, at 55% versus the
45% share captured by instructor-led methods.

•

In 1996, 44% of students enrolled in higher education
programs were adults over 24 years of age, up from
28% in 1970.

•

The ratio of students to computers in our nation’s K12 schools is rapidly improving, falling from 16-to-1
in 1992 to approximately 6-to-1 in 1999.

•

Nearly every K-12 school in the country (96%) has at
least one Internet-linked computer. To date, 51% of
classrooms have Internet-connected computers.

•

The number of K-12 students with Internet access has
grown from virtually zero in 1994 to 10 million in
1996 and is projected to grow to 40 million by 2002.

•

47% of 16-22 year-olds are on the web and control
$37 billion in spending. 40% have bought and paid
for something online. By 2003, 62% of 16-22 yearolds will be on the web.

•

College students spend nearly 19 hours per week on
the Internet, with 85% of their time spent on academic
pursuits.

•

The domestic broadband market will expand to 2.3

million homes this year, up 200% from approximately
750,000 in 1998. By 2004, we expect broadband to
reach 48% of Internet users, or 30 million households.


The Knowledge Web – 23 May 2000

CONTENTS
n Section

Page

Part 1: Introduction to the
Knowledge Economy

3

1. Executive Summary and Thesis

9

2. Price-to-Opportunity: The New Valuation Metric

15

3. The Four P’s

22

4. Mind Over Matter: Human Capital in the Knowledge Economy

31

5. The Emerging New Economy

36

6. The Technology Revolution

45

7. e-Commerce: The Current e-Business Wave

53

8. Advertising Exploding Online

56

9. The Coming Bandwidth Tidal Wave

60

10. “Kingmakers” will Determine the Winners
Part 2: Generation i

The K-12 Market

65
75

11. Generation i – @ Home, @ School, @ Play

77

12. Generation i – the K-12 Education Market

78

13. Kids with Clout: K-12 Marketplace is Huge

84

14. Investment Opportunity

86

15. Today’s Children Are Web Savvy “Clickerati”

87

16. K-12 Education Is Ripe for a R*e*volution

96

17. The K-12 E-Education Landscape

106

18. Linking Homes and Schools – The Next Online Land Grab For

e-Portals & Hubs

107

19. Learning Redefined – Content Goes Digital

115

20. e-Commerce

125

5


The Knowledge Web – 23 May 2000

n Section

Page

21. Infrastructure

131

22. Supplemental Services

143

23. Issues in K-12 e-Learning

149

24. The Empire Strikes Back? Publishing & Media Companies vs.
Web Upstarts

153

25. Appendix 1

165

Part 3: Higher Web –
Universities Online

167

26. Higher Web – Universities Online

169

27. The World Wide Web of Higher Education

170

28. The Market Opportunity

178

29. The Global Opportunity

181

30. Infrastructure – “Webifying” the University

184

31. Community and Commerce

193

32. E-Hubs – All Roads Lead to the E-Hub

201

33. Universities Online

207

34. The Corporate Market Opportunity

216

35. Appendix 2

223

Part 4: Corporate e-Learning –
Feeding Hungry Minds

225

36. Corporate e-Learning: Feeding Hungry Minds
37. Corporate e-Learning

228

38. Size of the Market

236

39. The Corporate e-Learning “Net-scape”

242

40. Content

261

41. Assessment

6

227

273


The Knowledge Web – 23 May 2000

n Section
Part 5: Human Capital
Management – People Power

Page
291

42. Human Capital Management: People Power

293

43. Trends & Predictions

294

44. Human Capital Management

296

45. Countering the “Brain Drain”

298

46. The Industry “Net-Scape”

301

47. The Net Shakes Up Human Capital Management

308

48. The Human Capital Management Landscape

314

49. Investable Themes

322

50. Select Company Profiles

323

51. Appendix 3

352

7


The Knowledge Web – 23 May 2000

Introduction to the
Knowledge Economy

8


The Knowledge Web – 23 May 2000

1. Executive Summary and Thesis
Technology is the driver of the
New Economy, and human
capital is its fuel.

“Take our twenty best people away, and I can tell you that Microsoft would
become an unimportant company.”
– Bill Gates
When the puck goes in the net, all the sticks go in the air. Likewise, attributing
what or who deserves the credit for the incredible economic boom we are
experiencing is a crowded stage. Silicon Valley, Alan Greenspan, the fall of the
Berlin Wall and, of course, the Internet are all lead actors amongst the cast of
thousands in the New Economy script.
Technology is the driver of the New Economy, and human capital is its fuel. In
today’s world, knowledge is making the difference not only in how an individual
does, but also in how well a company does and, for that matter, in how well a
country does. While the future possibilities of the knowledge economy look both
exciting and, at the same time, daunting, the transformation to a knowledge
economy is now evident.

In today’s knowledge-based
global marketplace, human
capital has replaced physical
capital as the source of
competitive advantage.

• Most striking—the dramatic pay gap between those with education and
those without has more than doubled in less than 20 years. Looked at
another way, the purchasing power of a 30-year-old man with a high-school
diploma has dropped by over one-third over the past two decades.

• Also significant—our analysis illustrating a seismic shift in how the
market values companies, discounting traditional analysis of earnings
derived from physical capital and replacing it with analysis of earnings
power derived from human capital.
• Finally, the structural changes that have occurred in our economy mean
that the new jobs being created today are service and skill-based jobs rather
than manufacturing jobs. In 1950, unskilled jobs constituted 60% of all
jobs, with professional and skilled jobs representing the remainder. Fast
forward the clock to today, and it is expected that 65% of all new jobs
created will be skilled jobs and that by 2005 skilled jobs will represent 85%
of all new jobs created. Fundamental to the investment opportunity is the
significant demand imbalance for knowledge workers versus the supply of
skill-based jobs.

The truly revolutionary impact
of the Internet is just beginning
to be felt. In the old economy,
geographic distance needed to
be mastered to shop, be serviced
or to learn. In the new
economy, distance has been
eliminated. We are rapidly
evolving into one economy and
one market.

In today’s knowledge-based global marketplace, human capital has replaced
physical capital as the source of competitive advantage. A key result of the
confluence of technology and the Internet Economy is the need for better, faster
and smarter workers. The reality of a 4% unemployment rate in the U.S., the “free
agent” mindset of the most talented workers, and the fact that only 21% of the

U.S. adult population has a college degree is making this task more difficult than
ever before. e-Commerce forces even traditional businesses to operate at Internet
speed, with “time-to-competency,” now a major factor determining the
competitiveness of all companies.
The truly revolutionary impact of the Internet is just beginning to be felt. In the
old economy, geographic distance needed to be mastered to shop, be serviced or to
learn. In the new economy, distance has been eliminated. We are rapidly
evolving into one economy and one market.
We see the e-knowledge market being the next major growth phase of the Internet,
following huge business and investment opportunities in business-to-consumer
(B2C) e-commerce and business-to-business (B2B) commerce and services.

9


The Knowledge Web – 23 May 2000

Evolutionary Phases of e-Business
Growth

e-Knowledge
B2B Commerce:
VerticalNet,
CommerceOne

B2C Commerce:
Amazon.com

At no previous time has human
capital been so important,

meaning finding, attracting and
retaining knowledge workers
will be mission-critical
functions – and high growth
sectors – in the New Economy.

Growth of Internet
Market

Content:
Yahoo!,
Lycos
Access:
Prodigy,
AOL

1992

1994-5

1995-6

1998-9

2000

Time
Source: Merrill Lynch Global Growth Group

At no previous time has human capital been so important, meaning finding,

developing and retaining knowledge workers will be mission-critical
functions – and high growth sectors – in the new economy. Accordingly, we
look at the continuum of human capital solutions holistically – a Knowledge Web
– and believe the most important companies will have an appreciation for and/or
involvement in a comprehensive solution. We believe those companies that can
link different elements of the human capital value chain – stretching from
recruiting to assessment to training and through retention – while leveraging the
Internet’s capabilities to deliver a total solution, will be the big winners.
The Knowledge Services Continuum: The Human Capital Value Chain

Find &
Recruit

Assess

Train

Test

Certify

Retain

Source: Merrill Lynch Global Growth Group

Unleashing the Killer App
The death of distance and the compression of time have powerful implications in
the knowledge-based economy. The biggest investment ideas are often where
there is a problem – and the bigger the problem, the bigger the opportunity. There
is no bigger problem in the global marketplace today than how to obtain, train and

retain knowledge workers. Seventy percent of Fortune 1000 CEOs cite the ability
to attract and keep adequately skilled employees as a major issue for growth and
competitiveness. Given that essentially all of the 20 million net new jobs that were
created in the past 20 years were from small and mid-sized companies, obtaining,
training and retaining talent is even more critical to what has become the growth
engine of the new economy.

10


The Knowledge Web – 23 May 2000

“The killer app for the next decade is talent acquisition and retention.”
— John Doerr
Kleiner, Perkins,Caufield & Byers

“The next big killer application for the Internet is going to be education.”
— John Chambers, CEO, Cisco Systems

Techies are the heroes of the
New Economy: they influence
the spending of $1 trillion of
annual purchases.

Nowhere is the importance of people more evident than with technology
professionals, or “techies.” Techies are the heroes of the New Economy: they
influence the spending of $1 trillion of annual purchases; they are mission-critical
for any organization; and they are in extremely short supply. In fact, there are
currently 700,000 open IT jobs, or one-third of the total of all IT jobs, with the
shortage expected to more than double in the next five years. Compounding the

complexity of dearth of IT professionals is that Moore’s Law is alive and well
making IT skills obsolete at the blink of an eye.
Fast-forward the clock five years and, unfortunately, the supply of students
coming out of America’s schools doesn’t promise much relief. Twelfth-graders in
U.S. schools in the most recent international comparisons finished dead last and
next to last in the key new economy subjects of math and science, respectively.

Twelfth-graders in U.S. schools
in the most recent international
comparisons finished dead last
and next to last in the key new
economy subjects of math and
science, respectively.

Hence, the fundamental and massive problem of global competitiveness and
obtaining knowledge workers reaches all the way down to the K-12 level. As the
human capital demand funnel is triggered, global corporations need to more
effectively recruit knowledge workers and provide lifelong learning for their
employees and create supply for the future by improving the K-12 education
system. The Internet acts as a major enabler linking corporations to people,
providing management systems, anytime/anywhere learning and a catalyst to help
revolutionize a failing primary education system.

11


The Knowledge Web – 23 May 2000

The Human Capital Demand Funnel

Global Corporations

Demand for Knowledge Workers

Internet-Based Employee Solutions

E-Cruitment

E-Human Capital Solutions

E-Corporate Learning

Better K-12 & Higher Ed Solutions

Source: Merrill Lynch Global Growth Group

What’s a Mother to Do?
Favorite Bookmarks of
Michael Milken, Chairman & CEO
of Knowledge Universe
www.knowledgeu.com
www.oncology.com
www.nci.nih.com
www.interactive.wsj.com
www.tasteforliving.com

The Information Revolution is really the Knowledge Revolution, and the Internet
is to the Knowledge Revolution what the railroad was to the Industrial Revolution.
The Internet has the potential to “democratize” knowledge and learning,
increasing the access, lowering the cost and improving the quality.

Communication of rich information has historically required proximity or
dedicated channels. Key to realizing the potential of the Internet is to
reconceptualize how knowledge is obtained and leverage the advantage of the
medium. By combining “richness” and “reach,” e-knowledge enterprises can drive
utilization, leading to a network effect and monetization.

“A high growth strategy for the New Economy needs to create more inclusive
politics, a new learning society and opportunities available to all.”
– The Long Boom
Peter Schwartz, Peter Leyden and Joel Hyatt

12


The Knowledge Web – 23 May 2000

Online Human Capital Solutions – Combining Richness and Reach
Network
Effect

=

Optimal
Monetization

Companies providing online
human capital solutions have
the potential to bring together
both richness and reach,
creating a powerful and

revolutionary user experience.

Richness

Local
Physical
One-to-One
Interactivity

Global
Virtual
Mass Market
Isolated

Reach
Source: Merrill Lynch Global Growth Group

Enormous Market Opportunity

The ubiquitous nature of PCs
combined with the power of the
Internet are both catalysts and
enablers revolutionizing what is
already a $2 plus-trillion
market.

Add it all up, and we see a gigantic opportunity for companies that provide scale
solutions to the most vexing problem facing our global economy. The ubiquitous
nature of PCs combined with the power of the Internet are both catalysts and
enablers revolutionizing what is already a $2 plus-trillion market. Currently there

is approximately $14 billion of market capitalization for the “born on the web”
knowledge enterprises and $20 billion of market capitalization when we include
“clicks and bricks.” Our estimates are for the U.S. online market opportunity for
knowledge enterprises to grow from $9.4 billion in 1999 to $53.3 billion in 2003
representing a CAGR of 54%. Providing additional fuel, venture capitalists have
invested over $3 billion in the knowledge enterprise industry since January 1999.
Huge and Growing Market Opportunity
U.S. Online Market Size
Human Capital Solutions
Learning Sectors (excludes Pre-K)
K-12
+ Higher Ed
+ Corporate + Gov’t Learning
Total Learning Sectors
+ Recruiting & Staffing
Total Human Capital Solutions

U.S. Addressable
Market (2000E)

1999E

2003E

CAGR:
1999E-2003E

$375 billion
$250 billion
$110 billion

$735 billion
$75 billion
$810 billion

$1.3 billion
$1.2 billion
$1.1 billion*
$3.6 billion
$5.8 billion
$9.4 billion

$6.9 billion
$7.0 billion
$11.4 billion*
$25.3 billion
$28.0 billion
$53.3 billion

52%
55%
79%
63%
48%
54%

Source: Merrill Lynch Global Growth Group, IDC, Forrester, Jupiter, Training Magazine
*Online figures include corporate learning only. They exclude the government learning market.

Our estimates are for the U.S.
online market opportunity for

knowledge enterprises to grow
from $9.4 billion in 1999 to
$53.3 billion in 2003
representing a CAGR of 54%.

Given the size of the problem, the necessity to solve it, and the momentum of the
worldwide web, we see the e-knowledge industry having explosive growth. The
aggregate market growth of the learning sectors is estimated to grow from $3.6
billion in 1999 to $25.3 billion in 2003, or a CAGR of 63%. Representing even
more potential for growth, the corporate learning market is expected to grow from
$1.1 billion in 1999 to $11.4 billion in 2003 or a CAGR of 79%.

13


The Knowledge Web – 23 May 2000

Publicly Traded e-Knowledge Enterprise Companies
% Price
Appreciation
Mkt. Cap.
Since IPO

IPO
Date

Subsector

Price
5/15/00

Sales
2000E
2001E

Price / Sales
2000E
2001E

B2B eLEARNING
CTRA Centra Software
CLKS CLICK2LEARN.COM
DTHK DigitalThink
ECLG eCollege.com
ELOQ Eloquent
RVDP RiverDeep
SABA Saba Software (D-1-1-9)
SKIL SkillSoft Corporation
SMTF SmartForce plc (D-1-1-9)

03-Feb-00
12-Jun-98
25-Feb-00
15-Dec-99
17-Feb-00
09-Mar-00
07-April-00
05-Feb-00
13-Apr-95

Corp. Learning
Corp. Learning
Corp. Learning
Higher Ed
Corp. Learning
K-12
Corp. Learning
Corp. Learning
Corp. Learning

$7.69
12.00
24.75
4.88
8.13
26.00
18.75
13.50
43.13

$178.7
176.6
813.0
67.6
137.5
709.3
804.5
169.9
2,328.8

(45.1%)
9.1%
76.8%
(55.7%)
(49.2%)
30.0%
25.0%
(3.6%)
978.1%

$16.1
42.8
19.1
15.3
NA
22.0
28.9
16.2
152.5

$28.3
59.7
37.0
NA
NA
45.0
63.6
42.5
255.8

11.1x
4.1
42.6
4.4
NA
32.2
27.8
10.5
15.3

6.3x
3.0
22.0
NA
NA
15.8
12.6
4.0
9.1

B2C eLEARNING
LTWO Learn2.com, Inc.
SKDS SmarterKids.com
NETS YouthStream Media Networks

20-Oct-94
23-Nov-99
03-Apr-96

Corp. Learning

K-12
Higher Ed

$2.28
2.63
7.06

$116.3
50.8
189.4

(77.2%)
(81.3%)
(41.3%)

$50.0
40.0
NA

NA
91.0
NA

2.3x
1.3
NA

NA
0.6x
NA

EDUCATION TECHNOLOGY / INFRASTRUCTURE
LSPN Lightspan
10-Feb-00
NTWO N2H2, Inc.
30-Jul-99
NLCS National Computer Syst. (C-2-1-7) 15-Apr-86
SCIL Scientific Learning Corp (D-1-1-9) 22-Jul-99
IZAP ZapMe! Corporation (D-1-1-9)
20-Oct-99

K-12
K-12
K-12
K-12
K-12

8.06
$4.44
51.19
16.13
2.91

349.0
$98.3
1,638.3
169.2
127.1

(32.8%)

(65.9%)
485.0%
0.8%
(73.6%)

62.9
$24.3
748.8
26.2
36.0

88.9
NA
861.1
65.5
123.7

5.5
4.0x
2.2
6.4
3.5

3.9
NA
1.9x
2.6
1.0

ECRUITING / HUMAN CAPITAL SERVICES

CBDR Careerbuilder
12-May-99
EWBX EarthWeb, Inc. (D-2-1-9)
11-Nov-98
HHNT HeadHunter.NET
19-Aug-99
HOTJ HotJobs.com Ltd.
10-Aug-99
KFRC kforce
15-Aug-95
NIKU Niku Corporation
29-Feb-00
OPUS Opus360 Corporation
07-Apr-00
TMPW TMP Worldwide (D-2-1-9)
13-Dec-96
TJOB topjobs.net plc
28-Apr-99
HIRE Webhire
23-Jul-96

Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.
Human Cap Serv.

Human Cap Serv.

$2.34
14.88
11.50
7.50
12.38
22.75
4.50
58.81
5.88
6.00

$55.5
145.2
123.9
237.9
577.9
1,570.8
224.0
5,287.1
47.0
87.1

(82.0%)
6.3%
15.0%
(6.3%)
295.4%
(5.2%)

(55.0%)
740.2%
(51.0%)
(45.5%)

$31.0
64.0
25.1
46.3
901.2
NA
11.1
881.0
7.8
26.6

$60.9
102.0
NA
70.2
1,141.3
NA
33.0
1,023.1
21.9
NA

1.8x
2.3
4.9

5.1
0.6
NA
20.2x
6.0
6.0
3.3

0.9x
1.4
NA
3.4
0.5
NA
6.8x
5.2
2.1
NA

CLICKS & BRICKS LEARNING AND HUMAN CAPITAL SERVICES
APOL Apollo Group (C-1-1-9)
06-Dec-94
Higher Ed.
DV
DeVry (C-1-1-9)
24-Jun-91
Higher Ed.
HSII
Heidrick & Struggles International 27-Apr-99 Human Cap Serv.
KFY

Korn/Ferry International
11-Feb-99 Human Cap Serv.
LTRE Learning Tree Int’l (D-2-2-9)
06-Dec-95 Corp. Learning
POSO ProsoftTraining.com
06-Dec-96 Corp. Learning
POVT Provant (D-3-2-9)
29-Apr-98 Corp. Learning
SLVN Sylvan Learning Syst. (D-2-1-9) 15-Dec-93
K-12

$27.56
27.44
41.00
22.00
49.06
15.06
5.06
12.50

$2,076.1
1,909.2
788.4
810.6
1,062.0
277.4
106.2
636.9

1,591.0%

2,095.0%
192.9%
57.1%
513.3%
653.1%
(61.1%)
155.6%

$652.9
562.5
523.0
568.7
216.8
22.4
217.0
356.1

$783.5
646.9
659.0
625.6
242.8
24.6
NA
391.7

3.2x
3.4
1.5x
1.4x

4.9
12.4
0.5
1.8

2.6x
3.0
1.2x
1.3x
4.4
11.3
NA
1.6

PUBLISHERS
H
Harcourt, Inc.
HTN Houghton-Mifflin
LSE:PES Pearson plc
SCHL Scholastic
TOC Thomson Corporation

$37.00
39.81
33.00
46.69
33.29

$1,913.6
1,209.6

20,136.6
754.7
20,725.8

702.6%
451.4%
NA
107.5%
NA

0.8x
1.3
5.4
0.6
3.3

0.7x
1.1
4.9
0.5
3.0

12.0%

4.0x

2.8x

(5.7%)
(3.6%)

4.9x
5.5x

3.2x
4.0x

Ticker Company

May-69
Sep-84
NA
Feb-94
NA

Education Publish.
Education Publish.
Education Publish.
Education Publish.
Education Publish.

Median:
Total:
Total w/o Clicks & Bricks or Publishers:
Total eLearning & Education Infrastructure:

$313.2
68,887.8
11,193.6
8,124.3

(US$ in millions, except per share; fully-diluted shares used for all relevant calculations; all historical prices are split-adjusted)

14

$2,329.5 $2,562.5
947.3
1,089.4
3,725.0 4,083.0
1,248.9 1,373.8
6,327.2 6,959.9


The Knowledge Web – 23 May 2000

2. Price-to-Opportunity:
The New Valuation Metric

Five years ago, the Internet
didn’t even register a blip in
terms of market value in U.S.
capital markets. Today, Internet
companies represent a combined
half trillion dollars out of
$15 trillion.

We have watched in awe and delight the unprecedented velocity of market value
created by the Internet economy. Five years ago, the Internet didn’t even register
as a blip in terms of market value in U.S. capital markets. Today, Internet
companies represent a combined half trillion dollars out of $15 trillion with

corresponding valuations at stratospheric heights.
In this report, we introduce a new valuation metric – price-to-opportunity – that
we believe makes Net valuations more comprehensible, at least in the framework
of three of the primary forces driving the new economy. The first of these is the
unprecedented improvement in and adoption of technology and the Internet, best
captured by Moore’s Law. The second force is dictated by Metcalfe’s Law.
Companies leveraging the power of the Internet, with its anytime, anywhere,
anyone access, have the opportunity to expand at exponential growth rates as users
build. Third is the winner-take-all environment that provides disproportionate
gains to category killers in their respective segments.
We believe that e-knowledge enterprises that successfully leverage this
opportunity and receive these outsized valuations will possess certain key
characteristics:
•
•

A service based on the unique advantages of the Internet − or made possible
due to the Internet − to deliver knowledge. For example, given that we learn
most through highly interactive experiences, successful companies will not
simply repurpose educational content, but re-think the entire delivery of
education;

•

A service that expands both the reach and richness of learning and human
capital solutions through the Internet’s capabilities;

•

The Internet will “democratize”

knowledge, increasing access,
lowering the cost and
improving the quality.

An ability to capitalize on Metcalfe’s Law, the Network Effect;

A business model based on recurring revenues, low customer acquisition
costs or high lifetime customer value (or both), revenues from multiple
sources and high gross margins;

•

A strong management team and backers, able to function at the rapid fire pace
of the evolving Internet economy.

The network effect is all about rapidly building utilization by the delivery of
highly relevant content and services to accessible markets.

An Instant History of the Internet Business:
1996:
1999:
2003:

Great profits propheted
Great prophets profit
The great profit, greatly
– Po Bronson, author

15

The Knowledge Web – 23 May 2000

e-Knowledge Network Effect

E -K now ledge N etw ork E ffect
U sers

C ontent & Services

*ORE DO
& RUSRUDWLRQV

/HDUQ LQ J
& RX UVHV

. QRZ OHGJ H
: RUNHUV

6FKRROV
7HDFK HUV

-RE V5 HFUXLWLQJ

E-K now ledge
E nterprises

6WX GHQWV
3D UHQWV

$ VVHVVP HQ W

& ULWLFDO
,QIRUP DWLRQ

Source: Merrill Lynch Global Growth Group

The correlation between the productivity of a company’s intangible assets – its
intellectual and human capital – and the need to pay those assets a competitive
wage is clearly illustrated by the close relationship between rising price-to-book
ratios and the rising income gap. The market perceives the value of human capital,
assigning significantly greater value to knowledge workers than others.

The Internet is all about
disproportionate gains to the
winners in each category. The
five largest Internet companies
ranked by market cap account
for nearly 50% of the half
trillion dollars of total Internetcompany market capitalization.

The Internet is all about disproportionate gains to the winners in each category.
For example, the five largest Internet companies ranked by market cap account for
nearly 50% of the half trillion dollars of total Internet-company market
capitalization. The ten largest Internet companies account for 62%. Clearly, the
market believes the Net is a “winner-take-all” playing field.
Pre-Net, it took a company decades to reach a $1-billion market value, if it ever
reached that milestone. In startling contrast, Yahoo! went public in 1996 with a
market cap of $347 million, and today it is $66 billion; Amazon.com had its IPO
in 1997 with a market cap of $366 million, and currently its market cap is $18

billion; AOL went public in 1992 with a market cap of $62 million, and today it is
at $137 billion. Internet Capital Group, with a market value today of almost
$11.5 billion, did not exist five years ago.
New Economy Companies
Year Value at Number of
Founded IPO ($M) Employees
Yahoo!
1994
$347
1,992
Amazon.com
1995
$366
7,600
Priceline
1998 $2,277
373
Ariba
1996
$983
386
CMGI
1996
$23
1,594
Internet Capital Group
1996
$984
70
Commerce One

1994
$471
594
America Online
1985
$62
12,100
Average:
Median:
Source: FactSet, Securities Data Corp
Market Cap data as of April 24, 2000

16

Market Cap / Market
Employees Cap ($B)
$32,932,099
$65.6
$2,378,616
$18.1
$29,818,961
$11.1
$41,829,016
$16.1
$10,125,025
$16.1
$164,736,813
$11.5
$13,367,778
$7.9

$11,314,552 $136.9
$38,312,857
$21,593,370

2000E
Price /
Sales
63.7x
7.0x
10.4x
92.9x
21.3x
N/A
52.7x
20.3x
38.3x
21.3x

2000E
Price /
Book
73.3x
42.6x
44.4x
56.6x
4.0x
26.5x
32.0x
21.9x
37.6x

37.3x


The Knowledge Web – 23 May 2000

Another stunning contrast between old and new economy companies is the
comparison of market cap-per-employees and price-to-book ratios. New economy
companies enjoy phenomenal valuations based on these metrics. Each employee at
Yahoo!, for example, is “worth” nearly $33 million. Each employee at Priceline is
“valued” at $30 million. On average, each employee at the leading new economy
companies in the table above is worth $38 million. The best companies are in a
war for talent, realizing that brainpower drives market value in the new economy.
In contrast, each employee at Disney is valued at $743,530, and each employee at
GM is valued at just $141,682. On average, each employee at the leading old
economy companies is worth “only” $689,020, or less than 2% of employee value
at the new economy companies.
Old Economy Companies

General Electric
Wal-Mart
General Motors
McDonalds
3M
Exxon Mobil
Disney
Phillip Morris
Boeing

In the old economy, price-tobook was a useful valuation
metric, as it was physical

capital that companies
leveraged into earnings power.
What matters in the new
economy, however, is human
capital.

Year
Founded
1876
1962
1908
1955
1902
1882
1918
1854
1916

Number of
Employees
340,000
910,000
388,000
314,000
70,549
120,000
120,000
137,000
197,000
Average:

Median:

Market Cap / Market Cap
2000E
2000E
Employees
($B) Price/Sales Price/Book
$1,531,351
$520.7
5.9x
13.0x
$282,542
$257.1
1.4x
10.6x
$141,682
$55.0
0.3x
2.7x
$154,062
$48.4
3.3x
5.1x
$521,355
$36.8
2.2x
5.8x
$2,289,025
$274.7
1.3x

4.4x
$743,530
$89.2
3.6x
3.8x
$360,945
$49.4
0.6x
3.2x
$176,687
$34.8
0.7x
3.1x
$689,020
2.1x
5.7x
$360,945
1.4x
4.4x

Source: FactSet, Securities Data Corp
Market Cap data as of April 24, 2000

In the old economy, price-to-book was a useful valuation metric, as it was physical
capital that companies leveraged into earnings power. What matters in the new
economy, however, is human capital.
“WE ARE IN A GREAT WAR FOR TALENT. Century 21: Age of the Great
War for Talent. Talent = Wealth. Period. It’s the word – according to Tony
Blair. And Cisco CEO John Chambers. He is in the talent acquisition mode.
ALL THE TIME. Says he buys companies – typically start-ups – to get the

best talent at a price of $2 million or so per employee. Just like the NBA! The
Blair-Chambers dogma will rule! Talent is a fabulous word – a million miles
from employee.”
—Tom Peters, Forbes ASAP, February 21, 2000

In 1980, the price-to-book of the ten largest companies in the U.S. was 1.2x.
Today, the price-to-book is 12.1x, or 10x greater. One could argue that this is a
clear sign of a wildly inflated equity market; we believe, however, that it’s more
reflective of the fact that, in the knowledge economy, the key asset driving
corporate value is intangible: Intellectual and human capital. These stark
contrasts are summarized in the following table.
Two Different Worlds
Market Cap/Employee
Price/Sales
Price/Book

Old Economy Co.’s
$689,020
2.1x
5.7x

New Economy Co.’s
$38,312,857
38.3x
37.6x

Source: FactSet, Securities Data Corp
Market Cap data as of April 24, 2000

17

The Knowledge Web – 23 May 2000

The correlation between the productivity of a company’s intangible assets – its
intellectual and human capital – and the need to pay those assets a competitive
wage is clearly illustrated by the close relationship between rising price-to-book
ratios and the rising income gap. The market also perceives the value of human
capital, assigning significantly greater value to knowledge workers than others.
Human Capital is Replacing Physical Capital as the Primary Productive Asset
Salary Gap Between High School and College Graduates

Median Price-to-Book for 10 Largest Companies

111%
12.1x
120%

14.0x

100%

12.0x
10.0x

80%

50%
8.0x

60%
6.0x
40%

1.2x

4.0x

20%

2.0x

0%

0.0x
1980

2000

1980

2000

Source: U.S. Census Bureau, Compustat, Merrill Lynch Global Growth Group

n Evaluating the Valuations
The speed at which market value has been created and the valuations associated
with many Internet companies (i.e., 20x price to sales for a leading Internet
company is fairly normal, versus 20x earnings in the Old Economy as represented
by the Dow Jones Industrials) are unparalleled in history. Many market pundits

call this “a bubble ready to burst,” speculating that perhaps 75% of today’s public
Internet companies will be out of business in five years.
While we are in the camp that agrees that there is speculative excess reflected in
the market valuations of many Internet companies (with a corresponding
obliteration of capital being a reality if business performance does not pan out),
we also believe that changes in the global marketplace are unprecedented in speed,
scope and significance. The resultant opportunities are extraordinary, in our
opinion. To put some figures behind this powerful tailwind to the Internet
economy, business-to-consumer (B2C) Internet opportunities are expected to grow
at a 55% CAGR from $31 billion in 1999 to $274 billion in 2004. Business-tobusiness (B2B) activity is projected to dwarf this total, rising from $80 billion to
$2 trillion during the same period, a 91% CAGR.

“To swim a fast hundred meters, it’s better to swim with the tide than to work
on your stroke.”
— Warren Buffett

18


The Knowledge Web – 23 May 2000

e-Commerce Projected to Explode
Worldwide B2C e-Commerce

Worldwide B2B e-Commerce
$274

$300

$2,500

$2,027

( $ B illio n s )

$200

G
CA

$150

%

$2,000
$178

$116
$78

$100
$50

5
R5

( $ B illio n s )

$250

G

CA

$1,500

$1,000

1
R9

%
$1,140

$617

$51
$15

$320

$500

$31

$35

$0

$80

$167

$0
1998

1999E

2000E

2001E

2002E

2003E

2004E

1998

1999E

2000E

2001E

2002E

2003E

2004E

Source: Merrill Lynch, IDC, Forrester Research, Jupiter Communications

The most appropriate metric for
evaluating a dominant Internet
company is price-to-opportunity.

Due to the unique disproportionate advantages a leading Internet company has in
its category as a result of the network effect, operating leverage, global reach and
viral growth, the valuation metrics used to determine current share price are
necessarily different. However, these valuations ultimately reflect how all
companies are valued by discounting future cash flow to the present. Hence, in the
same way that growth companies are based on “futures,” the most appropriate
metric for evaluating a dominant Internet company, in our opinion, is price-toopportunity rather than the conventional metrics of price-to-earnings or the newer
– but too simplistic – price-to-sales.

“In investing money, the amount of interest you want should depend on whether
you want to eat well or sleep well.”
– J. Kenfield Morley, Some Things I Believe
In a simplified top-down analysis of an old economy company, investors look at
both the size and growth rate of the industry in question, as well as the company’s
market share and operating margin. They then calculate a future earnings stream
based on their assumptions and discount it back to the present using an appropriate
risk-adjusted rate, thus deriving the company’s theoretical market value.
New View of Human Capital and Learning in Our Knowledge-Based Economy

In the new economy, education
has become critical for both
individuals and employers.

Old Economy

Wages
Four-Year Degree
Learning As Cost Center
Help Wanted
Learner Mobility
Distance Education
Resume
Employee
Physical Capital
One-Size Fits All
Geographic Institutions
Just-in-Case

New Economy
Ownership/Options
Forty-Year Degree
Learning as #1 Source of Competitive Advantage
Talent Needed
Content Mobility
Distributed Learning
Competence
Talent
Human Capital
Tailored Programs
Brand Name Universities & Celebrity Professors
Just-in-Time

Source: Merrill Lynch Global Growth Group

19

The Knowledge Web – 23 May 2000

The Internet alters this analysis, ultimately leading to a theoretical market value
based on the size of the opportunity. Here, investors calculate the size of the
industry and estimate its growth based on industry factors, as well as account for
the growth of the Internet – the “Net Effect” – which is a powerful megatrend
cutting across all industries.
A primary “Net effect” is disintermediation – the virtual elimination of time and
distance between buyer and seller. Coupled with disintermediation is a tremendous
opportunity for scalability, where one company can seize control of a market in
less time than ever before. Both of these forces are rocket-fueled by the network
effect, as dictated by Metcalfe’s Law, inherent in some Internet companies’
business models. Combined, these three “Net effects” – disintermediation,
scalability and the network effect – create a winner-take-all competitive
environment in which speed kills.
“Speed is God, and time is the devil.”
– Silicon Valley saying

Net/e-Commerce Market Caps
Market Value ($mm)*
B2C
Access
Content
Commerce
Total B2C
Infrastructure
B2B
Total:

$156,619
$122,879
$62,976
$342,474
$114,261
$40,713
$497,448

Source: Factset and Merrill Lynch Internet Research
* Data as of April 25, 2000

In this environment, gross margin becomes an even more important metric, as the
Net affords tremendous operating leverage to the winner. All this leads to the size
of the opportunity, discounted back to today, from which current valuations can be
applied. Hence, “the new new thing” in many respects is “the old old thing,” the
value of an enterprise is its future cash flow discounted back to the present.
The outsized nature of a category killer’s market share opportunity creates a
winner-take-all environment on the Internet. The global reach afforded by the
Net, coupled with the viral potency of Metcalfe’s Law, fuels the race to market
dominance at speeds never seen before.
“Price to Opportunity” is the Appropriate Valuation Metric on the Internet

Old Economy
Valuation Metric:
Price/EPS or Price/Book

Valuation Metric:
Price to Opportunity

Size of Industry

Size of Industry

Growth Rate of
Industry
“The new new thing” in many
respects is “the old old thing,”
the value of an enterprise is its
future cash flow discounted
back to the present.

New Economy

Growth Rate of
Industry & Internet

Market Share

Disintermediated:
Winner Take All

Operating Margin
Future Earnings
Stream Discounted

Market Value
Source: Merrill Lynch Global Growth Group

20

Gross Margin
Based on
Discount Rate

Size of Opportunity
Discounted to Today

Market Value

O pportunity
D iscounted at 35%
Back to Today


The Knowledge Web – 23 May 2000

We have already seen this valuation metric applied to category killers on the
Internet, which enjoy premium multiples vis-à-vis their trailing competitors.
Yahoo!, for example, is priced at 59x its 2000 sales estimate, or at a 474%
premium to other aggregators/portals. Likewise, EBay is priced at 48x 2000
estimated sales, or at a 1425% premium to its peers.
The Internet is All About Disproportionate Gains to the Leaders

Category
Online Aggregators/Portals
Online Service Providers
Technology Vortals
Healthcare Vortals
Internet Software

Commerce – Principal Model

Leader(s)
Yahoo!
AOL
CNET
Healtheon
Ariba
Amazon, Priceline

Commerce – Agent Model

EBay

Comparables
Goto.com, Lycos, ivillage.com, theglobe.com, women.com
Juno, Earthlink/Mindspring, Prodigy, Concentric Network, Excite@Home
Intraware, pcOrder
Dr. Koop
Net Object, Net Perceptions, Sterling Commerce, Backweb, Marimba
Barnesandnoble.com, beyond.com, Cdnow, Cyberian Outpost, Egghead,
Onsale, Value America, uBid
Autobytel.com, Autoweb.com, Cheap Tickets, Preview Travel, Rowecom,
Ticketmaster Online-City Search, Tickets.com

Leader’s
Leader’s
Price/2000E Premium to
Comps
Sales

58.9x
474%
13.6x
294%
11.0x
191%
8.7x
505%
83.5x
598%
7.3x
1405%
48.0x

1425%

Source: Merrill Lynch Global Growth Group

“We are drowning in information and starving for knowledge.”
— Rutherford D. Rogers

21


The Knowledge Web – 23 May 2000

3. The Four P’s
To try to determine which Internet knowledge enterprises will be the category
killers in their respective areas, we have created an analytical and conceptual
framework, starting with the Four P’s, to evaluate attractiveness. This framework

reflects our belief that there are certain key fundamentals critical to identifying the
premier e-knowledge enterprise companies. To this end, we focus on four
principles of growth stock investing, which we call the Four P’s: People, Product,
Potential and Predictability.

People
More than half of our
investment focus is on the
people running the business.

More than half of our investment focus is on the people running the business.
There is no shortage of interesting business ideas, particularly on the Internet
where barriers to entry have been considerably reduced. Therefore, the ability to
execute is the key. Obviously, no Internet company has a long history, but their
management teams or advisors usually do. Netscape changed its business model
four times in four years and still wound up a phenomenal success. The reason, in
our view, was extraordinary leadership able to adjust on the fly at Internet speed
and make the right decisions.
Whether in a country, a company or even a sports team, one “world-class”
individual with vision and leadership skills often makes the difference.
Amazon.com, Yahoo!, Starbucks, AOL, EDS and Wal-Mart are but a few
examples of the truly great business success stories that were largely the result of
the dreams, skills and leadership of one entrepreneur: Jeff Bezos, Tim
Koogle/Jerry Yang, Howard Schultz, Steve Case, Ross Perot and Sam Walton,
respectively.
“The thing that has constrained us for the last fours years has always been
people bandwidth. Just having enough smart, hard-working, talented,
passionate people to execute against our vision.”
– Jeff Bezos, CEO, Amazon.com

We search for companies
holding leadership positions
within the segments of the eknowledge enterprise industry,
proprietary products, services,
technology or niches that set
them apart from the
competition or, better yet, “oneof-a-kind” businesses that have
no real competition.

22

The premium placed on strong management is greater in the New Economy than
ever before, while the evaluation of management has increased in complexity. We
believe the new economy “Kingmakers” can provide a beacon to investors seeking
strong management teams. As discussed later in this report, Kingmakers are
powerful partners who can lend credibility, experience and relationships to
netrepreneurs. Potential Kingmakers include venture capital firms, Wall Street
investment banks, management consulting firms and other enterprise-wide
relationship managers, technology companies, partners and customers. The
support of these constituencies can make or break the future of an Internet
knowledge enterprise.

Product
There are Internet companies, and there is an Internet economy, but the Internet is
not an industry. It’s a megatrend that cuts across all industries. We search for
companies holding leadership positions within the segments of the e-knowledge
enterprise industry, proprietary products, services, technology or niches that set
them apart from the competition or, better yet, “one-of-a-kind” businesses that
have no real competition.

The Knowledge Web – 23 May 2000

Favorite Bookmarks of James W.
Breyer, Managing Partner, Accel
Partners
www.take5.real.com – RealNetworks
www.cybertimes.com – New York Times
www.economist.com
www.amazon.com
www.myyahoo.com

Having a “claim to fame” is critical to us because we believe that the Internet does
not allow for “me, too” companies to be relevant for very long. We also look for
companies that leverage the full power of the Internet, which are often “born on
the web” companies built with the Internet in mind as a growth platform. We
further believe that significant opportunities exist for “clicks and bricks”
companies if they can operate with the mindset and speed of an Internet company
and also leverage the assets of their historical business. Leading New Economy
venture investors such as Accel Partners, Benchmark Capital and Kleiner, Perkins
have seen this opportunity and made significant investments to leverage offline
assets online.
In today’s world of innovation supernovas, big-bang-business ideas and speed-oflight information flow, we need a telescope to measure the future potential and
new growth perspectives to project the rate at which these universes will expand.
Our philosophy of trying to identify the ultimate winners may cost us some shortterm opportunities because we ignore companies that temporarily are in a vogue
space. Net Darwinism, however, shows that only the fittest ultimately survive, and
we want to invest in companies that not only survive, but will also thrive during
their corporate evolution.
To determine if a company has a leadership position in its space and really has a
“claim to fame,” we analyze various metrics. These metrics serve as both

measurements to market position as well as “signs on the highway” to help
correlate critical milestones for success. The key metric, which is driven by many
of these other metrics, is the Network Effect. Once the Network Effect kicks in,
market leadership is magnified, as are barriers to competition.

In today’s world of innovation
supernovas, big-bang-business
ideas and speed-of-light
information flow, we need a
telescope to measure the future
potential and new growth
perspectives to project the rate
at which these universes will
expand.

In the old economy, turning a
business around is like turning
a battleship. In the new
economy, one needs to be able
to turn it like a jet ski.

Internet Human Capital Solutions Company Scorecard
Rule
Metcalfe’s Law:
The Network Effect
Viral Growth

Explanation
Each new member, supplier, and user of the network adds
exponential value.

Creating grassroots, must-use, infectious applications is
essential to being the leader.
New Rules
Throw out the old ones: think differently, your competitor is
your partner; make more by giving it away; business is 24/7.
Customer Acquisition Cost Obtaining users of the network balanced against lifetime value
& Lifetime Value
of that user.
On the Internet, being first is key. Old economy: turning
Speed
business around like a battleship. New economy: need to be
able to turn like a jet ski.
Brainpower
The enterprise with the smartest people wins.
One Market (Reach)
Time, space and distance are eliminated; think one economy,
one market.
Brand is Key
In a just-in-time world, brands are a shortcut and provide an
assurance. Brands are everything in the e-Knowledge space
and the Internet.
In the land grab to establish leadership, “free” is a potent
Power of Free
motivator.
Click, Click, Click versus The Internet is quick, interactive and collaborative. Creating
Read, Read, Read
an offering tailored to the Internet is key. Just reading a
bunch of text or a book online doesn’t work.
Total:

Importance
20
10
10
10
10

10
10
10

5
5

100

Source: Merrill Lynch Global Growth Group

23


The Knowledge Web – 23 May 2000

Potential
We want to find companies with a meaningful market potential – smaller
companies that can become big ones. “Open-ended” growth stories with long
legs, where there is no real limit to how big a company could become, are
especially attractive to us. On the Net, it’s winner-take-all, exponentially
increasing the potential of growth companies. Potential has been scaled

upward, leading to astronomical valuations based on traditional pricing
metrics, but which are more understandable when viewed in the context of
the aforementioned price-to-opportunity metric.
“I skate to where the puck is going to be, not where it has been.”
– Wayne Gretzky

The core of e-Knowledge, the
Internet, will “democratize”
learning, providing greater
access at lower cost, ultimately
improving quality.

In The Book of Knowledge, we identified six key megatrends that propelled the
knowledge services market forward. Demographics, the Internet and technology,
globalization, consolidation, branding and outsourcing are having a significant
impact on how and why we gain knowledge. These same megatrends are at work
in the e-knowledge market, creating a powerful tailwind for growth.

di
ng

n

an

lid atio
C o ns o

Br

In t e
rn et

Six Megatrends Impacting the Knowledge Enterprises Market

De

Globalization

e-Knowledge
Enterprise

m

ra
og

i cs
ph

Outsourcing

Source: Merrill Lynch Global Growth Group

•

Today’s kids are the Internet
Generation – Generation i –
and are as comfortable on a
computer as a bicycle.

24

Internet – The core of e-Knowledge, the Internet, will “democratize”
learning, providing greater access at lower cost, ultimately improving quality.
Ubiquitous PCs combined with high-speed bandwidth will facilitate engaging
anytime, anywhere learning and human capital management. Online learning
should become the new "killer application" for the Internet, providing
attractive growth potential for e-knowledge enterprises that can effectively
marry learning, technology and electronic commerce.

•

Demographics –In today’s knowledge-based economy, the pay gap between
those with a college education and those without has more than doubled in the
last 20 years. Put another way, the purchasing power of a 30-year-old man
with a high-school diploma has dropped by over one-third over the past two
decades. Lifelong learning is now required for economic longevity, and the
successful e-knowledge enterprise will provide individuals with the ability to
gain the skills necessary to survive and thrive in the New Economy. Today’s
kids are the Internet Generation – Generation i – and are as comfortable on a
computer as a bicycle. Each demographic group, from Generation i to the
early retirees of the Baby Boom, will experience a growing economic need to
continue to access education throughout a lifetime.


The Knowledge Web – 23 May 2000
•

The Internet creates one market

and one economy.

Globalization – Approximately 30% of S&P 500 revenue comes from
outside of the United States. The Internet creates one market and one
economy. In today’s global knowledge-based economy, corporations need
consistent, multi-lingual learning resources that are accessible anywhere,
anytime. The successful e-knowledge enterprise will provide employees and
individuals with quality education and skills that are universally relevant and
accessible regardless of their time zone, uniquely combining richness and
reach. Less directly, but perhaps more important for the U.S worker, is the
fact that globalization has enabled economic specialization like never before.
For the workers of developed nations, this has further heightened the need for
continuous lifetime learning.

•

Branding – Brands are key to both the Internet and Knowledge Enterprises.
The winners in the space will build strong brand names known for unique
state-of-the art learning experiences where individuals can access first rate
content in an engaging, interactive virtual environment conveniently from the
home or the desktop. Established brands – those of prestigious universities,
for example – will find both potential in and a challenge from the Internet.
“The most valuable Web brands – including Yahoo!, Amazon.com, and
E*Trade – are not product brands. They are brands for a complex set of
services – solutions – that help people cut through the clutter and perform a
series of tasks.”
—Evan I. Schwartz
Digital Darwinism

•

A company’s ability to
“communitize” and then
“monetize” users to maximize
lifetime value is particularly
critical in determining the
potential for that enterprise.

Outsourcing – In today’s fast-changing market environment, the corporate
incentive is to focus on core competencies and outsource everything else.
Application service providers (ASPs) represent classic outsourcing and are
expected to enjoy explosive growth. Customers trade the headache and cost of
purchasing software and hardware, dealing with implementation and
obsolescence risk and managing internal IT for a single contract and a flat
monthly fee. ASPs providing corporations with highly scalable human capital
management services are likely to benefit from the critical solutions they
provide and an efficient business model.

•

Consolidation – While consolidation used to be the hallmark of a mature
industry, this is no longer the case, particularly in technology, where small
start-up companies are acquired for their technology and, as important, for
their talented people. Acquiring a competitor is often faster and easier than
hiring and training scarce computer programmers, sales people and leaders.
Being a net consolidator, an acquiror can add value-enhancing features to its
network, aggregate complementary communities and accelerate the network
effect. As niche players find it difficult to access or re-access the capital
markets, more consolidation should occur.

A company’s ability to “communitize” and then “monetize” users to maximize
lifetime value is particularly critical in determining the potential for that
enterprise. We look for high gross and long-term operating margins. These are
indicators of the strength of the business model and correlate to the price-to-sales
multiples investors are willing to pay. In general, the higher the gross and
operating margins, the higher the price-to-sales multiples.

25