By Madhu Suthanan

Meet Rashikbhai, a third generation stockbroker. Rashikbhai learnt the business of broking from his father. Despite not possessing any professional degree, he is able to understand his business, thanks to his hands-on approach. He understands the cyclicals, the utilities and the FMCG stocks. He tracks their movements continually. When he finds a fixed pattern in these stocks, he enters the stock early, much before the market could identify the winning stock.

Now Rashikbhai has a new passion. He is fascinated by the Internet stocks and he wants to invest in the potential winners among them, well before the market could spot them. Currently, he faces no problem about choosing Internet stocks. For, there is just one scrip -- Skumars.com -- listed on the Indian bourses. However, he is busy studying Internet stocks listed on Nasdaq so that he is ready with his stock-picking knowledge when Internet stocks make it to the Indian bourses in a big way.

No cash flows
Rashikbhai was surprised by what he discovered from his study of Internet stocks listed on the Nasdaq: he found that none of the traditional brick-and-mortar ratios such as return on net worth which measures return on shareholders' wealth and asset-turnover ratio which measures the degree of asset utilisation are relevant for identifying the potential winners among the new economy stocks. With reason. These new economy companies, particularly the Internet companies, had no or insignificant cash flows. Their expenses and overheads were met by issuing capital. Most Net companies were not making money, not even at the gross level. Not just that, these companies had no tangible assets worth talking about. So, Rashikbhai decided to work out a new set of financial parameters which could help him analyse and understand the new economy stocks.

If Internet companies do not have cash inflows and yet to make profits at the net level, how does one go about valuing their business and stocks. Rashikbhai stumbled on a new parameter called customer analysis.

Monetising eyeballs
What is this customer analysis all about? Most Internet business models are based on the concept of "monetising eyeballs". Put in simple language, monetisation of eyeballs concept works on the assumption that existing site-visitors and web-surfers will turn into sources of future income for the company. Reliance on this monetisation of eyeballs concept is now forcing Net companies concentrate more on gaining site-visitors and customers than on generating or increasing revenue. The rationale: increasing traffic to the site is a first step towards generating future revenues.

The result is Internet companies are ignoring the importance of assessing the quality of eyeballs. Consider this example: eyeballs glued to Amazon.com are not comparable with those surfing Yahoo.com.

For, Amazon.com is more a retailer while Yahoo.com is more an information-provider. The chances are that a visitor to Amazon.com will be more interested in e-commerce while a visitor to Yahoo.com is basically information-hungry. The implication is simple.

While Amazon.com can generate future revenues through selling and cross-selling its products, Yahoo.com can generate revenues only through display of advertisements on the site. Thus, eyeballs are not comparable.

New parameters
All said and done, Internet companies can be evaluated on four new parameters: total number of visitors to the site, average annual revenue per visitor, average cost of acquiring a visitor and the customer retention rate.

These parameters have their rationale. Total number of visitors to the site is a measure of popularity of the site. The average revenue per year per visitor includes annual purchases done by visitors and annual revenues from advertisements and space rentals expressed per visitor.

This parameter reflects the worth of a visitor. Average acquisition cost of a visitor is a measure of advertisement revenues. Customer retention rate helps to know the stickiness of a visitor. A low acquisition cost and higher values in all the other three parameters indicate high value of the Internet company.

Now look at the trends in these four parameters in the Indian Internet market. Thanks to the fact that the Indian Internet market is still nascent, it is attractive. True, markets such as the USA boast of deeper PC penetration, which has helped their Internet markets to grow fast. However, the growth rate has already begun to taper off. Happily, this is not the case in India. India is one of the fastest growing Internet markets in the world today.

Such a fast growth in the Internet market leads to an exponential growth in average revenue. At the same time, average acquisition cost is bound to be low in a growing market such as India. However, the USA Internet market is entirely different: the Internet market is not fast growing and visitors have to be lured away from other sites. This increases the cost of acquisition.

Cost of acquisition also depends on the visitor retention rate. Higher the retention rate, lower will be the acquisition cost. Moreover, cost of acquiring a visitor for a second time is higher than what is incurred for acquiring a new customer. The reason: bringing back a dissatisfied visitor needs increased efforts and results in higher cost of acquisition.