They were supposed to transform the world of business. But now the stars of the Internet are struggling to transform themselves, and to survive. Their best hope is to find an old-economy partner

JEFF BEZOS, the founder and chief executive of Amazon.com, has a word of advice for small investors or those looking for short-term gains: don't put your money into Internet stocks. And that includes his own company. Eventually Amazon will be a very valuable business, he claims, but at the moment: “we are not a stock you can sleep well with at night.” That is putting it mildly. Amazon has lost around 90% of its value since the beginning of last year. Like other dotcom stars, Amazon is experiencing traumatic changes. Even if such companies survive, they are unlikely to resemble the businesses they once were.

Amazon is not the only dotcom in trouble. Yahoo! is also in a perilous state. The tremors began on March 7th, when Yahoo!'s chief executive, Timothy Koogle, announced that he would hand over to someone else but remain chairman. Whoever takes up the reins at Yahoo! faces an increasingly bleak future. Until recently, Yahoo! had seemed a stunning success. In about six years it had transformed itself from a simple listing of interesting web sites to a leading Internet “portal”, a gateway which is used by around 185m people a month. But few of those visitors spend any money with Yahoo! and now the company's advertising revenue has fallen off a cliff. Instead of the $220m-240m it was expecting in the first three months of this year, its revenue estimates have been reduced to $170m-180m. What is worse, excluding a backlog of previous advertising commitments, the drop in new sales is even steeper. Yahoo! was rare among Internet firms in making a profit. This year, it may not.

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Koogle departs

Yahoo! is now trying to develop other sources of revenue, for instance by encouraging people to take out subscriptions to certain services. But this effort is in its infancy and, to survive, the company will have to rely on advertising. An example of how it might be able to generate more advertising—especially from non-Internet businesses—can be found at America Online (AOL), the world's biggest Internet provider. Since it merged with Time Warner, a magazine, movies and cable-TV group, AOL's advertising has held up far better. In large part, that is because AOL is now part of a diversified media conglomerate that sells both offline and online advertising.

The logic of this is that Yahoo! also needs a partner from the world of conventional media. Disney, Vivendi and Viacom have in the past been suggested as possible partners. Viacom once said it might be interested in acquiring Yahoo! at $15 a share. At the time this seemed laughable. At their peak Yahoo!'s shares were worth $237. Recently, the firm's share price has fallen below the $15 which Viacom thought reasonable. Yahoo!'s current management is fiercely independent and would probably resist such a takeover. But unless they can quickly find a way to boost revenue, they many not have much choice. In the longer term, Yahoo!'s future as an independent firm, despite its huge customer base, looks increasingly unlikely. Much the same can be said for other big names on the Internet.

Old economy, old values

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Bezos advising investors

With nearly $3 billion of sales, Amazon has grown at an extraordinary rate. But the company has yet to turn a profit. And as it has grown, opening warehouses and overseas distribution centres, it has also come to look less like a cyber innovation, and more like a traditional mail-order company. Mr Bezos has pledged that Amazon will make a “pro forma” profit—which excludes such things as the payment of debt interest—by the end of this year. Yet some analysts still fear the company will run out of cash. And most shareholders seem to be praying that it will find a traditional retailer to buy it and save it. Recent reports that it was talking to Wal-Mart, America's big discount chain, sent Amazon's shares soaring. The talks were quickly dismissed by both sides as inconclusive. But the two firms look like a great fit: Wal-Mart's distribution network and buying clout together with Amazon's web-savvy marketing could make a powerful combination.

The Internet's third big star, eBay, already has a handsome business, which brought in profits of $25m in the three months to December 2000. eBay runs online auctions, acting as little more than an intermediary with low overheads. For its services it takes between 7% and 18% of any sales. Analysts expect that the company's operating margins could eventually average around 35% on revenues, which in turn could grow by up to 50% a year. And yet, despite trying to expand into other areas, eBay is still seen as a site on which to trade “collectables”—rare Barbie dolls and the like. To expand further, eBay also needs partners.

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Whitman and Ballmer do a deal

One of those could be Microsoft—which is not exactly an old-economy company, although in Internet terms the Seattle-based software giant is at least middle-aged. On March 12th Meg Whitman, eBay's chief executive, and Steve Ballmer, Microsoft's chief executive, signed a broad alliance. On the face of it, the deal mostly involves technical and software issues which will help the two companies develop their use of the Internet. However, it will also help eBay expand its influence because Microsoft sites will start to carry eBay's listings. Microsoft will also offer eBay's buyers and sellers additional services, such as billing information. As Microsoft's sites are, collectively, among the biggest in drawing worldwide Internet traffic, the alliance could prove a big boost for eBay.

Through mergers or alliances, it seems clear, dotcom companies will become increasingly like bricks-and-mortar firms. In the process, they will also come to be valued more like traditional companies—which in most cases means a sharp, downward revision even from the much-lower valuations to which they have sunk in the past year. There was always something absurd about Yahoo! being worth more than the combined value of General Motors, Heinz and Boeing. Such fantasies are over. The real question now is: has the Internet produced, in the likes of Amazon, Yahoo! and eBay, a new generation of firms substantial enough to survive the bursting of the dotcom bubble? On their own, probably not. Hand-in-hand with an old-economy partner, maybe.