E-Gov Companies Search for Profitable Business Models

The bursting of the dot-com bubble in the government market has left a nagging question for many startup companies still in business: What's the best way to make a profit?The transaction or convenience fee model, an early idea for delivering electronic government services, has fallen out of favor, according to many company executives and analysts. Under this model, users pay a fee when they make a purchase or complete a transaction online, such as filing property taxes."What we are seeing is everybody going away from transaction fees," said Thomas Meagher of BB&T Capital Markets.The transaction fee model is often called the self-funding model, because the company builds the e-gov system at no cost to government, and then recoups its investment through the fees.The problem facing startups is they don't have sufficient financial resources to survive the early years when the volume of transactions is low."Can you wait a year or more for the revenue to kick in?" Meagher said. "We have real doubts that many of these companies can."Behaviors have to change before the transaction fee model will yield profits, according to Tony Bansal, chief executive officer of Digital Commerce Corp. of Herndon, Va., which operates the business-to-government procurement site FedCenter.com and StateGovCenter.com.His company abandoned transaction fees and relies on membership fees paid by the vendors trying to reach customers. Membership fees bring steadier income to the company, because transaction fees rely on purchases being made online, Bansal said. "The percentage of buying online is still minuscule," he said.Digital Commerce, which closed a $20 million round in venture capital funding in December 2000, expects to be profitable by the end of 2001 with $20 million in revenue, Bansal said.Another part of the company's march toward profitability has been layoffs. At its peak, Digital Commerce had 400 employees; over the past year, that has been reduced to about 140, Bansal said.Because of poor conditions in the stock market, the company also backed away from an initial public offering in September 2000 that would have raised $115 million, he said.Bansal said he expects online buying by the government to become more accepted over the next three to five years. In the meantime, "we try to provide value that makes membership worthwhile," he said.Benefits include access to customers. For example, in January, the company signed an agreement to create an online procurement site for the Metropolitan Washington Council of Government, which represents about 40 government entities in the Maryland, Virginia and Washington region.While not a contract with guaranteed revenue, the strategy is that these government entities will use the site as their procurement vehicle. Digital Commerce's revenue will come when the regular vendors of these agencies sign up as members of the Digital Commerce procurement site, Bansal said. The company also will be training government users and marketing the site to drive more traffic to it.EzGov Inc. of Atlanta is another company that moved away from the transaction fee model, doing so in early 2000, said Randy Street, executive vice president for sales and marketing. The company builds Web portals and supplies electronic transaction software for government agencies.EzGov recently lost its co-founder Bryan Mundy, who died in a fire Jan. 15 at his home. His death will not affect the long-term success of the company, Street said.EzGov now only uses transaction-based models for pilot programs as a way of introducing a government to online services, he said. The company either licenses its transaction software to the government, or sells its services through an application service provider in which the government pays a subscription fee to use EzGov's online services, Street said.Transaction-fee based systems are too focused on a single application, such as paying taxes, Street said. "You have to offer much more than just the ability to pay a bill online," he said. "And to deliver that, you have to go beyond what a convenience fee can do."EzGov will be profitable by the fourth quarter of 2001 and is in the process of securing funding that will carry the company through 2002, Street said. The company declined to disclose current revenue.Procurenet Inc. of Great River, N.Y., has never relied on the transaction fee model, but instead has bid on and won contracts with agencies such as the Defense Logistics Agency and the Army and Navy to build and to run online procurement sites."These are 10-year contracts that provide a good stream of revenue," said Ken Farber, executive vice president of business development for Procurenet.The company brought in about $100 million in 2000 revenue. But, like Digital Commerce, it pulled out of its IPO in November 2000 because of poor market conditions. The company expects to be profitable this year.Clinging tenaciously to the transaction-fee-based model is the National Information Consortium Inc. of Overland Park, Kan."The transaction-based model works, because that is what governments are requesting," said Christopher Neff, vice president of marketing for NIC. "Some of our competitors criticize it because they can't get it to work."NIC announced a slew of new contracts during its fourth quarter, including deals with South Carolina and Hawaii to build online procurement systems. Other contracts include portals for Montana and Dallas County, Texas.NIC, which is the only publicly traded of the government dot-coms, reported a loss of $37.1 million on revenue of $77 million during 2000. The company's stock plunged from a high of $78 in March 2000 to a low of $1 Dec. 27. On Feb. 12, the stock closed at $4.31. The company expects to reach profitability in early 2002, Neff said.The contraction of venture capital markets is putting pressure on startups to show at least a clear path to profitability, analysts said. Venture capitalists invested $19.6 billion in the fourth quarter of 2000, down 30.7 percent from the $28.3 billion in the third quarter, according to the National Venture Capital Association, which represents venture capital and private equity firms."Every element of the market right now is in a bit of turmoil," said John Allen with the investment bank Quarterdeck Investment Partners of Los Angeles.The fallout could provide opportunities for large, established companies to make acquisitions if the startups falter on their way to profitability, or if investors are looking to get their cash out, he said.