The Internet is alive and, well...

Say good-bye to Web freebies—or say good-bye to the Web.

Not long ago, the Internet was being hailed as the most important advance since the printing press. Startups were being funded at an astounding pace, companies were going public early in their lives with no profits, and young companies were being valued at many billions of dollars.

Today, getting venture capital for a consumer Internet company is next to impossible, interest in initial public offerings has dried up, and companies that once traded at more than $100 per share are selling in single digits.

The picture isn't much rosier for Internet-access devices. Pioneering Web-appliance vendor Netpliance dropped out of the hardware business and stopped selling to consumers; Virgin Interactive abandoned its program to provide customers with Web terminals; and the heavily discussed Web tablets have hardly made an appearance. In the software realm, the much-anticipated explosion of Java that was supposed to result in independence from the PC standard has been a dud.

Were we all wrong to think the Internet was such an important change? Not at all. But in the enthusiasm surrounding the Internet, companies and investors both public and private lost track of basic business principles, and confused the frenetic pace of software revisions and growth in Internet usage with a fast pace of consumer change. As for the PC, it's shown remarkable vigor, repelling all attempts to establish platform-independent standards (more on this topic next month).

There's no question the Internet represents an enormous shift in the business and technology landscape. But no matter how momentous its effect may be, acquiring a loyal customer base takes time, and running a business that delivers physical products is complex and challenging, whether orders are taken over the Internet or over the phone.

Much of the money spent over the past few years on Internet startups was squandered on marketing, as companies tried to build leading brands quickly. "Get big fast" was the almost universally accepted mantra for creating a successful Internet company. Great brands, however, are earned, not bought. It takes time for people to gain experience with a company, understand and believe in the values of the brand, and accept it as part of their personal landscape. No matter how fast a company spends its marketing dollars, people change their habits and attitudes only at a certain rate.

One widely used technique Internet companies employed to build a large "customer" base quickly was to give things away—from e-mail access to Internet service to computers—with the intent of making money from them later. Unfortunately, "customers" who accept things for nothing don't necessarily have any desire to spend money. Consumers have been spoiled. Internet startups have trained them to expect things for free that can only be provided without cost when they're subsidized by venture capital. Web advertising doesn't work very well, and it certainly doesn't generate enough revenue to support an entire enterprise—or to make it affordable to give away hardware.

In the past year, venture capitalists have stopped funding businesses that have no clear prospects for getting paid for their products and services. The inability to raise successive rounds of funding has led directly to the demise of many Internet companies in the past year, and many more will fall in the coming year. A few will survive by charging for things that were free last year.

The collapse of stock prices has created a feeling of failure that's even more widespread. Inflated stock prices had nothing to do with real company values; they were merely a symptom of an investing public that had bought into the idea of the Internet as a huge business opportunity. This created far more demand for Internet stocks than there was supply. As in any severe supply/demand imbalance, prices were bid up to outrageous levels. Analogies to the famous tulip craze of the 17th century are entirely apt.

The venture-capital community, while realizing stock prices were unsupportable, nevertheless profited tremendously from shifting the risk of immature Internet businesses onto the retail investor. Now that the public has stopped playing the game and stock prices have collapsed, the investment community is in a deep funk.

Today, it's difficult for businesses that serve consumers to raise money. Investors have overreacted to their previous excesses, and most now avoid anything that serves consumers directly. Once the unsupportable free services die off, it will again be possible to create businesses that deliver real value for which consumers will pay, and that will be funded and grown at a sustainable pace. Ultimately, this will be good for consumers. The Web is a wonderful thing, but it needs to be on solid financial footing.