Digital Delta

Service provider flows in many streams

A label exists for just about every new form of internet service to come along, from application service providers, to hosting, managed service provider, e-customer relationship management, Web systems integration, e-logistics and e-fulfillment.

But Joel Ronning refuses to be pinned down by any of those categories. Ronning, CEO of Digital River, says he is creating an entirely new business model for the Internet -- one that encompasses all the familiar labels and adds a few other ingredients to the stew.

His preferred term for the Digital River business model: commerce service provider.

"Each of those terms describes a little of what we do, but its not the whole picture," Ronning says. "For example, a hosting company will host someones store, but not actually run it. We will step in and not only host someones store, well design it, run it, market it and handle all transactions -- everything that goes into making a Web site successful."

Its a proposition that appears to be gaining traction, particularly as companies re-evaluate their Internet strategies in light of the economic downturn. Rather than make a big investment in their own infrastructure, many companies are outsourcing pieces of their operations. Eventually, some come to the conclusion that the entire operation can be run cheaper, and possibly better, by an outside service provider.

Thats exactly the conclusion Major League Baseball came to earlier this month, when it signed a deal to have Digital River host and operate the leagues main Web site, as well as run stores for each of the organizations 30 clubs.

Noah Garden, senior vice president of electronic commerce at MLB Advanced Media, a unit created by the league to oversee its Internet initiatives, says it was a decision based on timing and economics. When he joined the company two months ago, he quickly realized he would have to go on a major spending spree to build up the units capabilities to ensure it could meet both his growth plans and demands for reliability and uptime.

"Rather than build out our infrastructure, I decided I wanted to focus more on what we do best -- building our brand," Garden says.

Terms of the deal were not released, but Digital River will operate stores offering more than 6,000 baseball-related products, including team jerseys, hats, outerwear and memorabilia. It also will operate and market an entirely new line of business -- subscriptions to game-day audio broadcasts.

Natural Evolution

The path to becoming a commerce service provider has not exactly been a straight one for Digital River. When it officially started operations in 1996, Digital River essentially packaged and delivered software for companies on a white-label basis in both electronic and CD-ROM form. White-label products are manufactured by a company and sold under another companys label -- such as the Wal-Mart Stores brand of cola.

As the software delivery business grew, customers like Symantec and Novell asked Digital River to take on more responsibility, such as handling customer inquiries by phone, fax and the Internet. Today, about 150 of the Minneapolis companys 400 employees are customer service agents.

As the relationship with software vendors evolved, Digital River began developing profit sharing arrangements. The better it became at marketing and selling a companys products, the more money it made. Then in 1999, the company saw an opportunity to capitalize on the boom in e-tailing, essentially offering to do for brick-and-mortar clients what it had been doing for the software industry. It now boasts more than 8,000 clients, including bowling ball manufacturer Brunswick; Nabisco; Polaris Industries, which makes all-terrain vehicles, motorcycles, personal watercraft and snowmobiles; Siemens; and Staples.

"It was never our aim or goal to become a Razorfish [an Internet systems integrator] or a Digex [a hosting company]" Ronning says. "Our clients just came to us and said, We will pay you if you take on this added service for us. It was more of a natural evolution."

Sitting in his office in one of four buildings that Digital River has gradually taken over in a Minneapolis suburb, Ronning outlines all the services a company needs to run an e-commerce operation. Strategy and creative design, Web site development, hosting, cataloging and content management, systems integration into back-end applications like Enterprise Resource Planning, transaction processing, fraud protection, marketing, customer service, delivery and returns processing. As he lists each one, he checks them off to show Digital Rivers complete package of services.

Al Cameron, head of the fraud prevention team, says that while some e-tailers typically complain of losses in the range of 15 percent to 25 percent from fraud, Digital River has been able to reduce its fraud rate to just 1.5 percent of sales worldwide. The company employs a team of eight fraud prevention officers and assumes all risks associated with bad sales. "We do this full time, so weve gotten to be really good at it," Cameron says.

While Digital River appears to be unique, it wont remain that way for long. A handful of start-ups are chasing the market, including Escalate in e-tailing and Asera in digital marketplaces. Even retailing giant has dipped its toes into the market by agreeing to run the online operations of Borders Online and Toys R Us. However, those sites are co-branded with Amazon, rather than run as independent storefronts the way Digital River does it.

Other promising models are beginning to show up in such sectors as health care, financial services, and oil and gas. Applied Terravision Systems, which offers a hosted oil and gas accounting application, has launched what it calls a business function outsourcing service.

Not only will ATS host and manage its accounting application, like an ASP would, it also will supply the actual accountants to input and process the data. It has partnered with energy giant Enron, so it can also offer financing to drill wells and market the oil and gas produced. ATS CEO Robert Tretiak says it is now possible for a company to concentrate on finding and producing the oil or gas and leave all other aspects of the business to ATS and Enron.

"The exciting thing to us is we are affecting a change in the mindset of the industry," Tretiak adds. "At one time accounting was sacred. Now they realize as long as they get the dough, its not so sacred."

Swollen River

Ronning has set profitability as a top priority, not only because it makes sense, but because large clients like Siemens have demanded it. In its latest quarter, Digital River had revenue of $13 million, up 90 percent from $6.9 million a year earlier. It lost $1.6 million, compared with $12.6 million a year earlier. Ronning predicts annual revenue of $50 million to $60 million, and a profit by years end.

"A year ago, reaching profitability wasnt that high a priority," Ronning says. "But now -- oh God its important."