The Market’s 5 Most Disappointing Business Ideas EVER

by James Brumley | December 5, 2012 11:08 am

Plenty of business ideas seem like winners when first unveiled, as most of them are big hits with consumers. As time goes on, however — and we’re given the gift of hindsight — a harsh reality can start to set in: Many of those great ideas simply can’t be operated profitably, or don’t have long-term viability.

Here’s a look back at the market’s five biggest letdowns, each of which was hailed as a brilliant business venture in their early days — and one of which has only recently started to show its true colors:

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Energy Trading

Though most traders might remember that energy trading firm Enron went belly-up in 2001 thanks to a massive accounting scandal, what most traders might not realize is that the energy trading market has existed in a semi-recognizable format since the early 1990s.

However, it wasn’t until the late ’90s and early 2000s that the energy trading market morphed from a hedging and power-management option to a speculative, profit-making activity.

That in itself isn’t a sin. The equity and future markets are ultimately designed to facilitate speculation and provide a liquid market that’s fair to all players of any size. The problem is, the stock market is highly regulated. The energy trading market is still highly unregulated, despite a handful of reforms that were put into place following Enron’s collapse.

But why was (and is) energy trading such a disappointing business? Because it never was designed to be securitized and turned into “buy low, sell high” game. Enron proved there’s just too much room for smoke and mirrors as the system is set up now, and given mankind’s inherent greed, that eventually will leave someone holding the bag.

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Yes, businesses buy products from other businesses. And yes, any middleman that can make buying those goods easier, cheaper and faster deserves a little piece of the action. That’s why names like Ariba (NASDAQ:ARBA[2]), PurchasePro and Commerce One were all the rage back in 1999, when Forrester Research predicted the B2B industry’s revenue would soar from that year’s $131 billion to $1.52 trillion.

It’s an outlook that seems ridiculous idiotic in retrospect, as business-to-business activity hasn’t reached anything close to that figure in any year since then.

It certainly was a “no-brainer” at the time, though.

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One-Hour Delivery

For the nearly four years the one-hour delivery service called Kozmo operated, its customers loved it. The company’s moped-powered delivery drivers would not only deliver nearly anything to its target market (movies, candy, fast food, etc.) in the nine cities it was last operating in, but it would pick those items up en route — all for a small fee, of course.

In the end, however, the delivery fee had to be small enough to remain palatable, yet big enough to make the company profitable — a dual mandate that never was achieved.

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Leveraged Fixed Income Arbitrage

Most folks might not even recognize what leveraged fixed income arbitrage is. Most folks will recall the name Long-Term Capital Management, though.

LTCM was the massive hedge fund that unraveled in 1998 after a small misstep for the global financial market led to a massive $4.6 billion collapse in the value of the fund’s holdings.

The reason the fund was able to collapse in the first place? Leveraged fixed income arbitrage, which essentially is the practice of buying bonds low in one place, and simultaneously selling those bonds in another place. The price difference might only be pennies, but if you can trade big enough positions, scraping those pennies off can lead to sizable profits.

So, to maximize the size of its scalping-like profits, Long Term Capital Management used so-called (and completely legal) leverage as a way to buy way more fixed income instruments than it actually had the cash to pay for. No big deal, as the odds of that leverage working against the company and closing the arbitrage gap was 1 in 1,000.

Funny thing, though. The market found itself in that 1-in-1,000 scenario in 1998, and LTCM began to fall apart as a result.

In hindsight, the fund’s investors should have known that those annual returns of 40% had meant the firm was walking a tightrope it couldn’t stay on forever.

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Daily Deals

Just to be fair, daily deal e-coupons probably will never go away completely — nor are daily deals entities like Groupon (NASDAQ:GRPN[3]) and LivingSocial.

Now that the euphoria is wearing off, however, it’s clear the triple and quadruple-digit growth rates from 2010 aren’t sustainable, even though traders plowed into these stocks as if they were sustainable[4].

One of the chief complaints about the e-coupon industry is that the marketing tactic doesn’t actually cultivate repeat customers — it just forces a merchant to sell goods or services at a loss. It’s not a complaint that applies universally, though; some vendors have been able convert those one-time customers into repeat customers. Those stores are just far less common than first assumed.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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  4. even though traders plowed into these stocks as if they were sustainable:

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