Only a matter of months ago, international venture capital houses were falling over themselves to back Latin American internet start-ups. More than $1.8bn was raised and, after a number of successful IPOs, the market value of the biggest companies quickly exceeded that of many of the region's well-established banks and industrial companies.

Timothy Purcell, managing director at JP Morgan Capital Corporation in New York, says that at the height of the boom his team was receiving between 50 and 100 business plans a week. "They were piling up on our desks and we had no idea what to do with them all."

But over the last few months, many of these new economy ventures have started to run into difficulties. The strongest, such as StarMedia, a portal company, have seen their share prices slide and have cut staffing and other costs in a bid to become profitable earlier than originally planned. The weakest are finding it increasingly difficult to raise more funds and a growing number have been forced to admit defeat.

Punto.com, a Miami-based Latin American internet magazine which itself has been financed by venture capital, has filled the pages of its first few editions with details of these woes. Companies like LatinAdvisor, a business-to-business portal, and Brazil's Super11, one of a string of companies offering a free internet service, have closed their doors.

Others are seeking to team up with competitors as the region's embryonic new economy braces itself for a wave of consolidation. "There will be a lot of consolidation in the industry. There is just not enough pie for everybody," says Rene Pimentel, a Latin American internet analyst with Deutsche Bank Alex Brown in New York.

Nevertheless, although painful, the events of the last few months do not mean the end for the new economy in Latin America. Many of the reasons why investors became excited about the region, such as its large, young, linguistically homogeneous and - above all - rapidly growing market, are still relevant. The problem was that too many of the new start-ups pursued a strategy based heavily on advertising revenues. Although successfully pioneered by StarMedia, this could not work for everybody.

Fernando Espuelas, StarMedia's founder, proved that Latin American new economy companies could raise money in a market that had been suspicious of more established businesses from the same region. In May 1999, he raised $105m with an IPO in New York, stimulating many other young Latin entrepreneurs to follow suit.

The StarMedia IPO "marked a breaking point," says Isaac Lee of Punto.com. In Latin America, "he was responsible for the whole sector being possible."

But although potentially attractive in the long term, Latin America's advertising market is simply not big enough to support the number of new companies formed in the wake of StarMedia's success. Competition, sparked by a flood of new entrants, has depressed rates. In some markets - such as Argentina - recession means that even conventional advertisers are struggling, making matters worse. One Argentine executive estimates that in that country, only about $7m and $8m in revenues are available to internet businesses.

Jupiter, the internet analysis group, estimates some $1.2bn in advertising revenue will be available to internet players in 2005, but says that last year total revenues amounted to only $52m. Lucas Graves, an analyst at Jupiter, expects a small number of sites to dominate that market. "It is very difficult to be a small advertising driven site."

Many of the newcomers had not properly thought through their strategies. Daniel Korn, a lawyer with Allende and Brea in Buenos Aires, says: "Sometimes their business really amounted to saying 'my content is so interesting and my pictures so enticing that traffic will just happen'. It never made sense. When it all came tumbling down, I said, 'at last'."

Some companies had looked to supplement income from advertising with fees from internet service provision and commissions from e-commerce. But these have not proved good sources of revenue. Since the end of last year, Latin America has seen a profusion of companies offering free internet service. E-commerce has been slow to take off in some sectors because of worries about credit card fraud and continuing problems with poor delivery.

Since the Nasdaq fell sharply in April, it has become progressively more difficult for companies to raise finance. IPO plans have been pulled or scaled back. AOL - whose IPO in August was one of the few to go ahead this year - raised less than half as much as it expected when it floated its Latin American businesses. Companies such as Yupi.com, which had planned a $172m issue in April, have been forced to scrap their plans. Venture capitalists are taking longer to process applications and asking tougher questions.

"Things used to be so much faster - it would take four weeks to get a deal organised. Now it is taking between three and six months. We're seeing substantial reductions in valuations and changes in what they are looking for," says Mr Korn. "In the old days, a good idea would do it. Now you need a serious revenue model and a credible management team."

In spite of this, long-term prospects, particularly for well capitalised companies, such as those who have already raised money or those that have one foot in the old economy - the so-called clicks-and-mortar companies - are good. For a start, Latin America is still the most rapidly growing internet market in the world. Jupiter predicts that the number of users in Latin America will grow at an annual compound rate of 36 per cent between 1999 and 2005.

That compares with a rate of 30 per cent for Asia, 18 per cent for western Europe, and 11 per cent for North America. And there are indications that numbers could grow faster. Recent research indicates that 8.6m Brazilians are now using the internet compared with Jupiter's own forecasts of 8.4m.

A recent study by Boston Consulting Group and Visa showed that revenues from e-commerce are growing strongly. It predicts that business-to-consumer revenues will reach $580m in 2000, compared with $109m in 1999. Consumer auctions are proving particularly popular in Latin America because they allow users to bypass problems, such as poor postal services and widespread credit card fraud, that have held up developments in other areas.

Other positive trends are becoming more pronounced. Telecommunications costs are falling sharply as a result of deregulation and the introduction of new technologies. New rules allowing more competition will be unveiled later this month in both Argentina and Venezuela and should lead to cheaper prices for consumers, for example. In Brazil, the auction early next year of licences for a new generation of cellular telephone services is pushing land line companies to bring forward targets for customer service.

The development of intercontinental broadband networks - fibre optic cable that allows for high-speed transmission of data and images as well as voice - should improve quality and reduce costs. The use of advanced cellular phones - many of them able to access the internet - is also growing quickly, especially in Brazil.

Computers and charges by internet service providers are both becoming cheaper. BCG estimates that overall costs of accessing the internet (including telecommunications charges) have fallen in the last year on average by 23 per cent in Argentina, 20 per cent in Brazil and 8 per cent in Mexico.

Indeed, in a number of areas Latin America seems to be exhibiting greater potential for internet development than more developed markets. This is in part, at least, because of the backwardness of the conventional economy.

In some countries the quality of banking and other financial services has been so poor that many people are much keener than their counterparts in Europe and the US to embrace alternatives. Brazilians have been particularly quick to latch onto online banking. According to a recent study, Bradesco - the country's biggest bank - has more online customers than any other bank in the world apart from Wells Fargo and Bank of America. "Conventional services are frequently of a poorer quality and so there is less resistance to change," says Juan Carlos Garcia of Valores Bavaria, a Colombian internet fund.

The same rationale might also be applicable to government services. Brazil has sought to promote the internet as a means of delivering more efficient public services and it has enjoyed success in some areas. Nine out of ten Brazilian taxpayers filed declarations via the internet this year.

In the same ways, Latin American companies have been slower to implement computer-based - but pre-internet - electronic planning and data interchange systems, such as enterprise resource planning software. Some analysts think that it may be easier for them to implement the new internet based electronic marketplaces and other business-to-business systems.

Cellular telephony would provide another opportunity for Latin America to leapfrog more developed markets. Consumers in a number of countries have been quick to use cellphones, partly because of deficiencies in land line services. But they are doing so at a time when new mobile phones are being sold with web access protocols and other internet messaging systems. "In Latin America, half the 40m cellphones can carry internet messages," says Mr Garcia. "A lot of people think m-commerce will grow more quickly than e-commerce."