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AMAZON.COM: THE WILD WORLD OF E-COMMERCE

By pioneering--and damn near perfecting--the art of selling online, Amazon is redefining retailing

When giant retailer Wal-Mart Stores Inc. sued upstart Internet bookseller Amazon.com Inc. on Oct. 16, jaws dropped. Wal-Mart accused Amazon of raiding its executives to steal its computerized merchandising and distribution trade secrets. The amazing part: Wal-Mart said tiny, money-losing Amazon had caused it ''economic damage'' and continues to do so. Amazon Chief Executive Jeffrey P. Bezos isn't talking about the suit--except for this calculation: ''Even if all our employees came from Wal-Mart, it would be less than two-tenths of 1% of their workforce,'' he says--and then bursts into a raucous laugh.

Clearly, Wal-Mart isn't laughing. And Bezos? He didn't hee-haw long. He promptly bought three books--from Amazon, of course--on the subject of Wal-Mart to learn more about how the company works. What he found: Comments from Wal-Mart founder Sam Walton saying he trolled rivals for talent--which were then used in Amazon's court filings. Legal experts say it's a long shot for Wal-Mart to win, even though Amazon has hired several Wal-Mart executives, including one who is now Amazon's chief information officer overseeing the company's crucial technology operations.

Regardless of the outcome, this case may well signal a watershed in the history of the Internet: the moment when cyberspace retailers began to turn the tables on earthly ones. Indeed, Amazon is blazing a trail in the world of commerce where no merchant has gone before. By pioneering--and darn near perfecting--the art of selling online, it is forcing the titans of retail to scramble onto the Net. More than that, it's jolting them into rethinking whether their traditional advantages--physical size, mass-media branding, and even the sensory appeal of shopping in stores--will be enough to thrive in the New Economy. Says Duke University marketing professor Martha Rogers: ''Amazon is an example of how an upstart can redefine its whole industry.''

Consider this: Amazon offers an easily searchable trove of 3.1 million titles--15 times more than any bookstore on the planet and without the costly overhead of multimillion-dollar buildings and scads of store clerks. That paves the way for each of its 1,600 employees to generate, on average, $375,000 in annual revenues--more than triple that of No. 1 bricks-and-mortar bookseller Barnes & Noble Inc.'s 27,000 employees.

Amazon's cutting-edge technology gives it a leg up, too, by automatically analyzing past purchases to make recommendations customized to each buyer--a trick that confounds 20th century mass marketing. And with a single mouse click, an order can be placed on its Web site, making shopping a friendly, frictionless, even fun experience that can take less time than finding a parking space at the mall.

Now, Amazon is extending its warm and fuzzy formula far beyond the bibliophile set. On Nov. 17, the online merchant debuted a video store, as well as an expanded gift shop--the clearest sign yet that Bezos aims to make Amazon the Net's premier shopping destination. Buyers who visit the Web site can now find everything from Pictionary games and Holiday Barbies to Sony Walkmen and watches. And Amazon isn't apt to stop there. Not surprisingly, Bezos, who abruptly left a cushy job as a Wall Street hedge-fund manager in 1994 to race across the country and launch Amazon in his Seattle garage, is keeping his plans close to the vest. But experts say he's eyeing everything from software and apparel to flowers and travel packages--markets that could pit the upstart against more heavyweights, such as Microsoft Corp. and Nordstrom Inc., as early as next year.

Can Bezos, a 34-year-old computer whiz with no previous experience in retail, pull it off? Don't bet against him: In Amazon's first full quarter selling music CDs, ending last September, it drew $14.4 million in sales, quickly edging out two-year-old cyberleader CDnow Inc. Says analyst Lauren Cooks Levitan of BancBoston Robertson Stephens: ''When you think of Web shopping, you think of Amazon first.''

Indeed, in nearly the blink of a cursor, Amazon has blossomed into cyberspace's biggest consumer merchant, with 4.5 million customers and an expected $540 million in sales this year, up from $148 million last year. No wonder investors are gaga. Even after an Internet stock sell-off on Nov. 30, Amazon's stock is trading at about 209 a share, 23 times its May, 1997, initial public offering price of $9 a share, post-split. That's a market value of--hold on to your seat--$11.1 billion, or five times higher than Barnes & Noble's. All for a company that's losing more millions every year and isn't expected to turn a profit until at least 2001.

Call these investors nuts, but their underlying assumption is dead-on: The potential for E-commerce, and Amazon in particular, is as vast as cyberspace. More people keep swarming online--nearly 100 million worldwide now, swelling to some 320 million by 2002, predicts market researcher International Data Corp. A new Visa USA Inc. survey of some 1,000 Internet users found that nearly half plan to shop on the Web this fall alone. All told, cybershoppers are expected to spend $7.8 billion this year, jumping to $108 billion by 2003, or 6% of all U.S. retail spending, says Forrester Research Inc.

Yet for all of Amazon's success, there is much debate as to just how much of that the company will pocket. In books, Bezos chose a clear winner: a market that had no big online rivals and no dominant traditional players--even No. 1 Barnes & Noble has only abOut 11% of the U.S. market. But as Amazon plunges into each new category, it no longer has that crucial first-mover advantage. Instead, it faces entrenched and often much bigger rivals in virtually every corner it may choose to enter. That's what led Forrester CEO George F. Colony to declare last year that the pioneer online merchant soon would be ''Amazon.toast.''

Amazon can't even dismiss the booksellers, who, Despite their lumbering start, are making a mad dash for the Net now. Last month, Bertelsmann, the German media giant and owner of several publishers, including top Random House Inc., paid $200 million for a 50% stake in the online arm of Barnes & Noble, giving it a considerable war chest for its battle with Amazon. And on Nov. 6, Barnes & Noble jolted Amazon and the entire publishing world by announcing a $600 million deal to buy the leading book distributor Ingram Book Group--which supplies 60% of Amazon's books. Barnes & Noble promises no favoritism, but prudence will force Amazon to find other sources, likely at higher cost. All that adds up to a fearsome force in Amazon's core market. Says Barnes & Noble Vice-Chairman Stephen Riggio: ''The biggest piece of the market is ahead of us.''

CYBERMALL. The seasoned online crowd is no less determined to fight off Amazon. On Nov. 23, CDnow--which has announced a deal to merge with rival N2K, nearly doubling its sales--joined with movie seller Reel.com, computer merchant Cyberian Outpost, eToys, and others to form a virtual mall called ShopperConnection. Buyers can access each of those online retailers from a single site. Likewise, Web portals such as Yahoo! Inc. and the bulked-up America Online Inc.-Netscape Communications Corp. combo are angling for a bigger slice of the E-commerce pie. So are fast-growing merchants such as Buy.com (page 130).

And as Bezos moves into new markets, he will run smack into traditional retailers that are starting to wield their brands online. A new study by Boston Consulting Group found that 59% of consumer E-commerce revenues--including retail sites and online financial and travel services--are generated by companies such as Eddie Bauer and 1-800-FLOWERS that also sell through traditional channels. Says Carol Sanger, a vice-president at Macy's parent Federated Department Stores Inc.: ''We think the brand of Macy's is far more meaningful to the consumer who is looking for traditional department-store goods than any Internet brand name.''

As if all the rivals aren't scary enough, Amazon faces an even more fundamental uncertainty: Retailing is a business with razor-thin margins, prompting some analysts to question whether the company will ever be profitable. The theory: Its ambitious growth plans will keep it on the fast track for entering new markets, propelling costs ever upward--and earnings out of reach. Analysts estimate that Amazon will spend nearly $200 million on marketing next year, up 50% over a year ago. ''The company has been able to show it can sell lots of books for less without making money, and now it has shown it can sell lots of music for less without making money,'' says Merrill Lynch & Co. analyst Jonathan Cohen, one of only two analysts with a sell rating on the stock.

For every Cohen, though, there are seven analysts who think Amazon ultimately will fulfill investors' seemingly outsized expectations. For one thing, it has an almost unheard-of two-year head start on key software that handles millions of transactions and personalizes the customers' experience. Amazon, for instance, was the first commerce site to use so-called collaborative-filtering technology, which analyzes a customer's purchases and suggests other books that people with similar purchase histories bought: the ultimate in targeted marketing (page 112).

Besides spurring more purchases, there's another huge bonus for Amazon: It can gather instant feedback on customer preferences to divine what else they might want to buy. Such valuable information has proven forbiddingly effective in capturing new markets online. While it may appear as though the company is careening willy-nilly into new terrain, Amazon is in fact targeting areas its customers have already requested. ''We want Amazon.com to be the right store for you as an individual,'' says Bezos. ''If we have 4.5 million customers, we should have 4.5 million stores.''

Not since superstores and mail-order catalogers came along in the 1980s have merchants faced such a wrenching shift to a new way of doing business. It's a lot like what Wal-Mart did in the past decade: It used computers to transform the entire process of getting products to customers, all the way from the warehouse to Wal-Mart's welcome mats. Now Bezos is using Net technologies to shatter the perennial retail trade-off--he can offer a rich selection and personalized service, while still reaching millions of customers.

But technology is just one way Amazon is trying to rewrite the rules of retail. Bookstore and other retail chains largely depend on opening new stores to boost revenues--a huge cost that Amazon completely avoids. In the reverse of traditional retailers, Amazon has relatively high initial costs for things such as computer systems and editorial staff--which partly explain its red ink today. But unlike retailers, who must continually invest in new stores to hike revenues, Amazon can boost sales by simply getting more people to come to its single online store. Says Chief Financial Officer Joy Covey: ''I don't think we could have grown a physical store base four times in one year.''

Of course, for now, Amazon has to spend millions on marketing to bring in new customers--about 24 cents per dollar of revenue last quarter, compared with 4 cents for traditional retailers. But it's little understood just how much leverage Amazon's low capital costs provide to support that spending. Here's how it works: Physical bookstores must stock up to 160 days' worth of inventory to provide the kind of in-store selection people want. Yet they must pay distributors and publishers 45 to 90 days after they buy the books--so on average, they carry the costs of those books for up to four months. Amazon, by contrast, carries only 15 days' worth of inventory and is paid immediately by credit card. So it gets about a month's use of interest-free money.

That float--amounting to well over $25 million so far this year--actually provides a large chunk of the cash Amazon needs to cover its operating expenses. In its latest quarter, Amazon used a mere $600,000 in operating cash while jacking up its customer base by 37%, or 1.4 million customers.

Even though Amazon is still a long way from making a profit, its basic economics suggest the upstart will someday look more like a fat-cat software company than a scrambling-for-profits retailer. Once Amazon gets enough customers and sales to pay off its initial marketing and technology investments--and as that technology pays off in falling labor costs--additional revenue drops to the bottom line. ''Amazon's changing the business model of retailing,'' says Ann Winblad, a principal at Hummer Winblad Venture Partners.

ALMOST ENDLESS. It's no accident that Bezos named Amazon after the river that carries the greatest volume of water. ''He wants Amazon to be a $10 billion [in revenues] company,'' says early investor and board member Tom A. Alberg. To look at Amazon's crowded, grubby Seattle headquarters, you'd never suspect such grand ambitions: It's an unmarked building across from Wigland, the Holy Ghost Revivals mission, and the Seattle-King County needle-exchange program. Unlike most of his Silicon Valley colleagues, Bezos is so cheap that the desks are made of doors and four-by-fours, while computer monitors sit on stacks of phone books. Of course, there's one big bonus: Everyone gets stock options, which have made dozens of Amazonians millionaires. But the usual Valley perks such as free neck massages? Yeah, right.

And it's only natural that in a company where everything is being created from whole cloth, the people don't exactly fit either the Silicon Valley or the Microsoft mold. Dogs, sometimes including Bezos' golden retriever, Kamala (named after a minor Star Trek character), and green-haired twentysomethings with multiple piercings run loose, often around the clock. Says Acting Customer Service Director Jane Slade: ''We tell the temp agencies, 'Send us your freaks.'''

Bezos' executive staff is nearly as eclectic. It's a motley, though whip-smart, band of executives ranging from Microsoft refugees to liberal-arts majors and rock musicians. Ryan Sawyer, for instance, the vice-president for strategic growth, was a Rhodes scholar who studied poetry at Oxford. ''They don't care what has been done in the past,'' says Anne Martin, a principal at BT Alex. Brown Inc., who was on Amazon's IPO road show.

And that includes Bezos. What he understood before most people was that the ability of the Web to connect almost anyone with almost any product meant that he could do things that couldn't be done in the physical world--such as sell 3 million books in a single store. Starting the company in his suburban Bellevue (Wash.) garage, Bezos interviewed suppliers and prospective employees at, ironically, a nearby cafe inside a Barnes & Noble superstore. Launching Amazon.com quietly in July, 1995, Bezos quickly set out to make the customer's experience as appealing as sipping a latte in a bookstore cafe.

Besides the huge selection and simple Web pages that load fast, he created a sense of online community. He invited people to post their own reviews of books; some 800,000 are now up. He brought in authors for chats and more: John Updike started a short story, and 400,000 people sent in contributions to finish it.

Most important, Bezos made it irresistibly easy to buy a book. After the first purchase, a customer's shipping and credit-card information are stored securely, so the next time, all it takes is a single click to send the books winging their way to a mailbox. And to assure people that their purchase went through, Amazon sent E-mail confirmations of orders--which were often upgraded to priority shipping for free.

Rivals have since copied those tactics, but Amazon continues to give customers the red-carpet treatment. This month, it introduced GiftClick, which lets customers choose a gift and simply type in the recipient's E-mail address--Amazon takes care of the rest. The result: Some 64% of orders are from repeat customers, and that's rising steadily. For many, Amazon's a lifeline to literature. Marcia Ellis, an American attorney working in Hong Kong, used to drag home a suitcase full of books when she visited the U.S. Now, she orders two books a month online. ''Most of the people we know here get books from Amazon,'' she says.

Bezos also was one of the first merchants to leverage the Web's power in unique ways to spread the Amazon brand. Early on, he offered other Web sites the chance to sell books related to their visitors' interests through a link to Amazon. Their inducement: a cut of up to 15% of sales. Now, he has 140,000 sites in the so-called Associates Program.

That's what has kept even the online arm of Barnes & Noble at bay. Certainly the No. 1 bookseller, which built its first store 125 years ago, is a savvy merchant, but it proved vulnerable when it came to the ways of the Web. For one thing, it was late in arriving, and its store-trained executives took longer to learn the new rules of E-commerce than Amazon's Net-centric staff. ''In the early days, there's a big advantage in not having that baggage,'' says William McKiernan, chairman of E-commerce services provider CyberSource Corp.

Even after Barnes & Noble went online, it was slower to take advantage of the Net's ability to customize its site to each shopper. That allowed Amazon to use its appealing customer experience as a branding tool far more powerful than conventional advertising. And Barnes & Noble? Despite its well-known name and huge online marketing campaign, only 37% of Internet users recognized the brand without prompting, vs. 50% that knew Amazon, according to Intelliquest Information Group.

The result: 18 months after Barnes & Noble went online, Amazon.com's $153.6 million in third-quarter sales, up 306% from a year ago, still overwhelm the book giant's online sales by 11 times. And Barnes & Noble's online customer base rose 29%, to 930,000---still less than a quarter of Amazon's.

Still, the bottom line is that Amazon needs to get customers to buy more. Indeed, with the bruising price wars that are sure to come, getting each customer to spend a tad extra may be critical for survival. It's just that the next step--the first beyond entertainment media--is a doozy. For one thing, it's unclear that the Amazon brand will extend into, say, toys or consumer electronics. ''I get the combination of books and music and videos,'' says Robert Kagle, a venture capitalist who invests in Internet startups for Benchmark Capital. ''Beyond that, I don't know how far their brand goes.''

Even if the brand does travel well, it's almost guaranteed that other products won't be as profitable. Take CDs: They have lower margins than books. Same for videos. Toys have the disadvantage of not having as established a distribution network as books and music. So Amazon may have to stock more on its own, increasing its inventory costs and skimming off some of that nice float.

Already, established competitors are forcing it to do just that. Reel.com says 96% of the 20,000 titles it stocks are on the backlist. Those videos constitute most of its sales--and by far the most profitable portion. ''If Amazon wants to ship them in a reasonable time, they'll have to stock them,'' says Reel.com CEO Julie Wainwright. And some products, such as cars, real estate, or office products, are simply too cumbersome or expensive to ship. Or they may require too much aftersale support--which makes software a dicey product for Amazon to sell.

That's why Bezos will likely branch out beyond retail. In August, he spent $270 million for two companies that steer Amazon even more firmly toward becoming a shopping service rather than just a retailer. One of them, Junglee, has technology that makes it easy to scour the Web for products and compare prices or other features. ''We don't even necessarily have to be selling all those things,'' says Bezos. ''We just help people find things that are being sold elsewhere on the Web.'' Amazon might take a cut of revenues from other retailers if its customers buy their products. Says marketing prof Rogers, who is a partner in consultancy Peppers & Rogers: ''Their next mission is to be a service agent.''

TENUOUS ADVANTAGE. It's a tricky mission. Why? It will be tough to guarantee that the entire customer experience will measure up to Amazon's standard. Any glitches could quickly damage the company's carefully crafted brand name. ''In three or four years, they'll be known for 'big,''' says CDnow CEO Jason Olim. ''Well, whoop-di-do.''

In the end, Amazon's success or failure will ride on maintaining a delightful experience for all of those new customers. Indeed, satisfied Amazon customers may well be helping more than most people realize: Analysts say one key to the sky-high stock price, which underwrites so much of its coming opportunity, is that investors can get a personal feel for Amazon's prospects by trying it out--something that's tough to do with most technology companies. Says Halsey Minor, CEO of online network CNET Inc.: ''His greatest advantage is a lot of people who buy his stock buy his books.''

But Bezos knows that advantage is a tenuous one. ''There are plenty of opportunities to stumble and become a VisiCalc,'' he says of the pioneering spreadsheet that is now all but forgotten. Bezos is acutely aware of Amazon's place in history. He carries a camera in his pocket, snapping a photo a day to provide a reminder years from now of what really happened--though it seems unlikely anyone will forget.

By Robert D. Hof in Seattle, with Ellen Neuborne and Heather Green in New York and bureau reports

To read a letter to the editor about this story, click here.



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