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Business Week e.biz
STREET WISE By Sam Jaffe September 16, 1999


How Secure Is eBay's Edge?
Investors love the cyber-auction juggernaut's seemingly flawless business plan. So why is it paying protection money to AOL?

If there's one Web star that every other e-commerce competitor envies, it's eBay (EBAY). Its business plan is simple: Charge sellers of goods a small fee for using its electronic auction. There's no messing with advertising, no worry about razor-thin margins in commodity retailing (take note, Amazon). The costs are minimal, and best of all, eBay is already profitable.

The biggest problem, of course, is getting people to keep using your service rather than the competition's. eBay grabbed an edge by being the first auction site to gain scope and recognition: Already it has attracted more than 6 million registered customers, and it averages about 2 million items for sale each day. Even when heavyweights such as Yahoo! (YHOO) and Amazon (AMZN) got into the business, they made minimal gains against the eBay juggernaut. As a result, eBay has been awarded a price-to-sales ratio of 133, more than 25 times the price-to-sales ratio of the Standard & Poor's 500-stock index. Investors love the stock so much that they didn't even blink when eBay issued $700 million in new shares in April.

The next question is whether eBay can use that money wisely to build its business. Alas, a recent deal with America Online (AOL) should make investors a little nervous about that.

 

The deal's most tangible strategic benefit: AOL agrees to stay out of the auction business for at least two years
 

In a nutshell, eBay will pay $75 million over four years to AOL in exchange for delivering to the online king a co-branded version of its Web site. According to eBay, the primary reason is to draw more traffic. AOL has 18 million customers who theoretically could become prime buyers and sellers of auctioned merchandise. A back-of-the-envelope calculation by Warburg Dillon Read analyst Sara Zeilstra shows that eBay will be paying about $2.50 for each new registered user -- assuming that 7.5 million AOL members eventually come to its site. "That's extraordinarily cheap when you figure that some e-commerce companies are paying as much as $30 for a new registered user," says Zeilstra, who rates eBay a strong buy.

The flaw in such a calculation, which Zeilstra concedes, is that it's nearly impossible to estimate how many new users the deal will actually deliver. There are signs, though, that the number won't be anywhere near 7.5 million. For one thing, many of eBay's users are already AOL members, and there's nothing to keep them from logging directly onto eBay's site, bypassing the AOL version.

AOL "BLOCKADE"? In fact, more than 80% of eBay's visits come from people who have the site bookmarked or who type in the URL themselves, according to figures provided by Nielsen/NetRatings. The rest are referrals from other sites, most notably Yahoo!, which accounts for 3.7% of visits. Of course, eBay has no partnership with rival Yahoo! -- which just goes to show how topsy turvy are the ways of the Net.

Maybe, though, eBay isn't really after extra traffic. The deal's most tangible strategic benefit is that AOL has agreed to stay out of the auction business for at least two years. In other words, eBay has paid $75 million in protection money to AOL. Warburg's Zeilstra phrases it more gently: "Essentially, eBay has bought a blockade. In addition to AOL not competing directly, eBay has also purchased all the prime advertising space on AOL for auctions."

 

Who's to say that AOL, if it jumped in, wouldn't have joined the list of auction also-rans?
 

On the face of things, it seems like a brilliant move: AOL would be a formidable competitor in just about any online business. Still, eBay has fended off even the biggest competitors in the past. Both Yahoo! and Amazon are examples of that. "No one comes close to matching the breadth or scope of eBay's marketplace," says Nicole Schmidt, an analyst with Josephthal & Co. who rates eBay a strong buy. Who's to say that AOL, if it did choose to compete with eBay, wouldn't have joined the growing list of auction also-rans?

What else could eBay have done with the money it's paying AOL? One thing would be to establish itself as the market leader overseas, where it is faced with multiple homegrown challengers.

TECH FLAW. An even more pressing need is to halt the system outages that have plagued the site so far this year. One day in early June, for instance, eBay was down for 22 hours, disrupting hundreds of thousands of auctions and no doubt prompting many sellers to contemplate looking elsewhere. "The outages worry me, but in the end they are a technological problem," says Josephthal's Schmidt. "I'd much rather see a technological flaw, which can be fixed, than a flaw in the business plan, which I haven't been able to find."

And so if eBay is blessed with an apparently perfect plan, wouldn't its $75 million have been better spent shoring up Web servers, or expanding its reach, rather than paying off potential competitors?

Sam Jaffe writes about the markets for Business Week Online.


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WEB POINTERS
To visit some of the sites mentioned in the story, click here:
eBay
AOL
Warburg Dillon Read
Josephthal


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