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Business Week e.biz -- Cover Story
It's a live-or-die season for e-tailers. But out of the carnage will emerge a more viable bricks-and-clicks model
The merchandise once adorned the elegant Web site called Miadora.com like an imperial bazaar: Cartier watches, Italian leather tote bags, even a $12,000 antique Faberge spoon. Yet despite $20 million from sterling names like Sequoia Capital (SEQUX) and Oracle Corp. (ORCL), it's suddenly all gone. All that remained of the luxury e-tailer's site recently was a stark electronic epitaph posted on Sept. 22. "Miadora.com is no longer in business. We appreciate your past support." Now, even that terse farewell is gone. In fact, the entire site has vanished, as if it never existed.
The Great Internet Shakeout has arrived, and not just for the dogs and dregs of the Web. As once-limitless venture capital runs out, some of the Web's most pedigreed merchants are crashing and burning--from Miadora to Amazon.com-backed Living.com, which limped to bankruptcy court in August. Even publicly held e-commerce companies are facing oblivion: Goldman, Sachs & Co. predicts that at least 15 of 28 public e-tailers will run out of money by the end of next year unless they can raise more cash. Some, like apparel merchant Bluefly (BFLY) and software site Beyond.com (BYND), have narrowly avoided getting delisted from the Nasdaq stock exchange.
Brace yourself for the last-gasp Christmas for e-tailing. This holiday season is shaping up as the biggest test yet for the viability of selling to consumers over the Internet. "Anyone who doesn't have flawless execution this holiday season will be in trouble," says Greg Drew, president and CEO of electronics e-tailer 800.com. "Everyone will be waiting around with a bag of popcorn to watch the show."
Mainly, a lot of people will be watching whether e-tailing "pure plays," those stores that exist solely in cyberspace, can survive on their own. Most won't. Onetime Net stocks bull Henry Blodget of Merrill Lynch & Co. now thinks 75% of the 300-odd public dot-coms will be gone in five years. Even companies that shook off the shakeout are struggling. Bellwether name-your-own-price site Priceline.com Inc.'s (PCLN) growth has slowed, and it said in late September that it will shut down its WebHouse Club gas-and-groceries affiliate for lack of demand.
Traditional merchants could fall just as flat on their faces online. Indeed, some of e-tailing's biggest flameouts have been the online units of these companies. Walt Disney's Toysmart, Discovery Channel's PetStore, and even Walmart.com have flailed on the Web. OfficeMax, Kmart, Staples, and others have seen their stocks tumble as they announce they're putting more money into online ventures that are still losing money. As of last year, in fact, pure-play e-tailers were still largely gaining on their brick-and-mortar brethren when it comes to online sales (table).
Out of all this carnage, however, online merchants are gravitating to a new model of e-tailing that they're praying will be the one that's sustainable, powerful, even revolutionary. The central notion: Both pure e-tailers and traditional retailers need to tap the expertise of the other to make online selling work. Now, the rush is on to fund deals that bring together the best of clicks and bricks. The beacon for this vision is a groundbreaking deal that Toys `R' Us (TOY) and Amazon.com (AMZN) signed in August, in which each will share the duties of a joint site (page 42). Such alliances, says analyst Kevin Silverman of investment bank ABN Amro (ABN), will help the whole industry. "Instead of people having a disappointing experience at either one, you've got positive experiences on both ends."
There's no guarantee such arrangements will mature beyond their current status as the latest online fad. Traditional and online companies have vastly different business models, cultures, and goals. Nor is the consumer appeal of bricks-and-clicks yet clear. Although some surveys show consumers want the option, for instance, to return merchandise bought online to stores, there's little evidence consumers are doing so.
Nevertheless, the approach is spreading fast. Veteran electronics e-tailer Outpost.com runs the Web store for leading camera retailer Wolf Camera, in return for in-store promotion at Wolf's 700 outlets in 30 states. On Oct. 3, the two debuted their first in-store kiosk at a Wolf store in Atlanta where customers can order out-of-stock products for next-day delivery from Outpost (COOL). Meanwhile, 800.com and luxury e-tailer Ashford.com (ASFD) have been approached by traditional companies eager to use all or part of their online operations. "We're pursuing this kind of thing aggressively," says David K. Pecaut, president of iFormation Group, a new $300 million venture formed to help traditional companies get online.
After all, it's not that people don't want to buy online. Although the Web accounts for only 1.4% of overall retail sales, Americans continue to flood the electronic shopping aisles. Some 63 million are expected to shop on the Web by yearend, up from 37 million in 1999. And they'll buy $10 billion worth of goods this holiday season--twice last year's rate, according to Forrester Research Inc., even though retail sales are expected to grow just 5%. That's why many experts still believe Web sellers, with their ability to achieve massive scale with fewer resources, will climb out of their seemingly bottomless pit of losses and make a permanent mark. Says analyst James Vogtle of Boston Consulting Group Inc.: "Online retailing will work because of one fundamental driver. Consumers love it."
The ultimate shape of e-tailing remains highly fluid. But the outlines of a third era are emerging, beyond the flighty dot-coms with no retailing experience, beyond the ponderous giants that didn't understand online consumers. With a few exceptions--perhaps Amazon.com Inc., a few boutique e-shops, the neighborhood dry cleaner--a new generation of merchants might not exist exclusively online or in buildings. They intend to mix and match the strongest elements of bricks and clicks to come up with what customers really want, where and when they want it. "Customers are going to be free to shop however they choose," says Thomas Weisel Partners LLC analyst Anne-Marie Lillestrand. "Companies need to be there."
The transformation must begin the moment customers walk in the virtual door. Early on, e-tailers dispatched artistes to build code-clogged Web pages. Dumb idea. "Forget the bells and whistles," says Joanna Barsh, head of McKinsey & Co.'s e-commerce group. "People want to make a purchase, and we're slowing them down." Victoria's Secret now posts its paper catalogue directly on the Web and lets users "flip" through each page and make purchases. At iQVC, a revamped search function lets users hunt for jewelry by size, color, price, and brand. "You have to get the customer to the product quickly," says Stephen Hamlin, iQVC's operations chief.
E-tailers also have to get those customers a lot more cheaply. Thanks to those clever multimillion-dollar TV ads, pure plays have been crippled by soaring customer-acquisition costs. Last year, they hit $82 per customer, vs. $12 for catalogers and $38 for store-based Net sellers, according to online trade group shop.org. Now, e-tailers are placing fewer, more targeted bets--most of all, to existing customers. While a first-time buyer on average spends $300 to $400 at luxury-goods retailer Ashford.com, repeat buyers spend twice that. Little wonder Ashford is digging into its 600,000 customer and visitor e-mail addresses to increase its repeat sales, which were only 26% of revenues last quarter.Mix it up. Of course, e-tailers still need to bring in new customers. To do it more cheaply, they're borrowing old-world tactics. Besides sending e-mails to its 6 million users, teen apparel site Alloy Online Inc. (ALOY) will ship out some 40 million catalogs this Thanksgiving. "Nothing beats direct marketing," says CEO Matthew C. Diamond. His plan should drop per-customer acquisition costs from about $30 to $20, he says, and help Alloy break even by yearend.
Even more critical than marketing now is providing the right mix of products once customers arrive. But merchandising is one skill sorely lacking among online folks, says Lauren Freedman, president of E-Tailing Group, a Chicago consulting firm. That's why this year Amazon is leaving it up to Toysrus.com to buy toys and do the virtual window displays.
If only for their own survival, e-tailers also are turning to selling what's right for them: more profitable products. Drugstore.com Inc. (DSCM), for example, had negative 10% gross margins last year selling toothpaste and Tylenol. Now it offers the likes of Burt's Bees, a high-end bath and skin line. Taking another page from conventional retailing, this year eToys Inc. will debut its own private-label line of 600 toys, which sport 60% gross margins--triple those of brand-name toys.
For all their challenges, e-tailers have an advantage that bricks-and-mortar guys don't: They can use the Web as a platform for reaping other toil-free but high-payoff revenues--from advertising to online store hosting. Alloy sold $4.8 million in ads in the first half of 2000, at margins as high as 90%. Ashford has built custom sites for companies such as Enron and AT&T, with specific gifts employees can send to clients. Programs like that are expected to make up 10% of Ashford's revenues by yearend.Service counts. More than ever, success ultimately will come down to getting the products all the way to the customer's door on time. The only long-term solution is a bulletproof logistics operation. And while small players can only afford to hire outside distribution experts, more and more e-tailers believe they must eventually bring it in-house. That way, they can tightly integrate their shipping and inventory data, giving them better control over costs and closer bonds with customers. Sears.com's inventory system, for instance, e-mails a customer when that out-of-stock drill bit is available again. "The ultimate winners in e-commerce will be the companies that focus on what happens after the order button is pushed," says Tim Quillin, a fulfillment analyst with Little Rock investment bank Stephens Inc.
What happens after the order is delivered is becoming a critical factor in success as well. More than ever, customer service counts. Last year, fewer than 30% said that service was adequate, according to Forrester. That's why e-tailers are scrambling to improve. At Lands' End Inc. (LE), some 2,500 sales reps help answer questions live online. As a result, more than half the people who put items in their online shopping cart end up buying, more than twice the industry average (page 48).
Finally, new-age e-tailers need to get a grip on the one thing that underlies all those tasks: data. Using sophisticated new data-mining and analysis software to constantly refine and personalize offerings, companies such as Amazon.com can create essentially unique stores for each returning customer. At iQVC, when merchandisers notice an item buried in the Web site is picking up sales numbers, they will quickly move it to the home page. Once someone becomes an iQVC buyer, he spends 25% more than QVC customers who buy via TV and phone.
What's pushing all this rich experimentation is more than just a desperate stab at survival. Savvy companies are realizing the Web is more than simply another channel to reach customers. Much more, it's ushering what some hope will be a compelling new vision of retailing: the "360-degree" shopping experience. The notion is that customers can reach their favorite retailers anytime, anywhere, in any way they choose. The potentially profitable flip side is that retailers, too, can reach their customers wherever they may be--in the mall, at home, or in their car via a Web phone or handheld computer. "If they can adapt to the online world, the mixed models will emerge as winners," says John Hurley, managing partner at Bowman Capital LP, an investment firm in San Mateo, Calif.
Here's the payoff: Once retailers can get customers onto two or more channels, shoppers tend to be far more profitable than store-only or online-only customers. Consider Eddie Bauer, which now has 570 stores, ships 110 million catalogs per year, and runs four Web sites. It found that shoppers who use all three methods spend five times more than those who shop only by catalog. Says J.P. Morgan Securities Inc. analyst Tom Wyman:"The three different channels expand the company's share of your wallet."
Clearly, that reality favors those that know how to sell through multiple channels, such as Nordstrom (JWN) and QVC. Even more likely to prosper are those that sell their own specialty products, such as Lands' End and Eddie Bauer. And the ability to share costs among multiple channels is a big boon vs. online-only companies, which don't have stores to reinforce their brand or drive customers from one venue to the other. By 2005, Jupiter predicts online spending will total $199 billion, but the Net will influence $632 billion in offline purchases.
Despite the successes of some traditional retailers and catalog operations, many still haven't translated physical-world dominance to the Internet. The reason, says eToys CEO Edward Lenk, is that "you have to do something different than consumers find in the stores." He notes that Barnes & Noble Inc.'s brand hasn't helped it gain an inch on Amazon. Moreover, traditional players' technology and Web design are still spotty, and many don't know how to ship packages profitably to individuals. The Toys `R' Us-Amazon deal, in fact, was an admission that retailers can't do it all from scratch. "It was a watershed moment," says Robert Labatt, research director at Gartner Group Inc. "Finally, a brick-and-mortar retailer discovered that they can't do it all themselves."
That's why there's still at least some room left for pure online players. Despite its current huge losses, Amazon could defy the doomsayers if it meets analyst's expectations this Christmas. Amazon is expected to boost annual sales per ordering customer to $124 from $116 last year. At the same time, operating expenses are expected to fall from 39% of revenue last year to 29% in the fourth quarter. If Amazon succeeds, analysts forecast profits by the end of 2002. A few other e-superstores like Buy.com (BUYC) might make a go, and specialists like Alloy and Ashford. If eToys has a strong enough showing this Christmas, it could raise more cash to get to breakeven late next year.
But they're in a race against time. Despite their high growth, most pure plays are still too darn small to break even, and it's unclear most will be able to get big fast enough to survive (table, page 34). A McKinsey analysis of leading e-tailers found that an online bookseller would have to sell $1.2 billion worth before it makes its first penny in operating profit, a level only Amazon has reached so far. An online apparel store needs nearly $1 billion. For comparison, apparel and sporting goods site Fogdog Inc. (FOGD) sold just $5.8 million last quarter.
No one knows whether combining forces will be the salvation for dot-coms, or make retailers successful online. But it's clear they need each other. "There isn't anyone who is a pure play who will survive without a bricks-and-clicks play, and no retailer who will make it without an Internet strategy," says Elliott Ettenberg, CEO of retailing consultancy Customer Strategies Worldwide. These alliances are sure to be messy, strife-ridden affairs for years to come. It will be up to both players to pluck from the e-tail wreckage the building blocks for new empires that will stand the test of time.By Dennis K. Berman and Heather Green; Contributors: Ellen Neuborne, Jeanette Brown, Faith Keenan, and Bureau ReportsReturn to top