For Online Pet Stores, It's Dog Eat Dog

Slim margins and a crowded market point to a brutal shakeout

Jack Gorman, an account manager for Seattle-based data processing outfit NCS, used to face quite a hassle in catering to the likes of Woody and Casper, his Labrador Retrievers. The dogs are so picky that they won't eat much besides a dog food called Wellness. And at snack time, Woody and Casper aren't happy unless they can gnaw on Old West meat treats. These days, however, Gorman is having an easier time with his pooches. He orders Old West snacks at a Web site called for less than he was paying at the corner pet store. And every two weeks a 30-pound bag of Wellness Fish & Sweet Potato formula arrives at his door, courtesy of Smiley Dog, the Web site of a local Seattle pet store. "I can [order] at three o'clock in the morning if I want," says Gorman. "When I saw there were pet stores online, I got pretty excited."

He isn't the only one panting over pet treats on the Net. Within the past year, more than a dozen major pet supply sites have popped up, including some backed by powerhouse players, cable television's Discovery Communications, and the nation's two largest pet supply chains, PETsMART and Petco Animal Supplies. The appeal? A market bigger than either toys or music. Americans spend $23 billion on pet food and supplies, according to the American Pet Products Manufacturers Assn. And while pet owners plunked down just $299 million of that online last year, the Web market for pet goodies is expected to hit $2.5 billion in 2002, says Forrester Research Inc. "Sixty percent of all homes have pets," says Michela English, chief operating officer for, a sister company to the Animal Planet cable channel, which invested $97 million in "It's a market that we can imagine rapidly shifting online."

But Fido should have chewed up a few of these online pet store business plans. Because so many pet stores are rushing to the Web, the market is almost certainly headed for a messy shakeout. Pet supplies have never been a lucrative business. Operating margins are a razor-thin 2% at leading retailer PETsMART and 4.5% at rival Petco. And the prospect of competitors willing to lose millions to grab market share has investors skittish. went public on Feb. 11 at $11 a share and was trading at $6.13 on Feb. 22--hardly the enthusiastic welcome most Net stocks get. "A lot of these companies are going to get eaten up," says Forrester Research analyst Carrie Johnson. "Only the sites with the best-known names are going to win."

Check out the initial public offering documents of and, which filed on Feb. 4. Between the time it started operating last February and the end of 1999, lost $61.8 million on a meager $5.8 million in sales. fared only slightly better in the 10 months it operated last year: It lost $47.5 million on sales of $10.4 million.

THE SCARY PART. And that's not even the scariest part of their business plans.'s financial statements show that it paid $13.4 million for the goods it sold for just $5.8 million. For every dollar that pays suppliers such as Ralston Purina Co. for dog food and United Parcel Service Inc. for shipping, it collects 43 cents from its customers. That means it's losing 57 cents on every dollar of sales--even before the really big expenses like advertising and overhead. PETsMART isn't doing much better: For every dollar that it pays suppliers, it's collecting 62 cents.

Pet site executives say things aren't as dire as they seem. What they're doing is grabbing market share now so that they can profit in the future. "We're building ahead of the curve," says Julie L. Wainwright,'s chief executive. One big expense, she says, comes from shipping goods by air to the East Coast so that customers get their orders in three days. Those costs will ease once builds its distribution center in Indianapolis. She argues that the margins on products such as dog food are a healthy 20% to 25%. Sure, she's disappointed in the company's stock price, but she says has loads of potential: It's 30% owned by, so it gets exposure to the retailer's 17 million customers.

Indeed, the Net looks to be a natural for pet owners. Most tend to buy the same stuff regularly and welcome the convenience. Consider Laura Medley, a Web designer for Wit Capital Group Inc. in New York. Every eight weeks a 40-pound bag of dog food is delivered from With three cats and a dog, she shops on the Web for specials on kitty litter, cat food, vitamins, and cat pan liners. "They all e-mail me specials," says Medley. "I order from whoever has the special. Sometimes, it's even free."

BIG SPENDERS. The fact that Medley has bookmarked four sites and toggles among them looking for sales shows how crowded the market already is. And becoming a standout costs dearly. and appear to have the early lead, in large part because they've been spending heavily for the limelight. has burned $21 million on marketing and advertising in the past year trying to create a unique identity. Its branding campaign centers on a sock puppet that looks like a white dog with black patches. It made an appearance in Macy's Thanksgiving Day Parade in New York as a 36-foot-high balloon. The singing mascot also was featured in a Super Bowl ad that cost more than $2 million. Yet, according to a survey by e-commerce consultant Gomez Advisors Inc., of 550 people logging on to the site, some 30% of those who had seen the ad thought it belonged to another pet site.

While is a pure Net company,, the online arm of the 493-store chain, is showing the advantages of a clicks-and-mortar strategy. Financially, is doing slightly better than in part because its stores help promote the Web site at a relatively low cost. will use PETsMART's warehouses to fulfill its orders. And the company acquired some Net expertise. For example, it struck an alliance with idealab!, the Los Angeles-based Internet incubator that has spawned successes such as eToys Inc. and now owns 22% of

Partnerships with existing pet supply chains may prove critical., which is 20% owned by the second-largest retailer, Petco, figures it has a big cost advantage over Net upstarts. "We have the opportunity to carve out a piece of each of Petco's distribution centers," says Andrea Reisman, CEO of "That means we can have a new distribution center up in a couple of weeks as opposed to a couple of months, and we can do it at a cost of $1 million, vs. $7 million if we started from scratch." has said that its new distribution center will cost $7 million to $9 million.

Even more important than logistics may be marketing. Because the pet supply business has such thin margins, companies need to sell more than just dog food. Where the companies rake it in is on extras, such as neon yellow collars and dog beds. "In a store, you can put the 20-pound bags of dog food in the back, so people have to walk past the colored leashes," says Michael Shinall, managing director of Meridian Consulting Group Inc. "How do you merchandise those things online?" Pet sites are trying: Most regularly send e-mail to customers, pointing out whatever they have on sale.

While the pet sites are struggling to figure out how to make profits, their popularity continues to grow with time-crunched customers like Denise Proctor. The Clarksville (Tenn.) mother of six orders her three birds' favorite brand of seed, Nutri-Berries, from instead of driving miles to one of the few local stores that carry it. "It's much more convenient to go online than to drag everybody to the pet store," says Proctor. Although pet shops online are headed for brutal competition over the next few years, customers like Proctor will make winners out of a few.

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