Shakeout E Tailers

In this brave new world, only the profitable survive

Even among battered dot-com companies, has seen its stock take a mighty beating. From a high of 67 1/2, the online pharmacy's stock has plummeted to as low as 6 3/8. Another dead-duck dot-com? Don't count on it. In January and March, Inc. raised $138 million from giant e-tailer Inc. and public investors, bringing its total cash to $175 million-enough to fund operations through the middle of next year. Then, in April, the company won a prime spot on Amazon's front page--right in front of 20 million Amazon customers--and posted better-than-expected quarterly results and gross margins.

Make no mistake: still has a lot to prove. The company, founded on the classic Net model of spending millions of dollars on TV ads to "get big fast," must adapt itself to harsh new rules. That's why CEO Peter M. Neupert is changing gears--fast. In place of TV ads, he's targeting customers more cheaply through e-mail. To allow Drugstore to buy in bulk to get lower pricing from suppliers, he has built a new $30 million distribution center. He has even raised prices on some products and started charging more for shipping. Says a defiant Neupert: "We're going to be among the survivors."

Wakeup. Sound a lot like Business 101? Welcome to the new era of e-tailing. Its motto: Get down to business. Up till now, it seemed the laws of commerce had been suspended on the Web. The motto was "Growth at any cost." But spend, spend, spend at e-tailers soon met sell, sell, sell among investors. Many e-tailers' shares are worth less than 10% of their highs. And why not? Too often, they can't demonstrate how they stand out from a half-dozen rivals. "It's a wakeup call," says Amazon CEO Jeffrey P. Bezos. "The markets are getting more discerning."

Does that mean that e-tailing is dead and consumers don't want to buy online after all? Not on your life. Consolidation happened in every emerging industry, from autos to retailing, and e-tailing will be no exception--just a lot faster. Consumer e-commerce sales doubled last year to $20 billion and are pegged to hit $143.8 billion by 2003, says Forrester Research Inc. Perhaps more surprising, there are signs that e-tailing is ultimately profitable after all. A recent Boston Consulting Group study of 221 online retailers, including traditional retailers and cataloguers selling online, found that almost 40% are making money. "By no means is this the demise of online retailing," says Forrester analyst David Cooperstein.

Of course, things have changed--oh, how they've changed. The new mantra is "Show me the profits." E-tailers who can't do that may find that when the money runs out, investors won't pony up again. That's why the business people are grabbing the reins--from revamping the cool sites their techies set up to building distribution centers to ensure better service.

The basics start with the site itself. Some sites still take too long to load because of fancy graphics, and key information about shipping is buried. Tools to personalize the site to each visitor, intended to make people come back and spend more, have often gone wrong, too. Beauty products merchant, owned by Procter & Gamble, inflicts 23 pages of questions on first-time visitors before letting them get to the products. "The complicated experience makes it so hard that many customers will never enjoy Reflect's benefit--customized products," says Mark Hurst, founder of design consultant Creative Good Inc.

Just as important, e-tailers need to get more creative with marketing. Pull back the crazy marketing budgets--not just on TV ads, but on pricey but dicey deals for exposure on Web portals like Yahoo., for instance, distributes copies of its own magazine, which also serves as a catalog. The garden products site converts 60% of the people who phone in catalog orders into online members. That translates into purchases: In the most recent quarter, the number of buying customers rose 27%, to 1.1 million, while gross margins increased to 30.3%.

What about the interactivity the Web's supposed to be so good for? Too many sites have forgotten the value of good old e-mail, selectively targeted to likely buyers. The cost of gaining each customer is around $6 for e-mail, a third the cost of direct mail, market researcher Jupiter Communications estimates. For instance, Inc., owned by Getty Images Inc., swaps e-mail lists with sites such as, then sends out targeted messages to people who have bought at, suggesting art that would go along with, say, a new bedroom set. The company says it gets back $2 for every $1 it spends.

The abundance of capital that made spending too easy also allowed e-tailers to fall into sloppy pricing practices: rampant discounts and free shipping to get people to buy something--anything! But the freebie frenzy is fading. Inc., for instance, has abandoned its strategy of selling things below cost and making up the margin on advertising. Now it has raised its prices, leaving only a few at below cost. The result: In the latest quarter gross margins turned positive for the first time, to 4.3%, compared with negative 0.8% in the fourth quarter.

Just as important is serving customers well once they're on the site. In a recent study, Jupiter found that only 41% of online buyers were happy with dot-com customer service. Improving that can pay huge dividends: Home furnishings site Goodhome attributes 60% of its sales to calls online shoppers make to its customer service lines. The average order done with help over the phone is also higher: $650, vs. $250 online. "When you're talking about a big-ticket item, it's critical there is someone to answer questions," says Goodhome CEO Douglas Mack.

When it comes to the final step of getting products out the door, e-tailers have to face the fact that the Web today just isn't the seamless connection among myriad suppliers they had hoped for. So they have to get their hands dirty to ensure the products get to customers on time. Either they have to build their own distribution centers or find ways to ensure on-time deliveries. One reason Amazon has kept its lead is that it spent hundreds of millions of dollars on warehouses, ensuring fast, reliable deliveries--something that has earned the loyalty of customers. Repeat customers now constitute 76% of Amazon's orders.

Many of those skills, from savvier marketing to ace customer service and fulfillment, might seem to favor traditional retailers. Locked out by dot-coms' nosebleed spending, many traditional retailers sat on the sidelines. Now they can get in the game with a vengeance. They have the supplier partnerships, the customer relationships, and the brand name to blow away pure-click outfits that haven't mastered the basics. And in some cases they have joined with Silicon Valley venture capitalists for Web expertise--and to tap into dot-com capital sources. Softbank Corp. is working with Kmart and Toys `R' Us, Benchmark Capital is partnered with Nordstrom, and Accel Partners is teamed up with Wal-Mart Stores Inc.

Bricks-and-mortar companies also are banking on their brands to attract new folks just now coming onto the Internet. Wal-Mart and Kmart are priming the pump, either already offering or planning to offer low-cost or free Internet service as a hook. "It's an incredible opportunity for those Wal-Mart customers who haven't yet experienced online shopping to do so with a brand they trust," says Jeanne Jackson, new CEO of (Page EB74)

Still, it's way too early to count out the dot-coms. Companies such as Amazon--and its growing cadre of partners, from to furniture site to rapidly developing the skills necessary for success, often through hiring experienced execs. The Net companies can still move faster than their fatter bricks-and-mortar rivals, and they're more focused. Amazon's distribution centers, for instance, are expressly built to ship small packages to individuals--something traditional retailers' distribution systems can't do efficiently.

And those building real assets could have a leg up on both bricks-and-mortar and virtual rivals. Web grocers Webvan Group Inc. and Inc. are making mindbending bets on home delivery. If they can demonstrate that their networks of trucks and vans appeal to consumers, the sky's the limit on how much they can sell--assuming backers are willing to keep the money tap open. Says one Webvan backer, Benchmark Capital General Partner William Gurley: "A company like Webvan is a very different value proposition than just having a catalog on the Web."

Yet, while the company's revenue, gross margins, and customer base are growing faster than analysts' estimates, the company has to raise more money to fund the expansion plans so crucial to its success. HomeGrocer is expected to break even in 12 to 15 months, while Webvan's first big center should do so this September, estimates analyst Anthony Noto of Sachs.

Also expected to thrive are companies with business models unlike anything in the physical world, such as Inc.'s "name-your-own-price" approach. Buyers, who now number 5.3 million, have rocketed the company into one of the few dot-coms, along with Amazon and auctioneer eBay Inc., expected to survive long-term. Priceline on Apr. 23 bolstered expectations that it will turn profitable next year by reporting better-than-expected first-quarter results.

It's also becoming clear that there's room for at least some category killers--specialty e-tailers--just as there is in the physical world. Sports equipment e-tailer Fogdog Sports is hardly home free, with just $60 million in cash after meeting expectations in its first quarter. But with a 10% stake from Nike Inc. and rights to all Nike product lines, it has managed to establish a relatively well-known brand name--and more important, leadership in site traffic--in a field with no national counterpart in the physical world.

But woe to those dot-coms that haven't already established themselves as No. 1 or No. 2 in their markets--or choose markets just a little too small. Consider iCelebrate, for instance: Late last year, the online holiday decorations service hit up 75 venture capitalists for cash but came up dry. Finally, with a $7 million angel investment from Dallas businesspeople, the company did an impressive series of shimmering TV ads. No dice. Now, all that remains on the site is a statement in stark black type: "We are no longer accepting orders."

Right now, it's uncertain what's going to characterize the impending consolidation--dot-coms eating each other, a trend that's already begun, or bricks-and-mortar giants swooping in to scoop up deals, which hasn't happened much yet. Either way, the new rules of e-commerce will be good for e-tailers. So much for Business 101. Now it's onto Business 201. online

For more from venture capitalists, a closeup of e-tailer Blue Nile, and a talk with Cook Express' founder, go to

Before it's here, it's on the Bloomberg Terminal.