He's Not Playing

Can eToys' Toby Lenk turn around his embattled e-tailer before Christmas?

Hanging out in the playpen that is his office, you'd never guess that eToys Inc. CEO Edward "Toby" Lenk is in the fight of his life. The embattled online toy retailer shows off his Lost in Space robot and Scuba G.I. Joe, as he winds up a plush Tigger doll and sends it bouncing across his cluttered desk. "I love Bounce Around Tigger," he exclaims. A second later he's rifling through a pile of toys, looking for his prized possession. "No office is complete," he deadpans, "without a Darth Vader action figure."

This is vintage Lenk: terminally cheerful, enthusiastic almost to the point of hyperactivity, and always in the mood to play, whether he's slamming golf balls down the long hallways of eToys' office, or holding his own in a Super Soaker water-gun battle with his niece and nephew.

But overcoming the troubles dogging his once high-flying Internet company is no game for the 38-year-old Lenk. While sales for the online toy retailer rose fivefold--to $151 million--in the year ended Mar. 31, eToys lost $189.6 million. With a huge shakeout in the e-tailing industry under way, eToys' stock price has plummeted from an October high of $86 to a paltry $5. And raising money is downright painful. In June, Lenk had to scramble to nab $100 million by selling convertible preferred stock to private investors--enough to keep the e-tailer afloat for another year.

That gives Lenk a little breathing room--emphasis on a little. He has about five months to turn his company around. That's when the next crucial Christmas selling season will be upon him, and he must demonstrate that eToys can keep revenues rocketing upward, while sales and marketing costs as a percentage of sales head downward. Analysts think he might just make it, assuming he executes on plan. They see business doubling this fiscal year. And Merrill Lynch & Co. expects sales and marketing costs will decline from 79.7% of sales in fiscal year 1999 to 43.9% this fiscal year. That would pave the way for eToys to break even in 2002 and make it easier to raise more money in the interim.

Out of cash? The outcome will determine whether eToys can avoid becoming another broken dream on the dot-com rubbish pile. Lenk must regain the confidence of both consumers who felt let down by eToys in the last holiday season and investors who are wondering if the company can pull off a turnaround before it runs out of money. Even Lenk's biggest supporters say the writing is on the wall--in bright red crayon. "How they execute this season is going to dictate their future," says James O'Brien, managing member of Promethean Asset Management, which led eToys' recent financing round.

It has been many months since eToys' future looked bright. The Santa Monica (Calif.) company's problems started with the rocky 1999 holiday season, when some customers didn't get their gifts until Dec. 26. Then, as losses mounted and investors fled, Lenk had to go out on a limb and predict profitability by 2003. Investors still didn't come back, and Lenk had to set out on the institutional-investment circuit. He's still confident about his prospects. "The growth in the number of consumers who want to shop on the Web will be an immovable force, and there will always be opportunities for companies that do a good job serving them," Lenk says.

At the heart of his survival strategy: a new in-house distribution system, anchored by two new warehouses, one on each coast. Lenk insists that will prevent a rerun of last year's fiasco, when eToys tried to back up its California warehouse by outsourcing some fulfillment to Fingerhut. Sales were up 366% over the previous holiday season, and 99% of the 1 million packages arrived before Christmas. That wasn't good enough, though, for the kids whose presents weren't under the tree Christmas morning. "Our experiment with outsourcing was a failure," Lenk admits. "It was a hard lesson to learn."

Lenk has taken a lot of lessons to heart since he launched eToys in June, 1997. After five years working on theme park projects for Walt Disney Co., Lenk joined Bill Gross's incubator idealab! in early 1997 and was appointed to head up its new online toy store. EToys got to the online-toy business first, but Lenk planned from the start on building something bigger. "What I wanted to look at was kids, not toys," he says. His plan: Start small, build eToys into a brand, and then expand into other kid-related categories. "From Disney, I knew that once you have a relationship with a family, you have them for 10 years."

Lenk works hard to build those relationships. He takes cues from his own experience shopping for his niece and nephew as well as from customer e-mails and focus groups. Based on that input, he has even made decisions that ran counter to his instincts. After customers complained that the eToys boxes were tipping off their children and spoiling surprises, Lenk took the company's name off the boxes. He still cringes when he thinks about it. "That UPS guy carrying a box with your name on it is a major branding opportunity," he says, punctuating his words with such huge gestures he almost knocks over his coffee cup. "We're the only big Web company with anonymous boxes."

For a time, the bond-building strategy worked. Last summer, with eToys consistently beating Toysrus.com and the handful of smaller players, Lenk moved to expand the company's focus. Hoping to grab parents while their children are still in the womb, he acquired BabyCenter Inc., which sells infant supplies. EToys also started selling children's books and later this year will open a hobby shop and party-supply channel. "The reality is, the toy business grows only 3% to 4% a year, so you can't succeed just by showing up," says analyst Sean McGowan of Gerard Klauer Mattison & Co. "To leverage their existing structure across other categories that aren't subject to the whimsy of seasonality is a good idea."

And unlike other e-tailers, Lenk has no plans to engage in a cost-cutting jihad. Nor will he get into the discounting game. "It's not a sustainable model," he says. He insists that a rapid rise in sales--which would reduce costs-per-units-sold--will solve the expense problem.

Yellow band? Early this year, Lenk resisted pressures to predict when the company would make a profit. In May, with eToys' stock in shambles, he changed his tune. He called analysts to a conference in New York--the company's first analyst meeting--and vowed to make the company profitable in less than three years.

Lenk also has been forced to change his role in the company. The more eToys grows, the further he moves away from day-to-day management--not easy for someone who's legendary for his attention to detail. EToys' first employee, Frank Han, remembers one Friday in the company's early days when Lenk locked horns with a site developer over the design of the bar on the top of the home page. "They spent two hours arguing about whether it should be yellow," says Han, senior vice-president for product development. Now, with the employee count at about 1,000, Lenk is disappointed that he doesn't know everybody's name anymore, but he finds ways to keep in touch. After returning from the analysts' conference, he repeated the entire presentation for all of his employees.

All this growth, however, hasn't changed Lenk outside the office. He's wealthy--with stock worth $49 million--but he rents a small house and drives a leased Toyota Land Cruiser. "He only buys practical things, nothing glitzy," says sister Mindy Whitman. While visiting from Atlanta this spring, Whitman was shocked to hear Lenk hadn't bought a pair of shoes in four years.

Lenk's friends call him a big kid, and it's a characterization the 6'3" entrepreneur doesn't dispute. Born and raised in the Boston suburbs, the younger of two, Lenk took playtime seriously. An animal lover, he rode horses and showed ponies as a kid, then gave the hobby up in high school to play on the basketball team. Staying active, says his sister, helped him get through his parents' divorce when he was 9. "He just focused on something else," she says.

Leadership came naturally--and early. At age 19, Lenk was the caddy master at a golf course in Hyannisport, Mass. He whipped the 70 caddies into shape, setting up a formal work schedule and an incentive-pay program. "It was the first time I ever tried to do anything managerial, though the kids would say it was just like the movie Caddyshack," he says.

Lenk is single. Being a more-than-full-time CEO doesn't allow much time for cementing a romantic attachment. He's happy showering his paternal instincts on his sister's kids, Anna and Georden. "He's a great uncle," Whitman says. "He's always horsing around with them. He wants any excuse to play." For companionship at home, he has his two Labrador retrievers, Amos and Tucker. "They keep me calm," he says.

That calming influence will come in handy later this year, when Lenk will face the most stressful test of his career: delivering on all his promises. If he can, he'll have succeeded where many e-tailers haven't. If he fails, he'll have lots of free time to play with Bounce Around Tigger.

For a Q&A with Toby Lenk, go to ebiz.businessweek.com

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