The eBay Economy

The company is not just a wildly successful startup. It has invented a whole new business world

Maybe the folks at eBay Inc.'s annual analyst conference in late 2001 were simply too dazzled by the Web marketplace's blockbuster financial results. Or maybe they had heard one too many dot-com platitudes to heed yet another one. Whatever the reason, when Chief Executive Margaret C. Whitman had the audacity to describe eBay as a "dynamic self-regulating economy," no one in the room even blinked. This overgrown flea market -- an economy?

From its humble origins as a trading post for Beanie Babies, eBay is indeed morphing into something entirely new -- and a lot bigger than most people realize. This year, at least 30 million people will buy and sell well over $20 billion in merchandise -- more than the gross domestic product of all but 70 of the world's countries. More than 150,000 entrepreneurs will earn a full-time living selling everything from diet pills and Kate Spade handbags to $30,000 BMWs and hulking industrial lathes. More automobiles, of all things, sell on eBay than even No. 1 U.S. dealer AutoNation (AN ). So what does this add up to? "This is a whole new way of doing business," says Whitman. "We're creating something that didn't exist before."

Not inside one company, anyway. More than a corporation, eBay is a nexus of economic activity, a new and vibrant hub for global commerce. As much as anything, this commercial force is just what Whitman said: It's the eBay economy.

Dig into the history of the world's great trading centers, and the parallels to eBay's global marketplace jump out. Consider Manhattan, suggests Morgan Stanley & Co. analyst and amateur historian Mary Meeker: The Dutch East India Co. began with a trading community of ragtag merchants. Shut out of the prime markets of the day -- slaves and spices -- they dealt in less lucrative goods, such as beaver pelts. Over time, the traders flourished, and a larger community began to settle around them. As the community prospered, it needed order. The Dutch turned to a hard-nosed, peg-legged leader named Peter Stuyvesant, who, as governor of New Amsterdam, arranged the construction of streets and other services, such as a police force. Later, Alexander Hamilton greased the burgeoning economy's wheels of commerce by setting up the Bank of New York.

Meg Whitman
Now look at eBay (EBAY ). It began as trading site for nerds, the newly jobless, and bored homebound parents to sell subprime goods: collectibles and attic trash. But it quickly grew into a teeming metropolis of 30 million, with its own laws and norms, such as a feedback system in which buyers and sellers rate each other on each transaction. When that wasn't quite enough, eBay formed its own police force to patrol the listings for fraud and kick out offenders.

There's an educational system that offers classes around the country on how to sell on eBay. The company even has something akin to a bank: Its PayPal payment-processing unit allows buyers to make electronic payments to eBay sellers who can't afford a merchant credit-card account. "EBay is creating a second, virtual economy," says W. Brian Arthur, an economist at think tank Santa Fe Institute. "It's opening up a whole new medium of exchange."

It's also introducing a whole new mode of management in this Internet era. If Stuyvesant had a tough job bringing the scruffy denizens of his freewheeling city to heel in the backwater frontier of the New World, Whitman and her team face even more challenges leading their economy in the full glare of the wide-open Internet. Through the Web, eBay's citizens have access, 24 hours a day, to every trend, every sale, every new regulation in the eBay world. The system is utterly transparent.

Now, thanks to the Web, this transparency is spreading, at varying speeds, throughout the entire economy. Executives everywhere are seeing a flood of information jumble long-standing relationships with partners, customers, and investors. Think of auto dealers, whose customers can learn with a few mouse clicks precisely how much the dealer paid for a car. Or electronics companies whose products can be subjected to scathing reviews on the very sites where they're sold.

As information spreads, power moves to outsiders and makes life miserable for managers who fail to adapt. But this new people power offers rich rewards for companies that figure out how to channel it. The key is to embrace this new transparency and use it to turn customers and vendors into collaborators and colleagues. "The Internet creates an economic imperative for transparency," says consultant David Ticoll, co-author with Don Tapscott of the upcoming book, The Naked Corporation: How the Age of Transparency Will Revolutionize Business.

That's why eBay's success holds potent management lessons for many businesses. In place of Stuyvesant's tyrannical approach, seemingly a model for conventional business management, Meg Whitman must take a more laissez-faire approach. It is based on cooperation and finesse, not coercion and force. To make sure eBay doesn't do something that incurs the wrath of its citizens and incites a revolt, eBay's executives work more like civil servants than corporate managers. They poll the populace through online town hall meetings and provide services to keep them happy -- and business humming.

As challenging as it is, the collaborative approach offers awesome benefits. Unlike most traditional companies, eBay presides over an expanding ecosystem -- one whose limits are still unknown. Its magic is that as buyers and sellers flock to the site, they not only feed on it, but nourish it. By rating each other on transactions, for instance, both buyers and sellers build up reputations they then strive to maintain, setting a standard of behavior that reinforces eBay's appeal. It's a powerful dynamic that only a handful of other companies can claim. One example is Microsoft Corp. It builds a software universe that grows bigger and richer as thousands of companies and programmers add their own applications. This in turn attracts more users, fueling an ever-expanding ecosystem. The upshot, says Harvard Business School professor David B. Yoffie: "You get the incredible leverage of other people doing all your work for you."

EBay's powerful vortex is pulling ever larger players into its economy. The company's sellers are stretching far beyond eBay's specialty of used and remaindered goods -- they're pushing into the heart of traditional retailing, a $2 trillion market. Among eBay's 12 million daily listings are new Crest toothbrushes and the latest DVD players, and giants such as Sears Roebuck & Co. and Walt Disney (DIS ) Co. are selling brand-new items there as well. More than a quarter of offerings are listed at fixed prices familiar to mass-market consumers. The result, says Bernard H. Tenenbaum, president of the Princeton (N.J.) retail buyout firm Children's Leisure Products Group: "They're coming right for the mainstream of the retail business."

EBay's deft management is apparent in its financials. Last year, profits rocketed 176%, to $250 million. Net sales, from transaction fees on $15 billion in gross revenues, hit $1.2 billion. In the second quarter, revenues shot up 91% from a year ago, to $509 million. It now looks as if Whitman's forecast two years ago that eBay would grow to $3 billion in net revenues by 2005 -- derided at the time as a stretch -- will be met easily, barring an unexpected slowdown. That kind of growth has pushed eBay's stock into the stratosphere, with shares rising 47% from the start of the year, to $102.

As the eBay economy expands, managing it could get a lot tougher. The move into the mainstream, in particular, poses thorny challenges. It not only means balancing the needs of big corporate vendors with those of small fry -- no easy task -- but also remodeling eBay to attract millions of newcomers. For the many who haven't yet tried eBay, the process of listing items on the site, packing them up, and mailing them can be cumbersome and confusing. And, for many, the brand still emits the stale odor of thrift stores -- or worse. Reports of fraud on auction sites -- mostly on eBay, which still accounts for 80% of the market -- are rising sharply even as eBay keeps hiring more virtual cops.

The question is whether the company's traditional laissez-faire governance can sustain its growing economy. It now appears that making shopping on eBay as safe and easy as a trip to Wal-Mart may well require a more forceful approach -- simplifying payments, reducing the hassles of shipping goods, and cracking down on the rising number of crooks who are prowling the site. But pushing through reforms is tough because eBay's millions of passionate and clamorous users demand a voice in all major decisions. Concedes eBay director Robert C. Kagle, a general partner at venture firm Benchmark Capital: "These users can organize themselves if we do something they really don't like."

EBay managers are reminded of this day after day. Whitman says it often takes six months for new managers to adjust to the democratic regime. "Some of the terms you learn in business school -- drive, force, commit -- don't apply," says former PepsiCo (PEP ) Inc. exec William C. Cobb, now senior vice-president in charge of eBay's international operations. "We're over here listening, adapting, enabling."

This process is clear in one of eBay's most cherished institutions: the Voice of the Customer program. Every couple of months, eBay brings in as many as a dozen sellers and buyers to ask them questions about how they work and what else eBay needs to do. And at least twice a week, it holds hour-long teleconferences to poll users on almost every new feature or policy, no matter how small.

The result is that users feel like owners, and they take the initiative to expand the eBay Economy -- often beyond the execs' wildest dreams. Stung by an aerospace downturn, for instance, machine-tool shop Reliable Tools Inc. tried listing a few items on eBay in late 1998. Some were huge, hulking chunks of metal, such as a $7,000, 2,300-pound milling machine. Yet they sold like ice cream in August. Since then, says Reliable's auction manager, Richard Smith, the company's eBay business has "turned into a monster." Now, the Irwindale (Calif.) shop's $1 million in monthly eBay sales constitutes 75% of its overall business. Pioneers such as Reliable prompted eBay to set up an industrial products marketplace in January that's on track to top $500 million in gross sales this year.

Yet as far as eBay's entrepreneurs have taken its economy, they can't do everything. Just as people and businesses in a national or regional economy often need the rules and assistance only a government can provide, eBay often has to step in. So the company is increasingly supplementing the invisible hand of its economy.

Nowhere has this approach been more apparent than in eBay Motors. When eBay manager Simon Rothman first recognized a fledgling market for cars on eBay in early 1999, he quickly realized that such high-ticket, high-touch items would require a different strategy than simply opening a new category. To jump-start its supply of cars and customers, eBay immediately bought a collector-car auction company, Kruse International, for $150 million in stock, and later did a deal to include listings from online classifieds site LLC. Rothman also arranged insurance and warranty plans, an escrow service, and shipping and inspection services.

This public-works project did wonders. Sales of cars and car parts, at a $5 billion-plus annual clip, are eBay's single largest market. That has catapulted eBay in front of No. 1 U.S. auto dealer AutoNation in number of used cars sold. About half of the sellers are brick-and-mortar dealers who now have a much larger audience than their local area. "EBay is by far one of my better sources for buyers," says Bradley Bonifacius, Internet sales director at Dean Stallings Ford in Oak Ridge, Tenn.

EBay is also beefing up its services -- most of all, its police force. While the company claims that fraud happens in less than 0.01% of all transactions, its own surveys reveal that fear of fraud is a major turnoff for prospective customers. So early last year, eBay formed a Trust & Safety Dept., now staffed by several hundred eBay employees worldwide. They do everything from trolling the site for suspicious listings to working with law enforcement agencies to catch crooks. EBay also has developed software that recognizes patterns of behavior common to previous fraud cases, such as sellers from Romania who recently started selling large numbers of big-ticket items. Says Trust & Safety Vice-President Robert Chesnut: "As time goes on, we're exercising more control."

How much? Figuring that out is eBay's overriding challenge in years to come. As it tries to accommodate mainstream merchants, for instance, eBay is facing the same challenge city councils face when Wal-Mart comes to town. "EBay's walking a fine line trying to satisfy both merchandising powers and mom-and-pops," says Pacific Growth Equities Inc. analyst Derek L. Brown.

For now, the big brands, which still account for under 5% of eBay's gross sales, seem to be bringing in more customers than they steal. Motorola Inc., for example, helped kick off a new wholesale business for eBay last year, selling excess and returned cell phones in large lots. "We bring a community of buyers to eBay," says Chip Yager, a director of channel development at Motorola PCS. Thanks to the initiative of established companies such as Motorola, eBay's wholesale business jumped ninefold, to $23 million, in the first quarter.

As businesses on eBay grow larger, they spur the creation of even more businesses. A new army of merchants, for instance, is making a business out of selling for other people. From almost none a couple of years ago, these so-called Trading Assistants now number nearly 23,000. One of them, a startup called AuctionDrop Inc., plans to open a nationwide chain of storefronts where people can drag in stuff for AuctionDrop to sell on eBay -- no clicks, no hassles.

That organic growth makes it exceedingly tough to predict how far the eBay economy can go. Ask an analyst, a seller, a partner, and they all have different forecasts for eBay's future: the world's biggest mall, the Windows of e-commerce, even the next Wal-Mart. Whitman professes not to know. "We don't actually control this," she admits. "We are not building this company by ourselves. We have a unique partner -- millions of people." For the foreseeable future, eBay's fate will be up to them.

Corrections and Clarifications In "The eBay economy" ("The future of technology," Cover Story, Aug. 18-25), a reference to eBay Inc. selling more automobiles than AutoNation is incorrect. As noted later in the story, eBay sold more used cars than AutoNation.

By Robert D. Hof

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