E-tailing: What went right and wrong

"They kept almost nothing in inventory," says Robert Broadhead, coauthor of the recently published Selling Online: How to Become a Successful E-Commerce Merchant. "After taking orders on the Web, they would send trucks over to wholesalers, pick up only the books that customers had ordered, drive them back to Amazon, and ship them out."

This was the original promise of e-tailing. The term disintermediation could have been coined specifically for this new model: E-tailing was supposed to cut out the middleman and the back end, selling goods directly to consumers without the need for expensive warehouses and inventory that saddled traditional retail stores. Yet as Amazon and its many imitators soon realized, this notion was flawed. To keep up with orders, Amazon needed warehouses and inventory after all. By the end of last year, after building eight distribution centers across the country, covering 3.8 million square feet, Amazon had over $366 million in fixed assets and $174 million in inventory. This build-out is a key reason that Amazon, despite $2.7 billion in revenue last year, has yet to turn a profit.

Amazon, of course, is lucky to be alive. According to research firm Webmergers.com, 435 "substantial" dot-coms have shut down since January 2000, and nearly half of those were e-commerce companies. Supply simply outweighed demand. "In virtually every segment you look at, the market was completely oversaturated," says Broadhead. "If you've got six to ten players trying to be large-scale online sellers of pet food, then, unless the demand for pet food suddenly goes up 1,000 percent, few of them are going to be successful." And then there's the psychological bubble. Too many entrepreneurs believed that Jeff Bezos, Amazon's CEO, had unearthed the perfect business model.

"Amazon stirred up the notion that the Internet was going to be the most cost- effective way to do retail," says Gene Alvarez, program director for electronic business strategies at the META Group, a research firm based in Stamford, Connecticut. "Amidst all the fervor, no one understood the actual infrastructure it would take to support online sales."

Still, e-tailing is far from a one-shot, short-lived phenomenon. Research firm Giga Information says that U.S. business-to-consumer (B2C) Internet sales will exceed catalog sales in 2001, and it predicts that e-tailing will become a $220 billion market by 2004, up from $49 billion in 2000.

Its first project, finished in time for Christmas 1994, was the Godiva Chocolatier site, and the company now counts Crate & Barrel, Coach, Eddie Bauer, Nestlé, and 1-800-Flowers among its major customers.

Founder and CEO David Fry, a Harvard computer science Ph.D., attributes the firm's success to the fact that it avoids pure-play dot-coms. Instead, Fry Multimedia's clients are companies that already sell through retail stores, over the phone, or by mail. "We felt, even years ago, that the long-term viability of dot-coms was in question," he says. "Since the market took a downturn last year, sales on our sites are virtually unchanged, while many of our competitors have seen sales drop to as little as one-quarter of what they used to be."

The companies that Fry works with have an advantage, because their all-important back-end infrastructure—or at least part of it—is already in place. They typically have existing warehouses for storing products, existing customer service operations, and existing supply chains that provide access to cheaper inventory. And they often have operations set up for processing orders and shipping goods to customers quickly. Says META's Alvarez, "These organizations have thrived because they've interwoven their Web presence with the rest of their business."

On top of this infrastructure head start, the click-and-mortars have some secondary advantages as well. They benefit from existing brand-name recognition, and because they sell through a variety of channels, they're more likely to satisfy disparate customer needs. "Very often, consumers will start out preferring the phone or the store," says Will Headpohl, vice president of e-commerce at Gateway. "But then, after purchasing from us maybe three or four times, they'll start transacting deals on the Web." Conversely, consumers often like to browse on the Web before purchasing over the phone or in a retail store. Only click-and-mortars can capitalize on this trend.

Real-estate and automotive sellers—companies you might not associate with successful e-tailing—have greatly benefited from this phenomenon. According to research firm Greenfield Online, 76 percent of people who purchase new cars do research online before going to the dealership. Hardly anyone buys cars online. Says Fry, "They want to sit in them and drive them before purchasing." In some cases, a successful e-tailing site is merely one that facilitates purchases through other channels.

"If they were a traditional company, Wall Street would have dumped their stock by now," says META's Alvarez. Amazon has so far managed to stay afloat where investors haven't been so kind to other dot-com retailers, including big names such as eToys and Furniture.com, whose stocks plunged along with their revenue.

When eToys shut down this spring, it was carrying over $274 million in debt (including $72 million incurred during the fourth quarter of 2000 alone) after building two major distribution centers totaling close to 2 million square feet and spending hundreds of thousands of dollars on advertising its fledgling brand name. The company was simply too deep in the hole. In the fourth quarter, it took in $130 million in revenue, but far more was needed to keep the operation going. In the end, those laws of supply and demand won. When the company was founded, executives figured it would be successful if just 5 percent of the U.S. toy market moved from retail stores to its site. "Well, maybe 5 percent of the market moved online, but that 5 percent was split between dozens of companies," says Broadhead.

Furniture.com's chances were even slimmer. For starters, the company never created a viable infrastructure. Worse, its fulfillment operations, critical to customer relations and to revenue flow, were always in disarray. In some cases, the company shipped products to customers and never billed them. And Furniture.com had no procedure for tracking orders, frustrating many customers who wanted to know when they would get their shipments. Also, in trying to build a brand name, the company made several inexplicable decisions, such as offering free shipping. "They would get an order for a $200 end table and spend $300 to ship it," says Broadhead. "Their shipping costs were apparently 50 percent of sales, at one point."

Such problems aren't limited to dot-coms. A company that runs a chain of retail stores but has not run a catalog, for instance, won't be used to packing products and shipping through the mail—as that famous e-tailing failure Toys "R" Us knows all too well. "You'd think that when Toys "R" Us moved onto the Internet they'd be able to execute brilliantly," says Broadhead. "But running an online retail site is not the same as running a traditional business. A company like Toys "R" Us is not used to fulfilling orders, like direct-mail companies such as L.L. Bean and J. Crew."

Eventually, however, Toys "R" Us found a successful formula: It formed a partnership with Amazon. Amazon handles the fulfillment, while Toys "R" Us provides an up-to-date inventory by taking advantage of its privileged relationships with suppliers; it also contributes a familiar brand. This is a partnership that uses the best elements of each to create a successful blend of two worlds.