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Dow Jones Newswires -- May 22, 1998
TALES OF THE TAPE: Web Retailers Face Onslaught
Of Giants
By JOELLE TESSLER
Dow Jones Newswires
NEW YORK -- Investors have pinned some of their biggest expectations for the high-flying
Internet sector on Web-based retailers.
These are companies such as Internet bookseller Amazon.com Inc. (AMZN) and on-line music
stores CDNow Inc. (CDNW) and N2K Inc. (NTKI), which say they are positioned to capitalize
on the hottest new opportunity to come along in retail in years: electronic commerce. Over the
past five months, these stocks have soared to new highs, along with most other big Web names.
But, as more and more traditional big-name retailers, including Kmart Corp. (KM) and Wal-Mart
Stores Inc. (WMT), start selling their wares on the Web, some say the risks for Web-only
retailers are growing as quickly as the opportunities.
The biggest threat to the online-only retailers may well be the established brand names and
customer loyalties that the off-line giants bring to their Web operations, said David Simons,
managing director of Digital Video Investments.
"They have brand names consumers are familiar with and comfortable with," agreed Volpe
Brown Whelan analyst Derek Brown.
Simons believes Egghead.com Inc. (EGGS), a retailer of software and computer products that
recently closed all of its off-line stores and moved its operations entirely to the Web, offers a
good test case for how well an electronic merchant will fare without a presence in the off-line
world.
The big mainline retailers all have large ad budgets to spend on the traditional media of
newspapers, magazines and television, Simons pointed out. And, it doesn't cost much to add a
Web address to a TV commercial or a print ad.
To compete, Web retailers like Amazon.com and the on-line auction service Onsale Inc. (ONSL)
must therefore spend huge amounts of money - on both traditional advertising and on
promotions on other Web sites - to build up their brands.
Underlining how expensive this can be, Simons stressed that marketing spending is an ongoing
cost."It's not once you have it, you have it," he said. "It requires constant replenishment and
nurturing. ... Brand is not immutable."
It is unlikely that the advertising budgets of small on-line players such as Onsale, which has
annual revenue of $88.9 million, can keep pace with established off-line giant such as Kmart,
with its $32.18 billion in annual revenue.
As a result, the on-line retailers are posting losses and have been forced to finance their
marketing efforts with the proceeds from initial public offerings and secondaries, Simons said.
"People are looking only at the upside of the Web," said David Rocker, general partner of money
manager Rocker Partners who has held short positions in some Internet stocks. While on-line
retailers like to point out that they don't have to deal with store leases, large work forces and
other so-called bricks-and-mortar costs, "the expenses aren't going away," he said.
As more and more traditional retailers set up shop on the Web, competition will intensify on-line,
of course. But, Rocker believes the nature of the Internet makes this a particular concern for
electronic merchants since the Web makes comparison shopping easy. After all, a lower price
may be just a mouse click - rather than a car ride - away.
Rocker noted, in fact, that there is technology available on the Web, such as "shopping agents,"
that can do comparison shopping and find the best prices for consumers. This will pressure
margins for on-line merchants of commodity products such as books, Rocker believes. "The
ease of use that makes the Web so enticing to users makes it risky for retailers, he said.
Still, Web-based merchants have advantages over traditional retailers, others maintained.
For one thing, they have the early lead on-line. This is largely because the big off-line retailers
have been slow to pay attention to the Internet, giving on-line merchants a chance to build
credible Web brands and lock up valuable ad space on well-trafficked sites such as America
Online Inc. (AOL) and Yahoo! Inc. (YHOO), said Brown of Volpe Brown Whelan
"They filled the void," explained William Blair analyst Abhishek Gami. "This is a unique time in
history when you can develop a brand that no one has ever seen before and build a real
company."
According to Steve Harmon, vice president of business development and senior investment
analyst at Mecklermedia Corp. (MECK), these companies' early experiences on-line, and the
expertise they gained, help them "figure it out."
Harmon added that the Web-only players have a much greater incentive to succeed on-line since
their very survival depends on it. "Those that live or die by the Net are much more motivated,"
Harmon said.
Meanwhile, Gami said, many traditional retailers that have paid scant attention to the Internet
until recently are now "playing catch up." Harmon estimates it costs at least $100 million for a
major retailer to set up shop on-line and lure buyers. The cost to advertise on other Web sites is
"far more expensive than it was two years ago," noted Kenneth Orton, president and chief
executive of on-line travel service Preview Travel Inc. (PTVL).
Many mainline retailers also are finding that the business practices they use off-line don't
guarantee success in cyberspace. For instance, off-line retailers must locate warehouses close to
their stores and buy goods to suit local tastes, while Web merchants "need to build a distribution
network based on where the customers are coming from and they can come from anywhere at
anytime," Orton said.
Moreover, added CIBC Oppenheimer analyst Henry Blodget, "off-line brand strength ... does
not necessarily translate to brand power on-line."
Many real-world retailers face concerns that their on-line operations could cannibalize their
real-world sales.
Orton believes the success of many traditional merchants in the on-line world will depend in
large part on whether they approach the Internet defensively or offensively. Companies that think
they are being attacked - such as Barnes & Noble, which stepped up its on-line plans after it
came to see Amazon.com as a real threat - tend to shoot from the hip, while merchants that lay
out careful strategies to offer convenience, value and an easy-to-use site will appeal to
consumers, Orton said.
"It seems that Kmart is betting on its brand name attracting an audience on-line," said Evan
Schwartz, author of "WEBONOMICS," a book about growing businesses on the Net. "But the
Web demographic is not the Kmart demographic, at least not currently. As a group, general
retailers have not done well online. ... It's mainly because they are applying their retail business
model to the Web economy, which doesn't work. The Web calls for new business models."
Ultimately, Harmon believes, as more and more traditional retailers figure out how to succeed in
cyberspace, the window of opportunity for small upstarts may start to close. He speculated, for
instance, that Amazon.com probably would not exist today if Barnes & Noble had gone on-line
in 1993. Amazon.com was founded in 1995.
But in the meantime, Harmon said, the on-line retailers "have a two-year window before the big
guys finally figure out this space."
-Joelle Tessler; 201-938-5285
Briefing Book for: AMZN | AOL | BKS | CDNW | EGGS | KM | NTKI | ONSL | PTVL | WMT | YHOO
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