E-tailers' mad scramble may well end in tears

THE SUNDAY TIMES (LONDON)

December 19, 1999

Scrambling. That's the word that best describes what is going on in this red hot American economy.

Employers are scrambling for staff, hiring part-timers over the telephone, without troubling applicants to show up for an interview.

Consumers are scrambling in the face of shortages of some of the most popular gift items - and of the fact that it is no easy chore to find something for the friend or relative who, after years of prosperity, already has everything.

Retailers, when not scrambling for workers or to meet the demands of customers who are pouring into their shops in record numbers, are scrambling to adapt to the newest trend - e-tailing. And e-tailers, the darlings of punters large and small, are scrambling to keep their web sites from collapsing under the pressure of growing demand. And to turn a profit.

It is this latter scramble that may turn out to be the real story of the Christmas shopping season. There is no question that the volume of business being done by e-tailers is soaring. But are they making any money?

Most are not. Indeed, for many e-tailers the name of the game is to build customer lists that are expected to generate profits some day - maybe. Old-line trade unions, when asked to forgo pay rises, now, in favor of more money at some future date, were wont to reject the offer of what they called "pie in the sky in the sweet bye-and-bye". Investors are either more gullible or more patient. We will soon know which.

Which is why Amazon.com is valued at more than $30 billion, even though its losses are running at an annual rate of almost $1 billion. The more business Amazon.com does, the more money it loses. It seems to be satisfying its more than 11 million customers by selling them ú10 notes for ú5.

The company's theory is that it will eventually sell just about everything to just about everyone, and that economies of scale will eventually produce rising profit margins and fabulous profit levels. So losses on its book and music sales are really investments in building customer lists.

That Jeff Bezos, the founding genius of Amazon.com has designed probably the world's most user-friendly web site there can be no doubt. Nor is there any question of his ability to charm and persuade securities analysts and the investors who witness his frequent appearances on the 24-hour financial news channels that are for investors what soap operas are for those housewives not yet addicted to on-line trading. But a few critics are starting to wonder whether his business plan is sound.

Start with the notion that there are huge economies of scale in e-tailing. Bezos is fond of saying that a 1,000-store bookseller has to add 1,000 stores in order to double volume. That means spending money on B&M - the bricks and mortar on which e-tailers need not waste their money. E-tailers, on the other hand, having spent what is necessary to design their web sites and get them up and running, need only sit back and watch sales volumes rise, with no additional outlays required.

Well, not quite. It seems that in order to fulfill orders e-tailers need more and more warehouses, either of their own or on hire from companies that specialize in warehousing and order fulfillment. The latter function will become increasingly expensive, as more and more e-tailers promise one-hour delivery of items such as videos and same-day delivery of books and CDs, and firms such as Webvan scramble to cover the so-called "last mile" that separates the customer from the goods he ordered from his e-tailer.

Still, if the millions of customers who have bought books from Amazon.com can be persuaded to buy other things, Amazon.com can realize its stated ambition of becoming "the place where you can discover anything you want to buy online." The problem is that transforming one's self from a successful bookseller into an all-purpose shopping mall is no easy trick, as my family's experience with Amazon.com's diversification effort suggests.

My wife tried the e-tailer's drug site, only to find the selection of brands and sizes more limited, and the prices well above those in the local pharmacy and supermarket. And, lured by the promise of 2-3 day delivery, I ordered a computer printer. When some ten days passed, and I called to inquire about my order, a very nice man told me that it would come in about a week, and offered me a $10 credit by way of compensation for the delay. "No," he said, "the order cannot be cancelled as it is already in process."

The moral: e-tailers that seek to diversify may find that they antagonize their customer bases to the point of damaging their core businesses.

There is a more fundamental problem with the e-tail strategy. True, he who gets there first with a good web site and attractive merchandise at rock-bottom prices has a leg up on the competition. But the innovator doesn't have a formula for permanently barring new entrants. Bright young men and women are busily designing the better mousetraps that may lure customers away from the early-entry e-tailers that have spent billions building customer lists.

Then, of course, there are those old-fashioned B&M retailers who are not about to stand around and concede the field to e-tailers. Surveys show that shopping remains a social experience for many, and that shrewd retailers and mall operators can enhance that experience with everything from cappuccino to child-care centres. And, at the same time, add on-line selling as a supplement to their B&M. With delivery systems already in place, with proven methods of handling returns, these stores may prove to be the ones with the true economies of scale. If so, lots of investors may look back on Christmas 1999 as the year in which they discovered that even Santa Claus cannot turn red ink into ever-higher share prices.