Imagine a world without

Last modified: September 1, 2000, 5:00 AM PDT
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picpicpicpic is arguably the biggest name in online shopping, the gold
standard against which all dot-coms are judged. Is it really possible,
then, that someday we will be forced to live in a virtual world without
this mammoth bookseller?
Certainly, it’s too soon to write a eulogy. But on the savage frontier of
Internet commerce, even the biggest and toughest–though they may have been
the first to stake the choicest claim–are not assured survival.

“I don’t know if the company is smart or stupid,” jokes Peter S. Fader, who
teaches marketing at Wharton. Fader says the Internet-retailing industry is
so young, so full of money-losing behemoths like Amazon, that there is no
way to tell which business models will succeed.

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The 6-year-old seller of books and CDs sits atop millions of computer
users’ Favorites lists. But many investors, Wall Streeters and academics
who have studied the company cannot ignore some frightening facts: The
company has lost well in excess of $1 billion, and its losses have grown
even though sales have skyrocketed. Most seriously, it is saddled with
enormous debts.

Amazon is struggling to attract more customers by offering an ever-wider
range of products, including toys and even cars. But the attempt to be more
than a book and record store, to offer everything to everyone, smacks of

“Now the company is broad but shallow,” Fader says. Costs could soar even
higher, and the new offerings could create a management nightmare. And,
most important, Amazon risks “diluting what the brand means,” Fader says.

For Amazon, it’s a reversal of fortune. The company went public in May 1997
at a share price, adjusted for subsequent splits, of $1.50. By any measure
the stock was an enormous success in the first two years, peaking at $113
on Dec. 9. But it has been sinking ever since, hitting a low of just under
$28 on July 31. Recently, it has traded around $39.

While falling share prices have afflicted many Internet companies this
year, Amazon clearly has real problems. Despite attracting 23 million
shoppers, it lost nearly $720 million in 1999, compared with losses of $125
million in 1998, $31 million in 1997 and $6 million in 1996. Losses soared
despite the enormous gains in sales–$1.64 billion in 1999 vs. $610 million
the year before, for instance.

Investors were particularly concerned when the company reported late in
July that sales growth had nearly come to a standstill. For the second
quarter of 2000, sales were only 1 percent higher than in the first

Rather than focus on that number, the company emphasized the comparison
with the same quarter a year earlier, showing an 84 percent jump in sales.

Amazon CEO Jeff Bezos has bristled at suggestions that the company is in
serious trouble, arguing it will pay off in the long run to stomach losses
to broaden the customer base and expand product offerings. Trying to reach
profitability too soon would force the company to spend less on expansion,
stunting its long-term growth, he argues. In announcing the recent
quarter’s results, Bezos says new automated systems at the company’s
warehouses and marketing efforts to get past customers to buy more should
help the company become profitable. But he has repeatedly declined to say
when he expects the company to move into the black.

Reality check
Still, the company clearly recognizes it has problems. Last month Amazon
was forced to give new stock options to employees because the falling share
price had made earlier options grants worthless. Like many online
companies, Amazon’s low pay is counterbalanced by what are intended to be
generous options grants. If options look like they won’t pay off, vital
employees and executives may jump ship.

One high-profile departure has already caught media attention. Amazon
president and chief operating officer Joseph Galli quit in July to become
president and chief executive of VerticalNet, a Horsham, Pa., business-to-
business Web site. Galli walked away from Amazon options that, according to
one estimate, could have been worth more than $1 billion if Amazon shares
rose by even a relatively modest 10 percent a year. He said he wanted to
run a company and be closer to his family.

Wall Street analysts have been losing their ardor for Amazon, with about a
third of them recently shifting their ratings from “buy” to “hold,” a kind
of purgatory that’s not much better than the outright damnation of a “sell”

“Despite our personal fondness for the site, we are cautious on the shares
near term,” Faye Landes, an analyst for Sanford C. Bernstein, said in an
early August note to investors. Landes was concerned that her firm’s
research had shown that few Amazon customers knew it sold products other
than books and CDs. The cost of getting the message out on cookware, patio
furniture and other newer offerings could drive Amazon shares down as low
as $12, she said. Landes made that estimate before Amazon announced
ambitious, promotion-dependent partnerships for selling toys and cars. It
has also just announced that it will sell electronic books in partnership
with Microsoft.

Landes is one among many Amazon watchers to have focused on the company’s
immense costs. Amazon claims to sell 18 million items, requiring a network
of expensive warehouses and legions of employees to find and ship items
that customers order. Like many Internet retailers, Amazon also spends
enormously on marketing and promotion.

By contrast, one of the most successful online enterprises–and one of the
few profitable ones–is eBay, the auction site. The key to eBay’s
profitability is its lean costs, says Gerald Lee Lohse, research director
of the Wharton Forum on Electronic Commerce, who studies Internet
companies. When eBay’s sales double, costs rise only 4 percent, he says.

That’s because eBay doesn’t take possession of the items sold on the site.

It merely brings buyer and seller together., where customers bid for airline tickets, groceries and other
products, also doesn’t need to build its own inventory, leading some
observers to suggest its approach may ultimately prove better than
Amazon’s. Priceline also has yet to turn a profit.

Clearly, staggering costs could swamp Amazon. Ravi Suria, a Lehman Brothers
analyst, wrote in a July report that the company might already be out of
business had it not been able to borrow $681 million through a convertible
bond sale last February. Amazon’s “negative cash flow, poor working capital
management and high debt load” make the future questionable, he wrote.

Searching for loyal subjects
Amazon’s vast product offerings recall a 19th-century gold rush, with
miners racing to stake claims at any cost before competitors could tie up
promising territory. But there’s a big difference: A gold prospector might
really secure exclusive rights to a claim, but no one gets exclusive rights
to Internet territory, where competitors can pop up overnight.

“What’s going to stop me from starting a Web site and selling books?” asks
Wharton accounting professor Peter H. Knutson. All it would take, he adds,
is some deals with book publishers and a few accounts with credit card

And although Amazon would appear to have a tremendous asset in its widely
recognized name, there is every sign that Internet shoppers’ loyalties are
shallow, making brand names less important, Knutson points out. If another
bookseller offers a lower price, easier ordering system or friendlier
customer service, the customer may well desert–especially as trying
another online store takes only a few keystrokes, not a drive across town.

And now customers don’t even need to know what other online stores are out
there, as there are search engines, like, which will scour
many sites at once for the best prices, Knutson says. “Customers have no
loyalty at all,” he adds.

Eric Bradlow, professor of marketing and statistics at Wharton, notes that
selling products is not Amazon’s only game. The company can also sell
advertising space on its site. To make this pay, Amazon must be able to
provide advertisers with large numbers of potential customers. At the same
time, the company must minimize its own cost of obtaining these so-called
eyeballs. But the key to this is, again, creating customer loyalty–getting
people to come back again and again on their own. So far, Bradlow says,
it’s not clear that any Web site can achieve such customer “stickiness”
without continually spending enormous sums on marketing and promotion.

“If people were not price-sensitive, if people were loyal, if stickiness
actually held on the Internet, that would be a good model,” Bradlow notes.

“The question is whether that is true…Customer acquisition is very
costly, and many companies spend way too much on customer acquisition and
not enough on customer retention.”
Despite all the costs, obstacles and unknowns in the new frontier of
Internet retailing, Amazon does have an edge on many competitors. “You have
to look on Amazon as the bellwether for all dot-coms,” Lohse says. Research
has shown that customers are impressed with Amazon’s site, a key to
building customer loyalty, he adds.

“People find Amazon easier to use than Barnes & Noble’s site, for example.”
But the data also show that many people who click on Internet retail sites
are just curious, he says.

On average, only 2 percent of the people who visit a site make purchases,
according to Fader. Given that, Amazon’s figure of 10 percent is
impressive. But it’s far from clear that even this is enough to make an e-
retailer profitable. Certainly, the manager of any traditional brick-and-
mortar business would be in despair if only one in 10 visitors made a

Moreover, many visitors who do make online purchases quickly lose interest
when the novelty wears off or they are disappointed for one reason or
another, or if they conclude that prices aren’t low enough to justify the
wait for delivery. About 15 percent of first-time purchasers “drop out,”
meaning they make no additional Internet purchase for at least a year,
Lohse says. Others make a few purchases, then drop out.

Another dark cloud: Lohse sees signs that the growth in Internet purchases
over the past few years is leveling off. The industry may thus be
approaching a saturation point at which the current base of customers is
buying as much as it ever will.

Typically, the current Internet customer comes from a household with an
annual income of $56,000, nearly double the national average of about
$30,000. As computer ownership gets cheaper and machines are acquired by
less affluent households, there may be a second wave of potential
customers, he says. But that group doesn’t have as much to spend.

Fortunately for Amazon, some research has shown that customers return to
the site even though they can get books cheaper elsewhere, indicating
Amazon is, in fact, building loyalty. The main reason, Lohse says, is
Amazon’s added features, such as reviews, shopping suggestions and one-
click purchasing. Amazon has done a good job keeping shopping pleasant and
easy for customers, and that should encourage customers to try Amazon’s new
product offerings.

“For Amazon to grow, it has the right strategy,” he points out. Still, he
adds, it’s not a given that many pure Internet retailers will be able to
survive against competitors, such as Barnes & Noble, which use their online
businesses merely to complement their brick-and-mortar stores. These more
traditional competitors can come to the table with a big stake–strong
revenues, loyal customers and lots of know-how.

Internet retailing looks like it will be a war of attrition, with victory
going to those with the best staying power. At best, Amazon’s ability to
endure is in doubt. A company can only gush red ink for so long.

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