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Last modified: September 1, 2000, 5:00 AM PDTFrom emailprotectedSpecial to CNET News.compicpicpicpicAmazon.com is arguably the biggest name in online shopping, the goldstandard against which all dot-coms are judged. Is it really possible,then, that someday we will be forced to live in a virtual world withoutthis mammoth bookseller?Certainly, it’s too soon to write a eulogy. But on the savage frontier ofInternet commerce, even the biggest and toughest–though they may have beenthe 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, whoteaches marketing at Wharton.

Fader says the Internet-retailing industry isso young, so full of money-losing behemoths like Amazon, that there is noway to tell which business models will succeed.The 6-year-old seller of books and CDs sits atop millions of computerusers’ Favorites lists. But many investors, Wall Streeters and academicswho have studied the company cannot ignore some frightening facts: Thecompany has lost well in excess of $1 billion, and its losses have growneven though sales have skyrocketed. Most seriously, it is saddled withenormous debts.Amazon is struggling to attract more customers by offering an ever-widerrange of products, including toys and even cars. But the attempt to be morethan a book and record store, to offer everything to everyone, smacks ofdesperation.

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“Now the company is broad but shallow,” Fader says. Costs could soar evenhigher, 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 1997at a share price, adjusted for subsequent splits, of $1.50. By any measurethe stock was an enormous success in the first two years, peaking at $113on 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 thisyear, Amazon clearly has real problems. Despite attracting 23 millionshoppers, it lost nearly $720 million in 1999, compared with losses of $125million in 1998, $31 million in 1997 and $6 million in 1996. Losses soareddespite the enormous gains in sales–$1.64 billion in 1999 vs. $610 millionthe year before, for instance.

Investors were particularly concerned when the company reported late inJuly that sales growth had nearly come to a standstill. For the secondquarter of 2000, sales were only 1 percent higher than in the firstquarter.Rather than focus on that number, the company emphasized the comparisonwith 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 inserious trouble, arguing it will pay off in the long run to stomach lossesto broaden the customer base and expand product offerings. Trying to reachprofitability too soon would force the company to spend less on expansion,stunting its long-term growth, he argues.

In announcing the recentquarter’s results, Bezos says new automated systems at the company’swarehouses and marketing efforts to get past customers to buy more shouldhelp the company become profitable. But he has repeatedly declined to saywhen he expects the company to move into the black.Reality checkStill, the company clearly recognizes it has problems. Last month Amazonwas forced to give new stock options to employees because the falling shareprice had made earlier options grants worthless. Like many onlinecompanies, Amazon’s low pay is counterbalanced by what are intended to begenerous options grants. If options look like they won’t pay off, vitalemployees and executives may jump ship.One high-profile departure has already caught media attention. Amazonpresident and chief operating officer Joseph Galli quit in July to becomepresident and chief executive of VerticalNet, a Horsham, Pa.

, business-to-business Web site. Galli walked away from Amazon options that, according toone estimate, could have been worth more than $1 billion if Amazon sharesrose by even a relatively modest 10 percent a year. He said he wanted torun a company and be closer to his family.Wall Street analysts have been losing their ardor for Amazon, with about athird of them recently shifting their ratings from “buy” to “hold,” a kindof purgatory that’s not much better than the outright damnation of a “sell”rating.

“Despite our personal fondness for the site, we are cautious on the sharesnear term,” Faye Landes, an analyst for Sanford C. Bernstein, said in anearly August note to investors. Landes was concerned that her firm’sresearch had shown that few Amazon customers knew it sold products otherthan books and CDs. The cost of getting the message out on cookware, patiofurniture and other newer offerings could drive Amazon shares down as lowas $12, she said. Landes made that estimate before Amazon announcedambitious, promotion-dependent partnerships for selling toys and cars. Ithas also just announced that it will sell electronic books in partnershipwith Microsoft.

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

By contrast, one of the most successful online enterprises–and one of thefew profitable ones–is eBay, the auction site. The key to eBay’sprofitability is its lean costs, says Gerald Lee Lohse, research directorof the Wharton Forum on Electronic Commerce, who studies Internetcompanies. 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.Priceline.com, where customers bid for airline tickets, groceries and otherproducts, also doesn’t need to build its own inventory, leading someobservers to suggest its approach may ultimately prove better thanAmazon’s.

Priceline also has yet to turn a profit.Clearly, staggering costs could swamp Amazon. Ravi Suria, a Lehman Brothersanalyst, wrote in a July report that the company might already be out ofbusiness had it not been able to borrow $681 million through a convertiblebond sale last February.

Amazon’s “negative cash flow, poor working capitalmanagement and high debt load” make the future questionable, he wrote.Searching for loyal subjectsAmazon’s vast product offerings recall a 19th-century gold rush, withminers racing to stake claims at any cost before competitors could tie uppromising territory. But there’s a big difference: A gold prospector mightreally secure exclusive rights to a claim, but no one gets exclusive rightsto Internet territory, where competitors can pop up overnight.”What’s going to stop me from starting a Web site and selling books?” asksWharton accounting professor Peter H. Knutson. All it would take, he adds,is some deals with book publishers and a few accounts with credit cardcompanies.And although Amazon would appear to have a tremendous asset in its widelyrecognized name, there is every sign that Internet shoppers’ loyalties areshallow, making brand names less important, Knutson points out. If anotherbookseller offers a lower price, easier ordering system or friendliercustomer service, the customer may well desert–especially as tryinganother 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 outthere, as there are search engines, like DealTime.com, which will scourmany sites at once for the best prices, Knutson says. “Customers have noloyalty at all,” he adds.Eric Bradlow, professor of marketing and statistics at Wharton, notes thatselling products is not Amazon’s only game.

The company can also selladvertising space on its site. To make this pay, Amazon must be able toprovide advertisers with large numbers of potential customers. At the sametime, the company must minimize its own cost of obtaining these so-calledeyeballs. But the key to this is, again, creating customer loyalty–gettingpeople 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 stickinessactually held on the Internet, that would be a good model,” Bradlow notes.”The question is whether that is true…Customer acquisition is verycostly, and many companies spend way too much on customer acquisition andnot enough on customer retention.”Despite all the costs, obstacles and unknowns in the new frontier ofInternet retailing, Amazon does have an edge on many competitors.

“You haveto look on Amazon as the bellwether for all dot-coms,” Lohse says. Researchhas shown that customers are impressed with Amazon’s site, a key tobuilding 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 sitesare 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 isimpressive. 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 apurchase.

Moreover, many visitors who do make online purchases quickly lose interestwhen the novelty wears off or they are disappointed for one reason oranother, or if they conclude that prices aren’t low enough to justify thewait 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 purchasesover the past few years is leveling off. The industry may thus beapproaching a saturation point at which the current base of customers isbuying as much as it ever will.Typically, the current Internet customer comes from a household with anannual income of $56,000, nearly double the national average of about$30,000. As computer ownership gets cheaper and machines are acquired byless affluent households, there may be a second wave of potentialcustomers, he says. But that group doesn’t have as much to spend.

Fortunately for Amazon, some research has shown that customers return tothe site even though they can get books cheaper elsewhere, indicatingAmazon is, in fact, building loyalty. The main reason, Lohse says, isAmazon’s added features, such as reviews, shopping suggestions and one-click purchasing. Amazon has done a good job keeping shopping pleasant andeasy for customers, and that should encourage customers to try Amazon’s newproduct offerings.”For Amazon to grow, it has the right strategy,” he points out. Still, headds, it’s not a given that many pure Internet retailers will be able tosurvive against competitors, such as Barnes & Noble, which use their onlinebusinesses merely to complement their brick-and-mortar stores. These moretraditional competitors can come to the table with a big stake–strongrevenues, loyal customers and lots of know-how.Internet retailing looks like it will be a war of attrition, with victorygoing to those with the best staying power.

At best, Amazon’s ability toendure is in doubt. A company can only gush red ink for so long.To read more articles like this one, visit emailprotectedAll materials copyright 2000 of the Wharton School of the University ofPennsylvania.pic What do you think about this story? Tell us now.Track this story’s companies and topics|Amazon.com Inc |Create alert||Ebay Inc |Create alert||Priceline.com Inc|Create alert|Create your own e-mail alert >Related stories.

Microsoft, Amazon curl up with digital book dealAugust 28, 2000. An Amazon bull pulls backJuly 27, 2000. Amazon president resigning to head B2B exchangeJuly 25, 2000Get this story’s “Big Picture” >Related quotesQuotes delayed 20+ minutespicpicpic

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