Year of the Internet Shakeout (Fool on the Hill) January 3, 2000

An Investment Opinion

Year of the Internet Shakeout

By Yi-Hsin Chang (TMF Puck)
January 3, 2000

As Y2K has arrived more or less without a glitch (which we have long predicted here at the Fool), it will be interesting to watch the shakeout and increasing pace of consolidation among online retailers over the next year.

Already there are signs that random websites are finding it harder to get in on the action, dot-com or no dot-com. As The Wall Street Journal pointed out today, according to the latest report from Internet traffic tracker Media Metrix, almost half of the 50 most visited websites in the five weeks before Christmas were those of familiar brick-and-mortar retailers. Apparently, the millions of dollars spent on advertising this holiday season weren't enough to distinguish most Internet start-ups.

"In terms of categories, toy and bricks and mortar sites appear to be the biggest success stories, with major gainers in both categories since last year and significant week-to-week increases this holiday season," said Doug McFarland, senior vice
president and general manager of Media Metrix.

It makes sense that popular traditional retailers are building a significant presence online. Because their brands are already well-known and respected, it costs them a lot less to market their websites.

Take (Nasdaq: bnbn), for instance. Essentially, every Barnes & Noble (NYSE: BKS) bookstore in the country doubles as a giant, prominently placed ad for the online purveyor of books, music, and gifts. According to CEO Jonathan Bulkeley (see Nov. 9, 1999 special feature), the number one reason people shop at a website is that it has an offline presence and therefore is trusted by customers.

Given the choice to order from a well-known brand versus some new dot-com, all else being equal, it's not surprising that most people would go with the name they know. That's the whole point of building a brand, whether it's Coca-Cola (which has yet to start selling Cokes from its website) or McDonald's.

That's one reason why so many brick-and-mortar retailers have succeeded in expanding into the online space. One of the trendsetters has been Gap Inc.'s (NYSE: GPS) Gap Online, along with the online stores of GapKids, babyGap, Banana Republic, and soon-to-come Old Navy.

The best feature of the Gap sites: a hassle-free return policy that allows you to return purchases to any corresponding Gap store. No more trying to repack that gift in the box you already ripped or standing in long lines at the post office -- not to mention paying to ship the item you want to return. As this type of customer-oriented return policy catches on among traditional retailers, purely online players may have to counter with offers of free shipping on returns, which would further cut into potential profits.

Some people have said that the most successful Internet companies are ones with first-mover or first-to-scale (i.e., first to become really big) advantage. I think that the most important thing actually is becoming the first to brand -- the first to create an online following, an online brand that people trust. As I wrote last week, very few Internet players have succeeded in actually building a distinctive brand despite spending millions to "get the name out." There's a big difference between marketing and branding.

Still, according to Media Metrix's latest findings, a handful of big-name Internet companies fortified their positions as leaders in e-commerce: (Nasdaq: AMZN), eBay (Nasdaq: EBAY), and eToys (Nasdaq: ETYS) made up the top three most-visited sites, with Amazon and eBay way ahead of all other competitors -- 5.69 million and 4.07 million average daily unique visitors, respectively, compared with eToys' 1.66 million.

But right on eToys' heels were traditional names (1.52 million average daily unique visitors) and Toys "R" Us' (NYSE: TOY) (1.49 million). Other familiar names in the top 25: (799,000, a 510% increase -- is a joint venture between Consolidated Stores (NYSE: CNS), which runs KB Toys retail stores, and, (782,000), (638,000), (594,000), and (513,000).

As the competition heats up, traditional retailers will leverage their presence in the real-world and edge out many Internet-only stores that lack the brands and the experience to deliver quality customer service. So far, top-tier Internet companies such as Amazon and eBay have little to fear, but second- and third-tier firms still struggling to publicize their URLs and follow through on filling orders likely will be bought out or driven out of business this year.

Fun, fun. In the meantime, here are some websites to watch: -- Wal-Mart Stores (NYSE: WMT), the world's largest retailer, just launched a revamped online store and plans to start providing its own Internet access service through an alliance with America Online (NYSE: AOL). -- With categories to "Fix It," "Build It," "Grow It," "Decorate It," and "Install It," the website gives detailed instructions on just about every problem around the house. Home Depot (NYSE: HD) is "working hard and fast to deliver" a full-fledged online store by Spring 2000. In the works: the option to have products delivered or available for pick-up at Home Depot stores, the flexibility to return online purchases to a store, and the ability to access through computer kiosks in the stores. -- This website offers a wide range of high-ticket personal accessories. It has a retail shop in Houston, and, believe it or not, it offers free shipping, free gift-wrapping, and a 60-day return policy.