0 Overstock's Business Model [Special] February 17, 2004

David and Tom Gardner recently (Nasdaq: OSTK) CEO Patrick Byrne onThe Motley Fool Radio Show  on NPR. The company purchases excess inventory from manufacturers and distributors and resells it on its website. This is the first of four parts.

TMF: Patrick, your company,, reported fourth-quarter earnings recently. Sales were up around $55 million; up 94% over this same period last year. It's a great retail environment and you are doing pretty well. You lost around $3 million for the quarter. What is going on?

Byrne: What we did differently this year is we did a mass-branding campaign. You may have seen us on TV with a "Discover the Secret of the Big O" campaign. That took a few million dollars, but it got our name out there and we have really broken into the big leagues. We are now about a ninth of the size of AMZN) in North America and we have done that without losing, without owing people $5 billion, so we are comfortable.

TMF: Patrick Byrne, when do you expect your company,, to be sustainably profitable without it really ever having to look back on a quarter that lost money?

Byrne: I do think that we will be profitable for this year; of course, I can't promise that. I think we will be profitable for this year.

TMF: 2004.

Byrne: 2004. I can't say that on a quarter-by-quarter basis, but for the year as a whole. There is no such thing as ever being complacent and saying well, now we are profitable. Great businesses get wiped out when they get complacent so we will always be assuming that we have got to do everything right to keep from losing money.

TMF: What is the most profitable thing you do at Overstock? Is it books and CDs? Is it shoes and clothing? Household appliances?

Byrne: Well, I would have to say divided into two areas really. In terms of the most profitable way to acquire a customer, it's through books. We sell books, bestsellers 25% below Amazon. That is a very cost-effective way for us to get customers. They can shop at our site instead of Amazon and save 25%.

TMF: So you are finding people that way, new people to be your customer. Those actual transactions can't be profitable themselves; you are talking about an effective loss leader to lure in people who will buy lots of other stuff from you.

Byrne: Exactly, except not quite a loss leader; we want to break even. We are basically selling the books at break-even along with the DVDs and CDs. Then when they, once they get to shop with us and they learn to like us, they come and buy clothing, jewelry, watches. We sell a lot of furniture and home decor. About 68% of our shoppers are actually female and so there is a skew towards what they tend to buy.

TMF: In a letter to your stockholders, you explained your company's results this way: You quoted a Chinese philosopher who said, "The rhythm of the Tao is like the drawing of a bow." For those not familiar with the Tao or this philosophy, can you explain?

Byrne: Sure, that is from Maltza, who is one of my favorite philosophers. In the real world, things don't proceed in a linear fashion. Sometimes you draw the bow and then you release it and you make a bunch of progress. That is really how our company has been bootstrapped up, really with a tiny amount of money compared with the other guys.

TMF: So I guess the point is, and I am still just trying to nail this metaphor in my own mind, you are going to be shooting an arrow from the bow and the arrow is going to be well-targeted because you have taken the time to draw the bow. The act of drawing back a bowstring feels like a backwards-moving thing; not directly integral to what you should be doing, making profits today. But the idea is you are setting yourself up. Is that it?

Byrne: That is exactly what I mean. Well said. It is a good thing you are the wordsmith.

TMF: I need to start reading Maltza.

Byrne: Oh, everybody should.

TMF: Speaking of important business developments, your company's COO, chief operating officer, recently stepped down. As you know, investors tend not to like surprises like that one too much. What happened?

Byrne: Well, I don't like to comment on relationships with individuals, and he is a fine guy and a great executive. We just mutually agreed, ultimately, that his strengths are probably better suited for a different company than what we need at the moment. So it was a very pleasant, amicable decision. We have worked together for over two years, but we amicably decided to go separate ways and stay friends.

TMF: Patrick, you are a charismatic individual and a leader. You are a founder of your own company. You own a lot of the stock yourself. Do you think you could be a hard person to work with? Is this the sort of thing that may recur from time to time? I guess it is my George Steinbrenner question. If it is true to say about people that they get more extreme in whoever they are as they age, am I talking to a future George Steinbrenner?

Byrne: Could be. It is hard to know who is caught within the matrix and who took the reality pill. I think I took the reality pill. I think I am about the most easy going, laid back president that you will ever find. I have got great friendships within the company, but I think that everyone who works here would say I am probably a tad eccentric. For some people who like to color within the lines, I am probably not a good fellow to work with. Then other people sort of get the hang of it. But I may be a tyrant and I just don't know it. I don't think so. You would have to ask someone else.

Tomorrow: How Byrne's honesty rankles Wall Street.

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