FW: "How Low Can You Go?" by Bill Gurley

Dan Kohn (dan@teledesic.com)
Wed, 6 Jan 1999 09:58:19 -0800

Bill Gurley is a very serious and (deservedly) well respected analyst.
The fact that he is willing to write a serious article about a business
as absurd as buy.com (a business that only exists to the degree that
Wall Street continues to believe in the greater fool theory), only
confirms my view of Internet mania as a speculative bubble approaching
the level of tulip bulbs.

I sold all of my tech stocks yesterday, because I think great companies
like Microsoft, Intel, and Cisco are going to be dragged down
undeservedly when the Internet bubble pops, and can then be repurchased
at a great discount.

For context, I highly recommend the following book:

- dan

Daniel Kohn <dan@teledesic.com>
Teledesic LLC
+1-425-602-6222 (voice)   602-0002 (fax)

-----Original Message----- From: Above the Crowd [mailto:Above_the_Crowd@atc.revnet.com] Sent: 1999-01-06, Wednesday 08:42 To: dan@TELEDESIC.COM Subject: "How Low Can You Go?" by Bill Gurley

"If you gave it away, would you be satisfied?" - Sammy Hagar, Would You Do it For Free?


A few months ago I suggested that in a world where the stock market seems to value revenues, page views, and growth more than profits, the ultimate business model would be to sell dollars for $0.85. As the argument went, you could always make up the difference through ad revenues. Where there is a will there is a way. Scott Blum, the CEO of Buy.Com, has introduced a model that is not too different from the one I imagined. He sells consumer products at or below cost, is creating a brand synonymous with low price, and hopes to become the leading e-commerce portal. He even plans to make up the difference through advertising. While most web sites are shifting from a content model to a commerce model, Scott is using commerce to drive eyeballs.

Buy.Com first opened its virtual doors as BuyComp, a company that focused on selling computer products at extremely low prices. As Blum has a passionate aversion to touching inventory, he chose a model in which products were dropshipped directly from the wholesaler. In mid-November, BuyComp acquired SpeedServ, a lesser-known online retailer of books and video, from the powerful Ingram distribution family. As a result of this product expansion, BuyComp changed its name to Buy.Com and is now planning to expand into multiple product categories. The company has purchased over 2,000 domain names that begin with B-U-Y, which may give some indication of their future direction.

Buy.Com's tag line, The Lowest Prices On Earth, may be the most precise positioning statement of any company that ever existed. The company is ruthlessly committed to being the low price leader -- even if this means they lose money on every sale. They have gone so far as to develop technology that searches competitor's sites (as well as the shopping agents/bots), to make sure they have the lowest prices on the Web. Perhaps the best example of their low-price commitment is the Palm III Organizer from 3Com. The product currently sells for $248.95 on Buy.com, but has sold for as low as $209 on the site. Compare that to $299.95 at Cyberian Outpost, $329.95 at CompUSA, and $369.00 on 3Com's own web site (prices as of Dec. 10, 1998).

How successful is Buy.Com? This all depends on how you measure success. The CEO states that the company sold $15 million worth of products in October and is forecasting sales of $19 million in December. At this pace he believes Buy.Com can break Compaq's first year sales record of $111M, making it the fastest growing company in U.S. history. Of course, one could argue that revenues are not the proper metric for measuring the success of a company with a potentially negative gross margin. Over the long run, industries with low margins have traditionally sold at significantly low price/sales ratios, with most distributors trading well below 1 times sales. Besides, if all you are interested in is revenue growth, you might want to sell a high priced commodity like oil or steel below cost. You could probably hit $1B in your first year.

As you might suspect, Buy.com's competitors shrug it off as a farce, often comparing the CEO to "Crazie Eddie," the low-price leader in a previous retailing revolution who eventually found his way to prison. The similarities do exist, as Blum is no stranger to controversy. A company he founded earlier in his career, Pinnacle Micro, was involved in some questionable behavior that raised the interest of the SEC. Again mirroring Mr. Eddie, Blum is as confident and boisterous as they come. He has openly challenged Amazon.com as his primary competitor, and has even reserved the URL www.10percentoffamazon.com for an upcoming promotion.

Other entrepreneurs and competitors, whose businesses are founded on the standard notion of selling goods at a profit, pooh-pooh the idea. "It's unproven," says Julie Wainwright, CEO of Reel.com. Others point out that retailing is about more than just pricing, and suggest that Buy.com comes up way short on other important metrics such as customer service, ease-of-use, and overall customer experience. While it's easy to be skeptical of this "crazy" new model, we may have more to learn by asking "what if it works," than by espousing "why it will fail."

Let's begin with branding. Is it reasonable to assume that someone could build a brand around the concept of "the lowest prices on earth?" This is fairly straightforward, as there really couldn't be a more simplistic message for customers to understand. The success of Wal-Mart, as well as the impressive early growth of Buy.com, are both testaments to this fact. Do customers want only low prices? Definitely not. Selection, customer service, and user experience all matter, but on the Web it is easy to "experience" these things on another site and still close the transaction with the low-price leader. This is particularly true for well-researched purchases of relatively expensive branded products such as computers and cameras.

Some might anticipate that the wholesalers and distributors would balk at this model. This does not appear to be the case. While extreme discounting by one reseller can unquestionably raise the eyebrows of the distributor's other customers, the distributors seem more concerned about losing these sales than anything else. And regardless of whether the virtual reseller loses money, the distributor still receives his standard margin. Buy.com could eventually circumvent the distributor, asking the manufacturer to drop ship directly to the customer, but Scott Blum has worked hard to position himself as "distributor-friendly". You might also suspect that extreme discounting would bother manufacturers, but having your product used as a lost-leader is actually quite beneficial. If the reseller is willing to lose money, this makes a product that is much more appealing vis--vis the competition.

The natural limit to a business model that loses money on every sale is access to capital, and for better or for worse, this has not yet been a problem for Buy.com. The company has raised over $60M from Softbank, the venture firm that backed successes such as Yahoo and E-Trade. The company's current employee base of 100 should equate to about a $12M annual operating expense budget. Additionally, the company plans to spend over $10M on a national advertising campaign. Assuming the company loses 5% on each sale and makes marginal money on advertising, the company could easily run for over a year with its current stockpile. If the company can convince Wall Street to buy into its model - which seems highly likely in this environment - this year-long threshold could easily extend to two or even three years.

It is unclear how a competitor should respond to such a threat. Should you match prices and hope that you can hold your breath longer than everyone else can? Or do you take solace in your other "features" and hope that growth doesn't slow? It is interesting to question whether or not this could be the beginning of a true "fight-to-the-death" battle royale. After all, the friction of store growth and local marketing that restricts the evolution of traditional retail competition are absent on the Web. Brand messages can spread like wildfire with tools such as bulletin boards and email capable of spurring exponential spirals of information dissemination. More importantly, the virtual reseller-- one that passes all orders to someone else for fulfillment -- is limited only by the capacity of its partner's inventory.

If Buy.com succeeds, it could have broad implications for the long-term structure of Internet retailing. Virtual resellers who sell commodity products and touch no inventory are likely to see extreme price competition. The simple ad space on the "page view" of the order form is valuable enough to someone to pass the order on at "no charge." For those that do touch inventory, we may see intensified competition between the wholesaler and the Internet retailer. Barnes and Noble's acquisition of Ingram Books may be the first in many channel consolidation mergers. "Brick and mortar" resellers, pressured by the continued contraction of the customer supply-chain, may be forced to restructure and consider new business models. Lastly, manufacturers may be pressured more and more to drop ship directly to the customer. Of course, there is one big winner if all of this comes true: YOU. It's never been a better time to be a customer.


J. William Gurley is a Partner at Hummer Winblad Venture Partners, the preeminent venture capital firm focused exclusively on software investments. To learn more about Hummer Winblad, visit www.humwin.com. ___________________________

J. William Gurley 1998. All rights reserved. Above the Crowd is a monthly publication focusing on the evolution and economics of high-technology business and strategy. . Please send feedback to atc@humwin.com. This column can also be found on CNET online at http://www.news.com/Perspectives/Column/Archive/0,194,5,00.html?st.ne.pe r.col.archive and in Fortune magazine. To be placed on the email distribution list, please send an e-mail to subscribe-above_the_crowd@atc.revnet.com. To be removed from the email distribution list, please send an e-mail to unsubscribe-above_the_crowd@atc.revnet.com. The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed herein are subject to change without notice. Hummer Winblad Venture Partners and its affiliated companies and/or individuals may, from time to time, have positions in the securities discussed herein. Above the Crowd is a service mark of J. William Gurley.

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