Online, brick-and-mortar retailers join up

Traditional retailers are anxious to get up and running online before the fall holiday shopping season, and as a result, deal-making has proceeded at a feverish pace this spring. Each week brings a new permutation of the online-offline partnership.

For example, giant chain Petsmart has teamed with start-up PetJungle.com to upgrade its Web store. Toys 'R Us simply scrapped its online store and turned to a venture capital firm to put together a start-up. And Getty Images recently entered the consumer market by buying online poster shop Art.com

"The more enlightened land-based retailers have begun to view the Web as an opportunity, rather than just a threat," said Robert Kagle, general partner with venture firm Benchmark Capital, which has been actively linking online retailers with real-world chains.

The trend is particularly clear in markets where one company doesn't yet dominate online sales, said Gary Rieschel, general partner with Softbank Technology Ventures.

"If there are market segments where there is not a clear early mover established, then partnering with the giant in that sector can make a lot of sense [for e-tailers]."

For the last few years, while nimble start-ups have staked their claims online, established companies have held back through fear that selling on the Internet would cannibalize their brick-and-mortar revenues.

Now, "They are acknowledging that their culture, their company organization, and the way they operate is not hospitable to growing an online business," said Lauren Cooks-Levitan, an e-tail analyst for BancBoston Robertson Stephens.

In a few short years, the uneasy relationship of e-tailers with traditional retailers has evolved. First came the get-online-quick phase, in which retailers and mail-order companies rushed to create Web sites. In that early period, a handful of retailers simply bought their way online--video rental chain Hollywood Entertainment snapped up Reel.com and Barry Diller's Home Shopping Network bought computer store Internet Shopping Network.

But as Internet stocks soared, a number of traditional retailers decided to jump on the bandwagon, spinning off their online divisions. Some products of that phase include BarnesandNoble.com, teen clothier iTurf, and computer auction uBid.

Now, savvy real-world retailers aren't simply cashing in their Net strategies on Wall Street. Instead, they are entering a bewildering array of new relationships with online counterparts, including partnerships, joint ventures, and outright purchases.

Last week, pet supply chain Petsmart entered into a 50-50 joint venture with PetJungle.com, one of the e-commerce companies incubated and funded by Bill Gross' Idealab.

"We plugged each other's holes but didn't overlap much," said Phil Francis, chief executive of land-based Petsmart, which has 472 physical stores and $1.8 billion in annual revenue, including $205.5 million in catalog sales.

"We went from hello to deal in less than five weeks," said PetJungle.com chief executive Tom McGovern, who'll run the joint venture, making the point that even real-world retailers can move at Internet speed. As for the 50-50 split between a billion-dollar company and a Web start-up, Petsmart's Francis said the opportunity is too big to waste time quibbling over ownership shares.

The joint venture marries Petsmart's considerable physical presence and back-office systems--Francis is racing to expand a distribution facility by October 1 to handle the Christmas rush, even for pets--with the accessibility of the Internet.

Sharing the wealth
In these corporate marriages of unequals, offline and online companies are being driven by different dynamics, said Kate Delhagen of Forrester Research.

The physical presence of land-based retailers is now considered an asset that can be leveraged in an online business as well, according to Delhagen. "That puts real pressure on pure-play Internet retailers to have a physical presence," she said. One key factor is customers' ability to return online purchases to physical stores.

Reducing the time to market is also a motivation behind many of the new online-offline relationships, including Getty Images' $200 million purchase on May 5 of online poster shop Art.com. Jonathan Klein, chief executive of Getty Images, which previously only sold to business customers online, said it would have been cheaper to buy than for Getty to build its own online consumer outlet and still have Art.com as a competitor.

"We do not have an art framing and distribution business," said Klein. "We were looking for the right way into the consumer market, and we saw Art.com as a good way to take our content to new customers. And it's a great URL."

For Toys 'R Us, it wasn't a question of getting a storefront up quickly. Upstart eToys, which was featured in Visa's TV commercials last fall, pummeled the toy store chain during the online shopping rush last holiday season.

So Toys 'R Us did what Net start-ups do--it turned to venture firm Benchmark Capital to launch a new company last month, but not for money. The toy chain is sinking $80 million into the new unit, while Benchmark will provide the management and technological savvy to get the new venture rolling in time for this year's holiday shopping season.

"They felt they were getting off to a slow start," said Benchmark's Kagle. "They had the enlightened view that to do it by Silicon Valley standards, it has to be done in a Silicon Valley way, properly capitalized and with meaningful incentives for the management team." The new venture hired a CEO earlier this month.

Getting the ball rolling
Some brick-and-mortar chains, like Walgreens, which plans to open an online pharmacy later this year, are testing both Internet technologies and relationships.

Walgreens, already besieged by three online competitors and with real-world rivals gearing up to move online, has a pact with online grocer Peapod to deliver prescriptions with the groceries to customers in the San Francisco Bay Area. Peapod benefits from the association with Walgreens' brand, and Walgreens can mine data on how online consumers react to refilling prescriptions online.

Many new online-offline partnerships are being initiated by some of the more successful Net e-commerce companies as well. In a $260 million deal last month, eBay purchased venerable Butterfield & Butterfield, a prestigious auction house founded in 1865. EBay wanted Butterfield's credibility and century-old contacts with buyers and sellers of high-end merchandise.

Some e-commerce companies have bought land-based businesses to gain entry into a market, said Petsmart.com's McGovern. His original company, PetJungle.com, bought a low-profile pet supply distribution firm in Southern California to capture its industry expertise, fulfill its orders, and get its hands on products to sell--a critical element for a no-name company, even one with Net cachet.

And online furniture start-up Living.com, a Benchmark-funded operation still in stealth mode, did a similar deal, snapping up a furniture distributor.

Analysts don't expect the flurry of mergers to end anytime soon. "There is going to be massive consolidation and massive partnering up of all shapes and forms," said Cooks-Levitan.