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eBay: Last man standing

As the online auction giant's ambitions widen, it faces a bevy of new--and potentially risky--challenges. Wharton experts take stock of its rapid ascent.

The eBay juggernaut rolls on. Few would have thought that the Web site created in 1995 by Pierre Omidyar to sell Pez dispensers and other collectibles would by 2002 be one of the few remaining companies that continue to demonstrate the potential of e-commerce.

So strong is eBay's hold, say some observers, that the only force capable of stopping eBay is eBay itself. Is that likely?

According to some Wharton professors, Omidyar's success was in creating a business model that doesn't require carrying any inventory but gets a cut of every transaction. The company operates as a "market mechanism," not a "market maker."

"We view eBay as perhaps the most successful of all the breakthrough applications on the Internet," said Wharton marketing professor George Day, who has made a broad study of digital economy winners and losers. Or, as operations and information management professor Ravi Aron said, "eBay is the last man standing. It skirted all the pitfalls and traps others fell into."

At the same time, however, skeptics point out that eBay faces risks despite its enormous reach. The company attracts 40 million or more people to its "community"--to use a favorite eBay expression--who sell countless products to one another. This ability to connect millions of people--who act as product developers, salespeople and buyers--lies at the heart of eBay's business model and its success.

Still, eBay has little control over this community except in the broadest of terms. The company must constantly be on guard about what members may do. If someone tries to use eBay to auction a live baby or sell chunks of the World Trade Center--and some people did--such actions put eBay and its brand at risk.

In that sense, eBay's biggest strength is also its greatest weakness. Being at the mercy of forces it cannot control makes eBay subject to greater volatility than if the company were in a more predictable business, such as making widgets.

The success, of course, is undeniable. Today, eBay commands more than 80 percent of the online consumer and small-business auction market. It operates a customer friendly site featuring more than 126 million auction listings and 18,000 categories, twice as many as the previous year. It boasts annualized gross merchandise sales of nearly $11 billion.

"eBay is the last man standing. It skirted all the pitfalls and traps others fell into."
--Ravi Aron, Wharton professor
For 2001, eBay generated consolidated net revenue of $749 million, representing a 74 percent annual growth rate. Consolidated net income nearly doubled to $90.4 million, or 32 cents per diluted share, from $48.3 million, or 17 cents per diluted share, in 2000. On a pro forma basis, excluding certain charges, eBay reported consolidated net income of $137.5 million, or 49 cents per diluted share.

Despite the worst economy in a decade, eBay increased its gross material sales by 72 percent from 2000 to 2001, its pro forma net income by 135 percent, and grew pro forma earnings per share by 133 percent. The company has a market cap of $15.4 billion--based on a stock that closed on April 8 at $55 a share--and a gross profit last year of nearly $614 million, up from $335 million in 2000.

Unlike scores of dot-coms that collapsed after their venture capitalists turned off the funding tap, eBay has been consistently profitable. Some observers caution, however, that this is no excuse to regard the company's financial results with blind enthusiasm. For example, while eBay made a net profit of $48.2 million in 2000, this was just slightly higher than its interest income of $46 million.

First mover advantage
Even so, Day believes eBay's success hinges on the fact that it had "first mover advantage," allowing the company to lock up its space early on, build a critical mass of users, and effectively prevent others from breaking in. That's why competitors have had no effect on eBay's business, Day said. In fact, eBay's pact with America Online has helped fuel its rapid growth.

eBay CEO Margaret Whitman predicts that by 2005 eBay will post $30 billion in gross sales for which its 10 percent cut would mean $3 billion in revenue. To achieve that growth, eBay must weather tough international competition amid a slow U.S. and world economy and find success with its new initiatives. While some said eBay's business model could be easily imitated, the fact is that Yahoo and Amazon.com, among others, tried to copy it and have failed. Even when Yahoo offered sellers commission-free auctions, and Amazon offered buyers quality guarantees on merchandise purchased through its auctions, the masses did not abandon eBay.

Much of eBay's growth is tied to huge new product categories. When eBay noticed a surge in autos and auto parts being sold, it created eBay Motors. Today, eBay Motors is the country's biggest car dealer with $1 billion in sales of cars and car parts last year. To help comfort skeptical online car buyers, eBay now offers a buyers assurance program that includes a free limited warranty on most used cars and fee-based programs that can be added to most used-car purchases to help sweeten any "lemon" problems.

Another innovation is the "Buy It Now" feature that lets bidders end an auction at a set price. Currently about 45 percent of all listings use it, which is attracting more mainstream buyers and helping close auctions nearly a day faster on average than a year ago.

CEO Whitman has said that fixed-price shopping will continue to become a bigger part of eBay's business, but the company refrains from predicting whether this service will one day dominate its sales.

In January eBay announced it was raising its overall fees and also would begin charging a fee for its Buy It Now feature. It was the company's second price increase in 13 months. Analyst Derek Brown of WR Hambrecht said that eBay raised prices "not because it had to, but because it can."

"If you look at the nature of what is traded on eBay it's more than a collectible bazaar today."
--Derek Brown, WR Hambrecht analyst
While some observers predicted there might be a backlash among eBay users because of the higher fees, nothing has happened. "The fact that eBay has been able to raise prices two times in the last 13 months with the type of global economy we've seen is a testament to the strength of its franchise," said Brown, who has followed eBay since 1999. "They are getting away with it because they represent the best marketplace for buyers and sellers on an international basis."

Brown noted that while many people consider eBay a "quirky destination," they fail to see it is the "largest venue for auto purchasing in the U.S. and that despite a stagnant personal computer market their sales of PCs have grown at a phenomenal rate." He added that eBay has moved well beyond a collectibles marketplace. There are now "few limitations about what can be bought or sold across eBay. That to me is the real key to understanding how big this company can become."

Best of all worlds?
Indeed, besides being the largest auto marketplace in the United States, eBay has created other new channels for buying and selling. Last year its gross merchandise sales of consumer electronics increased 66 percent; books, movies and music were up 54 percent, and toys increased 49 percent from the previous year.

eBay now also features marketplaces for mainstream consumer products from major companies such as Disney, IBM, Dell Computer, Sony, Sun Microsystems, Sharper Image and others. Its Half.com site offers previously owned mass-market goods ranging from books to DVDs to Palms at fixed prices. And eBay Stores has helped sellers create customized online storefronts to attract more buyers.

Aron said that eBay has been able to move into markets selling more practical everyday items and has "extended the online auction mechanism to go beyond products it was ideally suited for." He warned, however, that if eBay is going to be successful with its fixed-price Half.com model, people should "expect to see it skewed in favor of big sellers...which is a concern to some of the small sellers."

WR Hambrecht's Brown said bringing large-scale sellers onto the eBay platform is having "an altering effect" on the company, but that's not necessarily bad. "eBay has been morphing from day one," he said, "and if you look at the nature of what is traded on eBay it's more than a collectible bazaar today, but a true bazaar of goods, including boats, autos, real estate, airplanes and more."

Leadership is another area where eBay seems to be strong. Under the guidance of Whitman, eBay has earned accolades for its management style and customer-centric philosophy. "Meg Whitman is the top of the heap," said Michael Useem, director of Wharton's Center for Leadership and Change Management. "She is as well-known and properly respected as any executive on the scene. Here's a pioneer who has built a company into a fully developed form. When the history of this particular era is written, she will be in that history."

"When the history of this particular era is written (Meg Whitman) will be in that history."
--Michael Useem, Wharton director
Useem said a major key to understanding eBay's success is that "Whitman and her team really listen to the customers." He commended the company's ability to "respond quickly when competitive threats come along. I think it may be Whitman's unrelenting insistence on the customer that has made the difference." Whitman herself has used eBay to sell the entire contents of a Colorado vacation home.

When she joined eBay in 1998, Whitman agreed to a compensation deal that gave her options to buy 14.4 million shares at just 3.5 cents a piece. Today, she is worth about $850 million, and Omidyar is worth $4.6 billion. When Whitman walked in the door at eBay, the company had about 170 employees. Four years later it has about 2,500 employees, dominates the world online auction market, and is the largest sphere of economic activity on the Internet, including business-to-business and e-commerce sites.

Around the world, eBay is picking up steam--but the company's international expansion has been challenging. With eBay International's push into England, Germany, Singapore, Ireland and Canada--a total of 20 countries are listed on its Web site--eBay's worldwide business grew from 7 percent of sales in 2000 to 14 percent in 2001, and spiked up to 18 percent of total revenue in the fourth quarter. To get a toehold in Korea, the world's sixth largest auction market, eBay shelled out $120 million to buy the national market leader.

The Korean foray has been troublesome for eBay, though. In documents filed with the Securities and Exchange Commission in March, eBay disclosed that Korean credit card companies providing payment services to Internet Auction, eBay's Korean subsidiary, had "experienced higher-than-anticipated delinquency rates on transactions carried out on (its) platform." As a result, the credit card companies had withheld $2.6 million as "collateral" against certain auction accounts and threatened to terminate their agreements with Internet Auction.

OS aspirations
Another major Whitman initiative that could have a huge impact on the marketplace is eBay's aim to become the dominant operating system for e-commerce. By licensing eBay's technology to noncompetitors, Whitman hopes to make it the pre-eminent application for people and businesses to sell online. Her aim is to help companies meld eBay-like auctions into their own Web sites.

eBay has ambitious plans to create such an e-commerce platform, and the company is encouraging others to build software applications based on eBay technology much like Microsoft does with its Windows operating system. In addition, eBay's pact to use Microsoft's .Net services is being watched closely because of what it could mean to the use of middleware applications on the Internet over the next few years.

"Licensing its application programming interface (API) will create a fascinating revenue model for eBay," Day said. "The fact that eBay is the titan that straddles the market will bring big dividends and could potentially be a tremendous revenue stream in two to three years."

Even so, Brown said eBay faces two potential pitfalls. The first is that the company has a "number of irons in the fire right now and is trying to manage growth and many different initiatives at once." He said eBay can't afford to "drop the ball on international expansion and the integration of its fixed-price trading into its dynamically priced environment."

Brown is also watching how eBay "is bringing large-scale sellers online as well as add-on services, including transaction processing." The second potential pitfall he sees is "that eBay becomes so big that it is actually defeated from within because it becomes fairly generic, (allowing) category-specific marketplaces to crop up (that) are more liquid for that particular product or service, like stamps or coins."

Useem said the biggest potential pitfall facing eBay "is overconfidence." It is during periods of "untarnished success," he said, that a company should worry "about when the fall may come" or that the "competition may find a chink in the armor." He said the eBay team needs "to be vigilant not to make an error in the euphoria of success; they must stay ahead of the curve, must think strategically.

eBay must keep an eye 18 months to two years out and keep questioning all of its assumptions and business models to see if they have changed." Whitman, Useem added, "should follow (former Intel CEO) Andy Grove's dictum that only the paranoid will survive."

 
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All materials copyright © 2002 of the Wharton School of the University of Pennsylvania.