But what happens when the rent goes through the roof and everyone keeps paying anyway, knowing that a steady stream of rival tenants is right behind them?
That's the question facing virtually all businesses selling their products through electronic commerce today. And no easy answers are emerging, even though the payoff of this expensive real-estate practice is decidedly unclear.
"It's still very much an open question whether they are getting a return on their investment," said James Vogtle, research director for the Boston Consulting Group.
In fact, according to a study last month by research firm Jupiter Communications, more than two-thirds of e-commerce merchants surveyed failed to generate more than 30 percent of their sales from these portal deals. Fewer than 5 percent of executives polled at the time were "highly likely to renew" their portal agreements. And primary portals are expected to see only a minor rise in online buying in the next three years, from an 18 percent increase in 1999 to a 20 percent gain in 2002.
Still, in the hyperspeed of Internet business, many companies believe they can't afford to take the risk without such portal partners as America Online, Yahoo, Lycos, Excite, and MSN.com, which millions of Netizens visit daily for email, news, stock quotes, search services, and even their own home pages. Merchants regularly shell out millions of speculative dollars for a single deal, stressing the importance of getting in early and firmly on the ground floor.
Until then, the floodgates of cash are wide open. Ameritrade pays $25 million for two years with AOL; CDnow pays Lycos $18.5 million for three years; and Preview Travel pays Excite $15 million for five years. In one of the largest deals to date, First USA in February announced a $500 million agreement with AOL to be the exclusive credit card product marketer.
"These customer acquisition costs are very high," Shop.org executive director Robert L. Smith said.
No kidding. A November study by Shop.org and the Boston Consulting Group found that retailers with a Web site spend 65 percent of their revenues on advertising and marketing, online and off--producing an average cost of $26 to generate a single customer order.
Compare such acquisition costs to brick-and-mortar retailers with no Web site, which spend an average of 4 percent of their total revenues for marketing and advertising, which comes to about a $2 cost to generate an order. Catalog retailers spend about 6 percent of their revenues on marketing and advertising, about $3 per order.
Yet many public Net companies dismiss such numbers as irrelevant at this nascent stage in the Web's development as a commercial vehicle. They say online merchants are not subject to the same rules as traditional retailers.
"The stock market is willing to be very forgiving and to let [online companies] spend far more money on marketing than their businesses can support," said David Simons, managing director of Digital Video Investments.
That support appears limited indeed, at least so far. The Shop.org study found that only 2 percent of visitors to a merchant's site resulted in a purchase.
Entrepreneurs are banking on repeat business to raise that percentage exponentially. After customers become familiar with a merchant's service, the thinking goes, they can bookmark that site in their browser and bypass the original portal page altogether, eventually reducing the need for these megadeals. Perhaps the best-known illustration of this type of long-term gambit is the $100 million paid by Tel-Save in February 1997 to be AOL's exclusive domestic local, long distance, and wireless phone carrier.
The jury is still out on whether Tel-Save is seeing significant returns on its initial investment, despite a surge in sales from the deal and its ascension to the nation's largest e-commerce telecommunications provider from relative obscurity.
Analysts had expected Tel-Save to capture 10 percent of AOL's fast-growing domestic membership immediately, but that share has come more slowly than expected, reaching that level just this past fall. In the meantime, Tel-Save shareholders have seen their stock tumble by 50 percent since the deal was announced more than two years ago.
Let's make a deal
A number of merchants have struck multimillion-dollar deals with portals in an effort to attract greater traffic to their site and ramp up e-commerce revenues. The jury is still out on whether these alliances are worthwhile. Here is a sampling of some of the larger deals.
|Company||Portal||Date||Size (in millions)||Contract Length|
|First USA||AOL||2/99||$500||5 years|
|CUC International||AOL||6/97||$50||3 years|
|Preview Travel||Excite||9/97||$15||5 years|
"The view here is that the investment was a good investment and the results will become apparent later this year, in the year 2000, and beyond," said Ed Meyercord, Tel-Save executive vice president of corporate development.
Intuit's Quicken.com is also bullish on portals, citing larger revenues from sales and from advertisers because of increased traffic through America Online. "AOL has been responsible for over 20 percent month-over-month increases in our channel," said Quicken.com's director of marketing Roy Rosin. "It's scaling really quickly."
Others aren't so confident. The Fragrance Counter, an online cosmetics company, canceled a one-year contract with Lycos in April 1998. "We terminated the contract because we felt could reinvest our resources where they would be more effective," said Eli Katz, the Fragrance Counter's chief operating officer.
Another Web merchant, Cybermeals, stepped away from four-year contracts with Lycos and Excite shortly after they began. The company, which has since changed its name to Food.com, had signed a $15.5 million deal with Excite in early 1997 and a $16 million contract with Lycos in January 1998.
"We got traffic to the site, and that metric was met, but the order conversion rate was not because we didn't have restaurants in the cities were people were clicking," said Katie Vogelheim, vice president of marketing and business development. "After we did these deals, we realized a few months into them that we needed marketing that was targeted to certain times of the day and in certain regions of the country."
Ironically, the portals themselves are questioning the wisdom of such multimillion-dollar deals, at least when they're on the paying end of them. In particular, those that partnered with Netcenter to boost traffic say the portal has been contributing an increasingly smaller share of their overall traffic.
Kerry Glancy, director of online marketing for iOwn.com, said the portals tend to "over-promise" the number of consumer clicks a merchant will receive, especially those that will bring qualified or targeted buyers to the site.
That's a problem, considering that more merchants are putting a heavier emphasis on click-to-sale conversions when sizing up the performance of portal partnerships, as opposed to raw traffic flow and intangible branding benefits.
Given the amount of the money they're paying, merchants are also increasingly complaining that the portal deals amount to little more than static buttons on a site and have yet to offer content integration, said Nicole Vanderbilt, another Jupiter analyst.
iOwn, for example, said it does not plan to renew its contract with Lycos because it is seeking a portal that will offer integration features such as its mortgage calculator. "Primarily it was an advertising deal with static buttons," Glancy said of the Lycos arrangement.
Portal executives readily admit that these deals carry a high price tag. But they maintain that it's the price merchants must pay to position themselves for an e-commerce tidal wave expected to unleash $68 billion in revenues next year, according to International Data Corporation.
"Everyone has to be looking to the long term as a justification to the valuation they're putting on these deals," said Andy Halliday, Excite's vice president and general manager of the commerce group. "Because of the tremendous future potential of gaining brand equity early in the game, the market value is very high."
News.com's Dawn Kawamoto contributed to this report.