E-tailers gain profits by staying conservative

It is not uncommon for Diamond to bump into his company's investment bankers on cross-country flights--only to walk past them in their first-class seats on his way back to coach.

"You have no idea how cheap we are," says Diamond, 32, chief executive of New York-based Alloy Online, which operates teen site Alloy.com.

But Diamond knows his penny-pinching ways have been vindicated by the profits that his company is earning while so many other dot-coms that spent big are now losing big and shutting down.

Diamond points to a few guiding principles that have helped Alloy, just as they have other profitable companies: squeezing nickels, rejecting high-priced marketing schemes, and most notably, building businesses with little or no help from venture capitalists. Companies embracing these tactics have made it through almost a year-long downturn by digging in and satisfying themselves with slower growth and disciplining themselves to spend less than what they took in.

A year ago, that was crazy thinking. Not anymore.

"A popular school of thought exists right now that everything Internet is bad," Forrester Research senior analyst Paul Hagen said. "But some companies will thrive on the Net."

Besides Alloy, other profitable online companies include liquidation specialist Overstock.com, DVD retailer DVDEmpire.com and online car dealership InvoiceDealers.com. These companies have earned profits in the last year while hundreds of well-funded and well-known companies have blown through millions and, out of cash, have shut down.

Stand and deliver
One key to these companies' success was building a business that could support itself from the start. Companies needed to plan on slower growth, careful spending, and relying on word of mouth to acquire new customers.

But that flew in the face of the once-popular thinking that dominated Internet business culture. Most e-commerce companies spent most of their money on acquiring new customers, spending huge sums on advertising campaigns and, in many cases, enticing customers by selling goods at cut-rate prices and often at a loss.

DVDEmpire chief executive Jeff Rix remembers going up against some of the Internet's heaviest hitters, such as Buy.com, Reel.com and Amazon.com. They were spending millions on advertising and slashing prices by a whopping 40 percent to 50 percent.

"I kept telling myself, 'This can't last. Those guys can't keep selling products at a loss. I just have to hold out,'" Rix said.

Rix said he turned down venture capital for his small Warrendale, Pa.-based company because the VCs insisted most of the money be spent on advertising. That was an approach he did not want to take, having the so-called early mover advantage: He had been selling DVDs since 1997, years before they were widely popular.

"We lucked out," he said. "Word spread online because the early adopters were also buying DVDs. We didn't have to pay for advertising because our customers did that for us."

Instead, Rix turned his attention to strengthening ties to his customers by improving delivery, fulfillment and Web site performance. Without adding any snazzy graphics, he refined the site's speed and simplicity.

"It wasn't fluffy," Rix said. "It was a hard-core e-commerce application site. It did the job. Customers come in, find their product and get out. That's really all they want."

Ultimately, Rix was right. The cheap DVD sales at the big Web stores did not last. Reel.com, owned by Hollywood Video and one of the sector's biggest players, laid off its staff and sold its e-commerce operations to Buy.com in June.

In the meantime, DVDEmpire has grown from 12 employees to 49 employees and expects in 2001 to double last year's $15 million in sales. It's been profitable from day one, Rix said.

"One of the happiest days I've spent in business was the day Reel.com got out of the business," Rix said. "I wasn't happy that people lost their jobs, but it did mean that we could compete with anybody."

Watching the bottom line
Most profitable Internet companies say they held on to every penny, "earning two dollars before spending one," according to Greg Baszucki, president of auto-referral site InvoiceDealers.com. The San Diego-based company earns about 12 percent profit a year on $4 million in revenue.

One of the first areas profitable companies cut costs was in their advertising budgets. Most say they paid only for highly targeted advertising where they could get the most bang for their buck.

For Overstock, which reported its first profits in November, that meant placing ads on bus routes that ran near flea markets and outlet stores, according to chief executive Patrick Byrne.

Alloy's Diamond said he spent his advertising money to publish a catalog that was mailed to up to 5 million teenagers a month.

"Instead of going out and spending $5 million on AOL for a spot on their Web site, we went out and plastered our name in the kids' homes. It was vastly more cost-effective," Diamond said.

The companies have also learned to be happy with modest profits. Alloy is expecting to earn 2 cents a share on $35 million in sales for the fourth quarter. Analysts expect the company to earn about $135 million in 2001 and to be profitable for the year. Privately held Overstock, based in Salt Lake City, said it made $100,000 profit on $9 million in sales in November 2000.

Keeping control
Either turning away or not being able to get venture capital turned out to be a blessing for some companies.

At Alloy, advice from potential venture capital firms included dropping the catalog strategy, which turned out to be highly successful.

Overstock's Byrne said the fatal flaw with the business strategies that most venture capital firms promoted was that it would be cheaper to operate Web stores than physical stores.

"They thought it was going to be 20 percent less expensive not paying for a land-based store," Byrne said. "Without the rent or staff it had to be cheaper. But they didn't figure on losing all of that 20 percent savings on shipping costs. They thought the products were magically going to show up on people's doors."

Diamond said his company would probably have gone out of business by now if he had listened to most of the advice from venture capitalists.

"A number of companies that didn't receive venture funding means that they had to do things differently," W.R. Hambrecht analyst Derek Brown said.

"It probably made them wiser businesspeople."