eBay spends to eliminate lengthy outages

eBay is about to flip the switch on a new backup system that should eliminate lengthy site outages--and not a moment too soon for customers and investors.

Within the next few weeks, the leading auction site will complete the installation of a "parallel recovery system" that will limit outages to less than 75 minutes, according to spokesman Kevin Pursglove.

The timing is crucial for eBay, which has recently suffered a series of outages. As with most e-commerce companies, the holidays provide an important--if not necessary--bump in revenues.

Last year, for example, a big jump in auction activity in the December quarter lifted eBay revenues 642 percent compared with the previous year.

But eBay also suffered a series of outages during the period last year. Several outages also have taken place in recent weeks, just as the holiday shopping season gets underway.

eBay has steadily increased the amount of money it is throwing at the outage problem. Although this spending hurt profits in the third quarter, the company risked losing much more if it had ignored the problem.

eBay's gross margin fell to 70.8 percent in the third quarter and has been on the decline since the first quarter when it posted margins of 81.4 percent. The company, however, said it expects margins to bounce back to the mid-80 percent range by next year, as it curtails spending on improving the technology that runs its site.

eBay's new backup system will get its site running within 15 to 75 minutes of an outage, said Pursglove, who would not disclose the cost of the system. The company currently has a backup system that is designed to kick in two to four hours after the site goes down.

Despite the drag on eBay's earnings, Tim Albright, an analyst with Donaldson Lufkin & Jenrette, said the company's strategy makes sense, and he expects the margins to "snap back" next year.

eBay at a glance

HQ: San Jose, California   CEO: Margaret Whitman   Employees: 138   Annual sales: $47.4 million (1998)   Annual income: $2.4 million (1998)   52-week high: 234.00   52-week low: 28.17   Market cap: $17.3 billion More: eBay quotes eBay news Source: Bloomberg

eBay spent $8.8 million on engineering investments to improve its site performance in the third quarter and $10 million in the previous quarter. Pursglove said those investments were far more costly than what the company incurred in the first quarter.

The increased spending follows a major outage in June that lasted about 22 hours. That outage sent its stock in a tailspin. The company lost nearly 26 percent of its value in five days, and the outage cost it upward of $5 million in revenues in the second quarter.

Since then, the company has been hit with a string of smaller outages, the most recent occurring last Tuesday. In total, the outages lasted four hours and spanned three days.

Not just a customer relations nightmare, analysts have been quick to factor in the hit to the bottom line.

"When they had the June outage, I reduced our third- and fourth-quarter numbers significantly," said Derek Brown, an analyst with Volpe Brown Whelan. "I changed our third quarter [earnings per share] to 1 cent from 6 cents and the fourth quarter to 2 cents from 7 cents. This decision was largely related to the amount they would be spending for their infrastructure costs."

And does Pursglove believe Wall Street has taken a hard line with the company's backup system expenditures?

"If you look at the criticism we had in the second quarter, it was that we weren't spending enough in that area," Pursglove said. "We try to make stability and scalability our top priorities. If we do right by our users, Wall Street and analysts will do right by eBay."

Brown, meanwhile, said the revenue loss during an outage is not as great of a concern as the potential for eBay's customers to flock to competitors, such as Amazon or Yahoo.

Pursglove, however, noted that the company has not seen any evidence of large numbers of customers abandoning its site because of the outages. The company's membership and sales continue to grow, he said.

Although eBay's gross merchandise sales remained flat in the third quarter despite a rise in new members, analysts say that new members to any e-commerce site tend to be slow to purchase compared with frequent visitors.

Meanwhile, Donaldson Lufkin & Jenrette's Albright believes it will take several all-day outages to send eBay's customers away.

"You'd have to have a massive and ongoing problem like June-type outages every couple of weeks," Albright said. "eBay is addressing the issue, and they should have their new backup system going any day now."

He added that investors should be more concerned with the results of eBay's recently announced deal with AOL to cobrand four Web sites, which will combine eBay's auction with the navigational aids found on AOL. Also worth noting are the company's efforts to expand overseas, he said.

"The next leg of growth could come from these local roll outs and their international expansion," Albright said.

Despite reports that emerged after the June outage that the problem lied with Sun Microsystems' servers, Pursglove said eBay and Sun were a little premature in their assessment, and that the cause was much more complex.

Sun is expected to remain a seller to the company, he said. "We're happy with Sun and will continue to work with them. But as we expand, we will always keep our options open."

Pursglove noted that it is difficult for eBay to find one vendor that can provide end-to-end solutions for eBay's complex system.