Net firms locked in costly marketing race

Investors and the companies have rationalized the spending spree by claiming that once these Net firms become household names they will be able to cut their marketing budgets, immediately giving a boost to the bottom line.

But is it realistic for these companies to dream of such a day? After all, if a company such as E*Trade turns down the marketing machine from a roar to a whisper, what's to keep a new or current competitor from stepping into the void and stealing business?

The question is becoming more pertinent as Net companies appear to be locked in an arms race of ever-escalating ad campaigns.

As scores of Internet companies release their third-quarter results this week, nearly every one is posting a loss. Nothing new there. However, the reports show another trend: Most Net companies are spending a sizable chunk of change on marketing and advertising costs.

By the numbers
Internet companies spent $431 million on non-Internet advertising in the second quarter, about 36 percent more than the $315.8 million spent in the first quarter, according to Felice Arden, a spokeswoman for Competitive Media Reporting in San Francisco.

Online brokerages, publishing, and media firms helped to fuel the rise in the second quarter, she added.

Meanwhile, brands that contributed the most to the spending in the first half of the year were E*Trade at $73 million, followed by Value America Store at $37.7 million, and Charles Schwab at $33.6 million.

Some recent examples, gleaned from company earnings reports or anecdotal evidence, show the trend continued or picked up steam in the third quarter and will spill over into the current quarter:

• Discount broker TD Waterhouse Group plans to spend up to $100 million in advertising to build its brand.

• CNET, the publisher of News.com, undertook a $100 million advertising campaign that turned the profitable company into a loss-maker. The San Francisco company today reported losing 32 cents per share for the third quarter.

• EarthLink Network more than tripled its marketing costs in the third quarter.

• Internet service provider MindSpring plans to spend $90 million on marketing over the next year and posted a third-quarter loss of $10.8 million.

• E*Trade is looking for new customers by holding a contest: The person who correctly guesses the closing number for the Dow on December 31 wins $1 million.

• Tech companies that have little direct connection with consumers also are spending big to promote their Web sites. Mass transit riders in the San Francisco Bay Area this week could look at billboards promoting SAP while reading in the morning paper how the company's profits plunged by 64 percent last quarter. (The German company makes business software.)

• Countless Net firms are offering "loss-leaders," such as selling DVD movies for less than $7 or tossing in free shipping with every order. In many cases, these marketing campaigns sap all hope of posting a profit, at least in the short term.

For example, online brokers Ameritrade and E*Trade could be profitable if they cut back on some of these expenses, noted Tom Carter, an e-commerce analyst with U.S. Bancorp Piper Jaffray.

Bruising the bottom line
"Amazon and eBay can start to cut their spending as a percentage of sales by 2001," concurred Alan Mak, an analyst with Argus Research. "The reason is that they will have a substantial lead over their competitors and will have solidified their brand in the mind of the consumers, so they don't have to overwhelm you with advertising."

He added that these companies can then scale back their splash-your-name-everywhere campaigns to a more moderate level--similar to a tactic used by Coca-Cola.

"Everyone knows what Coke is, but they still need to advertise to keep their name fresh," Mak said.

"Our advertising and marketing budget is modest," said Kevin Pursglove, an eBay spokesman. The company, however, does not break out its advertising and marketing figures.

eBay spends a small amount of funds on radio, newspaper, and banner advertisements, while a larger portion is spent on collector trade shows, Pursglove said.

And as competition heats up in the auction space, Pursglove said the company will likely increase its ad spending.

"We are aware of significant players that have moved into the auction space in the past year and we expect others will come as well," he said. "We will probably continue to nudge up our advertising and marketing spending as circumstances warrant it."

Michael Sievert, E*Trade's vice president of marketing, said his company considers advertising costs to be a strategic investment, not simply an expense.

He noted that although the company spent nearly $350 for every new account in the latest quarter, the value of those new customers far exceeds outlay.

Last quarter, E*Trade actually lowered its marketing and advertising spending to about $65 million from its earlier indications projections of $80 million, said Carter of Piper Jaffray.

Sievert said his company pulled back last quarter because the summer is seasonally slow and it made more economic sense to reduce spending for the three-month period because the company did not anticipate losing momentum.

In sizing up the profitability picture, Sievert said the company would be "highly profitable" if it didn't spend a dime on marketing and advertising.

He declined to speculate on whether the day will come when the company can slash its advertising and marketing costs, given that competitors are entering the business seemingly daily. Morgan Stanley Dean Witter, the second-largest U.S. securities firm by number of brokers, today began allowing all of its 4 million customers to trade stocks and bonds over the Internet.

"It's tough to predict the future, especially in this category. This company is on a growth strategy. We'll spend the money where appropriate," Sievert said.

What investors want
Investors are demanding two things from the money allocated for marketing and advertising, Carter said.

They want companies to show a return for the money spent on the advertising and marketing with increased sales and customer accounts, and they would want the industry-wide customer base to level off before a pulling back on advertising expenses, he added. In other words, as long as the market is growing, companies should spend what's necessary to grab their piece.

"There is no cheaper time than now to acquire new accounts," Carter said.

Once companies have developed a brand name, their marketing efforts can shift to targeted advertising--a more appropriate method for the long-term strategy, said John Segrich, an analyst with CIBC World Markets.

He added that the money spent on advertising and marketing in the Internet space is likely larger than that seen in other industries.

"Advertising and marketing for this industry may be more than others since this is a new industry, a well-funded industry, and one where the companies taken public tend to be at an earlier stage compared to other industries, where they may be more mature and had gotten further in developing a brand name," Segrich said.