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THE DAY AHEAD: eToys ups marketing to prep for toy wars

Surprise, yet another e-tailer is increasing its marketing expenses for the holiday season. This time eToys Inc. (Nasdaq: ETYS) is bumping up marketing expenses by about 30 percent in the December quarter. But look for the market to be a little more forgiving with eToys' binge.

EToys beat estimates with a fiscal second quarter operating loss of 27 cents a share on sales of $13.3 million. Sales were well ahead of analyst expectations, which hovered around $10 million to $11 million.

But marketing expenses will go from an estimated $20 million for the December quarter to nearly $40 million.



eToys: Set to win the toy war?



So why be forgiving of another .com blowing the bottom line on marketing?

EToys is in a jump ball situation in the toy market and the company seems to be the tallest player on the court.

"We believe eToys' hold on the top spot in this category remains its to lose, and in our opinion, the company is well positioned to reassert its leadership position," said Robertson Stephens analyst Lauren Cooks Levitan. "We anticipate getting a steady flow of incremental data indicating that eToys is continuing to produce impressive results."

That early lead doesn't mean the company can't lose. Consider the marketing spending a much needed offensive and defensive move.

EToys has to defend its turf against Amazon.com (Nasdaq: AMZN) among others. Consolidated Stores' KBkids.com will spend $43 million in advertising to gain a foothold. Toysrus.com will be a big player despite its recent fumbles and upstarts such as Toysmart.com and Toytime.com are in the mix. And that field doesn't even include online players Disney (NYSE: DIS) and Wal-Mart (NYSE: WMT).

But eToys is well positioned to win that jump ball. EToys has a quality web site, lots of focus and a marketing pitch that appeals to its audience. It also has deals with Rosie O'Donnell to sell children's books and will be on McDonald's Happy Meal tray liners starting today. And new initiatives such as its Hobby Center and Idea Center have driven both purchases and traffic.

And eToys management seemed to be a little more focused on the bottom line even though profits won't come until 2001 at the earliest.

"We decided that the fish run for us in the holiday period," said Toby Lenk, CEO of eToys, on a conference call with analysts. "We have big ideas but focused ideas."

EToys is just focused on kids and seems to have an edge on the competition. Investors may also like what they hear. Officials said the marketing jump is a reaction to the heavy spending from other .coms, but added that the spending on advertising can't be sustained. EToys also isn't going to carry its higher marketing expenses forward if it can help it.

"Marketing in the near-term future will depend on how we do this quarter," said CFO Steven Schoch. "This doesn't mean they will always go up."

If you read between the lines eToys officials were hinting at what most observers have already put together -- some e-tailers are betting everything on this holiday season and will fail.

As if to show some financial discipline, eToy officials said they won't be subsidizing customers with gift certificates and free shipping. Management will reserve the right to play that game, but isn't planning on it.

Lenk and Schoch also added that they see gross margins holding steady at 19 percent. "There's not anything we see on the downside," said Schoch.

And that's good news for eToys investors.

EToys tinkers with IT

A large part of eToys' spending this quarter went to Oracle (Nasdaq: ORCL) and IBM (NYSE: IBM). The company said it is using Oracle's relational databases and IBM hardware to boost customer service and mine customer data.

It also said it will be rolling out a feedback and filtering mechanism with Net Perceptions (Nasdaq: NETP) technology. The technology will mine feedback from both kids and parents.

With the software in place, eToys can compile wish lists that will recommend toys based on items that are popular with other kids. The spending on information technology infrastructure will continue over the next few quarters.

Other odds and ends: eToys will begin shipping into Canada and said its launch into the United Kingdom has gotten off to a strong start. The company expects another Europe debut early next year and is testing the waters elsewhere. "We have to be comfortable we can make money long term before going in," said Lenk.

Inventory will be up in the fourth quarter so eToys can handle customer orders, but the company said it expects to manage merchandise well given this is its third holiday season.

"We have to be smart, we don't want to buy too much," said Lenk. "But we have to make sure we serve the customer and will err on the side of good selection."

Lenk added that left-over inventory should be able to move in its fiscal fourth quarter.