Net retailers shake hands with big brands for survival

That is the message industry experts are drawing from Amazon.com's deal with Toys "R" Us, which the companies announced last week. Although earlier pairings of online and offline companies have often ended in failure, analysts say the Amazon deal could start a new wave of partnerships, as pure-play e-tailers seek to draw on the strengths of their brick-and-mortar rivals.

That strength is largely derived from physical stores. Once seen as an Achilles' heel because of the expense, a network of storefronts is now seen as a positive, because it provides brand recognition and eases customer concerns about returns.

"There's a new business landscape, a new digital business environment," said Evan Schwartz, author of the book "Digital Darwinism," who added that both types of e-tailers are trying to adapt. "They both have to meet in the middle somewhere. This is the beginning of it."

The Amazon-Toys "R" Us deal comes as the market for e-tail stocks has been crushed under the weight of investor skepticism. With their stocks hovering near 52-week lows, many e-tailers have struggled to find financing to continue operations while they await profits.

The latest victim of the bear market for e-tailers was Value America, which closed its retail operation and filed for Chapter 11 bankruptcy protection last week. Value America's demise follows the death of such e-tailers as Toysmart.com, Boo.com and Reel.com.

Asserting themselves
Meanwhile, as pure-play e-tailers fade in the limelight, brick-and-mortar companies have begun to assert themselves online.

A recent survey by PC Data Online, for instance, indicated that JCPenney.com and Sears.com ranked among the top 10 e-tailers in July in terms of the number of buyers. In addition, Spiegel.com, VictoriasSecret.com, BestBuy.com and Staples.com were listed among the top 20. Except for VictoriasSecret.com, all of the brick-and-mortar affiliates ranked higher than they did in June.

Although many of these companies moved online slowly, if not reluctantly, they have a significant advantage over many of their e-tail rivals: well-known brands. Despite spending hundreds of millions on marketing campaigns during the past couple of years, most dot-coms have not been able to build anywhere near the name recognition of traditional companies.

"When (consumers) start to shop online they start with brands that they've heard of offline," Forrester Research e-commerce analyst Seema Williams said. "Online retailers have tried to catch up on the branding front, but no matter how much they spend every holiday season, they aren't going to catch up with retailers that have been out there for 10, 50, 100 years."

But the brick-and-mortar companies have more than well-known brands. They have advantages including physical outlets in most large cities--which can help ease consumer concerns about just who they are dealing with--and years of expertise in managing inventory.

Although Toys "R" Us ceded much of its online operation to Amazon, Amazon acknowledged that it needed help with managing its toy inventory. The e-commerce giant took a $39 million inventory-related charge in the fourth quarter last year on its toys and electronics products.

As part of Amazon's arrangement with Toys "R" Us, the toy giant will buy and own most of the inventory sold in their co-branded store and will be responsible for predicting toy fads and securing a sufficient supply of those toys to satisfy online shoppers.

"They were years from developing our e-commerce expertise," Amazon spokesman Bill Curry said. "We were years from developing their toy expertise. They have some incredible strengths in merchandising. This makes each store more profitable sooner than it otherwise would have been."

Better wholesale prices
Giant brick-and-mortar companies such as Toys "R" Us also have a significant advantage in pricing over their online competitors. Because they represent such a large share of the market, they can often negotiate much better wholesale prices than their online competitors.

Where a store like Wal-Mart can offer low prices on goods and still turn a profit, e-tailers from Pets.com to Buy.com to Drugstore.com have posted negative top-line margins, meaning that the cost of the goods they sold in a particular quarter was greater than what they received for the items.

Another big advantage for the brick-and-mortar stores: their physical presence. Many traditional companies offer customers the convenience of returning a product to a physical store, rather than having to pack and ship it back to an online retailer.

Michael Wagner, chief operating officer at KBkids.com, said the majority of the online store's returns are made through its KB Toys stores. "We offer the convenience of being in both places," Wagner said.

Offline stores' physical presence also helps drive traffic to their online stores in ways their online competitors cannot match. "You drive by a Kmart, a Wal-Mart or Toys 'R' Us every day, and that counts a lot to reminding you to shop at those stores," Forrester's Williams said. "You never drive past an eToys store."

Despite their inherent advantages, the offline companies have often struggled online. Many were slow to recognize the Internet opportunity and to invest in it.

Barnes & Noble was the first among many to lose market share to an online competitor. And that company's spinoff, Barnesandnoble.com, has continued to struggle to gain traction against Amazon, recently posting a slowdown in sales and far greater than expected losses.

E-tail troubles
Toys "R" Us, too, has had numerous problems with its online operation. Last year, Toysrus.com lost its designated chief executive, saw a highly touted deal with Benchmark Capital fall through, experienced a series of site slowdowns following a holiday catalog mailing, and had troubles shipping holiday orders on time, which led to a class-action suit.

But for Toys "R" Us and other traditional retailers, teaming with an offline player is no guarantee of success. Already, the hybrid model has produced a number of spectacular failures.

Hollywood Entertainment's 1998 acquisition of online video store Reel.com, for instance, ended in disaster as Reel.com laid off its entire staff in June and turned over its e-commerce operation to Buy.com.

In May, Toysmart ceased operations, just nine months after Disney bought a controlling stake in the online toy company. Toysmart has since been at the center of a legal storm over the proposed sale of its customer list.