eToys, Inc.

views updated

eToys, Inc.

2850 Ocean Park Boulevard, Suite 225
Santa Monica, California 90405
U.S.A.
Telephone: (310) 664-8100
Fax: (310) 663-8101
Web site: http://www.etoys.com

Public Company
Incorporated: 1997
Employees: 1,000
Sales: $151 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: ETYS
NAIC: 45112 Hobby, Toy, and Game Shops; 45411
Electronic Shopping and Mail-Order Houses

eToys Inc. is a leading on-line retailer of children’s products. Its emphasis is toys, but it aims to sell parents a vast array of things that their children might want or need. Its entire product line comprises more than 100,000 stock-keeping units of products such as children’s books, videos, music, and software, as well as toys. Its broad range of toy products includes such mass-market items as Barbie dolls, as well as less-well-known items for more specialized tastes. In total, eToys carries over 750 brands. eToys’ goods are sold exclusively on the Internet. Its web site catalogs its vast holdings, and shoppers can use the site’s advanced search capabilities to find items by a variety of strategies. For example, consumers can search eToys for toys of a specific color, or ask for suggestions for products designed for children of a particular age. The site regularly lists updated suggestions of Bestsellers, Birthday Gifts Made Easy, Favorites by Age, and 200 under $20. The eToys site also allows shoppers to sign up for a birthday reminder service. The company notifies shoppers by e-mail three weeks in advance of a child’s birthday, and appends a list of gifts appropriate for that age. The site also provides a Wish List service. Children or their parents can use it to e-mail friends and family members lists of the gifts they most hope for. Children can also visit the eToys web site to play computer games, through the site’s Play@eToys service. Other web site features offer tips, advice, and product ideas to parents.

Besides the company’s headquarters in Santa Monica, California, eToys maintains regional headquarters in San Francisco; Danville, Virginia; and London, England. It ships goods out of one east coast and one west coast warehouse. eToys operates a related web site, etoys.co.uk, to offer its goods and services to customers in the United Kingdom.

Disney Executive Turns to Internet Toy Sales

eToys Inc. was founded by Edward C. Lenk, known as Toby. Lenk was born in Boston in 1961 and graduated with a degree in economics from Bowdoin College, Maine, in 1983. From Bowdoin he went to Harvard Business School, where he earned his MBA in 1987. Lenk held a variety of positions in the 1980s. He worked in Washington as a health policy researcher and later was a consultant for a firm called LEK Partnership. In 1991 he joined Walt Disney, where he became vice president for strategic planning, overseeing growth of Disney’s theme parks. Lenk’s career at Disney lasted only five years. By the summer of 1996, Lenk was bored with climbing the corporate ladder. He quit to go into business for himself. He wanted to get in on the Internet craze, but wasn’t sure what kind of business he wanted to start. Then, while Christmas shopping for his niece and nephew, it occurred to Lenk that the hectic pace and desperate atmosphere of the late December toy store was something the world might very well do without. He decided to create a virtual toy store. His first proposal to investors was for a web site that would sell high-priced toys to wealthy consumers. This idea failed to get backing, and Lenk thought about ways to refine his plan. He came back with a proposal to outdo traditional toy stores by offering a huge selection on-line, of everything from mass-market toys to the kind of fancy, high-priced toys he had first considered.

No one else yet had a toy store on-line. Being first to the market is always considered a business advantage, and investors began shoving money at Lenk. He collected over $15 million from the venture capital firm Sequoia and other venture capital firms, plus $250,000 in seed capital from a web business incu-bator called Idealab. He raised money from friends at Disney as well. eToys seemed to be in the position Amazon.com had been in when it became the first on-line bookstore. Lenk was sure that the giant mass-market toy retailer Toys ‘R’ Us would soon start its own web site, and he rushed to get eToys going before that happened. In March 1997, eToys went on line.

Getting the site going was very expensive. Merely putting the site up on the web would not guarantee customers, so Lenk spent $3 million to become a so-called anchor tenant of America Online (AOL). This gave eToys a promotional space on AOL’s portal for two years. He signed a similar deal with another popular Internet portal, Yahoo! He enlisted 5,000 other web sites to spread the eToys name, offering a 25 percent commission on sales to any site that referred customers. He stocked his California warehouse with goods from more than 350 different manufacturers.

eToys expected competition from Toys ‘R’ Us, but in fact that company waited almost a year before it began offering goods on-line. In the meantime, eToys faced competition in cyberspace from the bookseller Amazon.com. Amazon had basically pioneered web-based retailing, building the business model others strove to emulate. After its first success with books, it began branching into other areas, including toys and music. In October 1998, eToys formed a marketing partnership with three other web retailers to promote each other’s sites. The other members of the group were CD-Now, Reel.com, and Cyberian Outpost. By promoting each other’s sites and sharing customer lists, the four hoped to counter some of the impact of Amazon’s dominance.

eToys ran through its cash quickly. It ended its first fiscal year $2.3 million in debt. Losses were even steeper the next year, yet the firm continued to attract investors. By 1998 it had raised approximately $2 billion, although eToys was admittedly far from turning a profit. Investors seemed to excuse the company’s poor finances, because eToys was building a market for itself. The toy industry in total had sales of $22 billion a year, and eToys was the first to take aim at this huge market from the Internet. Estimated total revenues from on-line toy sales across the industry for 1998 were only $40 million, far less than consumers were spending on books, music, and entertainment ($1,300 million), apparel ($300 million), food and wine ($200 million) or even on-line car sales ($70 million). Yet the growth rate from 1997 was more than 300 percent for toys, higher than almost all other categories tracked, according to a survey in Fortune published February 1, 1999.

1998’s e-Christmas

Christmas 1998 was the first time the Internet was a significant force in the yearly American shopping ritual. eToys prepared by spending even more money on advertising, using print and television ads for the first time. Its advertising campaign featured the tag line: “We bring the toy store to you,” hoping to emphasize the convenience of at-home shopping versus the crowded scramble at the mall. The most popular toy of the year was a talking creature called the Furby, which shortsighted retailers had underpurchased for the season, creating a wide demand. eToys held on-line sweepstakes to give away free Furbies, attracting thousands of potential customers. The company also made every effort to keep customers satisfied. It offered free upgrades from regular to express shipping for some, and gave out $5 coupons to mollify customers whose desired goods were out of stock. Operating out of a single warehouse near the Los Angeles airport, eToys shipped out 95 percent of its Christmas orders within 24 hours. The massive warehouse employed hundreds of people to pick, pack, check, and wrap orders. Sales for the fourth quarter of 1998 soared to more than 20 times that of 1997, and overall some 3.4 million people visited the eToys site. eToys surpassed the Toys ‘R’ Us site easily. The Toys ‘R’ Us web site drew few customers, and it was only able to offer half the merchandise that eToys had.

Initial Public Offering in 1999

With this successful Christmas behind it, eToys decided to go public. Its IPO was first valued at $115 million and underwritten by the venerable investment firms Goldman, Sachs & Co., Merrill Lynch, and others. The company cheerfully hoped to raise money by the sale, even as it advised that operating losses and negative cash flow were likely to continue. The IPO was first announced in March, but it was delayed when eToys decided to purchase a company that marketed goods for babies, Baby Center Inc. BabyCenter’s stockholders ended up with about a 15 percent share of the merged companies, and the IPO was put off so this deal could be cemented. The public offering finally took place at the end of May 1999. The results were astonishing. The stock began at $20 a share, and by the end of the first day, it had risen to $77. The company, which had consistently lost money and had revenues at that point of only $30 million, ended up worth on paper $7.7 billion. This made it worth over 30 percent more than Toys ‘R’ Us, although that company was a profitable national chain with annual sales of over $11 billion.

With the enormously successful public offering behind it, eToys began to prepare for increasing competition. This came from two directions. eToys had always had an eye on Toys ‘R’ Us, expecting that company to rush to the web and do on-line what it already did in its nationwide stores. However, the Toys ‘R’ Us web site had proved disappointing, and it did not do well over the 1998 Christmas toy season. In April 1999 Toys ‘R’ Us relaunched its web site. It spun its Internet operations off as a separate company and announced plans to invest $80 million in it. Meanwhile, Amazon.com also put the pressure on eToys. In July 1999 it opened a whole new toy section on its web site. With its huge customer base of an estimated 10 million people, Amazon’s CEO believed his company was already the top marketer of children’s goods on-line. Amazon had leveraged its name recognition and customer base to become the leading music and video seller on-line, squeezing out sites like CD-Now. It seemed possible that it could do the same thing with toys.

Company Perspectives:

eToys’ vision is to create the premier family-oriented destination on the Internet.

A Place for Kids’ Stuff

eToys believed it could match Amazon by presenting itself not so much as a toy store as a place for kids’ stuff. That meant it would sell maternity wear and strollers (through its BabyCenter affiliation), books, toys, and perhaps sporting goods, so that parents could go to the site looking for anything their kids might need. By September 1999 eToys had announced that it had 80,000 children’s book titles available for sale through its site. It hyped its new bookstore by arranging on-line interviews with notable children’s authors, and it made sample pages of some 400 books available for on-line browsing. Then it teamed up with television talk show hostess Rosie O’Donnell. O’Donnell began a “Rosie’s Readers” children’s book club on her show, and eToys tied in with her with a special “Rosie’s Readers” portion of its web site. Part of the proceeds of eToys’ Rosie’s Readers sales went to O’Donnell’s charitable foundation.

To prepare for the Christmas season, eToys began running advertising on television and in parenting magazines. The ads differed from its previous year’s campaign, which had empha-sized the convenience of on-line shopping versus going out to the toy store. The 1999 ads tried to portray the company as uniquely able to help parents meet the needs of children. One ad showed a mother looking at fish in a rock pool with her son. Next the mother was shown typing “fish” into eToys’ web site. The tag line ran, “Where will you find the perfect gift for your child? EToys. Where great ideas come to you.” The campaign cost eToys $20 million, which represented a significant portion of the company’s total revenues. The soft tone of the advertising sought to convey a new, broader image of the company. eToys was not just another place to shop for toys, but a parent’s ally in finding the best for a child.

Also to prepare for Christmas, eToys outsourced some of its order fulfillment to Fingerhut, a catalog company that had built a new business niche for itself helping out fledgling on-line retailers. Sales for the holiday season burgeoned, rising 366 percent over 1998’s figures. And 99 percent of the company’s orders were fulfilled on time. But this left one percent, or thousands of individual orders, arriving after Christmas. eToys blamed Fingerhut, though Fingerhut denied that its warehouse had been the problem. The company’s stock, which had actually started to fall in November, plummeted after December. Shares that had sold for as much as $86 fell to $5 before beginning to inch back up.

Although the company had done nothing but lose money since its inception, only now did investors seem troubled by that. The costs of running an on-line business had not fallen enough to allow eToys to make more money than it had to spend. CEO Lenk was sure the company would be profitable by 2003, when he predicted the business would reach a big enough market to take advantage of some economies of scale. In the meantime, eToys continued to spend money. It built two new warehouses, giving it an east coast as well as a west coast presence for the first time. And to run its warehouses, the company hired the former logistics manager from the computer dealer Gateway. eToys also searched for ways to use its customer lists to find consumers who would go for more of its higher margin toys. And the company put out a private label eToys line of toys ready for Christmas 2000. These goods promised the company a profit margin of close to 75 percent.

Although investor confidence in so-called dot-corn companies had fallen dramatically since eToys’ IPO, the company had no intention of trying to move off the Internet in any way, such as partnering with a traditional bricks-and-mortar retailer. Lenk’s experience at Disney had shown him that the proper family-friendly attitude could keep loyal customers for years. He hoped to make his company’s web site into a similar family-focused area, offering comprehensive service and goods that no other retailer could match. Though the high costs of running an on-line business seemed formidable, Lenk was sure he had a quality product. He believed it would take only a few more years before eToys fulfilled its promise.