Etoys Inc

views updated

ETOYS INC.

eToys was established in 1997 to provide a simplified shopping experience for toys and other children's merchandise—one that would eliminate annoyances like the long lines and loud kids found in typical toy stores. At eToys shoppers would not have to contend with packed parking lots and lack of sales support. The company's Web site, eToys.com, launched in October 1997 and let consumers browse for products based on age group and price range. Customers also could access detailed product descriptions, including lists of safety features, which were unavailable to shoppers at toy stores. As eToys founder Edward "Toby" Lenk, former vice president of corporate strategic planning at Walt Disney Co., told Inc., "We take two days of shopping and compress it into 15 minutes. That must be worth something."

For four holiday shopping seasons eToys was indeed worth something. In the end, however, the company ran out of money and had to close its online doors. At the eleventh hour, however, KB Holdings acquired the eToys Web site at a bankruptcy auction in May 2001 for about $3.35 million. Later in that year the eToys Website went live as a unit of KB's subsdiary, KBKids.com. Several factors contributed to its demise, especially the dot.com shakeout of 2000 that severely limited the company's access to capital. Hardly alone in its plummet, several other online toy retailers also went out of business in 2000. Perhaps the final nail in eToys's coffin came when Amazon.com and Toys 'R' Us teamed up to create the number one online Web site for toys, which cut into eToys' holiday revenue at a crucial time in 2000. Nonetheless, as the first online toy retailer, eToys was an important e-commerce player.

EMULATED Amazon.com'S ONLINE MODEL

eToys aimed to emulate Amazon.com, which was launched in 1995, by providing a Web site where customers could search among a large selection of items, order them online, pay by credit card, and receive delivery in a short period of time. In its first year eToys—which was headquartered in Santa Monica, California, and had a nearby warehouse—generated awareness for its site through marketing relationships with America Online and Yahoo!, among others. It established relationships with about 350 toy manufacturers, including all of the major ones, and offered some 8,000 products, some of which were stored in its warehouse. The company's initial financing included more than $10 million that Lenk raised from venture capital firms, former Disney colleagues, and other sources. In March 1998 the company acquired Toys.com, which was operated by Web Magic Inc.

In fall 1998 eToys launched its first national advertising campaign in anticipation of the all-important holiday shopping season. Although competitor Toys 'R' Us had launched its retail Web site in June 1998, analysts noted that Toys 'R' Us appeared to have difficulty developing an online strategy that worked with its traditional retail stores. For example, Toys 'R' Us neglected to establish any marketing partnerships with the major Internet portals, such as America Online and Yahoo!, and offered about half as many items online as eToys. According to Media Metrics, eToys had 3.4 million visitors during the 1998 holiday season, nearly three times that of Toys 'R' Us and the fifth-highest number of visitors for all online shopping destinations that December. As a result, eToys enjoyed fourth quarter revenues of $22.9 million. Sales for fiscal 1999 ending March 30th reached $34 million, third among all Internet retailers behind Amazon.com and barnesandnoble.com.

SPENT HEAVILY TO GAIN CUSTOMERS

At this point—and indeed throughout its four-year history—eToys was not concerned with turning a profit. The company had lost $2.3 million in its first fiscal year ending March 31, 1998, and another $15.3 million in the nine months ending December 31, 1998. Its goal was to acquire customers, and it spent heavily to do so. With venture capital running out, the company turned to the public equity markets and held its initial public offering (IPO) in May 1999. Eight percent of the company was offered to the public. Shares began trading on the NASDAQ on May 20, 1999 at $20 a share, raising $166 million for eToys. The stock rose as high as $85 on the first day of trading and ended the day around $76.50, giving eToys a market value of $7.8 billion, more than the $5.6 billion market value of Toys 'R' Us.

Around this time the company acquired Baby-Center Inc. (which it later sold off at the end of 1999), and outsourced its e-commerce order fulfillment to Fingerhut Companies Inc. Preparing for the 1999 holiday shopping season, eToys increased its stock to 15,000 items, not including children's books. It also carried music, videos, and video games. In July, eToys began selling children's books, offering some 80,000 titles, and its acquisition of BabyCenter expanded the company's demographic to infants and toddlers. Based on its 1998 performance, eToys had become the brand to beat in merchandise for children up to age 12. For 1999 it would face increased competition from Toys 'R' Us, which spun off its Web site as a separate company and planned to invest $80 million in it, as well as from Amazon.com ., which added a toy section in July 1999. Other competitors included KB Toys, a subsidiary of Consolidated Stores Corp., and Wal-Mart Stores Inc., the largest U.S. toy seller, which had plans to overhaul its Web site in time for the 1999 holiday season.

eToys attempted to distinguish itself from its competitors in several ways. One was the depth of its product offerings—15,000 items compared to Toys 'R' Us' 10,000. The company also focused on offering services that its competitors could not match, such as putting personalized gift tags on each item and offering multiple wrappings, a gift registry that parents could protect with a password, a wish-list feature for kids, and a spare parts and repair service for toys. The company also had a compelling product bundling strategy, whereby no item was treated as a single entity. Rather, toys were bundled with books and videos, for example, and customers could select which items they wanted to include in their bundle.

In August 1999 eToys expanded its marketing relationship with America Online by committing to a three-year, $18 million agreement that made eToys the premier retailer of children's products on several AOL channels, including Shop@AOL, AOL Families Channel, AOL.com, Netscape Netcenter, and CompuServe. The company's national print and television advertising campaign, which launched in October, was expected to cost $20 million. eToys also expanded into the United Kingdom for the 1999 holiday season, opening a U.K. Web site in October and stocking some 5,000 items at a British warehouse.

WALL STREET NOT IMPRESSED WITH STRONG HOLIDAY SALES

In January 2000 Business Week reported, "eToys remains the player to beat in this fast-growing field." The company had more customers for the holiday quarter than in its previous two years combined and was the third-most-visited e-commerce site behind Amazon.com and eBay.com. Although eToys's holiday sales for the quarter ending December 31, 1999 more than quadrupled to $107 million, the company reported a quarterly loss of $62.5 million, compared to a loss of $8.2 million for the same quarter in 1998. Responding to the news, Wall Street sent eToys's stock down to around $17 a share at the end of January 2000. eToys attributed its losses to the high cost of fulfilling orders, due mainly to its outsourcing arrangement with Fingerhut. eToys planned to bring its order fulfillment in-house for 2000, opening a new warehouse in Virginia to service the eastern United States and expanding its southern California facility. During the 1999 holiday season eToys also declined to copy its competitors, many of whom offered free shipping, deep price discounts, and coupons worth as much as $10. As a result, eToys enjoyed a healthy gross profit margin of 19 percent. The company's customer service was also able to keep up with the heavy traffic, and eToys did not experience a high level of customer complaints like many other online retailers did that holiday season.

As Wall Street continued to punish tech and e-commerce stocks, eToys's stock price fell to around $6 a share in April 2000. Both Fortune and Los Angeles Business Journal reported that some analysts now thought eToys would have difficulty making it through the next e-Christmas. The company had about $220 million in cash and liquid assets, and in June it raised another $100 million through a direct placement of convertible preferred stock to private equity funds and a group of investors. Analysts felt that eToys needed to raise another $100 million to continue operating until it could turn a profit.

Meanwhile, the rest of the online toy industry was suffering. In May, Walt Disney Co. closed its Toysmart.com site after it was unable to raise additional capital. Other toy sites that closed included ToyTime and Red Rocket, which was backed by Viacom International through its subsidiary Nickelodeon. KBkids.com remained open but cancelled plans for its IPO in June. The early shakeout in the online toy industry was attributed in part to falling stock prices—especially on the Nasdaq, a technology-heavy stock market, distinct from the New York and American Stock Exchanges—and difficulty in raising new capital. Click-and-mortar operations that had both online and physical storefronts were coming into favor at the expense of "pure play" Internet companies. As a result, the largest toy sellers, Toys 'R' Us and Wal-Mart, appeared to be in the strongest market position for the coming holiday season.

HOLIDAY SALES SHORTFALL LED TO OPERATIONS CRISIS

With everything riding on its holiday sales, eToys faced an operations crisis even before December 25 rolled around, when it reported that its holiday sales would be around $120 million to $130 million, well below the projected $210 million to $240 million. That meant the company would run out of operating cash three months sooner than expected and would have to raise new capital by March 31, 2001. Wall Street sent the company's stock below one dollar a share for the first time, giving eToys a market value of just $37 million. The biggest factor affecting eToys's holiday performance was the online joint venture between Amazon.com and Toys 'R' Us, which dominated holiday sales with 123 million visitors during the holiday season, compared with 21.12 million visits to eToys.

From there it was all downhill for eToys, which could not raise capital under those market conditions. In January it shuttered its European operations, and laid off 700 workers the United States, or 70 percent of its workforce. The company also quit delivering to Canada, closed its two distribution centers, and finally announced that it had sent layoff notices to its remaining 293 employees. The company planned to file for Chapter 11 bankruptcy protection and cease operations by April 2001.