Clicks And Bricks

By Karl Taro Greenfeld

Think of every Baby Tap-A-Tune piano or Makeup Pretty Angelica picked by the yellow-capped pickers, packed by the blue-hatted packers and loaded by the gray-brimmed loaders at this 100,000-sq.-ft. eToys warehouse in Commerce, Calif., as another round fired in the retail-vs.-e-tail battle. Christmas is always war in the toy industry, and nowhere more so this year than online, where pure e-tailers like eToys are for the first time fighting on several fronts.

Attacking from the Internet is Amazon.com the Web superstore that began selling toys this summer and plans to do to eToys what it did to CDnow in the online music business--knock it out of the top spot. Attacking from the street as well as from cyberspace are the classic "bricks-and-mortar" retailers Toys "R" Us and KB Toys, which were written off as Net players after the last holiday season but this year have developed online offshoots.

In the parlance of the Web, Toys "R" Us and KB Toys are "clicks-and-mortar" businesses, combining their retail stores with online versions. Retail observers and investors are watching this holiday season closely for clues as to which type of operation is better positioned to serve customers and make a profit in the 21st century--the eToys model, which operates online only, or the Toys "R" Us version, with which old-fashioned chains are finally forging a Web presence.

Plenty of reasons suggest that e-tail will crush retail. Take selection. There are the infinite miles of infinite shelf space that Amazon's Jeff Bezos loves to cackle about. And there's no need to set up those costly stores, with rent and utility bills due every month and a sales force to handle those pesky customers.

Instead, there is a cyberstore that never closes and is more likely to have what you desire in stock because of that infinite shelf space and the millions of square feet of cheap warehouse real estate in Utah or Nevada. "The pure Internet plays don't have nearly the infrastructure cost that off-line plays do," says Mike May, an analyst at Jupiter Communications, an e-commerce research firm in New York City. "A single point of sale can be used to reach an entire country or the entire world." As Jay Herratti, president of Boo.com North America, a sportswear e-tailer, put it, "We could be global from Day One."

Economists get dizzy thinking about this. It is all so scalable. Add a few servers, a dozen more Web pages, a couple more customer-service reps, run your traffic up another digit, expand into new product lines and sell a hundred thousand more books or CDs or power tools. This kind of growth--Internet gurus like David Wetherell, enthralled by the mathematics of community, call it viral growth--defies conventional valuation and makes the usual measure of retailing--same-store sales, sales per square foot--seem like roman numerals or the abacus, relics of another age.

Certainly, off-line merchants did their best to get rid of us. We've been going to the same malls with the same stores for a generation now, sipping Orange Juliuses as we wade past the Limited on the way to the food court. If you were cool, if you "got it," you shopped online: it was convenient, it was competitively priced, it was fun. Web retailers like Amazon could even engage the intellect, making recommendations and offering a venue for shared literary criticism. When was the last time a salesclerk offered that kind of guidance? "People are more and more fed up with the kind of service they get in the big stores," says Connie Keithahn, an office manager in St. Paul, Minn. "Online it's really amazing how much better the service is." How threatened do mall owners feel? Last month the Saint Louis Galleria briefly ordered its tenant stores to remove advertisements for their online counterparts, arguing that rents were calculated as a percentage of in-store sales.

Given that kind of willing audience, e-tailing start-ups emerged in virtually every "space." There are at least nine sites for pets, 17 for toys, six selling luxury goods and about two dozen peddling computers. Jewelry. Beef. Sex toys. Anything you can buy in the mall--and quite a few things you can't--is available online, shipped to your door within days, if not hours.

Investors clearly think the game is over, rewarding pure-play e-tailers with market capitalizations that dwarf their off-line competitors--Amazon's $32 billion, vs. Sears' and K Mart's combined $17 billion; eToys' $4.5 billion, vs. Toys "R" Us' $3.6 billion; and, even more amazing, airline-ticket broker Priceline.com's $8.3 billion, vs. the combined $8.6 billion market cap of Continental Airlines, US Airways and United Airlines.

All of this may persuade you that old-fashioned commerce is as dead as disco. Unless, of course, you've been to a mall lately, where the parking lot is packed and you can spend a vacation day in line to pay for a shirt. Malls still offer plenty of advantages. You can touch, compare and try on the merchandise--important for items like shoes. And, of course, you can buy it today. We still love instant gratification.

The counterattack is well under way and gathering momentum. Traditional merchants have taken heart from, of all places, Charles Schwab, which has broken down the walls between its off-line brokerage business (with 335 retail locations) and Schwab.com its online business. Schwab had to be spry enough to devise cross-channel pricing for stock trades; allow account access via the Web, telephone and in person; and create advertising that speaks to the Web savvy as well as the Net illiterate. The result: over the past two years, Schwab has emerged as the best-positioned retail brokerage, with more than $628 billion in customer assets ($264 billion of which is managed online), vs. $23 billion and $29 billion for Web-only brokers Ameritrade and Etrade.

Now that Schwab has proved that the clicks-and-mortar strategy works, this Christmas season we are seeing that Schwab may be the precursor rather than the exception. Robert Kenzer, CEO of Kenzer Corp., a retail executive-search firm, says retailers will have to do online, off-line and catalog in order to survive "or have strategic alliances that permit them to do all three." Companies such as Circuit City and eToys' competitors KB Toys and Toys "R" Us are proving they're not out of the game. "Clicks-and-mortar has a lot of inherent advantages," says Seema Williams, e-commerce analyst at Forrester Research. "For one thing, an existing, powerful brand presence. It's going to be awful tough for an online retailer to maintain its lead once the clicks-and-mortar people get their act together."

Initially, companies with powerful off-line brands had a difficult time overcoming the notion that they would be cannibalizing their core business if they sold through the Web. But as it became clear that e-commerce was a viable and complementary retail channel--albeit one that requires a new skill set--the big off-line players gradually came around to embracing it.

Toys "R" Us was at first regarded as an industry joke, its website plagued by overcrowding and inadequate order fulfillment. KBkids.com didn't even exist last year. The space belonged to eToys, the first online retailer to design a truly kid-friendly toy site. Kids could create electronic wish lists, gifts came wrapped, batteries came included. "I saw immediately that here was a channel that could revolutionize how you serve the toy market," says eToys CEO Toby Lenk.

Lenk, who started eToys in 1996, pioneered a tricky business. No one else was selling toys online at the volume Lenk envisioned. "There's nothing that's easy," Lenk says. "The details are really hard." Everything--the software, the shipping procedures, the wrapping system--had to be invented on the fly, including the ingenious idea of streamlining the warehouse process by having pickers, packers, loaders, replenishers and order processors all wear different-colored hats. Lenk discovered the hard way that e-businesses couldn't simply duplicate existing retail operations, such as catalog companies, online. "You can't take the mail-order model and plug and play here. For example, we need real-time inventory control. We need the website integrated with the back end, so a customer knows if we have an item or not."

For the off-line toy retailers, that kind of problem solving was intimidating enough to keep them on the sidelines during the holiday season, caroling that the Web was just a passing phase. As late as last year, Robert Nakasone, then Toys "R" Us CEO, was more eager to talk about store redesign than Web strategy. Toys "R" Us has had problems with its stores too.

But last Christmas, eToys proved you could sell Barbies and Brio trains on the Web, doing $20 million in sales and capturing more than 50% of the online toy biz. So this year off-line players had no choice but to go cyber and--surprise, surprise--they've been up to the task. Toys "R" Us, the bumbling, old-economy slow mover, has in the past two quarters come on like light sabers in the toy space, setting up a subsidiary, Toysrus.com and prepping that company to go public sometime next year.

This is not the Toys "R" Us of dingy stores, clogged inventory channels and checkout lines extending back to the diaper section. This is a sleek e-commerce start-up staffed by twentysomethings packing the same sort of techno-firepower as their feverish fellow travelers over at Amazon or eToys. They're here to change the world. New CEO John Barbour, 40, a chunky, jovial Scotsman who came over from Hasbro, may not be an old Net hand, but he certainly comes across as agile enough to play with the Web boys.

The two-pronged Toys "R" Us has several potential advantages over the e-gang. "Look, the pure plays certainly understand and leverage the Net faster and better than the bricks-and-mortar guys," says Barbour, who made his name at Hasbro with the Koosh ball, a plush ball toy. "But customers are finding they like the convenience of being able to walk down to the local Toys "R" Us and exchange a toy." Most toys are gift purchases--an aunt buying a Furby for a faraway nephew, a grandmother choosing from a confusing array of Pokemania for her grandkids--and there is a high likelihood of the wrong pick. "If you're a kid, what do you want to do? Pack a box and stand in line at the post office or go down to Toys "R" Us and pick out a new toy?" asks Barbour. As a father, Barbour knows what's mission critical here--a new toy ASAP.

Barbour is convinced that online toy space, like off-line, is more about having the hot toys than about having every toy. That's where a big brother can come in handy. With the buying muscle of the conventional Toys "R" Us behind it, cyber sibling Toysrus.com stands a better chance of "coaxing" a few extra pallets of hot toys like Harley-Davidson Barbies from the manufacturer.

Although Toys "R" Us is now two companies, customers expect a seamless relationship, and this has forced some adjustments. Barbour had to persuade store managers to take returned items bought on the Web and even to direct customers to the Web for items not in the store. Toysrus.com has set up a separate fulfillment arm at a 500,000-sq.-ft. warehouse in Memphis, Tenn., to handle online orders.

At the corporate level, the company had to offer off-line execs a share of the beefy stock options being extended to the hotshot managers of the Toysrus.com spin-off. It's expensive, but setting Toysrus.com up as a potential public offering allowed Barbour to lure the kind of top-tier Net employees who work for equity, not just salary.

While eToys remains the most efficient seller in this space, Toys "R" Us is closing the gap and has already proved to be a winner with shoppers, attracting more visitors than eToys during the last three weeks of November, according to Net-tracking firm Media Metrix. The site had its share of bugs, however. A tenfold increase in traffic following the release of its annual Big Book catalog crippled the site for several days. (The company says it has since added servers to increase transaction capacity.) Nonetheless, Toys "R" Us and fellow clicks-and-mortar player KB Toys are putting enough shoulder behind their online brands to make them e-players.

One year ago, the wisdom went, a bricks-and-mortar retailer couldn't afford not to be online. Today the case can be made that an online retailer might be well served by a multichannel approach that includes actual, physical stores. Retailers, like Williams-Sonoma, that have gone virtual are finding that old-fashioned stores are an efficient advertising medium. "Storefronts are as much a branding vehicle and advertising tool as billboards," says Bonnie Kramer Tonneson, an analyst at Hambrecht & Quist.

The "big box" retailers are on the move too. Last week discounter K Mart cast a wider net to snare online customers, teaming with Yahoo to launch a free Internet service and e-commerce site called BlueLight.com Wal-Mart announced a similar partnership with America Online (see following story). Also, Microsoft and Best Buy last week announced a deal to promote each other's Web offerings--MSN Internet service from Best Buy stores, BestBuy.com from MSN's Web pages. Home Depot will start selling lumber and cement from its website next spring, using local stores to fill online orders--a strategy, Tonneson says, that will give customers the most flexibility. The downside: rollout will be market by market, so it could be years before the company is a national e-tailer.

It sounds tediously old economy--very pre-Internet--but when it comes to building brand awareness, it's tough to beat the plain old walk-in store. "We're still a nation of tire kickers," says International Council of Shopping Centers spokesman Malachy Kavanagh. For every $1 spent online, $37 is spent off. That ratio is changing quickly, but where would you rather be today? Off-line shopping generally is having a banner year, with forecasters predicting a record shopping season: $184 billion in total consumer spending during the last two months of the year, an estimated 6.5% increase over the same period last year.

At least one e-tailer has cashed in on this off-line gold rush. CEO Soon-Chart Yu of health-products site Gazoontite.com--he calls it the "breathe happy" site--has opened an actual shop in San Francisco to sell blankets, air purifiers and other products for asthma and allergy sufferers. Yu says having a bricks-and-mortar location lowers the website's customer-acquisition cost to one-fifth of what it costs virtually. Television and billboard ads are expensive. With a store, a customer walks in and acquires himself. Yu may be the first Internet entrepreneur to discover the sidewalk; if his experience is any indication, he won't be the last.

There is one confusing by-product of the off-line store. "When we were planning it, we hoped it would break even," Yu recalls. "But it's actually profitable." Yu may have discovered the secret to steering his e-commerce company into the black: build a store.

--With reporting by Maryanne Murray Buechner/New York and Marc Hequet/St. Paul

With reporting by Maryanne Murray Buechner/New York and Marc Hequet/St. Paul