Reinhold Grether on 9 Dec 2000 15:24:37 -0000

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[Nettime-bold] Re: <nettime> Downbeat Mood at Tech Conference

[Get another and deeper glimpse into the actual condition
and future prospects of eCommerce. Read an interview
with Toby Lenk, founder and CEO of eToys, an online
toy retailer, published with The Wall Street Journal. eToys
did one of the most excellent IPO's in NASDAQ history
and was valued a stunning $ 11 billions  in October 1999.]

December 8, 2000
Boss Talk
EToys CEO Toby Lenk Affirms
Faith in Eventual Profitability

After fighting holiday crowds to buy toys for his nieces and nephews, Toby
Lenk launched eToys Inc. in 1997 with the goal of providing parents with a
hassle-free alternative to shopping for kids. A Harvard MBA and former Walt
Disney Co. strategic planner, Mr. Lenk attracted blue chip investors
including Bill Gross from Idealab!, Intel Corp. and Sequoia Capital. He
cherry picked managers from the nation's blue chip companies including Pepsi
Co., Proctor & Gamble, Walt Disney Co., Intuit, Times Mirror Co., Macy's,
and Gateway.

The market adored eToys at first, sending the stock from its IPO price of
$20 in May 1999 to a high of $86 in October that year. The bloom started
coming off the rose last Christmas when the company failed to fulfill some
orders on time. Still, despite competitors that include behemoth Toys "R"
Us, eToys has remained the number one destination for toys in site traffic,
revenue and average order size. The Web site consistently wins top rankings
for ease and effectiveness of use. This summer it was rated first of 50 top
e-commerce sites in overall experience by Resource Marketing.

But with its losses continuing to mount and investors snubbing e-commerce,
eToys stock has plummeted over the past year, raising questions over its
survival. EToys still needs another round of financing next year to see it
through to profitability, projected for 2002. With the stock hovering
precariously just above $1 and the pressures of performing flawlessly this
critical Christmas season bearing down on him, Mr. Lenk recently discussed
life in the eye of the storm.

WSJ: A lot of market pessimists have eToys on a death watch right now. But
you guys are plunging full steam ahead into Christmas, spending
substantially on advertising. So where's the disconnect?

Lenk: Probably ever since we went public you could argue there's been a
disconnect between the public market gyrations and the economic potential of
the company. You could argue it was way too high coming out of the gate,
it's gyrated wildly up and down, and now it's way, way down. As the CEO of
the company I believe passionately in our customer vision and our business
model and all we can do is operate against that as best we can and deal with
the deck of cards we have.

WSJ: Is the market wrong?

Lenk: Well, the market is what it is. Clearly I believe we have a lot of
economic potential and we have the DNA to build a very profitable brand
franchise in the future. But it depends on one's yardstick. We are losing
money and some people would say if you're losing money, you're not worth
anything. Clearly what we are is a bet on economic potential we can create
in the future.

WSJ: Do you think you've responded as quickly to the changes in the
marketplace as you could have?

Lenk: I think most startups over the past two or three years ... have
already failed or will fail because they don't have sufficient ingredients
to build both an economic and a customer model. One example would be
advertising and customer acquisition costs. There were a lot of companies
who wasted a ton of money on advertising. One company [] spent $30
million last year and got $5 million in revenue. Last year we did spend a
lot. We spent $25 million and that drove $107 million in revenue. We've got
to get more efficient in that. But if you look at that comparison, we were
24 times as revenue efficient.

Clearly we believe we got lumped in with the whole shebang. We have really
good core metrics that will give us the building blocks to profitability:
high order size, a product mix that allows us to drive our margins up well
beyond where they've been historically, and a customer acquisition dynamic
that is very strong but also has great potential to get better.

WSJ: Have you just been thrown in with the whole shebang, or is there
something that doesn't work with your model?

Lenk: I clearly, passionately believe our model works, but we need one more
financing to get to break-even. We're just a little bit short of the finish
line. The only thing that doesn't work is I didn't start this two or three
years earlier. Then I'd be profitable by now, I believe.

WSJ: You had more than $100 million in cash going into Christmas and you
just got a $40 million line of credit. Why not pull back and conserve cash
so that you don't need that round of financing next year?

Lenk: The holiday season is when the fish are running. Almost everybody
needs to buy something for children so it's the time of year when you want
to go after a lot of customers. It's not the time of year when you want to
shrink back. It's when you want to get your customer base to the next level.
That also means you have to have your infrastructure capable of handling
that burst as well, so all year long we focused on building a very scaleable
infrastructure and gearing marketing plans to getting a bunch of new
customers. It's the time when you attack, it's not the time when you go on
defense. ... After the holidays we've got to assess how we're going to
finance this thing to the finish line.

WSJ: Even if you have a flawless Christmas, is that going to be enough to
keep you going as an independent company?

Lenk: If I had the perfect crystal ball on that I'd be retired in Tahiti
right now. Right now a perfect Christmas for me is I take care of millions
of kids as flawlessly as possible. That's really what I want to do right
now. And I don't know the answer to your question. I wish I did.

WSJ: You will lose close to $500 million before getting to profitability,
according to some estimates. Could it have been done on a smaller scale?

Lenk: The net fixed assets on the balance sheet for Toys "R" Us are, I
believe, over $5 billion dollars. We have taken the whole [children's]
bookstore inside Borders books, the whole party store inside Party City, all
the videos and music you can get for kids at a record store, the toys you
can get at Toys "R" Us, all the hobby products you can get at a hobby store,
all the baby products at Babies "R" Us and put them in one place where we
can serve the whole country. That costs money. But it costs a fraction of
what it costs to build all those stores and chains I just mentioned. So the
answer is, could you spend a bit less? We probably could have spent a bit
less if the climate were more sane. We could have spent a bit less on
marketing, etc. etc. But you are fundamentally revolutionizing something and
mimicking all those stores where you buy children's products in one place
nationally and you have to expense almost every dollar of it. So if you get
abandoned right before the finish line, it's frustrating.

WSJ: Looking back, what would you have done differently?

Lenk: From a business perspective, one thing I clearly [shouldn't] have done
... was dabbling with outsourcing last holiday season. That's the clearest
thing from my perspective, because it doesn't work as well as maintaining
your operations in house.

[Otherwise] there's not necessarily a lot you really could do differently.
When the speculative frenzy was out there, there was way too much capital
from the venture community funding too many ideas, and too many management
teams. That makes it harder for the good ideas and companies to do their
jobs. ... The way the venture industry used to work broke down. They got
caught up in it too and it was this self-propagating wave that grew and grew
and it wasn't meant to be that big. ... So last holiday season there were 10
people in our space trying to have their piece of the eToys pie and that
made it harder for us.

WSJ: How has the decline in your stock price affected hiring and morale?

Lenk: I'd be lying if I said it didn't have an effect. But I always say if
you're a really bad place to work, it doesn't matter what your stock does,
people don't want to work with you. You have to create a place where people
like to work. They have to feel challenged. To feel part of something they
have to have some belief in what you're trying to do. And I think we have
all that. It makes it easier for us to weather storms than it would be at
some other companies. And the management team is very committed. We've had
no turnover in the senior management team, in fact we've added to it.

WSJ: What's been the low point for you personally this year?

Lenk: This year has been a challenging year in many respects. In many
respects it's a liability to be a public company because of the scrutiny and
the negative climate out there. It's certainly very distracting to the job
we're trying to do. At the same time we've clearly benefited from access to
public capital markets -- so you can't have your cake and eat it too. But
one of the things that's frustrating to me is the debate over e-commerce has
led the stock to be not grounded in fundamental economic potential. ... And
the economics of e-commerce still remain something that people don't write
accurately about. And that's frustrating.

WSJ: So give us a lesson right now. What is misunderstood?

Lenk: It's been clear from day one that the business is all about investing
heavily up front to have national retail distribution and the benefit is
that you get the actual retail distribution at a far lower cost than
building a national network of stores. There's a fundamental difference,
because when you build a store you're allowed to put it on the balance sheet
[as an asset] and you don't have to expense it. And when we're building this
national capability we expense virtually everything and that's why we lose
money right now.

For example if you wanted to build 500 stores [for] a national children's
store network, you'd have to spend billions of dollars. I'm spending a
fraction of that, but I'm expensing it all. If you look at the balance sheet
of retailers, they tend to have billions of dollars of net fixed assets on
them. A lot of brick and mortar guys say, 'We're profitable the first day.'
Well, if you have to expense the cost to build that store, most physical
world retailers are never profitable. We actually believe our path to
profitability has clarified this, but the public markets have abandoned the
model because they just don't care about the fundamental economic potential
of what you're reaching to.

WSJ: Investors worry that even when you get to your break-even levels of
$750 million to $900 million in revenue, your profit margins won't be high
enough and your growth rates won't be sustainable when Wal-mart, Amazon and
others will always be at your heels.

Lenk: Well we do have the ability to achieve different break-even levels.
The reality is you do need certain things in your business model to be
profitable. We do have those certain things. If you just sell mass market
merchandise, you can't make money. You need to have a diversified
merchandise mix, private label, advertising ... We are one of the few
companies that do all that.

WSJ: So you believe your business model works but people don't understand
what you're trying to do?

Lenk: Well it can work. I'm the first to admit that until we break even we
don't deserve to be able to say it works. But we believe it can work and
will work. But the proof is in the pudding and we've got to drive to break
even to do that.

WSJ: For years you said you wanted to remain a pure play Internet retailer
and weren't in favor of the whole bricks and clicks trend. A lot of people
are saying your best bet now is to hook up with a big retailer.

Lenk: For me it all comes down to the consumer. At the No. 2 competitor
behind us,, you no longer can buy online and return it to their
stores. So from a consumer perspective it repudiated the linkage between
brick and click, which I find kind of interesting. From a consumer
perspective there's so much difference between click and brick. There's 10
to 20 times the selection in click than in brick: content and editorial and
suggestions and wish lists. It's such a completely different thing and
there's so little overlap between what we see in brick and what you get in a
click. There's no question that bricks have a lot of money. That's a
financing question. But when you think of the strategy, operations,
software, customer needs and perspectives, where are the overlaps, those are
two very different things.

I'll give you a simple example: the returns to stores. Because we carry 20
times the merchandise of a store, it's very hard for the stores to receive
something that they've never seen before in their systems. Just that little
simple thing makes the whole concept very challenging. Like maybe not
possible without massive shrinkage.

The kids space has got as much channel conflict as you can imagine between
brick and click. The reason is sourcing and the supply chain. There is
fundamental scarcity [of hot products] and you've got to decide, where am I
gonna put my Lego Championship Soccer Challenges? In my store? Or on my Web
site? In the store, they drive so much foot traffic because they're scarce
that you make 10 times the profit by putting them in the store than putting
them in a Web site. So when you put brick and click together you have a
fundamental problem.

WSJ: So you wouldn't consider a combination with a retailer at this point?

Lenk: I'm the chairman and CEO and I have a fiduciary obligation to consider

WSJ: If the market wants profitability yesterday and you guys are losing
money this year and next year, at what point do you have to back off your
original thinking and listen to the market?

Lenk: What you're really asking is: How long can we be an independent
company? If the markets don't want to fund you as an independent company
then the company has to pursue other strategic alternatives. You have to
sell the company or find a partner if you can't continue to fund it as an
independent company.

WSJ: When do you get to that point?

Lenk: It's a decision in many ways made for us. We don't make it. At some
point you lose control over that decision. Certainly if we don't have access
to capital, the decision is made for us.

WSJ: Any lessons you would impart to fellow dot-com CEOs on what you have
learned from the turmoil this year?

Lenk: Pick a vision that works and pursue it relentlessly and passionately
and succeed or die trying.

Write to Lisa Bannon at lisa.bannon@wsj.com1


Toby Lenk's 5 Rules for Weathering the Dot-Com Storm
Invest your time and energy on what you can control - like serving your
customers brilliantly - and forget about what you can't.

Don't hide. Take every opportunity you can to tell your story. Act like
you're in an election campaign. Press the flesh and go door to door if you
have to.

Make internal communications an absolute imperative. Your employees will
follow you if you tell them where you are, where you're headed and how
you're going to get there.

Never lose your sense of humor.

Picture yourself as George Clooney in "The Perfect Storm" No matter how big
the waves get, hold on to the wheel and keep your eyes on the horizon. Also,
hope for a better ending than the movie.

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