December 26, 2000, 9:55 AM

If you can`t stand the heat, open an incubator

Cybershop helped lead the charge into Internet retailing. With its closing and rebirth as an Internet incubator, observers say the company is leading the charge out. “A lot of companies will be going dark or merging,” says Ernst & Young retail analyst Pam Stubing, “while others are changing the way they do business.” In almost every category-from books and CDs to electronics, cosmetics and pet supplies-the e-retail space is crammed with contenders.

Executives of Cybershop, which sold electronics, home furnishings and apparel, opted to change the business-radically. They funneled $8 million in funding obtained last fall into the launch of an Web incubator called Grove Street Ventures.

But shareholders were blindsided by the shutdown, apparently believing they were riding a wave of e-retailing success. Weeks before the strategy switch was announced, the company reported that revenue jumped 458% in the third quarter of 1999, compared to a year earlier. What they didn’t disclose until later was that the gains came from a joint venture and an acquisition, while sales in the core retail unit plunged 28%. Meanwhile, losses had widened considerably.

Initially, news of the strategic reversal caused Cybershop shares to jump as high as $14, before sliding back under $4. At the high, executives sold nearly $8 million worth of stock. The sell-off led shareholders to filed suit alleging the company violated federal securities law with the belated disclosures.

However and whenever the dispute is resolved, the incubator business may represent an effective “escape hatch,” from the cutthroat competition in electronics, says Tom Sawyer, senior analyst at Forrester Research. “They were smart to get out and work with other assets.”

In the face of a category-by-category shakeout, analysts expect other retailers to begin changing their businesses dramatically this year. Already, computer hardware and software e-retailer Beyond.com has shifted its emphasis from consumer sales to the business-to-business and government markets, in hopes of reversing a plunge in revenue last year.

Analysts aren’t speculating-on the record, at least-which online retailers they expect to see merging or going out of business. Every online category is ripe for consolidation, they say. At the same time, Net companies are nimble by nature-as Cybershop’s reincarnation shows. “E-retailers are learning from everything that happened with the Christmas season,” adds Mark Gambale, electronics analyst in the Chicago office of Gomez Advisors. “If they started out with a bad business model, they can easily adjust that and continue competing.”

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