December 26, 2000, 9:55 AM

Online and in the Black

Right now, the words “profitable” and “e-commerce” don’t appear to have much in common. Together, industry toy leaders Amazon.com Inc. and eToys Inc. had losses of $1 billion last year-$719 million for Amazon and $189 million for eToys. Much of the recent news coverage of e-commerce has concentrated on the failure of online retailers ranging from apparel (boo.com) to groceries (Peapod Inc.) to make a go of it on their own.

The hype notwithstanding, it is possible to make a profit on the web, as some e-retailers are proving. These online merchants are likely to be niche players, rather than mass-market behemoths. “A lot of the people that are profitable don’t have grandiose ideas about how big their companies will get,” says Geoff Wissman, a Columbus, Ohio-based principal consultant in the retail group of PricewaterhouseCoopers. “They have a narrow focus and specific customer.”

Indeed, a May 2000 study by Shop.org, a Silver Springs, Md.-based industry association, and Boston Consulting Group reports that the majority of pure-play e-commerce businesses in the black are small retailers focusing on a handful of product lines. These are largely bootstrap operations-sort of mom-and-pop stores of the web. Many started in their proprietors’ basements or living rooms. Owners wear a number of hats, including software developer, chief marketer and head of shipping and delivery. Rather than drive traffic with high-priced Super Bowl ads and extravagant portal deals, they’re making use of search engines and other lower-cost ways to get the word out. The employee phone list for most of these companies tops out at about a dozen.

Overall, profitable online retailers aren’t as few and far between as recent headlines suggest. In the BCG/Shop.org study, 38% of 221 online retailers indicated they are making a profit at the operating income level, or before accounting for such expenses as amortization and depreciation.

What’s more, the study showed that fully half of companies online more than a year are profitable at the operating income level. “Things aren’t as dire as they seem,” says Elaine Rubin, chair of Shop.org.

How does that square with the many articles that have likened e-commerce sites to an unending black hole? For one thing, many studies of e-commerce businesses focus on the 60 to 70 online retailers that are publicly traded, says James Vogtle, e-commerce research director with Boston Consulting Group in Toronto. However, these e-retailers make up a small portion of the estimated 1,000 online retailers with annual sales topping $500,000. “The ones capturing the headlines were extremes in all dimensions. It’s why they were in the headlines,” he notes.

In addition, the business models of many larger Internet retailers virtually guarantee that they will be unprofitable in the short term. “When you’re trying to grow aggressively, it involves substantial investments,” says Vogtle. “You’re marketing heavily, and building the capacity of the site and fulfillment capabilities in advance of demand.” That’s not the case for some online retailers that expanded at a more measured pace and concentrate on a handful of markets or product lines.

A good foundation

One example is Underneath.com, an Atlanta-based e-retailer of undergarments. Jeffrey T. Johnson, CEO, launched the site in December 1997. Johnson long had thought about doing something entrepreneurial, and the burgeoning world of e-commerce seemed like a good way to go. And, he had contacts in the intimate apparel industry, due to previous stints with retailers Macy’s and Nieman Marcus.

Coincidentally, Johnson’s friend had developed shopping cart technology. He was looking for someone to try it out at no cost-Johnson obliged. His business partner bought the book “FrontPage for Dummies” and the two began designing Underneath.com’s online store. Johnson also began heading to industry conventions to convince major undergarment manufacturers that it made sense to sell on the web. “We were the only site selling this at the time; we were a test for our vendors,” Johnson says. “They were afraid, but, one by one, we convinced them to do it.” Today, Underneath.com sells products from 30 vendors; brand names on the site include Jockey, Joe Boxer, Bali, and others. Inventory runs to approximately 2,000 SKUs; employees run to six.

However, Johnson’s attempts to secure venture capital for Underneath.com have come up empty. “Intimate apparel is not something people get excited about,” he says. The company’s start-up funding consisted of $48,000 that Johnson ran up on his credit cards. He since has been able to repay himself in monthly installments of $3,500. Not surprisingly, Johnson has worked hard to hold down costs. “We have to spend our dollars wisely,” he says. For instance, Underneath.com has done little advertising. Instead, Johnson uses lower-cost marketing opportunities, such as search engines.

Search-engine savvy

Getting the most from a search engine requires a bit of savvy, says Johnson. For example: some search engines kick out any sites that repeat their key word within seven words. Thus, if Underneath.com used “underwear” twice within a span of seven words to describe its site, the search engine would ignore the site.

Those search-engine smarts have paid off. About 60% of Underneath.com’s sales are a result of someone coming through a search engine. The rest are generated by a mix of publicity, word of mouth, repeat orders and an affiliate-marketing program. More than 12,000 other web sites include links to Underneath.com through affiliate program. They generate about 15% of sales. Affiliates receive an 8-12% commission for each referred visitor who makes a purchase.

Underneath.com gets as many as 10,000 unique visitors each day, and about 1% make a purchase. The average order size is about $50. While Johnson won’t disclose precise revenue and net profits, he says sales will far exceed $1 million this year. “We’re operating above water,” says Johnson, adding that by reinvesting profits, the site continues to add lines and styles each month.

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