January 29, 2010, 12:00 AM

Top priority: the bottom line

With credit hard to come by, web retailers focused on profits, and some are financially stronger than ever.

There`s a low barrier to getting started in Internet retail because e-retailers don`t have the expense of stores. But many e-retailers have relied on credit to launch a business, and often to pay for inventory or expand.

Growing e-retailers generally were able to get lines of credit from suppliers, and, in some cases, from banks. But online retailing has become a very different business since the financial crisis took hold in 2008, especially for privately held smaller and midsized companies that can`t raise capital by selling shares on Wall Street.

"Last year some lenders completely exited the market; they weren`t making any new loans," says Shael Wilder, CEO of multichannel retailer SportsGiant. "Regardless of the creditworthiness of the borrower, lenders were saying, `We`re going to manage the portfolio we have now and not make any new loans.`"

It wasn`t just banks pulling back on credit. Many suppliers that previously would wait 60 or 90 days for payment started demanding cash in advance.

With credit hard, if not impossible, to get, many e-retailers focused on generating sufficient cash flow to pay their bills. That led some to reduce costs, often laying off workers, as well as cutting marketing spend that wasn`t paying off, exiting money-losing side businesses, and sometimes taking a pass on potential acquisitions of troubled competitors.

For some, these adjustments made their companies stronger—several e-retailers say they were more profitable last year than before the downturn hit. But they entered 2010 in a cautious mood that`s likely to translate into slower revenue growth and careful scrutiny of new investments.

"Right now we`re working to run the business profitably," says Spencer Chesman, CEO of food e-retailer igourmet LLC. "Since we`re a 12-year-old company we have the infrastructure we need already in place. If we need a new piece of equipment we`re going to have to finance that through cash flows. We don`t want to take on new leases and new debt."

Credit crunch
That`s not entirely a matter of choice. It`s been tough for businesses of all types, especially smaller ones, to get credit since the financial crisis hit in the summer of 2008.

Loans backed by the U.S. Small Business Administration plummeted to $14.0 billion in fiscal 2009 from $21.7 billion two years earlier, according to research firm TowerGroup. And the Credit Managers Index of credit extended to the service sector, including retail, contracted for 13 consecutive months from September 2008 through September 2009 after never being in negative territory from the time the National Association of Credit Managers created the index in early 2002.

Investor capital also dried up as private equity firms scrambled to recover from steep losses. Angel investors, who typically invest in start-ups, reduced their investments by nearly 30% in the first half of 2009 over the prior year while during the same period the average size of venture capital deals fell 23% to $5.7 million from $7.4 million, according to the Center for Venture Research at the University of New Hampshire.

For online retailers, obtaining loans can be especially difficult, says Stuart Rose, managing director of investment bank Tully & Holland Inc.

The low initial investment that helps make e-retailing profitable also means web retailers have less collateral in the form of buildings, equipment and stock to borrow against. And with e-retailers typically paid within a few days through credit card receipts, few have accounts receivable balances to offer as security.

That leaves e-retailers largely borrowing on the basis of cash flows and character, which was a tough sell last year, Rose says.

While bricks-and-mortar merchants also typically lack receivables to post as collateral, many banks view e-retailers, especially small ones, as less likely to struggle through a crisis because they`ve not had to put up the capital required to set up and stock a store, says Mitch Jacobs, CEO of On Deck Capital, which specializes in lending to small businesses. Each bank typically has policies against lending to certain types of companies, and Jacobs says web retailers with less than $10 million in annual sales and under 25 employees would land on the restricted lists of many lenders.

There are signs the outlook is improving, including growth in credit extended to the service sector in the last three months of 2009, says Chris Kuehl, economic analyst for the National Association of Credit Managers. Last year`s strong showing by online retailers also should make them more attractive to bank loan officers, Kuehl says. "If you`re a pure-play Internet retailer you`re not getting the quizzical looks from banks any more," he says.

Money trail
But the thaw is just beginning, and SportsGiant`s Wilder predicts it will take much longer to get credit flowing than it did for lenders to slam their doors when the financial panic hit. E-retailers say they are still feeling the impact of the credit freeze, and have changed the way they do business as a result.

For DiscountRamps.com, a web-only retailer of loading ramps, the credit crisis led its bank to cut the retailer`s credit line from $2.3 million to about $1.3 million. DiscountRamps typically keeps about $5 million in inventory on hand, and relied on credit largely to pay suppliers, says president and CEO Joel Lederhause. With less credit available, and the economy tanking, the e-retailer spent 2009 taking a close look at every bill, looking for ways to cut costs, Lederhause says.

And it found some. For instance, instead of paying a hauling service to empty dumpsters filled largely with empty cardboard boxes, it found a company that provided a free box compacter and pays DiscountRamps $300 per month for its compressed cardboard.

The company added technology to manage paid search and comparison shopping engine campaigns, automating processes that had been manual. "We were able to minimize growth of our staff by employing more technology and less manpower," says Lederhause, whose company employs 30 and planned to add four employees early this year.

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