Helping Small Retailers

How Overstock is extending a proven b2c concept—deep discounts—to a b2b operation

Almost from the start of e-retailing consumers have turned to the web for deals on merchandise. Like other online discounters, Overstock.com Inc. and its CEO and majority shareholder Patrick Byrne have built a business on that trend. Deep discounter Overstock’s sales are rocketing—up 102% to $26.1 million in the second quarter from $12.9 million a year ago and up 22% from the first quarter. With the loss from operations narrowing to $959,000 for the year from $3.9 million a year earlier, it’s on the verge of profitability, no small feat for an Internet pure-play.

Now Overstock is proving that the idea of buying deeply discounted goods on the web has another whole constituency besides consumers—other retailers. Less than a year after it started targeting other retailers as prospective buyers of discounted merchandise, Overstock has moved 15% of its business to b2b and, while being careful as a newly public company not to raise expectations unduly, it’s clear that Byrne would not be surprised to see 50% of Overstock’s revenue coming from other retailers within 18 months.

“Small retailers never had access to liquidation product because liquidation typically sells by truckloads or multiple truckloads,” Byrne says. “They are not set up to have a mom-and-pop call to say they want six blenders. But that grafts seamlessly into the infrastructure that we have.”

Overstock’s success with consumers and retailers alike reflects the fact that it solves a problem for other retailers and manufacturers. It’s leveraged the Internet to open up the marketplace for closeout and end-of-model branded goods, cost-effectively moving merchandise that might have languished in sale displays, stockrooms and local outlet stores, taking up space and, unsold, cutting into the bottom line.

With a team of buyers that scours the country for such merchandise, Overstock scoops it up at 80% less than full retail and sells it online at retail less 60%. The web makes Overstock’s business possible because it allows it to sell merchandise in quantities too small for the traditional liquidation distribution network to handle efficiently.

A taste for deep discounts

In addition to solving manufacturers and retailers’ overstock problems, it’s developing shoppers’ taste for deeply discounted branded merchandise as served up on the web, and showing them that, given some flexibility, it’s not necessary to pay full retail price for branded merchandise. “Whether it’s the economy or a general sense of value associated with the product, the public’s appetite for deeply discounted merchandise is growing,” says Derek Brown, an analyst with W.R. Hambrecht + Co, which was a co-manager of Overstock’s recent IPO. “While that category’s growth doesn’t necessarily have to come out of anybody’s hide, the category that is more likely rather than less likely to feel pain is the full-price online channel.”

Indeed, online liquidators of branded goods are some of the fastest-growing retail sites, and among the only to win outside funding recently from capital markets now wary of dot-coms. Overstock isn’t the only such company to get investors’ attention. Deep discount site SmartBargains.com in August closed a $9 million round of financing with new VC backers and existing ones such as Time Warner AOL Ventures. And fashion discounter Bluefly.com Inc. received additional equity funding from existing investors of nearly $2 million in June with a commitment for more if needed. Probably the strongest measure of the power of discount sites on the web, though, was Overstock’s IPO in May. It raised $39 million from public investors at a time when the flood of Internet company IPOs has dried to a trickle.

The casual observer of the company might wonder exactly what it is that investors bought, for on the surface Overstock’s CEO and its business model seem to change as regularly as the seasons. Since the site went live in 1999, the outspoken Byrne has flashed the colors of a “rapacious capitalist,” building his fortunes by bone-picking the inventory of dead dot-coms; a corporate do-gooder giving third-world artisans a shot at the online marketplace; small businesses’ answer to sourcing discount merchandise; and a sort of GSI Commerce-in-training intent on bringing deep discount storefronts to high-traffic sites that have no e-commerce at all.

Byrne, however, sees no conflict between the changing labels that have earned the Salt Lake City-based company a fair amount of ink over the past few years. “I understand why it looks like we shift around in different directions, but there is a common theme,” Byrne says. “What we’ve built is a liquidation infrastructure. It has very different characteristics from how a typical warehouse operates. The retail system is set up for vast quantities of identical goods; liquidation becomes available in very small lots. We’re set up for that. And once we had that platform, we built from it.” The bottom line about OverstockB2B.com is that it’s simply a way of leveraging Overstock’s infrastructure to meet the needs of a different market, Byrne says.

Lining up

Viewed from that perspective, Overstock’s seemingly disparate elements fall into alignment. Byrne, with both a prior executive career and a string of degrees that includes a Master’s in moral philosophy from Cambridge University, has a fondness for the “rapacious capitalist” moniker. It was a title handed to him by the business press in the heyday of dot-com bust-outs whose inventory he scooped up at cents on the dollar. But in reality, bankruptcy acquisitions never constituted more than a fraction of Overstock’s inventory. “Bankruptcies were what got us a lot of attention, but it was never more than about 25% of our stock,” he says. “The bulk of what we do has always been just finding special opportunities to buy.”

And, he might add, to sell. Overstock was quick to recognize an opportunity when it noticed independent retailers without the buying clout of large chains had discovered the site and were sourcing from it for store resale. “We have a warehouse that already does a lot of sorting thorugh truckloads,” he says. “So we thought, let’s get a separate site that can sell the same products to small retailers in case packs and pallet loads at a discount to wholesale.”

Last year, the company set up OverstockB2B.com where it sells brand-name merchandise at 30% to 40% off wholesale prices the retailers would otherwise pay. Customers are small retailers, and some not so small ones, too. Safeway Inc., for instance, is purchasing merchandise through Overstock for placement in its stores.

The pricing, says Byrne, is “substantially better” than what chain stores pay for volume orders, and translates into lower acquisition costs and higher margins for the independent retailer. Prices on the b2b site depend on volume. The b2b operation also allows Overstock the prospect of faster growth and greater potential upside because the sales go out in pallet loads versus the higher cost of one-off, b2c sales.

While Overstock is helping independent stores buy goods at low prices, it also is helping create a market for manufacturers of a particular sort. Worldstock is an Overstock department that features the work of artisans from economically deprived Third World locales. So far, it contributes about 2% of sales. And because Worldstock is a break-even proposition for Overstock, Byrne is quick to point out that it’s not just a philanthropic undertaking.

Similar markets

Byrne tells of his epiphany while traveling through Cambodia that the market for artisan’s crafts—small, fragmented lots of diverse products—was similar to the liquidation market Overstock was built to service. That sparked the development of Worldstock, which buys crafts from non-profit cooperatives formed by the artisans. Today Worldstock, accessible via a button on Overstock’s home page, has sales of about $10,000 per day and supports 2,000 artisans, a number Byrne hopes to boost substantially over time.

Overstock’s latest initiative dusts off the old—in Internet time, anyway—concept that if you build it, they will come and they’ll spend money. Content sites sought to cash in on high traffic through paid advertising, but e-commerce was something else altogether, and that’s where Overstock saw a new opportunity for its liquidation machine. The company began its third quarter with the announcement that it would seek greater distribution of its products by partnering with content-focused sites having little or no e-commerce at all, delivering private-label, turnkey storefronts featuring selected Overstock merchandise—all installable within 24 hours.

Late last month, Overstock launched a private-label version of Worldstock on content site Salon.com. Byrne says a deal with another online magazine is in the works.

The private label initiative—admittedly something like GSI Commerce Inc.’s model, in which the consumer brand has the presence on the web and GSI does everything behind the scenes—is aimed at sites that already have a lot of traffic but not necessarily a way to monetize it. Visitors to Salon.com’s private label Worldstock site, accessible on Salon.com’s home page through an icon, see Worldstock’s assortment, presented in pages that mirror the rest of Salon.com. The items are flagged on the page as “powered by Worldstock.”

Revenue share

Such powered-by Overstock and powered-by-Worldstock sites are not link-throughs to Overstock.com, but, rather, independent sites that the company populates with Overstock departments, categories and products of the alliance partner’s choice. Byrne says Overstock pays a “hefty” revenue share under the agreements, though he did not disclose numbers

The deals are one way Overstock is broadening its reach on the web; advertising’s another. The company does no brand advertising, and about 30% of new customers are driven in by retail’s favorite, free form of advertising: word of mouth. Another 30% come in through paid advertising in the form of portal deals, coupons, and affiliate links through the LinkShare network.

Overstock tracks the performance of all its advertising in minute detail. Its internally built software gives a read in real time on the number of clicks, the percentage of conversions, the dollars and the profit generated for each link. That goes for paid search, too, though the company buys keywords on paid search engines such as Overture only sporadically. “I don’t want to get caught up in a bidding war,” Byrne says.

But long term, the marketplace could hold a reason for Overstock to get involved in bidding after all, though not on keywords. Overstock already has sold goods under its own name on eBay, though it’s a very minor part of its business. But beyond that, Overstock could, in theory, prove to be a valuable piece of eBay’s puzzle because of its relationships with manufacturers, says Hambrecht’s Brown. “One of eBay’s challenges is to bring large sellers onto its platform. But we’re not seeing mass distribution by manufacturers across the platform,” he says.

That’s because manufacturers don’t like selling on dynamically priced platforms, because they face channel conflict in selling direct, and because they don’t have the infrastructure to ship one item to one consumer at a time, Brown says. Overstock’s system is already set up to handle such issues. “If you think about it, Overstock has the exact merchandise, the relationships with manufacturers, and the infrastructure eBay wants and needs,” Brown says.

Value investors

Overstock’s shares have taken a recent tumble; down 28% as of Sept. 5 from Aug. 1, compared with a 12% drop in the NASDAQ composite over the same time. Brown, one of few analysts who cover the newly public Overstock so far, has said the decline reflects sluggish conditions in the marketplace rather than Overstock’s underlying fundaments. As for Byrne, he says he concentrates less on share price or competitors than on the value proposition he believes Overstock offers to consumers.

“Corny as it sounds, we’re value investors. That means we focus on the underlying economics of things on one side and on the other side, fair dealings with stakeholders, customers, the marketplace and vendors. If we do that right,” he says, “everything takes care of itself.”