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The Cutting Edge

More Retailers Testing Virtual Waters

Electronic commerce: Toys R Us, Tower Records and other chains of the physical world are entering cyberspace. But smaller online companies are giving them a run for their money.


With profits plunging, Toys R Us recently announced plans to close dozens of stores and lay off thousands of workers. But in the company's budding online business, it's a different story.

"We're hiring," said Joel Anderson, vice president of Toys R Us Direct. "I sat down with my boss yesterday and he basically said, 'What do you need?' The checkbook is there."

Profits remain a pipe dream across much of online retailing, but the giant chains of the physical world are on a cyberspace building binge. Toys R Us, Borders Books, Tower Records and many others have either rolled out or revamped their virtual superstores in recent months.

For them, it's part of an effort to seize control of the Internet much the way their superstores have overrun the retail landscape on terra firma over the last decade. But so far, cyberspace is proving to be a tougher market for them to crack.

Online pioneers such as, CDnow and EToys--companies that probably would have been crushed had they opened shop on a street corner--have built substantial electronic-commerce leads and are proving remarkably resilient.

The billion-dollar question on the Net is which of these two business breeds will prevail over time: the virtual companies or their carbon-based counterparts. Both sides claim the clear advantage.

Virtual companies say they alone can focus on e-commerce, unencumbered by giant payrolls, vast real estate empires and the fear that the Internet will erode their in-store sales. The bricks-and-mortar stores, however, boast universally recognized brands, enormous marketing muscle, vast inventories and unmatched buying power.

The stakes are hard to comprehend now, with most online retailers losing money hand over fist. Analysts say that could continue for years as companies spend heavily to build their brands in a business with minuscule margins.

But the payday is coming. Jupiter Communications, a New York-based research firm, estimates that online-shopping revenue will surpass $40 billion by 2002, up from $2.7 billion last year.

"The companies that are able to establish market share and mind share right now," said Ken Cassar, an analyst at Jupiter, "are the ones that will capitalize when these businesses represent serious dollars."

The fast-approaching holiday shopping season is shaping up as an early test for the newest retail category to be tested on the Net: toys.

In a cavernous building in Commerce, EToys, a Santa Monica start-up, is converting an old bottling warehouse into a high-tech North Pole. By November, nearly 500 employees working staggered shifts will be picking, packing, wrapping and shipping thousands of toys each day.

Meanwhile, across the country, Anderson and his 30-person team are scrambling to expand the 3-month-old site, fine-tuning computer systems, revamping a Chicago shipping center and adding hundreds of items to the online selection each week.

The outcome of this battle may hinge on whether the Internet is truly an opportunity for Toys R Us or merely a distraction. Toby Lenk is banking on the latter.

"We know Toys R Us is going to be a very strong company online, and we're not going to be able to stop that," said Lenk, co-founder and chief executive of EToys. "But their No. 1 competitive problem is not us and the Internet. It's that discount chains like Wal-Mart have muscled into the toy space. We think we can be No. 1 online because we're focused just on the Internet."

In fact, Toys R Us' preoccupation with the mounting threats to its physical stores gave EToys its most important break: a nine-month head start. Toys R Us set out to launch its online store last fall, but the project collapsed as department heads turned their attention to problems in the physical stores amid the crunch of the holiday season.

The Paramus, N.J.-based company finally launched the site in June, but only after creating a separate online division and putting Anderson, one of the company's top regional sales executives, in charge. "Initially, we were just borrowing resources from various departments," Anderson said. "But now we've got a core group of people with some skin in the game."

But now that the site is up and running, Toys R Us confronts one of the most nettlesome problems traditional retailers have faced online: getting shoppers to go to their virtual stores.

Amazon, for instance, continues to control 90% of the online book market, according to Jupiter, even though it has been under online assault by Barnes & Noble since May 1997.

Similarly, CDnow and Music Boulevard together account for 45% of online music sales and seem to be pulling away from Tower Records and other traditional retailers that sell online, analyst Cassar said. Tower will face even more pressure now that Amazon has also entered the online music market.

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