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Will Users Buy E-Tailer's Higher Rates? Ends Below-Cost Prices, Tailors Products to Stem Losses, Boost Sales


For much of the past year, Internet superstore Inc. has been nudging up its prices ever so carefully in a bid to make money without losing customers.

"It's like boiling a frog," said Chief Financial Officer Mitch Hill.

Now, the real test of the Aliso Viejo company's strategy has arrived. The holiday shopping season will tell how many consumers stay with's newly sober-eyed, more mature business plan and how many bolt.

"With Best Buy and Wal-Mart getting more serious about online sales, it's never going to get any easier," said Jim Williamson, a senior analyst at research firm IDC. "If they don't do well at Christmas, people may give up on them."'s predicament is hardly unique.

Online retailing has undergone an industrywide shakeout since the spring. One "dot-com" shuts down per day, a recent survey showed, and at least 130 have died this year. Despite an expected infusion of $10 billion from shoppers this holiday season, analysts expect the carnage to continue as marginal companies that went public in last year's frenzy run out of cash., although now the second-largest online store, endured a tepid summer in which its sales growth weakened and its gross profit margins improved only slightly. It continues to blow through more than $20 million per quarter and, at that rate, would be broke at the end of next year.

There's little hope of additional funding from public markets, analysts said:'s shares set a new low of $1.25 on Friday, down 90% since the company went public in February.

The company's long-term hopes ride on its extreme shift in approach. Once the enfant terrible of e-tailing, has thrown out its feckless, growth-at-any-cost philosophy in favor of old-fashioned fundamentals this year.

It identified its core consumers as mostly men, age 18 to 49, who are early adopters of the latest gadgetry, and it added product categories such as wireless devices and sporting goods tailored to them. It dumped stuff like travel packages they don't want or buy elsewhere, Hill said. customers are buyers, not browsers, so the company sank millions into redesigning its Web site for maximum convenience and speed. To conserve cash, the company eschewed an expensive holiday ad campaign and crafted guy-oriented giveaways linked to the Super Bowl and Howard Stern's radio show.

"We're one year smarter and a lot more targeted than we were last year," Hill said. "We view what we've been doing as resetting the business."

But the most important--and potentially perilous--change is this: The company that made its name by promising the "lowest prices on Earth" and giving products away at 10% to 20% below cost has been raising its rates.

Analysts applaud the company's newfound common sense, but remain skeptical that the Internet's ultimate hare can succeed by metamorphosing into a tortoise. They point to several signs that the company has fallen behind some of its main rivals:

* In the third quarter,'s sales grew 20%, compared with industry leader Inc.'s 80%.'s revenue comes mostly from nonseasonal computer products, so it expects 10% to 20% revenue gains for the holiday shopping season, well below the 60% some analysts project for online retailers overall.

"They need to be in that ballpark too," Williamson said.

* Despite's efforts to narrow its losses by gradually boosting prices, it lags competitors there too. It grosses less than 7 cents for every dollar of sales, while Inc., its chief rival for computer-products customers, pockets more than a dime. Cyberian Outpost Inc., another technology e-tailer, takes home 14 cents.

"If Egghead can raise gross margins faster, why can't they?" said Daniel Ries, an analyst at C.E. Unterberg, Towbin. "Because has always gotten its customers through pure pricing. The companies that are in better positions, like Amazon or Cyberian Outpost, are service leaders."

Hill acknowledged that's patient, methodical strategy may make for less showy results right now, but said the company is still on a pace to break even by early 2002. He also said it remains a strong enough player to benefit from the shakeout, acquiring partnerships and investors as other dot-coms fail.

"The good news is that a lot of [other] people are going to be gone," he said. "It's a really tough market for a lot of companies, and we're trying to power through."


E-Tailers Looking for Good Tidings

The holiday shopping season will prove crucial to many online retailers like Orange County-based Internet superstore Inc. as they struggle to survive a brutal market. How stacks up with rivals:*--*

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