Growing Pains: E-tailers' Spending Spree Ends as Profitability Comes into Focus

Until very recently, the spending habits of e-tailers bore a strong resemblance to those of a 16-year-old with a rich daddy and a brand new credit card.

Thanks to the recent plunge in their shares, though, they've had to get real, fast. So as the market has stopped rewarding losses and begun demanding profits, many e-tailers are taking the scissors (in some cases, a hatchet) to their marketing budgets. And while it will probably help them get to profitability quicker, the move may threaten their ability to compete for the long haul.

SmarterKids.com(SKDS), an online retailer of educational toys, cut its marketing budget by half in the first quarter. Now it's focusing on cheaper methods with trackable results. That means no more radio and television ads for now. "While we think our ads were great, you have to look at the cost of customer acquisition using that method vs. others," says David Blohm, CEO. Also out: a repeat of its splashy promotion providing tray liners to McDonald's (MCD), which cost the company $1 million but didn't bring in the traffic the company had hoped for.

Instead, SmarterKids' marketing will focus on lower-cost deals like developing relationships with schools and educational portals, says Blohm. It will focus more on getting money out of the existing customers, rather than on finding new ones. Chase H&Q estimates that will bring its customer-acquisition cost down from about $159 in the first quarter to about $135 in the fourth quarter. Through a representative, the company says its acquisition cost is already at or below $50.

Smarterkids isn't the only company rethinking its marketing spend. CDnow (CDNW), which needs a partner or cash infusion to survive beyond the next two or three quarters, trimmed its marketing budget by $11.4 million in the second quarter, an almost 50% reduction. eToys (ETYS), which spent $56 million (or 37% of revenue) on advertising last year, intends to decrease ad expense as a percentage of revenue this year, though it intends to keep advertising on television. Luxury goods e-tailer Ashford.com(ASFD) has trimmed its marketing budget from its original plan and is focusing on measurable methods like online ads and direct-email marketing. "It used to be all about customer acquisition, but the real winning proposition is the lifetime value of the customer," says Mary Lou Kelley, Ashford.com's vice president of marketing.

The e-tailers maintain that they have always taken their cues from Wall Street. When investors shrugged off widening losses and rewarded them for spending like crazy to get customers, they did it. But with the big drop in the market and the fear that many companies will use up cash before they can make money, the new mantra is to map a path to profitability. "Dot-coms are putting in as little money as possible to maximize their investments," says Jason Olim, CDnow's CEO.

Olim believes the pullback in marketing spend by e-tailers and other Internet companies will eventually cause a decline in ad rates both offline and online. But others aren't so sure, even with all the anecdotal evidence about smaller marketing budgets. For all the hype about gerbils being fired out of cannons and expensive Super Bowl ads, no Internet company cracked Advertising Age's list of top 200 national advertisers during 1998. Even the list of top 25 online advertisers contained only seven Internet companies (and that includes Barnes & Noble (BKS)) -- the rest were familiar offline brands like Ford (F) and Microsoft (MSFT).

More fundamentally, the Internet and e-commerce aren't going away. "Everyone knows there's a softening in the B2C business, but the C element is still growing," says Elliott Ettenberg, chairman and CEO of Customer Strategies Worldwide, a marketing consultant. While some companies are cutting back, e-tail isn't likely to go away. Brick-and-mortar companies with their own Internet brands are going to promote themselves, as Nordstrom(JWN) did when it launched its Nordstromshoes.com site. And not all Internet retailers are clamping down. "We're investing as aggressively as we can where things are working," says Ken Seiff, CEO of Bluefly.com(BFLY), an online discount retailer. That includes investing in marketing: The company will increase its spending this year.

And so far, there's no sign of any slump on the supply side. Chris Dixon, media analyst with PaineWebber (PWJ), says media companies are still experiencing "absolutely unbelievably strong" ad revenue, and that the market's new distaste for Internet companies will have no impact. In fact, many industries are now so fragmented, with both offline and online companies battling for market share, that advertising will only increase. "In financial services, if E*Trade (EGRP) and Schwab (SCH) are advertising, can PaineWebber or Salomon Smith Barney or Merrill Lynch (MER) sit on the sidelines?" he asks.

Probably not. Definitely not. And when the big guys are in the game, it will be even harder for the pure plays to compete. SmarterKids saw analysts downgrade its shares after it announced its shift away from customer acquisition to increasing sales from existing customers. Lower marketing costs may mean improved short-term profitability, but analysts fear it will also mean lower revenue in the future as it fails to bring in new buyers.

And that may make it hard for e-tailers to ever make it out of those tough teenage years, after all.

>To order reprints of this article, click here: Reprints