Amazon Isn't the Only E-tailer to Worry About

Now it's the top line they're worried about.

If there's going to be a weak link in e-tailers' second-quarter results, it will be sales growth, say analysts. Driven by a need to conserve cash, companies are spending less on marketing, and that's likely to cause at least some falloff in sales. In addition, there's the inevitable slowdown in the growth of demand after quarter after quarter of big sales gains.

While this isn't necessarily all bad -- after all, cutting costs means better margins and narrower losses, something Wall Street focused on in past quarters -- it's not at all clear how investors, who have become accustomed to seeing sales jump, will take the news. An early test case was Cyberian Outpost (COOL Quote), which beat analysts' estimates on everything except sales (it came up a tad short) when it released fiscal first-quarter financials late Tuesday. The market reaction? The stock has since fallen 9%.

It's not just the smaller e-tailers that are likely to see slower growth. Analysts say Amazon (AMZN Quote) could well show no sales growth compared with the first quarter. They say eBay's (EBAY Quote) sales will rise about 10%, compared with a 16% gain last quarter. And priceline's (PCLN Quote) sales are expected to rise about 4% sequentially.

No Surprise

It's not like slower sales growth should be a surprise to anyone. After all, e-tailers are doing exactly what investors wanted them to do: focusing on moving on down the yellow brick path to profitability faster. But one of the ways the e-tailers cut costs was to cut spending on advertising and promotions. That will certainly help bring down losses and the cost of acquiring customers.

Slowdown Crowd? Estimates show big e-tailers' sales growth* slowing
Second-quarter sales growth*	2000 (estimate)	1999 (actual)
Amazon.com (AMZN:Nasdaq)	4%	7%
eBay (EBAY:Nasdaq)	9%	22%
priceline.com (PCLN:Nasdaq)	4%	126%
Source: Goldman Sachs, company reports. *Change from previous quarter's levels.

But it also may depress sales. After all, Procter & Gamble (PG Quote) doesn't spend millions to promote Tide and Crest just for giggles. Advertising and marketing keep brands in consumers' minds, and therefore help boost sales. On the Internet, getting the word out is even more important, because, unlike bricks-and-mortar retailers, consumers aren't reminded of stores' existence simply by driving past the mall and noticing the sale signs in the window. And so, absent some of the television ads and tempting promotions -- free shipping! two CDs for $20! -- some consumers simply won't be buying.

"Companies have to be much more conservative in how they spend marketing dollars, and that does limit some of the revenue potential," says Steve Weinstein, an analyst with Pacific Crest Securities.

Anthony Noto, Internet analyst with Goldman Sachs, says companies simply don't have enough experience to be able to accurately gauge what an X% reduction in marketing spending will do to growth. He says they're unlikely to talk about huge future revenue gains when they report earnings. "My sense is that after looking at all the macro trends, I didn't want investors to think they'd be beating the numbers," he says.

Remember: This isn't necessarily bad. After all, lower spending on marketing boosts gross margins and reduces customer-acquisition costs, which, for some e-tailers, can be well in excess of astronomical. PlanetRx (PLRX Quote), for example, spent $121 to acquire each customer during the first quarter. And in return, the average customer spent just $22 during the quarter. Ouch.

This week, the company said its new focus on achieving profitability means its revenue growth will slow (it also said it had retained Goldman to explore those increasingly attractive strategic and financial alternatives). The silver lining, however, is that losses per share will be less than expected.

Slowdown Crowd

But there also may be more than marketing afoot: There's evidence that the high-growth phase of U.S. e-commerce growth is over. According to an online retail index released by the National Retail Federation and Forrester Research, overall spending in May rose just 2.4% from April, while sales of books, music and video products fell almost 13%.

Henry Blodget, who follows Amazon.com for Merrill Lynch (he rates it a buy and the bank hasn't underwritten for the bookseller), says he's expecting sequential quarterly sales growth at the e-tailing behemoth to be flat to just mildly positive for the second and third quarters. Future sales growth for Amazon, eBay and priceline, the holy trinity of the e-tailing world, increasingly depends on new markets, such as international expansion, and new product lines.

Add another wild card to the sales equation: There's still no telling what effect an economic slowdown will have on Internet companies. Most analysts say these companies are still acquiring new customers quickly enough to be protected from slower overall demand. But if companies are trying to cut costs, they may be in no position to aggressively court enough new customers to make up for slower spending by their existing customer base.

And how will investors react to slower sales growth? That depends on a host of factors -- improvement in gross margins and customer-acquisition costs, forecasts of future profitability, the tone of a conference call. It would be ironic, though, if investors pressing for profits then turned around and punished e-tailers for achieving those at the expense of lower sales. Be careful what you wish for. It may come true.