Everything Must Go ... Online: Some Sites Are Dying to Offer Low Prices

Editor's note: This story is part of

TSC's

three-day series on the e-tailing Internet wars.

SAN FRANCISCO -- Defying all economic sense, some online companies say the more they lose on every sale, the more they'll make in the long run.

Real-world retailers like discount stores and grocers have found profits using a similar strategy. But do these kooky economics add up, even in the Wonderland of Internet retailing?

Shopping.com

offers some of its items below cost.

Onsale

(ONSL)

sells products at cost.

Buy.com

guarantees "the lowest prices on earth." And

priceline.com

(PCLN)

sells a "substantial portion" of its airline tickets below cost. Those companies are referred to as "suicide e-tailers," and their seemingly twisted business models see losses as the inherent cost of attracting herds of customers.

By employing economies of scale, cutting deals with suppliers, selling advertising and snagging customer dollars through warranties and transaction fees, these companies plan to eventually make money.

Even Internet pillar

Amazon.com

(AMZN) - Get Report

has joined the price club and begun offering

New York Times

bestsellers at a 50% discount. Upon the announcement of the move, online units from

Barnes & Noble

(BKS) - Get Report

and

Borders

(BGP)

quickly followed suit.

The strategy is far from new. Grocery stores regularly price items below cost to attract shoppers, betting that once in the store, customers will pick up must-haves that aren't on sale. And Sam Walton perfected the model for discount retailing. When

Wal-Mart

(WMT) - Get Report

opened its first discount store in 1962, it purposely lost money on select items as a way to undercut the competition. Analysts say that's a tactic used by nearly all retailers: Sell certain categories at or below cost to lure shoppers.

The ultimate success of the low-price model will be based on the grocery-store format, where a company bundles low- or below-cost product sales with higher-priced goods, says Wayne Hood, a retail analyst at

Prudential Securities

. The predatory pricers also will come to rely more on services like online communities and specialized content to separate them from the pack, analysts say.

The problem with betting the farm on low prices alone is that they fail to foster customer loyalty. Switching to a competitor online is just a click away. "It doesn't take time" to find a better price, says one hedge fund manager who is short Onsale. "And I don't have to get in a car." Since it's cheaper to service existing customers than to acquire new ones, building repeat business is crucial for survival.

But first, suicide e-tailers must attract a large enough mass of first-timers to warrant those discounts from suppliers. And it seems these sites are eager to do so even if that produces a war that could price some of them into oblivion.

This cutthroat pricing is changing the whole retail game. The Buy.coms of the world are "acting like a boat anchor

and driving retail prices down on the Web and in the real world," says Kate Delhagen, director of e-commerce research at

Forrester Research

.

Buy.com promises to beat any competitor's price by 10% and will reimburse customers within seven days if they find an item bought from Buy.com elsewhere cheaper.

And Onsale, which operates an auction in addition to an at-cost business, recently said gross margins would be chopped in half to about 4.5% at least through the rest of 1999 as the company goes aggressively after Buy.com.

Jerry Kaplan, Onsale's chief executive, describes his company's at-cost business this way: The company has staff monitoring competitors' prices to make sure Onsale has the best deals. As a special incentive, the company has eliminated shipping and transaction fees to drum up more business. That promotion was supposed to expire April 30, but it's been extended indefinitely, a company spokesman says, because the cost of attracting new customers this way is cheaper than through an advertising program.

But even Kaplan admits this

hara-kiri

approach can't last forever. "My belief is that this will be a short-term strategy for most," he says. "Prices will ultimately rise as weaker players run out of marketing funds or go out of business."

For now, the consumer is the only real winner. Nick Moore, senior technology analyst with money manager

Jurika & Voyles

, is skeptical that the no-margin retailers can last. He holds no position in any of them. But that doesn't prevent him, as a consumer, from taking advantage of their prices. "It's a theme I call 'Shop till they drop,'" he says.

It's an attitude that might eventually leave some suicide kings for dead.