Amazon, Home Depot Talk Partnership as E-Tailers Look to Main Street

Even Internet-based companies are recognizing the need for distribution arrangements.
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Perhaps the virtual life isn't all that.

In its continuing attempt to gain a toehold on Main Street,

Amazon.com

(AMZN) - Get Report

has held preliminary discussions with

Home Depot

(HD) - Get Report

about a partnership with the do-it-yourself home-improvement retailer.

Home Depot, which itself is in the process of launching a full-scale e-commerce site, would gain access to the online retailing giant's 10.7 million customers, analysts say. Currently, Amazon's customer base is roughly 10 times that of Home Depot's Web site base. Meanwhile, Amazon could secure the real-world presence it has been seeking to facilitate customer returns. It could also offer its customers a new category without the hassle of fulfilling and shipping home-improvement products.

Jerry Shields, a spokesman for the Atlanta-based home-improvement giant, confirmed the discussions but declined to elaborate on what that alliance might look like. Amazon spokesman William Curry says the Seattle-based Internet retailer "never comments on what we may or may not be doing."

The fact that these two titans of retailing would even consider joining forces shows how drastically ideas about e-commerce have changed in the past few months.

Not long ago, Amazon was talking tough and predicting doom for other established retailers like

Barnes & Noble

(BKS) - Get Report

. Forget the meek retailers, pundits prophesied: Net players would inherit the earth. Virtual companies, they argued, were more efficient than their real-world counterparts since they didn't have to operate costly warehouses and stores.

"People were anxious to believe that because of the early success of the Net, we'd turn into a

Star Trek

society really quickly," says

Warburg Dillon Read

analyst Sara Zeilstra.

Now the new mantra is click-and-mortar, or hybrid, companies, physical-world retailers with Internet presence that combine the front-end expertise of e-commerce with the back-end fulfillment prowess of real-world operations.

One reason is that virtual companies are realizing that getting an order to a customer's door is tricky stuff. It means securing complicated and often expensive distribution networks, as is the case with Amazon. The company started the year with one distribution center in the U.S. and will end it with six. A year from now Amazon will have grown its warehouse space to 5.3 million square feet -- that's 18 times its current capacity. Most retailers are hard-pressed to add one of these facilities a year. And as e-tailers begin selling larger, more complicated products like

DVD

players or refrigerators, returns become an increasingly complex task.

Amazon's chief executive, Jeff Bezos, "went to books first for a reason," notes Tim Byrne, a vice president with

Mercer Management

, which hasn't performed consulting work for Amazon. "How many dot-coms can start shipping fridges tomorrow?"

There is the added consideration that customers, while appreciative of the Net's convenience, still want some personal attention. And stores on Main Street or at the mall have undeniable advertising appeal.

Charles Schwab

(SCH)

, for instances, which operates online and real-world brokerages, has said 70% of new accounts are opened at its 300 branches.

To that end,

E*Trade's

(EGRP)

chief executive, Christos Cotsakos, told analysts earlier this month that he would consider forming an alliance with a bricks-and-mortar financial institution.

"We are looking for ways to enhance the personal connection," says Patrick DiChiro, vice president of E*Trade's corporate communications. One way E*Trade is doing that is by tripling the number of customer-service staffers. "Sometimes an actual physical person is what's needed," DiChiro adds.

Some virtual players have already been quick to pair with real-world partners.

priceline.com's

(PCLN)

alliance, for instance, with

Autonation

(AN) - Get Report

helps the online reverse-auctioneer circumvent legal restrictions that allow only licensed automotive dealerships to sell new vehicles to consumers.

Drugstore.com

(DSCM)

, along with other virtual pharmacies, has linked up with a real-world counterpart in the form of

Rite Aid

(RAD) - Get Report

to gain access to crucial third-party insurance contracts.

But a partnership between Home Depot and Amazon has its share of risks, notes Eric Von der Porton, who manages Silicon Valley hedge fund

Leeward Investments

.

"On the one hand, virtual companies may need that

worldly presence," he says. "On the other, they've done everything they can to avoid looking like regular retailers, because the valuations have been so different."

Amazon's stock has lost more than half its value since it unveiled its warehouse-building plan. Friday, shares closed down 1 7/16 to 63 13/16, more than 40% off its 52-week high of 110 5/8.

Nevertheless, Amazon's customer base represents a valuable bargaining chip, one that the company will try to leverage with Home Depot or other retailers. "They'll say: 'You guys can develop an online store and battle it out in terms of trying to win eye share, or you can use us as an instant entrant into the hearts and minds of Web surfers,'" says Rick Miller, a senior analyst with

Cahners In-Stat Group

who hasn't performed consulting for Amazon.

Here's how a possible partnership might work: A customer buying a home-improvement book on Amazon may realize that she doesn't have all the tools needed for the project. She clicks on a link to the Home Depot Web site and buys that

DeWalt

power drill, which she can either pick up at a Home Depot store or have shipped to her home the following day. Amazon would collect a fee on that sale.

Then, another customer who was unsatisfied with the

Philips

(PHG) - Get Report

32-inch screen TV he purchased from Amazon could drop it off at a kiosk in his local Home Depot store instead of repacking it and mailing it back to Amazon.

One intriguing detail involves Amazon's new president and chief operating officer, Joseph Galli, who presumably knows his way around the home-improvement market. After all, he must have dealt with Home Depot in his former role as a

Black & Decker

(BDK)

executive.

With Home Depot's 864 stores, "there's hidden value in some of this real estate," Byrne notes. And e-commerce companies are only beginning to unlock it.

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