Net Retailers Chart New Course of Cutting Shipping Fees

But such initiatives that absorb shipping costs and eliminate transaction fees could damage margins.
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SAN FRANCISCO -- Whoever might have said e-commerce would be easy was wrong.

Setting up shop is a relatively easy task when compared to building a strong brand and a loyal customer base, an arduous process that's getting more expensive every day. Companies such as

Onsale

(ONSL)

,

Cyberian Outpost

(COOL)

and

Beyond.com

(BYND) - Get Report

are facing increasing competition from companies that sell directly to customers. Those competitors range from big companies like

Amazon.com

(AMZN) - Get Report

, with its "Shop the Web" and auction initiatives, to start-ups racing for a place in the sun.

Given such a cutthroat market, companies are trying to come up with new ways to attract and keep customers. Some retailers have taken to lopping off the shipping and transaction fees for purchases. They planned to rely on those types of fees to make a low-cost, at-cost or below-cost business work.

After the market closed Wednesday, Onsale announced free shipping on all products purchased through its

atCost

Web site through April 30. In addition, this month, the company will also waive the $5 to $10 transaction fee it charges on each product. That follows an announcement Monday from Cyberian Outpost that it will provide free overnight delivery for products, limited to the first $100 of shipping costs to customers in the U.S.

Making a purchase less expensive may draw in new customers, but it likely will mean more expenses for businesses to eat. That could result in another blow for these companies, which have been hoping to shore up their margins -- not just with shipping costs and transaction fees, but also from Web-site advertising and warranties.

Cyberian's spin is that all these efforts are an attempt to make online shopping less confusing. Users, who often don't know the full tally of their bill until the last step in ordering, now will know their purchase total up front. "In a market where shipping costs are not clearly defined, it is often difficult for consumers to understand who is offering the best deal," Cyberian Outpost President and CEO Darryl Peck said in a statement. The company says it won't raise prices as a result.

Not everyone buys that explanation. This could indicate that the companies are struggling to grow their programs for low-priced goods, says Greg Kleiner, a fund analyst for

Essex Investment Management

who declined to disclose any position in e-commerce stocks. "If nothing else, it probably means that

Buy.com

is having an impact that no one wants to admit." Privately held Buy.com is trying to build a brand by offering "the lowest prices on earth."

But the big question, as

Warburg Dillon Read

analyst Sara Zeilstra puts it, is: "Can at-cost or below-cost

sales work?" These efforts may drive traffic, she admits, but it's questionable whether they are a good business model. Zeilstra, who has Onsale at a hold rating and whose firm has no underwriting relationship to the company, says these customer-grabbing methods raise the question, "Do they need to drum up volume?"

Retail investors didn't seem sold on the offer either. One sarcastic posting on a message board for Onsale at

Yahoo!

(YHOO)

reads:

A possible future release by Onsale: Onsale today announced that it is offering free PCs purchased through its atCost Web site. ... In addition the company will pay every customer a transaction fee of up to $10. This site complements Onsale atAuction, where the customer with the lowest bid wins. This special offer is part of an aggressive marketing campaign to eliminate whatever little revenue remains.

But one message posted on a Cyberian board Monday approved of the changes. "Customer service is one of the most important aspects of online shopping," the message reads. "This is

big

news."

Big, maybe, for customers who like free stuff. From a business standpoint, however, it could be another barrier to higher margins. Onsale introduced its atCost business in January as a way to generate new revenue, if at a lower margin than the auction business.

One hedge fund manager who is short both Onsale and Cyberian Outpost succinctly sums up the new initiatives: "Bye-bye, gross margins."

It now looks like atCost is stealing from the auction business at a faster pace than Onsale expected, and the core auction business actually lost ground over the fourth quarter. Of the $67.8 million in first-quarter revenue Onsale reported Thursday, about $10.2 million, or 15%, came from atCost, with most of the remaining $57.6 million from atAuction. Total revenue rose about 70% from the same quarter last year but came in below last quarter's revenue of $59 million. The net loss of $5.5 million, or 28 cents a share, was a penny short of the

First Call

consensus estimate and more than last year's loss of 22 cents.

Other highlights from Onsale's earnings:

  • Onsale margins fell slightly to 9% from 9.1% in the fourth quarter, and they are going to be chopped in half to 4.5% at least through the rest of 1999, as the company goes aggressively after Buy.com.
  • The company canned the Yahoo! Auctions site because "revenues to date have not been significant and are not likely to cover costs for some time."
  • Planned promotions may more than double in the rest of the year, upping the expenses for print, radio and online advertising. The company may expand into television advertising in the second half of the year.
  • Orders increased by just 1,000 during the quarter to 356,000, up from 355,000 orders during the fourth quarter.
  • Because of aggressive pricing and increased advertising spending, Onsale's full 1999 loss will likely be more than $2 a share, according to several analysts. Zeilstra expects a full-year loss of $2.11 per share; underwriter BT Alex. Brown expects a loss of $2.35 a share. That's significantly larger than the 1999 loss of 79 cents a share that analysts had previously expected.

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Corrections and Clarifications.