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Once Wary of Warehouses, Amazon Branches Into Bricks-and-Mortar Tributaries

The bookseller's distribution plans have it looking more and more like its big store-based rivals.

SAN FRANCISCO -- E-commerce wasn't supposed to happen this way.

When

Amazon.com

(AMZN) - Get Amazon.com, Inc. Report

came public two years ago, the online bookseller cast itself as David taking on Goliaths such as

Barnes & Noble

(BKS) - Get Barnes & Noble, Inc. Report

and

Borders

(BGP)

. The company's prospectus trumpeted that it "carries minimal inventory." Amazon's sole warehouse, in Seattle, held only a few hundred bestselling titles. Others came from distributors like

Ingram Book Group

in southern Oregon and

Baker & Taylor

in North Carolina.

Here was the promise of the Internet economy in all its glory: selling books without carrying inventory. But as time passes, it's increasingly clear that Amazon isn't such a cyberspace wonder after all. The economic advantage of minimal inventory is eroding fast as the retailer adds warehouse after warehouse to store books, music and other products. As Amazon itself grows into a retail giant, it's looking more like the giants it set out to topple.

"There's been an evolution of the plans for warehouse facilities," says Lise Buyer, an analyst at

Credit Suisse First Boston

who worked for Deutsche Morgan Grenfell, now known as

Deutsche Bank Securities

, when it took Amazon.com public.

Or maybe a devolution. Amazon's prospectus said that, as an online store, it would enjoy "economic advantages relative to traditional retailers" because it "eliminates investment in expensive retail real estate and dramatically reduces personnel requirements." While the prospectus said Amazon would upgrade its technology and its networking infrastructure, no mention was made of new warehouses.

The implications were big: Savings could free up the company to offer regular discounts of up to 50% and concentrate spending on building a strong brand on the Net.

Media profiles of Amazon highlighted this edge. CEO Jeff Bezos boasted in

The Boston Globe

of his company's "infinite shelf space."

The Washington Post

focused on how Amazon "operates without the overhead of bricks-and-mortar outlets." "The Amazon model is beguilingly attractive,"

Fortune

TheStreet Recommends

gushed. "Expensive inventory and bricks-and-mortar warehouses are not needed by the New Age retailer."

Last spring, the cyberbusiness model quietly started to change. Amazon said in a filing that it "may establish one or more additional distribution centers" over the next year so that it could ship its bestselling books faster and buy in bulk to get books cheaper. The sole warehouse Amazon operated wasn't adequate to ensure delivery of books as fast as competitors.

"One or more" conservatively describes what has happened since. Last week, Amazon announced its seventh distribution facility, an 800,000-square-foot center in McDonough, Ga. When this latest center is fully functional in October, Amazon.com's distribution centers across the country will span more than 3.5 million square feet, nearly twice the space inside the

Empire State Building

, and they could fill up 135 Barnes & Noble 26,000-square-foot superstores. More warehouses may follow as Amazon expands overseas.

That's a lot of mortar. "They're becoming a Barnes & Noble without the storefronts," says

Warburg Dillon Read

analyst Sara Zeilstra, who rates Amazon hold and whose firm has no underwriting relationship with the company.

The company hasn't said how many of these warehouses it plans to open, but the year isn't up. And even if the company is content with its facilities in the U.S., it is starting to grow internationally. "We will expand our product and service offerings and our international operations," a filing with the

Securities and Exchange Commission

said. In order to do that, "we need to significantly expand our distribution-center network and improve our transaction-processing, operational and financial systems, procedures and controls." In March, Amazon leased a new distribution center in Bad Hersfeld, Germany, and it's expected to begin operations there during the second half of 1999.

Barnes & Noble's attempt to buy Ingram, which is Amazon.com's biggest book supplier, sped up Amazon's plans to build warehouses, Buyer says. Barnes & Noble scratched its $600 million bid for Ingram, citing antitrust concerns among regulators. Nonetheless, Amazon is pushing ahead to build warehouses to handle orders more efficiently.

Jimmy Wright, Amazon.com's chief logistics operator, says the facilities will give the company control over the full retail process -- from ordering to fulfillment. Wright downplays the bricks-and-mortar aspect, however. "We're still 100% Internet company," he says. "But we're building rapidly because of rapid growth."

The warehouses allow Amazon to make more bulk purchases ahead of demand. And that, despite all the early talk about reduced real-estate and personnel costs, is good for Amazon's margins. One analyst who asked not to be named says bulk book purchases could increase margins to about 33% once all the centers are operating. Underwriter

Deutsche Banc Alex. Brown

expects overall gross margins of 22.2% for the second quarter ending in June, compared with 22.1% in the first quarter. The firm sees 23.1% margins for full-year 2000.

Meanwhile, costs will mount elsewhere on the income statement. Fulfillment -- the cost of building, running and shipping from warehouses -- is recorded as a sales and marketing expense.

Volpe Brown Whelan

analyst Derek Brown estimates sales and marketing spending will reach $387.2 million this year and $502.5 million in 2000, compared with $103 million in 1998. Between 35% and 40% of the sales and marketing expenses will go to advertising, with most of the rest going to Amazon's distribution network, says Brown. Volpe has no underwriting relationship with Amazon.

Barnes & Noble has just one distribution facility based in Jamesburg, N.J. The company wouldn't disclose the size of the facility, but

Center Point Properties

, a local real-estate agency, says records show it's about 33,900 square feet. Barnes & Noble, including its

B. Dalton

chain, had 14.1 million square feet of total store and warehouse space as of January. Borders, including

Waldenbooks

and

Books Etc.

, had 10.1 million square feet.

But unlike Amazon, Barnes & Noble and Borders store most of their books on the shelves of their stores, where browsers can look them over. By building a big network of warehouses, Amazon has indeed created a new breed of bookstore -- but not one that's free from the costs of storing and maintaining books, as Bezos had hoped. Instead, Amazon's created a bookstore that keeps its wares completely out of the hands of its customers until they've paid for them.