Sector Spotlight: Christmas on the E-Tailing Brain - TheStreet

Admit it: If you hear someone say one more time that holiday 2000 is going to be "make or break" for e-tailers, you're going to lose your eggnog.

That's perfectly understandable. But there's simply no way around the fact that this holiday season is pretty important. Will the continued growth in e-commerce be enough to make up for a more widespread slowdown in consumer spending? And will revenue growth alone allay worries about e-tailer profitability? Now that the third quarter is over, all eyes are on the fourth.

A brief recap of what has changed since last Christmas. Most notably, after April's

Nasdaq rout, the e-tailing sector has gone from dancing queen to wallflower. Amazon's shares are 70% off their highs, while most of the sector would be happy just to get their shares out of the single-digit club. And those are just the publicly traded ones, which were lucky enough to get to the capital markets before funding completely dried up. Scores of private companies, from

Boo.com

to

Eve.com

, have simply thrown in the towel.

Meantime, there remains an intense skepticism about when (or whether) the e-tailing business model will actually result in profits. Only

eBay

(EBAY) - Get Report

-- which really isn't a traditional e-tailer -- and

FTD.com

(EFTD)

make money.

What does that mean for e-tailers heading into the holiday season?

More to Go Around

Good news first. For the survivors, there are fewer on the island. Take the toy category. Holiday 1999 had

Amazon.com

(AMZN) - Get Report

,

eToys

(ETYS)

,

Toysrus.com

,

KBkids.com

,

Smarterkids.com

and

Toysmart.com

(for starters) duking it out. Toysmart has since folded, while Amazon and Toysrus.com have joined forces. "The competitive landscape has been reduced," says Jonathan Cutler, spokesman for eToys.

However, online shopping is still growing, albeit at slower rates than were seen in the earliest days. Of course, one has to take forecasts about the Internet with a grain of salt, but still --

Jupiter Research

projects a 66% jump in online sales during November and December to $11.6 billion ($9 billion from retail, the rest from travel). More demand and less supply should, in theory, be good. "Logically, it means that each of us should do better," says Scott Galloway, whose

Brand Farm

company includes e-commerce firms

Gold Violin

and

Room 12

.

And companies are figuring out what works and what doesn't. Security fears are subsiding, says Elliott Ettenberg, chairman and CEO of

Customer Strategies Worldwide

, a marketing consultant. In part, that's because credit card companies have started using as a selling point limited liability for fraudulent charges, he says. After last year's service concerns, fulfillment will also likely be smoother -- Toysrus.com has handed over its own fulfillment to Amazon to guard against the problems the toy e-tailer saw in 1999.

All that would suggest smoother sailing ahead for e-tailers. But there are concerns -- like the economy.

What Goes Around...

Retailers such as

Williams-Sonoma

(WSM) - Get Report

have been warning all over the place about slower consumer spending. Why would e-tailers be any different? The latest figures from the

National Retail Federation

and

Forrester Research

may suggest some toll on online sales -- the numbers show no sequential growth in online sales from August to September. Online music and video sales declined during the month. Consumer electronics fell 21% sequentially. Books, meantime, were up 11%. Ken Cassar, analyst with Jupiter Research, says projections for a healthy 66% jump in online sales represent a slower rate of growth than last year's 126%. But "because it's such a nascent channel, it will largely be immune to the downturn," he says.

And the new fiscal conservatism means marketing spending as a percentage of sales will be lower this year. Not anymore. Of course, a lot of that spending was probably far too costly to justify the revenue that came in. "Now that they've learned that mass

market and banner ads don't work, they're following in the line of what worked for traditional retailers: newspaper ads and inserts," says Ettenberg. Amazon recently advertised its consumer electronics store with newspaper inserts.

But still, the slowdown in marketing spending "will probably make the top line a little less," says Bonnie Tonneson, who follows e-tailers and retailers for

Chase H&Q

. "There's been a definite correlation between marketing spend and top-line growth."

Ashford.com

(ASFD)

, the luxury goods e-tailer, recently reported lower-than-expected sales for its fiscal second quarter. In a research note,

Robertson Stephens

analyst Lauren Cooks Levitan wonders if the company's reduced marketing expenditures will hurt its ability to meet sales estimates for the crucial holiday quarter. "The shortfall highlights the challenges facing the company in building a brand with minimal advertising," she writes. (She rates Ashford a buy, and her firm has done underwriting for the company.)

And that's just the top line. These companies still have to prove that they can make money, and investors aren't likely to pile on board until they do. Even then, there's no guarantee: Shares in FTD.com still trade at under $4, even after the company said it turned a profit. E-tailers are going to have to start showing that the supposed benefits of being online will eventually translate into better margins.

It's too early to tell whether the influx of shoppers online will make up for what may be a more wary consumer; that information isn't going to trickle out until the holiday season really kicks off. But as long as the e-tailers are still highly valued, the holiday quarter is going to be a crucial time to prove they can ramp up sales, handle fulfillment and make a profit.

Dare we say it? It may even be make or break.