Blue Mountain Arts hatched a bold plan to transform its Web site's popularity into profits. But as it turned out, it could only go so far on its own
The investment banker has come to make his pitch, and Jared Schutz, shifting in his seat, is making it clear that he doesn't have much time to hear it. Schutz, the 24-year-old executive director of Blue Mountain Arts Inc., a greeting-card company in Boulder, Colo., has entertained a vice-president from nearly every major money house on Wall Street in the past year. He can't remember all the VPs' names. In his mind, they all morph into one gray suit with one shared goal: becoming the underwriter for an initial public offering that could fatten their bonus checks by a BMW come Christmas.
"What are you looking at in terms of cash needs?" asks the VP.
"We have no need for capital right now," says Schutz politely. "But we're keeping our options open."
Schutz is uncomfortable talking about finance, an area in which he has had little experience. What makes this dance tolerable for him is that every suitor confirms a bit of intelligence that he finds particularly agreeable: at current market valuations, bluemountain.com, the company's three-year-old Web site, is worth about $1 billion. Schutz and his parents own the whole thing.
Why is the valuation so high? Five months into the year, 54 million customers have stormed the virtual doors of the Schutzes' greeting-card store, an extraordinary number that would give even the sales managers of, say, Sears reason for jubilation. Taking advantage of thousands of offerings, visitors to bluemountain.com have sent cards for every conceivable holiday (National Boss Day, October 16) and pseudospecial occasion (coffee breaks). Under ordinary circumstances, such a large volume of customers would produce sales of about a quarter of a billion dollars -- and that's with more than half the year and the biggest holiday months still to come.
The Schutzes' army of customers, however, have produced not one cent of sales for the company's line of electronic greeting cards. It's not that they don't like the cards, and they aren't deadbeats. It's that Schutz has kept his price on electronic cards very attractive: they're free. "We have," Schutz tells the banker, "negligible revenues."
"Got it. Got the scoop," the banker replies. He's not surprised. Fifty-four million customers and negligible revenues -- a deal to die for. After all, this is a market in which eToys, with revenues of $35 million and losses of $73 million, reached a market valuation on May 20, the day of its IPO, that was a third higher than that of Toys 'R' Us, a rival with more than 300 times the revenues. The market valuation of Barnesandnoble.com reached $3.5 billion at its IPO, on May 25 -- a valuation 50% higher than its brick-and-mortar counterpart.
Blue Mountain's site, according to September figures compiled by Media Metrix Inc., ranks 14th on the list of the most-visited sites on the Internet. Although it's classified as a commercial site, commercial is used loosely when the Internet is involved, since the term covers sites that give away their products. What's considered as important as revenues or profits, at least in these adolescent days of electronic commerce, is a site that attracts a crowd -- a big crowd. And Blue Mountain draws a throng almost as large as that of the much-celebrated Amazon.com.
Eventually, so the thinking goes, sites like Blue Mountain will coax many of those 10 million or so monthly customers to treat it like a real business and actually spend money there. But that requires making a tough leap: after all, people who have found the proverbial free lunch may not be the kind of customers who dig deep into their pockets. They may, in fact, be the kind who are likely to tune out any commercial messages.
That's clearly not a theory that Schutz buys. Over the past couple of years he began putting together what may have been the boldest plan yet for making money in the new world of E-commerce. But he could go only so far on the company's limited resources. So on October 25 Blue Mountain agreed to sell its Web site to Excite@Home. The Internet portal company plans to broaden the Web site's E-commerce offerings. "The person sending a card should be given the opportunity to engage in a commercial activity," reasons Mark Stevens, executive VP of corporate and business development at Excite@Home.
Then again, it's too early to tell how customers have reacted to the presence of any E-commerce at all. "This is risky," says consultant Peter S. Cohan, author of Net Profit: How to Invest and Compete in the Real World of Internet Business. "I have a feeling that people using the site would react negatively to any commercialization. There's a purity to it now, a sharing of emotions with each other. If they try to turn it into a business and the values of the business are not consistent with the values that got them there, that's the biggest risk. They'll just be another E-commerce site that's trying to make money."
Even before selling out to Excite -- in a deal valued at $780 million in cash and stock -- Schutz says he found it "bizarre" that the company could be worth so much. Others agree. "The purchase price seems fairly extraordinary for a business that has little revenue," confirms Ken Cassar, an electronic-commerce analyst at Jupiter Communications, the Internet consulting firm. "But it's an appealing acquisition for Excite, which values traffic."
The interest from investors began with the cards themselves. On the same day in May that Schutz was meeting with the investment banker, Faith Gowan was creating one of those free electronic greeting cards -- for Bankers' Day, no less. Gowan, an art director for the Blue Mountain Web site, is one of 18 or so artists who work on the site. "I put up a few new cards each day," says Gowan, who works in a studio in downtown Boulder.
The animated bankers' card was a simple design. Dale Beisel, a staff artist in Sausalito, Calif., had drawn images of a banker, some with arms bent, some with arms outstretched, and all with dollar bills flying overhead. When the images were scanned into a computer, the series of pictures showed the banker jubilantly throwing money into the air -- which, of course, a banker never does, except when E-commerce is involved.
Gowan chose a clip of music to accompany the animation and combined it with a program that enables customers to customize the card -- they can choose either a male or a female banker, for instance -- and write a sensitive message. (Such as, "Thanks for calling the loan, bozo. You've forced me out of business. See you in court.") Once a customer chooses the card and types in a recipient's E-mail address, the card is stored on a computer at Blue Mountain Arts. An E-mail note then is sent to the recipient notifying him or her that a card waits at Blue Mountain. By clicking on a link, the banker is connected to the Blue Mountain Web site and picks up the card. Once there, he or she can write a personal message on a return card. (Such as, "I give you my personal assurance that foreclosure on your house will be carried out in a most respectful way.")
Because of the way Blue Mountain designed its site, each card produces a new customer in the recipient, and awareness of the Blue Mountain site thereby spreads quickly -- a concept known as "viral marketing." Before it was acquired, the on-line operation was subsidized by the company's line of printed cards, which got its start in the early 1970s. Back then Jared's parents, Stephen and Susan Polis Schutz, a pair of '60s flower children, produced posters and cards in their Boulder home. Stephen drew pastel airbrushed landscapes that framed Susan's free verse about love and friendship. The all-occasion Blue Mountain cards secured a new niche in a market filled with cards written for specific events such as birthdays, anniversaries, and holidays. With sales now amounting to about $60 million, Blue Mountain owns perhaps 1% of a market dominated by Hallmark, American Greetings, and Gibson Greetings.
It was Jared who expanded Blue Mountain's domain to the Internet. As an undergraduate at Princeton University, he started two Internet companies and sat on the board of a third. One of his two start-ups, American Information Systems, an Internet service provider in the Chicago area, attracted about 15,000 subscribers. He and his partners sold it last February, with Schutz taking 25% of the $21-million selling price.
In September 1996, Jared put Blue Mountain's Web site on-line with half a dozen free electronic greetings. "We didn't know we were launching an Internet company," he says. "We were just offering a service that would be fun and would help build our brand of printed cards. Only three years later we had one of the most-visited sites, but it was serendipitous."
While companies in the brick-and-mortar economy cling to the archaic notion that they should charge for their products or services, freebies are an accepted norm in cybercommerce. There's a certain logic behind the giveaways, which include such services as E-mail, Internet faxing, and digital publications. "The hope in E-commerce is to exploit the economies of scale," says Hal Varian, dean of the School of Information Management and Systems at the University of California at Berkeley. "There's a fixed cost to set up a system and then a very low cost to add each customer after that. Also, E-commerce is a new way of buying and selling for most people. Promotions help get people to try a product or service."
Last, and perhaps most important, is the perceived advantage gained by being the first to attract customers. "There is a belief, correct or not, that people will stay with the merchant they try first and get good service from," says Varian.
Maybe so, but there's no proven business model for converting eager freeloaders into eager paying customers. That leaves companies like Blue Mountain facing outsized risks, walking on the high wire of capitalism's odd new three-ring circus -- with no net underneath them.
Schutz's most important lesson in E-commerce came shortly after he began toying with the Blue Mountain site. In February 1997, Dan Cunningham, a Princeton classmate, opened a sporting-goods site called Sportscape.com. About six months later Schutz signed on as a director of Cunningham's company.
"We were selling other people's brands," says Schutz. "There were no margins in it."
On the Web, consumers can find the lowest price on any item with just a few clicks of the mouse -- there are even sites, known as shopping bots, that perform that task for bargain hunters (at no charge, naturally). For Schutz the lesson of Sportscape.com, which Cunningham sold in November 1998, was plain enough. "You have to brand your own stuff," he says.
That insight sent Schutz running in a different direction from the one taken by most other sites. The conventional Web-business model looks somewhat like that of a print publication. A site presents some type of content -- news, entertainment, or, in the case of Blue Mountain, electronic greetings -- that attracts a large number of people. Then it sells space on the site to advertisers that want exposure to that audience. In addition, content sites also form affiliations with on-line retailers. By embedding icons on their pages, affiliates encourage their customers to click through to the sites of various retailers selling books, videos, airline tickets, and other products. The affiliates usually take a 5% to 12% cut of the purchase price as a fee for the referral. But to Schutz, ads and affiliations by themselves looked like a dead end.
Internet advertising, although it's growing quickly, is relatively small at this point. This year $3.2 billion will be spent on on-line ads, and on-line ad revenues are projected to grow to $11.5 billion in 2003. But "80% of the on-line-ad inventory goes unsold," notes Jupiter's Cassar. Furthermore, some recent studies have shown that Internet advertising is generally ineffective; new software may even enable users to block ads from their computer screens.
Affiliations may be more promising, but referrals to the most popular commercial sites like Amazon.com are so plentiful that consumers may well become inured to them. It's unclear how successful ads are in getting visitors to click through to partners' sites and make a purchase. And the more upscale the affiliate, the more difficult it generally is for a site like Blue Mountain's to gain generous referral fees from it. "You have to look at the details of each deal," says Berkeley's Varian. "But when you partner with a strong brand, you get less favorable terms."
Schutz put a limited amount of advertising on the Blue Mountain site this year. Instead, he pursued a much more daring strategy: launching new companies, each one producing a branded product aimed at appealing to Blue Mountain's customers. Doing so, he figured, would give Blue Mountain the opportunity to make bigger profit margins on the sales -- and to build equity in a successful brand name. "If you buy books, you can buy the same book at Barnes & Noble or Amazon.com. But this is a brand strategy," Schutz explains. "We looked at brandable, high-margin goods."
Fortunately for Schutz, deciding which goods to offer wasn't a matter of utter guesswork. Even without asking for any personal information about his customers -- a practice followed by many sites, including competitor Egreetings Network -- Schutz gained valuable insights by seeing which particular cards visitors sent. "Cards provide very meaningful information," he says. "It's about the mind-set of the person, rather than about the person. It's the same mind-set involved in sending a greeting card that's involved in sending a gift. Everyone who comes to the site is engaged in an event-oriented communication with a loved one."
With 2,000 cards to choose from, customers can reveal something important about themselves, giving Blue Mountain the opportunity to make an appropriate offer. Although the Blue Mountain site hasn't done so, the possibilities for highly targeted sales pitches are legion. If, for example, a customer sends a Bastille Day card to a friend in Paris, perhaps either or both of them might be interested in a special phone rate or a discounted airline ticket between the two countries. Such an ad could pop up as soon as the card is sent. Customers exchanging cards for a holiday such as Passover might want to buy special holiday foods, or a person sending a birthday card to a grandchild might buy calcium and vitamin supplements.
But a much bigger opportunity likely lies in selling traditional gifts related to card giving. Customers who come to the Blue Mountain site to send a card may be celebrating an occasion that also calls for a gift. Therefore, Schutz figured, customers might appreciate the convenience of taking care of a special occasion with a few mouse clicks. Which gift offer, for instance, might attract the attention of a man sending an electronic birthday greeting to his girlfriend? "After the card is sent, there's an opportunity to sell flowers," says Schutz. Which is why, he adds, "we've used the site as a launching pad for our own flower company."
Blue Mountain could have referred customers to many other flower sites, including those owned by industry giants 1-800-Flowers and FTD, but Schutz saw that there was money to be made in building his own brand. And so, in July 1998, Blue Mountain Arts launched Proflowers.com, a flower company in San Diego owned primarily by Jared Schutz and his parents. It has been taking orders over the Internet -- and enjoying its status as the only flower company with access to the millions of customers using the Blue Mountain site.
Exposure alone guarantees nothing, of course. Proflowers, though, draws attention to itself by undercutting other flower companies on price. Schutz followed the Staples business model of buying inventory right from the manufacturers. Because customers' orders are filled directly by the growers -- a system that eliminates wholesalers and local flower shops -- Schutz offers cut flowers and bouquets for about half the going rate of his big competitors. "We cut all the inefficiencies out," he says.
Schutz contracts with 10 flower farms in California to supply the new company. After Blue Mountain customers send an electronic greeting card, they receive an offer to buy flowers. Their order travels electronically to a computer at Proflowers, which verifies their credit-card information and then faxes the order, a gift message, and a FedEx label to the flower farm that has the inventory to fulfill the purchase. Schutz says that the flowers are cut just a few days before they are delivered overnight in a box, still in a bud state, making them fresher by far than flowers purchased from a shop.
Because of the low price, "we can be the Southwest Airlines of the flower industry," says Bill Strauss, president and CEO of Proflowers and a former vice-president at Intuit, the software company. "We can get a lot of people to send flowers who don't send them now." By this fall sales were running at an annualized rate of only $16 million. Strauss says annual sales could reach $200 million within three years. "It's a big industry and highly fragmented," he says.
Schutz wanted to entice customers with more than flowers. "We wanted to develop the premium gift portal on the Internet," he says. To that end, Schutz also began selling his own brand of premium chocolates through the Blue Mountain site.
Like Proflowers, Dan's Chocolates owns no production facilities but concentrates instead on marketing and distribution. Schutz hired his old Princeton buddy, Dan Cunningham of Sportscape.com, to run the company. They contracted with a chocolate factory in Wisconsin to produce the candy, which Dan's Chocolates ships from a building just down the road.
The product competes at the high end of the market against brands like Godiva. Typical prices are $19.95 for half a pound and $32.95 for a full pound, a price point that Schutz says should be attractive to customers wanting to send a nice gift -- and one that should produce gross margins of up to 30%. "People buy chocolates that denote prestige," says Schutz. As Cunningham points out, only on the Internet could Blue Mountain even contemplate building a brand name in chocolates; in normal retail channels, it's unlikely that Dan's Chocolates could get even a toehold against established competitors.
After Dan's Chocolates, Schutz set out to launch a fruit company, Grandmajune.com (named after Schutz's grandmother June Polis, who for many years was the national sales manager for the company's printed cards). Like the flower and chocolate companies, the fruit business will bypass the standard distribution chain. Customers could pick an assortment of fruit or one of a number of baskets displayed on the site, with orders routed directly to a handful of growers around Fresno, Calif. "We have control over who we choose as growers," says Schutz. "We work with the farmers whose oranges we like the best."
Excite@Home's acquisition of the Web site didn't include Proflowers.com or Dan's Chocolates, although the start-ups separately agreed to pay fees to advertise on Excite's site. Grandmajune.com, Schutz says, was too young to be part of the deal.
Schutz believes that cost savings will enable Grandmajune.com to compete against the big catalog companies like Harry and David. "What we're doing is brandable, has little competition, and has good synergies with the Web site," says Schutz. And, of course, all the gift offerings will receive wide exposure -- if nothing else. "What better way to launch something than to be attached to one of the largest traffic generators on the Web?" says James McQuivey, a senior electronic-commerce analyst at Forrester Research, an Internet research company.
Not every idea Jared Schutz has had for selling branded products on the Web has taken off. Far from it, in fact.
Just after the launch of Proflowers, Schutz got the idea for Prolobsters, which packaged and delivered lobsters off the docks in Maine. Customers ordered from a Web page whose mascot was a lobster dressed in a tuxedo. If crustaceans in penguin dress seemed an odd image, not many consumers ever saw it. Schutz received some orders, but the idea went nowhere, and the life of the site was blessedly short.
Schutz won't say how much money he's burned in building Blue Mountain's Web site during the past three and a half years. In E-commerce, investors obviously don't care about losses -- at least in the short term -- as long as a site is a popular surfing spot. "We needed to grow," says Schutz. "Now is the time for rapid growth."
Until the acquisition by Excite@Home the Schutz family, not Wall Street, sustained the losses. Schutz believes that the Web site is largely responsible for the 20% annual growth in sales of the company's printed cards over the past three years -- at a time when the rest of the industry was growing in the low single digits.
The site's business model "has a lot of different possibilities," says Excite@ Home's Stevens. He says Excite@Home will add such services as on-line calendars, free E-mail, and voice mail. For Blue Mountain -- whose the-world-is-a-happy-place-full-of-love approach to life seems far removed from gritty questions of shipping fees and credit-card verification -- the reality of expanding its E-commerce offerings looks especially challenging. "Blue Mountain has created a great brand name, and it's a brand predicated on a trusting, noncommercial relationship with consumers," says analyst Cassar. "Consumers are wrapped up in good vibes."
Schutz, who remains chairman of Proflowers, showed sensitivity to that problem by separately branding each new business -- using the name Proflowers, for example, not Blue Mountain Flowers. And the businesses seem consumer friendly because they offer low prices.
But before the sale Schutz's biggest challenge may have been starting too many small companies with the idea of growing them quickly. Entrepreneurs know how difficult it is to run one fast-growth company successfully and to execute all the myriad functions well -- let alone do it in a constellation of new companies. Schutz already faced more than a full-time job just running his sprawling Web site. And although he had hired executives to run the new companies, neither he nor his top managers at each company had in-depth experience with the products they're selling. "It's a lot harder to sell things than it looks," warns Cassar. "Retailing is difficult."
And even though the spin-off companies have contracted out production, they will have to accept the blame for any glitches. "If there are delayed shipments or shipments arrive damaged, it reflects back poorly on you," says Hal Varian, the Berkeley dean. "You have to worry about fulfillment issues. You don't want the problems to do damage to the brand name you're trying to build."
Even if his suppliers perform well, Schutz and his managers face a difficult -- and unfamiliar -- task in forecasting demand. Flowers, chocolates, and fruit are seasonal businesses centered on holidays and other special occasions. Among the millions of people using the Blue Mountain site and seeing the ads for these products, how many will make purchases? Even if total orders are close to the target, customers may surprise Blue Mountain by ordering more red roses and fewer yellow roses than expected, or more of one chocolate assortment than another. "It's a very tough problem," says Cunningham. "It's tricky because ordering comes in peaks."
So as not to disappoint any customers, Cunningham says, Dan's Chocolates will err on the side of carrying a large inventory of candy. "We'll oversupply what we think our highest sales numbers will be," he says. "We have our production systems lined up so that if we see a particular SKU moving well, we can go in that direction." But overestimating demand would be costly. "If we project the numbers too high for the holidays, we can sell the chocolates through January and February," he says. "But we have to come close to projections on Mother's Day because it's slower during the summer. If we overstock, we would have to clean out at low prices or get stuck with it."
There's less and less room for error. Excite@Home's purchase of the Web site came at a time when it was facing more and more competition. New competitors, in fact, may very well be responsible for the more than 20% drop in traffic at the site since a February peak of nearly 13 million. Both Amazon.com and Microsoft's msn.com have added free electronic cards to their sites this year. Aggressive new rivals like Egreetings Network, in San Francisco, already have attracted a few million visitors a month. Egreetings, which filed to go public in October, was initially funded in part with about $25 million from Microsoft cofounder Paul Allen's venture-capital fund, Vulcan Ventures.
Gordon Tucker, president and director of Egreetings, doesn't hesitate to label Blue Mountain's cards "sentimental" and "somewhat cheesy stuff," arguing that selling flowers wouldn't have taken Blue Mountain very far. "Most consumers want to deal with a known retailer," says Tucker, who uses an advertising and partnership approach. "It's potentially a small business for Blue Mountain. It's not on our scale -- we'll get much faster growth."
"It was clear," says Jared Schutz, "that we couldn't continue to fund this out of our own pockets." Even so, Excite@Home's acquisition of Blue Mountain's Web site doesn't put to rest the tough strategic questions that drove Schutz's initial strategy. On their own, the owners of bluemountain.com "had some tough decisions ahead of them," says Carrie L. Ardito, an associate analyst at Forrester Research."Now Excite@ Home can deal with those decisions and can probably deal with them better."
Chief among those challenges is figuring out how far the owners ought to go in terms of commercializing the site. "It looks like Excite's objective is to monetize the relationships that Bluemountain.com has created," says consultant Peter Cohan. "That's quite at odds with the culture that it has promulgated since its inception."
How much at odds may depend on just how Excite@Home puts its stamp on its newfound acquisition. Stevens, of Excite@Home, insists that the company will take "very careful steps. The feel of the site and the community aspects to it are very important to us." What Excite@ Home wants to sell visitors on, he notes, is the chance to become subscribers to the company's consumer broadband service. "It's a very attractive market for us to offer broadband services to," Stevens says. Ardito, for one, isn't so sure. "The homemade value of Blue Mountain is earthy, and this is a service for traditionally technologically savvy people," she says. "There's no proof that these people would pay for broadband service. And add-on services like gifts are not proven to work, either."
Then again, bluemountain.com operates in an industry where not much has been proved. A Web site that attracts 10 million monthly users has provided all the proof it needs -- to justify a price tag of more than three-quarters of a billion dollars, anyway. It almost makes sense. "It doesn't matter that our revenues were negligible," says Schutz. "We've been losing a lot less money than anyone else out there. When you look at the terrible Internet companies Wall Street has taken public, we look great by comparison."
Stephen D. Solomon is an associate professor of journalism and director of the program in business and economic reporting at New York University. Additional research was provided by Anne Marie Borrego.