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The Next Next Thing

Three entrepreneurs decided they could turn their money-losing brick-and-mortar business into a well-funded dot-com. The question: Will they be able to win SmarterKids.com a place in the market?
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For years Jeff Pucci and Richard Viard struggled to find a profitable formula for their company. Then -- eureka! -- they realized they could turn their money-losing brick-and-mortar into a well-funded dot-com. So far, it seems to be working

The jury is impaneled at the Newman Elementary School, ready to carry out its duty of analyzing the evidence. Paper fish with red stripes and green fins festoon one classroom wall. All the fish are grinning. So are the jurors. Susan Graham calls the proceedings to order: "All right, let's go." Five jurors, gathered around a table, begin playing a newfangled version of Monopoly that features a trip to the wilds of Alaska. A red-haired second-grader moves her piece, shaped like an igloo. What's this square? she wants to know. "Go to Jail" has been changed in this Monopoly game to "Go to Lunch." What a disappointment -- she'd like to see her classmates serve some time.

Four toys are spread out on tables in the classroom. One, a card game, has attracted no players. That's a bad sign. Graham scribbles a note to herself.

Graham, director of education for SmarterKids.com Inc., performs a critical task for her company, which sits on the edge of a busy highway in Needham, Mass., a few miles away from the school. With her staff of eight former teachers and a merchandising team, Graham evaluates kids' products and chooses those that SmarterKids.com will offer on its site, which sells educational toys, games, books, and software. Graham's group -- with the help of test labs of school kids, like this one -- chooses some toys and discards the boring ones and the ones that, for reasons not apparent to adult eyes, don't pass the demanding playtime criteria of, say, a seven-year-old. Most important, the group refuses toys that have no redeeming educational or developmental value. This focus on education, of course, eliminates many best-sellers with buzz. "No games -- nothing -- that blows anybody up," declares Graham definitively. You won't find Sega's Zombie Revenge on SmarterKids.com. No Furby, either. "The educational value is not substantial," says Graham. G.I. Joe patrols on Neptune, for all she knows.

Once they've made their choices, Graham and the rest of her crew spend from one to four hours with each product, rating it for fun, ease of use, and depth (how often a child will continue to play with the toy once the novelty has worn off). The idea behind these evaluations goes beyond that of a typical product review. These ratings, combined with other features on the site, are intended to help Web-surfing parents choose toys that meet the individual needs and tastes of their kids -- not just kids of the same age and gender.

That personalization, in a nutshell, is what separates SmarterKids.com from its much larger online competitors, which include big names like Toysrus.com, eToys Inc., and the ubiquitous Amazon.com Inc. On the SmarterKids.com site, parents can build individual learning profiles of their children, comprising their ages, grades, learning goals, and most effective learning styles -- linguistic, visual, physical, or musical, for example. In addition, children can take skills tests on the site -- tests through which parents can learn their kids' academic strengths and weaknesses. Those scores also are factored into the learning profiles.

From the profiles the company recommends products tailored to fit each child. Even leading terra firma educational retailers like Learning Express and Zany Brainy Inc. can't do that. "We reshuffle store shelves," says David Blohm, SmarterKids.com's CEO. "If you could go to a store and tell the clerk all about your child, and he could push a button and reshuffle the aisles and shelves to show only products for your child, that's what we do."

Blohm, 49, and his colleagues, cofounders Jeff Pucci, 39, and Richard Viard, 40, understand all too well the differences between what they can achieve on physical store shelves and what they can do in cyberspace, having struggled for years in the brick-and-mortar economy. For eight years the company, first under the name Virtual Entertainment Inc. and later Virtual Knowledge Inc., developed software that it sold in retail stores. It lost big money for the last five years. Only around Thanksgiving, 1998, did it awaken, utterly transformed from an old-economy company into a sexy Internet play soon to be valued at $63 million at its initial public offering. Investors didn't seem to care that at the time of its IPO, in November 1999, the company had just $1.1 million in sales for the previous nine months. They didn't seem to care that SmarterKids.com lost $14.1 million on those meager sales. (Adding in the three-month retail holiday season, the company finished 1999 with sales of $5.4 million and losses of $34.7 million.) And they didn't seem to care that for years Pucci, Viard, and Blohm had been unable to find the formula for a profitable educational company. Or so it appeared until they transformed their venture into SmarterKids.com, almost a decade after its founding.

As it is with many of the toys the SmarterKids' kids evaluate under the gaze of green and red fish, the jury is still out on SmarterKids.com itself, despite the success of its IPO. Until recently, investors tolerated losses in dot-coms that would send them stampeding for the exits in traditional retailing. What they had loved, even at dizzying valuations, were companies with great ideas that promised to attract millions of Web surfers; the profits could come later. Investors saw in SmarterKids.com something that seemed unusual in the toy market: the company's potential to leverage the Internet's power to build one-to-one, interactive relationships with customers. "Theirs is the only customized educational tool out there," says Liz Leonard, a senior analyst at Gomez Advisors Inc., an Internet-research company in Lincoln, Mass.

Will that be enough to win SmarterKids.com a place in the market, especially considering that it has drawn not a single breath of profitability since 1994? And will that be enough to make the cofounders' strategy -- of reinventing their company to take advantage of new technologies and trends -- finally pay off?

The transformation from traditional retail to E-commerce is a perilous one for the company. Virtually all the other online toy sellers feature much broader product offerings than SmarterKids.com does. For instance, eToys boasts more than 100,000 products to SmarterKids.com's 4,000. And the big toy sellers last Christmas generated two to three times more traffic to their sites than SmarterKids did. (See "Toy Traffic," below.)

Last November, when SmarterKids.com offered its shares to the public, ultimately raising $63 million, it told prospective investors it might burn through the money in a year. That's about how long Blohm, Pucci, and Viard have to show that their innovative idea has life.


"No games -- nothing -- that blows anybody up," declares Susan Graham definitively.


The founders of SmarterKids.com arrived at this juncture by the most circuitous of routes, re-creating their entire company, from strategic direction to corporate moniker, not once but twice. Jeff Pucci and Richard Viard both attended Boston's Berklee College of Music in the early 1980s. Viard, who had grown up 40 miles outside Paris, came to the United States for a semester and never left.

Although they went on to become entrepreneurs, neither founder quite left Berklee behind. Viard maintains a music studio in his basement, where he plays guitar, drums, and keyboard. Pucci, too, plays guitar -- his original songs. And he has an entrepreneurial drive that seems to need one more outlet beyond his busy dot-com; he cofounded and still keeps a hand in managing a small CD label, Curve of the Earth, that publishes the work of Boston musicians.

The two men didn't meet, however, until both landed in 1988 at Dr. T's Music Software, a Boston-area company that published software for musicians. It was a season of momentous change for the computer industry, for just coming to market was an exciting new generation of multimedia machines. Pucci and Viard talked about developing software that would bring music history alive, and multimedia provided their obvious avenue. Moonlighting, the two musicians created a CD-ROM that enabled people to listen to four centuries of great music while reading about the composers and the social and political developments that influenced them. In 1991 Dr. T's published their CD-ROM, called Composer Quest, and it became a kind of poster child for the capabilities of multimedia.


There was no home run for Jeff Pucci and Richard Viard as publishers. "No way to create real wealth," says Pucci.


Leaving Dr. T's and going out on their own later that year under the name of Virtual Entertainment, Pucci and Viard worked from a room in Viard's house and produced two more CD-ROMs, both children's educational products, that were published under a royalty arrangement by Opcode Systems Inc. The nature of the partners' collaboration was becoming clear. Viard loved the technology itself and took charge of all the important technical decisions and details. Pucci assumed the role of the technical neophyte; if a CD-ROM was easy enough for him to use, then it would be so for any customer. Meanwhile, Pucci focused on the creative end -- writing the text, obtaining the illustrations, and figuring out how everything fit together.

For three years their partnership was profitable, says Pucci, because they kept costs low by doing almost all the creative work themselves. And the publisher incurred the costs of sales and marketing. But Pucci quickly grasped that two developers working on their own could not leverage their skills into a bigger business. "There was no home run in it," says Pucci. "No way to create real wealth."

In 1994, Pucci and Viard, intent on creating and publishing CD-ROMs themselves, moved to an office in Needham and hired a handful of employees. For Pucci, shouldering the management responsibilities was no fun at all. "That was the highest level of stress in my life," he says. "I wasn't any good at it, and I didn't enjoy it. It was depressing."

In September 1995 they brought on David Blohm to run the company. Blohm had cofounded and run software company MathSoft Inc., which he had taken public in 1993. A year after the IPO, he had cut himself loose from MathSoft and was trying to raise money to start his own educational-software business. Besides sharing an interest in education with Pucci and Viard, Blohm brought to the founders the down-to-earth management skills they were missing.

With Blohm hired, the top management structure of the company was in place. Blohm would manage the daily operations and would use his extensive contacts for raising money. Free from day-to-day managing responsibilities, Pucci, the visionary, would serve as chief strategist, looking for new products to develop and ways to position the company in the marketplace. Viard would focus on the technology and on how to make the CD-ROMs easy for customers to use.


For Pucci, shouldering management responsibilities was no fun. "That was the highest level of stress in my life," he says.


The team quickly developed an approach to identifying opportunities that would serve the company well in the future. Pucci enjoyed nothing better than viewing the big picture, almost as if he were orbiting earth and looking down to find trends in the collage of business and society that portended demand for certain products. Blohm, feet planted on terra firma, scrutinized customer surveys and product-registration cards. Pragmatist and dreamer shared a strategy: they would identify a need and then develop a product to satisfy it. "Many companies have a cool idea chasing customers," says Blohm. "You get in trouble that way."

That thinking produced a hit in 1996. In late 1994 Pucci had noticed that a controversial book, The Bell Curve, by Richard Herrnstein and Charles Murray, had generated interest in adult intelligence tests. Why not produce and sell an intelligence test for adults? Pucci suggested. The company published an adult IQ test on CD-ROM. "We shipped it, and it flew off the shelves," says Pucci. After that success, the company developed a full suite of self-assessment software.

Although it sold hundreds of thousands of CDs, the company became buried in losses. In 1996 it lost $1.6 million on sales of $1.2 million, and 1997 was little better. The CD-ROM market was a difficult place for anyone to make money, because so many competitors -- new companies, old-line publishers, and others -- were drawn to it. Some, like the Learning Co. and Knowledge Adventure Inc., fought for market share by slashing prices. Rebates were so generous that many products were effectively free. Meanwhile, national retailers such as Best Buy and CompUSA were charging sizable fees for shelf space. "The pricing pressure was tremendous," says Pucci. "Retailing got squashed." Trying to compete in that environment, Virtual Entertainment spent more than half of every dollar of revenues on marketing from 1994 to 1998.

Pucci remained upbeat, at least for a while. "It typically takes several years of losses before you see any profits," he says. "And I always thought that one of the categories we got into would be the one that would spike up for us."

Customers themselves signaled the next opportunity. When Blohm studied customers' software-registration cards, a surprise was waiting: many parents who had used the IQ tests asked for a similar test for their kids. The potential market seemed large. "The testing done in schools appeared to be obscure to parents," says Blohm.

The company responded by producing skills tests that measured achievement in math, reading, and spelling. To make the tests fun, Pucci and Viard combined the questions with multimedia enhancements. With these new CD-ROM products the company became a testing company for both parents and children. To reflect that academic turn, Virtual Entertainment changed its name to Virtual Knowledge in 1997.

New products, new name -- it made no difference to the bottom line. With price cutting still rampant, the company lost $3.3 million in 1998 on sales of $2.3 million.

By 1997, says Pucci, "I felt we were going to go under. We had little money in the bank. What were we going to do?"

The answer came as Pucci watched the Internet grow. What he saw was more and more content available at no cost on the Web. It seemed likely, he reasoned, that the CD-ROM market would be slammed yet again. "People wouldn't buy as much if they could get material for free online," he says. "The Internet's potential was huge. For us, it might be annihilating the business we were in. We were going to get wiped out."

On a Tuesday evening in September 1997 as Pucci drove home, the solution dawned on him. Once again, it was the result of coupling a broad vision of the market with attention to the details of customer feedback. Some parents had asked the company to recommend educational products after their children had taken the company's skills tests. Pucci's epiphany? "The parents could go to a site called SmarterKids.com," he remembers thinking. "We'll provide ways to diagnose kids' strengths and weaknesses and provide products for remediation."

The next day Pucci asked Viard to secure the domain name of smarterkids.com and then wrote a memo to the company's senior managers. (See "Pucci's Epiphany," below.) Pucci wrote that "it's just a matter of time before a true critical mass of Internet/online users emerges, and with it, in time, will emerge a viable business model or two, even for selling our sort of goods and services. ... Imagine doing a massive ad campaign down the road that has the term 'smarterkids.com' plastered everywhere. ... Just as Sylvan uses 'educate.com' for their URL, 'smarterkids.com' is more targeted, arguably more memorable, actually means something, and presumably, it's something that every parent wants. And it's something that we can deliver for a fee."

And that, essentially, was the idea: provide diagnostic skills tests free online, and earn the "fee" by selling a variety of products -- other companies' products -- that addressed the educational needs that the tests uncovered.

Within a few days, Pucci had met with the management team. Pucci made the case for the Internet. He recalls, "I said the only way to hit a home run with this business is to embrace the Internet fully."

This would be the company's most radical reinvention yet, from a 15-employee business that sold its own products, developing them a few at a time, to what today is a 110-employee dot-com that tries to capitalize on a huge market by selling hundreds of other people's products. From Pucci's perspective of watching for opportunities, it made sense: the market appeared immense, and with the Internet, the mechanism to reach it was finally available. (Americans bought some $28 billion worth of children's toys, games, books, and videos in 1999, according to Gomez Advisors. About $360 million of it went to online retailers, up from just $43 million a year earlier. Gomez predicts the toy market will climb to $33.6 billion in 2003, with online retailers taking a little more than $3 billion of that.)

But the company would play in another market with even greater potential: education. American parents spend $19 billion a year on educational games, books, and software, according to Thomas Weisel Partners LLC, a merchant-banking firm in San Francisco that assisted SmarterKids.com in a private placement in 1999.

Private industry sees many opportunities in the education groundswell. During the 1990s, for-profit education companies raised about $6 billion in private capital, a little more than half of that in 1999 alone, according to Eduventures.com LLC, an education-industry research and information-services company in Boston. Eduventures.com forecasts that in 2000 education companies will raise another $4 billion in private capital. Much of the money will go to ventures that deliver educational products and services online.

If success in electronic commerce requires a huge market, as many believe it does, then education is the real thing: the K­12 market alone consists of 3.1 million teachers and 50 million parents, a growing number of whom are connected to the Internet. With many thousands of products of uncertain quality available for purchase, the opportunity could be enormous for a company like SmarterKids.com, which would rate products as well as match them to the needs of individual students.

It sounded like a good sell. But at first, raising money was difficult. Because at the end of 1998 the company was still selling CDs while positioning itself for the Internet, says Blohm, "it wasn't clear to investors what business the company was in. So we had to ditch the CD business. We realized we had to be a pure play in the Internet." The company didn't have much choice. "We were desperate at that time," says Pucci. "If we couldn't raise the money, I'm not sure how we could have continued with our Internet strategy."

The strategic decision to stop producing CD-ROMs worked. SmarterKids.com raised $2.1 million from a pool of individual investors, enough to develop the Web site.

In 1998 the company went on a flat-out sprint to open its doors before potential competitors could. To get the job done quickly, Blohm outsourced some key tasks. He forged a deal with the J.L. Hammett Co., a leading distributor of educational products to schools, to stock SmarterKids' inventory and fulfill customer orders. He hired an outside design team to create the Web site. Over a period of seven months the site took shape. At the same time, the company continued to raise money. Riding the wave of investor interest in E-commerce, it raised more than $33 million in private placements and venture capital over nine months.

As SmarterKids.com began selling other companies' products on its site, it sold off the remaining inventory of its CD-ROM testing products. By Christmas, 1998, SmarterKids.com had begun deriving all its revenues from selling third-party products online.

Pucci and his friends, in their third incarnation, had bet the company on electronic commerce.

If Pucci's idea has legs, the company may find out how strong they are by looking at a pilot program it's running in Michigan.

Parents there get personalized help for their children by going to a Web site called WeHelpKids.com. Operated by National Computer Systems Inc. (NCS), which scores the assessment tests for more than 30 million K­12 students nationwide, the site provides a page where parents can type in the scores their children achieve on Michigan's standardized tests. In a few seconds parents are taken to the site of NCS's partner, SmarterKids.com, which suggests educational products appropriate to the student's assessment. If a student has a specific weakness in mathematics, for example, the parent can select from an array of products that are supposed to boost Tommy's ability in arithmetic.

Intriguing to many experts is the unique way that SmarterKids.com constructs a bridge connecting standardized test scores -- a source of confusion and worry for most parents -- to opportunities for learning. "The power of the Internet is that learning can be tied to individuals," says R. Keith Gay, a partner at Thomas Weisel Partners. "Assessment is the key to driving product purchases."

Until now, standardized tests have had limited benefits for students and parents. They're used chiefly for the purposes of ranking schools and school districts. "The assessment tests now aren't tied to anything prescriptive," says Gay. "It's like going to your doctor for cardiovascular tests and finding out how you rank in the county."

Blohm expects to add half a dozen states to the WeHelpKids.com site by the fall and others later, which will give SmarterKids.com access to many more of the 30 million children whose tests are processed by NCS. "This is the future," says Blohm. "Linking assessment with education is the Holy Grail of education, but it's not been easy to do."

The company's various attempts to create that link seem to be working -- at least, that is, when measured by the E-commerce metric of registered users (who, says Blohm, buy more products than casual visitors do). By the end of 1999, parents had entered more than 100,000 children's learning profiles into SmarterKids.com -- profiles that, not incidentally, provide valuable demographic information to the company.

Despite how useful the Web site may seem to parents, CEO Blohm must still find ways to get them to visit it in the first place. It's through the disproportionate marketing expenses typical of many E-commerce start-ups that SmarterKids.com could burn quickly through its $63 million: during the last quarter of 1999, it shelled out $18 million for marketing on sales of $4.3 million.

The company had rich fodder with which to create its marketing campaign: recommendations based on each child's needs make a strong selling point. The company sends as many as 20 million E-mail messages monthly to people who match the demographics of an average SmarterKids.com shopper. The target SmarterKids.com shopper is a woman, 25 to 49 years of age, with children ages 2 to 15, who works outside the home. In the brick-and-mortar world, a direct-mail campaign typically requires months to conclude. On the Internet, by contrast, a direct-mail campaign through E-mail produces results immediately. "Within minutes you get a response," says Blohm. "Within a day you know whether the list is working or not."

Whether the list works depends in large part on the company's home page, its most valuable real estate. Every inch must contribute to driving sales or otherwise satisfying customers. As many as eight spots on the home page change each week, in response to measurements of consumer interest. The company keeps running counts of how many times visitors hit each link on the home page, how they move through the site, and what links produce the most sales. "This is like putting a LoJack on every visitor and seeing where they go in the store," says Lisa Tanzer, vice-president of product management.

When an area of the home page isn't drawing interest, programmers replace it with something else. Tanzer has learned, for example, that products do best when they're positioned as both educational and fun. Featuring a product at the top of the page is better than putting it "below the fold," where customers must scroll down their screen to see it. Even more important than placement, however, is the size of the selection of products offered. Blohm says the company plans to expand its product offerings this year.

In the future, the company wants more parents to click through to its Parents Center, where it's adding features such as advice columns and practice tests. The idea is to increase "stickiness" -- the time a customer spends on the site, which translates into increased loyalty and repeat business.

It's here where the blend of Blohm's pragmatism and Pucci's ability to spot the next trend are at work once again. The two, watching the growing market for long-distance learning, have spotted a way to add services to the site -- services that could keep children and their parents coming back again and again and staying on the site longer. Soon, through partnerships or even acquisitions, they hope to sell enrichment courses and one-to-one tutoring. Mom's not home after school? Turn to the site for some live, on-the-spot help with homework. "Most parents are willing to spend money all day long if it will help their kids to improve," says Thomas Weisel partner Gay.


Pucci and his friends, in their third incarnation, had bet the company on electronic commerce.


At Newman Elementary School, a second-grader confides that she doesn't like a card game that she and several other children are playing. "It's kind of boring," she says. If the producers of the game were present, they would feel the dagger in their hearts.

"If we didn't reject products," says education director Susan Graham, "we wouldn't be doing our job. If it disseminates or perpetuates stereotypes, we reject it. We don't offer any Barbies." The teachers turn down 40% of the products they consider.

There is no such problem with the Monopoly game. Five kids are enthusiastically playing the game, including a girl with long brown hair who was virtually cleaned out in 15 minutes. A girl to her left has won all her money and controls the board with the confidence of the pretrial Bill Gates. Who knows -- maybe she'll start a dot-com company by seventh grade. "Monopoly is a good teaching tool," says Graham. "There are elements of math, accounting, reading, strategy, and problem solving."

Still, another five kids have decided not to test the fancy games at all. They've been playing over in a corner with plain wooden blocks -- blocks so nicked and scratched that they have probably been here as long as the school has been standing.

Just in case, SmarterKids offers wooden blocks on its Web site, too. Sans scratches.

Stephen D. Solomon is an associate professor of journalism at New York University, where he is director of the program in Business and Economic Reporting.


Pucci's Epiphany

FROM: Jeff Pucci
SENT: Wednesday, September 24, 1997 6:46 PM
TO: Al Noyes; David Blohm; Steven Thomas
CC: Richard Viard
SUBJECT: Internet URL "smarterkids.com"

Yesterday I was contemplating our place in the Internet/online universe while driving home, and was trying to envision how things might evolve over the next several years.

It's become painfully apparent to me (as it has to y'all, I'm sure) that this "Internet deal" is not only here to stay, but is poised to completely supplant many a business model in a staggeringly diverse number of companies. The business that we're in -- delivering software content -- seems particularly vulnerable to drastic change.

I honestly feel that we have not "missed out" on any significant Internet-based business opportunities yet, at least up to the present. This opinion is based in large part to remaining cognizant of the fact that content-based software publishers like us have yet (to my knowledge) to generate sales over the Internet that represent even a meager 1% of overall revenues.

But it's feeling very much to me like it's just a matter of time before a true critical mass of Internet/online users emerges, and with it, in time, will emerge a viable business model or two, even for selling our sort of goods and services. The fact that the online universe is, for the first time, tangibly beginning to "steal" eyeballs away from various traditional media -- magazines, newspapers and television -- seems like hard evidence to me.

Although I earnestly expect that it'll take at least another 2­3 years minimum before we hit critical mass that is really meaningful for our kind of business -- in terms of revenue generating opportunities where you actually make substantial net commerce based sales projections that you realistically intend to meet -- the fact is that once you project beyond 9 months or so in Internet land, you simply just don't know.

What does it all mean? I guess I'm just suggesting that we maybe gradually endeavor to try a few things; ideas that may result from our meeting about it now and again over the next few months.

For example, today I had Rich contact T3 (our Internet architect partners) and secure the URL "smarterkids.com". Turns out that that URL is available, and the fee for securing it is very nominal, so we're getting it.

My thinking re that idea is as follows: Yes, the company name is Virtual Knowledge, and that's fine. But imagine doing a massive ad campaign down the road that has the term "smarterkids.com" plastered everywhere. You know, maybe even have full page ads that run for successive months in all sorts of publications that are simply an entirely black page with "smarterkids.com" in a 16-point white font. Pretty soon, you'd have some people with kids that are just dying of curiosity to just type that into their browser some evening. Because as we have learned, the toughest challenge is to somehow get people to your site. Then you've got to make the compelling pitch, of course, but that's a separate issue.

Just as Sylvan uses "educate.com" for their URL, "smarterkids.com" is more targeted, arguably more memorable, actually means something, and presumably, it's something that every parent wants. And it's something that we can deliver for a fee.


Toy Traffic

In December 1999, when toy buyers did most of their shopping for the year, SmarterKids.com fared decently against some hefty competition, attracting almost 2 million unique visitors. Media Metrix Inc., which measures Web-site traffic, defines unique visitors as "the estimated number of total users who visited the Web site once in the given month."

Unique Visitors (in 000s)
Web site 12/99 3/00
ETOYS.COM 5,549 1,475
TOYSRUS.COM 4,420 1,235
SMARTERKIDS.COM 1,976 780
KBKIDS.COM 2,636 590
TOYTIME.COM 1,467 -- *
TOYSMART.COM 1,556 -- *

*Insufficient sample size.
Source: Media Metrix Inc.


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