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The Bootstrapper

How do you compete with Amazon? By building a business the old-fashioned way

Company: DVD Empire, in Warrendale, Pa.
What it does: Sells DVDs and related products online
Number of employees: 42
Conventional wisdom: You need to give your business away in order to compete in the big leagues.
Unconventional wisdom: It is possible to bootstrap your way to dot-com success.
Revenue growth: From $250,000 in 1997 to $16 million in 2000
Profit profile: Profitable since day one
Capital: Start-up investment, $6,000; total capital raised to date, $6,000

There was a time not too long ago when people thought they could sell anything over the Web: furniture, gardening equipment, dog food, you name it. And, who knows, someday there just might be an online market for 50-pound bags of puppy chow and ceramic lawn gnomes.

But if the past year has taught us anything, it's that E-commerce isn't as simple as throwing up a Web site and waiting for the inevitable flood of orders to pour in. Jeff Rix found that out when he started working for his father's safety-equipment company, in 1994. Having caught the Internet bug while attending Bowling Green State University, Rix emerged eager to get Pro-Am Safety Inc. onto the Web.

But after two years of trying, Rix found a less-than-enthusiastic online audience for the gas masks and fire extinguishers he was attempting to sell. In July 1997 a cyber-discouraged Harry Rix moved his son from Web development to outside sales, a transfer that left the younger Rix nonplussed. "He was grooming me to take over," says Rix, referring to his father's $11-million company. "I could have been set for life."

Instead, Rix took advantage of a chance discussion he had with his key programmer at Pro-Am, John-Michael D'Arcangelo. D'Arcangelo had recently purchased a DVD player -- then a still nascent technology -- and found a meager title selection at local stores. When D'Arcangelo visited www.DVDExpress.com (now Express.com), he deemed the site's technology inferior to the E-commerce setup he had put in place for Pro-Am.

At the time, only about 200 DVD titles were in circulation, but Rix and D'Arcangelo were betting that the technology would eventually replace VHS as definitively as CDs had replaced LPs. Plus, to their minds, DVDs were the perfect product to sell online: they were compact and uniform and therefore easy to store and ship. And the DVD demographic -- then mostly technically savvy, affluent males -- was the perfect candidate for Web sales.

So in August 1997, using the technology they had developed at Pro-Am Safety and personal funds totaling $6,000, Rix and D'Arcangelo started DVD Empire as a side project. After taking in $250,000 in their first four months, they began to realize that their "hobby" was consuming more and more of their work time. So they quit their jobs at Pro-Am and moved to their own facility in February 1998.

DVD Empire's bootstrapped beginnings came from necessity but also from the urging of Harry Rix, a former Marine, who put up $2,000 of his own money for seed capital. "Harry runs his business very conservatively," says Erik Ross, another former Pro-Am employee who joined DVD Empire as director of operations in June 1999. "Harry's got a strong grasp of technology but also the hard-nosed business sense of someone who's been through the sales ranks. That's really given us perspective in a get-big-fast Internet world."

One especially important page the cofounders took from the elder Rix's book was to keep everything in-house, from developing their own Web site and fulfillment database to setting up their own warehouse and shipping systems. Outsourcing didn't make sense. "Depending on the relationship we have with the studio, we make about a 15% margin on each DVD we sell, and that's really squeezing it," Ross adds.

Using a third party for fulfillment, for example, would cut that margin down another 5 to 7 points. "Now you're down to less than 10%," says Ross, "and when you factor in the number of orders screwed up and the people you'd have to employ to deal with them, you're looking at 2% to 3%. And unless we got a ton of venture capital, we'd never get the volume to make 2% to 3% work." Of course, the downside of keeping everything in-house is that inventory ties up cash, to the tune of $1 million in DVD Empire's case, although Ross claims that the company turns that inventory an average of six to eight times a year.

From the beginning, Rix and Ross followed a strategy that was wildly different from that of their competitors, many of whom took the venture-based, free-spending, low-margin, high-volume route. "Why should we spend $40 million on branding when there are only 10 million people with DVD players anyway?" says Rix. Adds Ross: "We decided that rather than spending on marketing, we'd put it all into the infrastructure to support the sales we were getting. We figured if we were growing any faster, we'd probably go out of business."

The test of that philosophy came soon and hard. The company ran into difficult times around the beginning of 2000, when its competitors -- including Amazon.com, Reel.com, Buy.com, Express.com, and 800.com -- engaged in an aggressive price war. "We noticed our growth rate started to slow," says Ross. "We were used to 50% to 75% growth every month, and it went down to 25% to 30%." Without outside funding, DVD Empire couldn't cut its prices and survive.

"We started second-guessing ourselves," says Ross. Should they seek outside investment money? Spend more on marketing? "The worst part was knowing that there were life preservers all over the place," he says, referring to the then-plentiful venture capital. "But we knew we didn't want to go that way."

Their quandary ended -- at least temporarily -- when high-profile competitor Reel.com closed its doors, causing the rest of the industry to pull back from its price war. According to Chris Chiarella, an editor at Home Theater Magazine, Reel.com was simply one of the most notorious examples of the industry's price-cutting absurdity. "The loss-leader concept has to be the exception, not your day-to-day way of doing business," he says.

By contrast, Chiarella says, DVD Empire's strength was combining consistent, realistic pricing with timely shipping and good customer service. The infrastructure investment that the cofounders had committed themselves to making seems to have paid off. "Now we're three E-Christmases into it, and everyone is spending money on infrastructure and customer service," says Ross. "Well, we've already done that spending."

Now they're ready to expand by adding products that are of interest to their existing customer base, like games for Sony's new DVD-based Playstation 2. Still, the cofounders have no current plans to court outside funding. "We never say never," says Ross, "but for the next five years we don't foresee any scenario where we would."

DVD Empire's diversification strategy has led the company in some unexpected directions. DVDs have a number of features unique to the medium, including director-commentary and foreign-language tracks, alternate takes, deleted scenes, and a multiangle feature, which allows viewers to change the direction from which they're watching the action. The first segment of the video trade to take advantage of the multiangle feature was the adult-film industry. Curious customers began asking DVD Empire to carry certain multiangle-enabled titles, and the adult segment has since swelled to comprise 20% to 30% of the company's business.

Did Rix and Ross have any hesitation about carrying items that some customers might find offensive? "If our customers want it, we're willing to sell it," says Rix, although he adds that they took great care in segregating the adult titles onto a separate site. "Our tech-head following had no problem with it, and the price point is higher, so we make more money on it." Does such a higher-margin product line have a deceptively positive impact on the company's enviably positive bottom line? Rix admits that 60% of the company's total net profits come from its adult division. "But we'd still be profitable without the adult merchandise," insists Ross. "The biggest downside is it's harder to hire for that part of the business."