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."
Not to mention the fact that employees need to be extra careful about storing salacious materials. When this writer visited the company's new facilities just north of Pittsburgh, an open box in a well-traveled hallway revealed a provocative promotional flyer for some of the product -- much to the embarrassment of staffers who had intended to present a more family-friendly face. Still, Home Theater Magazine's Chiarella asserts that selling prurient material doesn't have to be a black mark for the company. "As long as they police it fastidiously and make sure kids aren't getting it, then people really have no right to complain," he says.
Of far greater concern to Rix and Ross is their remaining competition, some of it ailing (Express.com and Buy .com) and some seemingly stronger than ever (Amazon.com). Ross sees no reason why the DVD market can't support more than one E-tailer. "Everybody seems to be forecasting against capitalism, saying it can only be a monopoly," he says. "But I don't really think you can squash every competitor, and I don't think you have to."
Christopher Caggiano is executive editor of Inc. Technology.
Ones to Watch
The Inc. Technology staff considered quite a few companies for our "realbusiness.com" package. Most of the candidates ended up on the cutting-room floor. Some hadn't been around long enough; others had great concepts that were yet to be proven. But a few companies (all founded in 1999) are starting with the right foundations in place. Here are some that we'll be keeping an eye on.
eKnitting.com, Berkeley, Calif.
What it does: Sells yarn and knitting supplies to consumers.
Founder: First-time entrepreneur Sarah Veit, a 28-year-old Stanford M.B.A. and inveterate knitter.
How it makes money: Veit sells only the good stuff, from high-quality wools and cottons to more exotic silks and alpacas. "I have no desire to go head-to-head with Wal-Mart," she says.
What makes it "real": A targeted niche market and tightly controlled finances. Veit conserved her precious marketing resources by attending the few trade shows that knitters flock to and advertising in the magazines she knew they read.
Investment: A $150,000 SBA loan plus $350,000 in personal, family, and angel funding.
Revenues: Projecting $500,000 for the fiscal year ending June 30, 2001.
Profitability ETA: Profitable as of December 2000.
Number of employees: 3.
Why the jury's still out: The company sells high-end products in a targeted niche. But it's simply too soon to tell whether eKnitting has its market sewn up.
Tutor.com, New York City
What it does: Helps students find online or in-person tutoring in 400 subjects.
Founder: CEO George Cigale, previously vice-president of the Princeton Review.
How it makes money: Independent tutors charge students fees averaging $30 an hour; the company takes 10% of each transaction plus $1.
What makes it "real": The company struck partnerships with brands like the Princeton Review and Scholastic Inc. to attract students and tutors. By early 2001, with no advertising, Tutor.com had registered 25,000 tutors and averaged 20,000 tutoring transactions a month. The company plans to expand its reach by offering real-time homework help, services for adult learners, and licensing deals for school districts.
Investment: $16 million in venture capital in 1999 and 2000; projecting another $15-million round late in 2001.
Revenues: Less than $100,000 for 2000; shooting for $5 million in 2001 as new partnerships and expanded services take effect.
Profitability ETA: Fourth quarter of 2001.
Number of employees: 30.
Why the jury's still out: No serious revenues for 2000.
MrSwap.com, San Francisco
What it does: Gives consumers a forum for swapping used CDs, DVDs, and video games.
Founders: Patrick Ford, a marketing veteran who worked at Microsoft and several Internet companies; Robert Kohler, a lawyer and veteran company founder.
How it makes money: By charging swap recipients a "shipping and handling" fee for each transaction ($2.99 per CD, $4.99 per DVD, and so forth). The company also sells new merchandise for swappers who can't find the used items they're looking for.
What makes it "real": Among numerous Web-based swapping sites, MrSwap has a model that works. Its customers earn "SwapPoints" for the items they list, which they in turn use to "buy" the items they desire. Ford and Kohler have outsourced almost everything, including the fulfillment of the shipping and postage materials customers use to send items to one another.
Investment: $750,000 in seed financing; $3.4 million in venture capital.
Revenues: Under $1 million in 2000.
Profitability ETA: November 2001.
Number of employees: 15.
Why the jury's still out: The swap concept has a catch-22: In order for the swapping mechanism to work, the company has to attract a critical mass of users. But to attract those users, it needs to have sufficient swappable merchandise.
With no fanfare and little venture money, the companies profiled here are delivering real stuff to paying customers and making a buck in the process. There may not be any "new rules," but there are rules, and we suspect every one of them will look familiar.
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