eToys Strikes Out

When eToys went public in 1999, its market value reached $7.7 billion. The company was backed by Intel, Sequoia Capital, and Idealab. What a great beginning! Its Web site included a sophisticated search engine that let parents look for toys appropriate for a child of a particular age, or for toys of a particular brand or theme. It created “wish lists” that let children choose gifts and email their lists to family members. Once the firm’s Web site was out there for everyone to see, however, competitors like Amazon and Wal-Mart were in a position to copy the firm’s ideas and beat its prices, and they did. Soon competitors began to sprout up everywhere: KBKids, Smarterkids, Toysmart, ZanyBrainy, NuttyPutty, JC Penney, Target, and FAO Schwarz joined Amazon and Wal-Mart in selling toys on the Web. Many of them spent lavishly on advertising.

eToys assumed that loyal customers would come back once they had been acquired. On the Web, customers soon learn that it is very easy to shop around—and they do. Proximity works with bricks-and-mortar stores. You can drive to them, park in their parking lots, and go inside. The Web is very different. It is very hard to create and maintain customer loyalty on the Web. eToys could not count on its customers coming back, and they didn’t.

Even given the competition, eToys assumed that the growth of the Web would provide enough buyers for everyone. The company planned to double its sales every year. That was achievable only when sales were very small. In fact, competitors multiplied and national sales grew only modestly, and so eToys’ forecasts were worthless.

Perhaps eToys’ biggest mistake was spending too much to create a distribution network. The company’s investment in property and equipment amounted to more than $120 million. This meant that property investment equaled about 95 percent of the year’s revenue. A similar figure for retailers was 20 percent, and one for catalogers was 13 percent. Faced with these investments, eToys could not make a profit without a massive sales increase. That increase did not occur.