TCS Daily


Profit-from-doom Overstock boss prophesizes e-tailing's quick demise

By James K. Glassman - January 15, 2001 12:00 AM

"All the pure e-tailers, essentially, will be gone," Patrick Byrne, CEO of inventory liquidator Overstock.com, tells TechCentralStation Host James Glassman. He predicts only eBay, Amazon, uBid, and his own company will be around after September; calls venture capitalists "crybabies," and compares Microsoft prosecutors to "Chihuahuas that nip at the heels" of great creators.

Jim Glassman: Your company, Overstock.com, reported being the first Internet e-tailer to make a profit. What makes your business model better than that of other e-tailers?

Patrick Byrne: Well, first I should point out, though we did make a profit in November, we had a loss in December. Yet we should be profitable from January on out. So it is not like we are gushing with cash yet, but we did get to break even, or even a little bit better.

Our business model is not like other e-tailers. I think that in a year or two, people, if they haven`t already, will really smack their heads and say, why did we ever think the Internet was made for retail? You know, the Internet really has no distribution cost advantage over retailers. So e-tailers really can`t give any discounts below what retail can give. Any discounts e-tailers do give are really just subsidies from capitalists to consumers.

Glassman: And Overstock?

Byrne: What is different about Overstock is that we buy excess inventory and liquidation inventory, from bankruptcies and so on, and bring it directly to the consumer through the Internet. And that is not really a business you could do efficiently in the offline world. The way the liquidation market works now, there are several layers of distribution between the pool of excess inventory or bankruptcies and the consumer. The Internet cuts through those several layers. So, in short, I view our business as trading on information diseconomies in the offline world, where most e-tailers are really just trying to compete based on lower distribution costs, when there really are none.

Glassman: Don`t e-tailers, though, have, at least potentially, lower capital cost in the sense that they don`t have to build stores and pay rent and that sort of thing?

Byrne: Well, yes and no. First of all, even if that were true, that only matters when you get talking about return on capital, and return on capital only becomes a concept when you are profitable and they are not there yet. But, furthermore, it turns out to have been far more expensive to build two things.

First, it is far more expensive to build a good website than people envisioned five or six years ago. People thought you just threw a site up and it was $50,000. In fact, people spend several tens of millions of dollars getting a good site going; that`s too much, and the customer service that goes along with it is quite expensive. When Amazon built their site, it probably cost $25 million to $50 million; Levi spent $30 million on theirs. The day will come, in five years, when excellent prepackaged sites are available for $25,000. But initially, anyway, the point is that although there may not be stores, the cost of the website was very high.

Second, you can add to that the cost of the distribution facilities. One thing that a lot of people on the Internet took for granted was distribution. They had no concept of how difficult running a good distribution warehouse was. They built too many warehouses, and they then they spent too much money on automation. You know, they spent $30 million building a warehouse in some cases. So, it`s not that the capital costs have actually been that much less.

Glassman: Isn`t that a problem for you? You are buying up stock from failed companies. Don`t you have to move it from their warehouse to your warehouse?

Byrne: Yes, we do. And our warehouse in Salt Lake City was built for $2-1/2 million. The question most people - Internet executives -- ask about warehouses is a dumb one like: What`s your warehouse management system, what`s your automation, what`s your technology? That`s the last thing you want to think about. We have a very basic warehouse that is automated in parts, but is quite manual in other parts. And that`s what you need to do liquidation, because we may get 20 pallets of inventory from some failed company, and we have to sort through it, and there is a lot of touch involved. If you try to run a warehouse like Fingerhut -- if you are selling a million identical CDs -- then, yes, you can automate that; you can put robotics in. But, you can`t do that in our kind of business. And it also meant that we built our warehouse for $2-1/2 half million instead of $30 million.

Glassman: You`re the son of the Byrne of GEICO, the insurance company?

Byrne: Yes, only I like to say that he is the father of the Byrne of Overstock.

Glassman: I can understand that. News stories, though, have mentioned that you learned from Warren Buffett, who was your father`s partner, that the key to success is buying a dollar for 30 cents. But one of the problems in doing that is that success breeds imitation. Do you think there will be other Overstock.com-type companies that will pop up since the Internet really does not have high barriers to entry and could drive down your market?

Byrne: Well, it could happen. But, there are actually some unique dynamics to this industry that makes it harder than you would think. For one thing, if somebody is already selling in the inline world, they really can`t get access to excess inventory from manufacturers. A manufacturer doesn`t want to see a bunch of its VCRs, for example, at below wholesale price, in one of their normal retail channels. They don`t want to see them selling on the shelf of a Circuit City next to their current models at half the price. That is called sales channel pollution, and manufacturers avoid that. So, no one can really come in and do this who is already doing inline. For example, Amazon would have a lot of trouble coming in here. Their current suppliers would not supply them liquidation products, for the most part.

Glassman: Now, when you say inline, you mean, someone who is selling it direct - a conventional retailer or e-tailer?

Byrne: Yes, a conventional retailer or e-tailer, those just buying stuff at wholesale and then marking it up and selling it at retail, would have trouble getting brand-conscious manufacturers to sell them their Fendi handbags or their Maytag washers if they bought at liquidation, as well.

Also, we have about 5 million unique visitors now, according to Jupiter Media Metrics. We have about a quarter of the traffic of Amazon at about a hundredth of what they spend on marketing. That would be pretty hard to duplicate, cheaply, for anybody. And, in the same sense that if you went to a venture capitalist and said, "Hey, I`m going to open an online bookstore," no venture capitalists would give you money. They`d say, "Hey, Amazon is > already there." So, Overstock has some unique dynamics.

But, I know, the truth is, as Buffett often says, a businessman should think every day that there is a moat around his business and his competitors are out there trying to squeeze the moat down. He`s got to think, every day, "How can I broaden my moat?" And, so, we try not to rest on our laurels, and we always are thinking about how to broaden the moat.

Glassman: Overstock.com is not a public company. Do you have plans to take it public?

Byrne: Not really. In the last couple of months, we are getting crawled over by investment bankers who want to talk about taking us public this year. We are OK without going public. One of the areas where I think the Internet hyperbole has been extensive is the whole focus on the IPO (initial public offering). The IPO was not a finish line.

Buffett teaches that you run a business as if you are going to own it forever. It is grounds for dismissal in our company to talk about an IPO. We run the company as if we are going to own it forever. Now, we`ve said from the beginning, the best exit strategy is getting profitable. When people talk about exit strategies, I tune them out. The only reason to take in cash now is to have the dry gunpowder to go after these big failures as they occur.

Glassman: Do you expect a lot of failures in the next six months?

Byrne: Yeah, most everyone will be gone, except for Amazon. And, Amazon, I think, will have to take in some more capital. But with a few exceptions, all the pure e-tailers, essentially, will be gone.

Glassman: It`s been reported that you were predicting that even Amazon.com, which now has about a tenth of the total of Internet retail sales, was going to be out of business by June?

Byrne: What I actually told the guy was June to September, unless they change their business model. I`ve actually gone back and forth on Amazon. I`ve been quoted in other papers as saying Amazon is going to be the only e-tailer that is going to be left standing. I think there is going to be eBay, Amazon, probably uBid, and us. Now, Amazon, if you just look at the financials, you say how are they going to get there. But with everybody else dropping by the wayside, they could end up spanning the whole category outside of liquidation.

Glassman: What about WalMart.com, bricks-and-mortar companies that have set up sites and are selling that way?

Byrne: They`ll be around because the marginal costs for them are so much lower. And I think that they will do well. But all of the pet food ones will all shrivel up. They are not going to get any more money and they are not going to get profitable in time. So, I expect, you know, Buy.com should be gone within a couple of months. Beyond.com also, probably -- I don`t have any inside information -- maybe Egghead as well; I haven`t looked at their numbers in a while. I expect uBid to make it, but they will be the only B2C auction site that does, I think. I think of the jewelry sites, there will be one or two left. Ashford may make it. They just did a good deal with GUILD.com, so they got $11 million more in cash. But there is also Blue Nile, which is really a very good site, and Mondera. I think one or maybe two of those three jewelry sites will make it.

Glassman: Let me ask you about something you said about venture capitalists. You said you have nothing but contempt for most venture capitalists. Why?

Byrne: In general, I think they are crybabies. I got three different term sheets from three different venture capitalist groups a year ago, and all the term sheets are structured in ways -- I`m a private investor by background -- that I would be embarrassed to give somebody. They tell you, "OK, we`ll put $30 million in your business." But then you read the fine print on page 6, and it says, "You guarantee to triple our money; and if you sell the business, we get our $30 million back, another $30 million, and then our pro rata share of what`s left. And if, at any time, we don`t like what you are doing, we can put the stock back on you, and you`ve got to give us our $30 million back with interest. And, if you go under, you owe us the $30 million back yourself." Well, that`s just a crybaby. So, that aspect bothered me.

And, the other aspect is that the vast majority of them -- and I did meet a couple of intelligent ones that I have respect for -- are not interested in understanding what makes the business good. They are interested in: Is this going to be hot in six months, and, can I put some money in now and flip out of it in six months? I want as an investor somebody who understands the business, decides to take a risk, and puts his money in next to mine like an adult. Having seen the industry up close, I would never invest a dollar with VCs.

Glassman: There is a lot of concern about privacy these days, especially after DoubleClick, because of its financial trouble, considered selling its customer list. What privacy policy does your company follow, and do you think the government has a role in policing or setting privacy policies?

Byrne: I`ll take those questions in order. Number one, we have probably the strictest privacy policy. We don`t pass out e-mails. We guarantee the people that the information they give us stays with us. We don`t pass anything along. We do some partnerships with other companies where we take orders for their products and send them the orders. But, when we do that, we redact any e-mail or personal information that we send to the other company other than what they need to fulfill the order and ship the products. They just get a shipping address. So, we are about as conservative as it gets.

As far as public policy, this is my first crack at it, and there is going to be an asterisk on this. But, as a libertarian at heart, I feel like, hey, as long there is a stated policy on the site that the user can read, and the company sticks to that policy, it is a semi-contractual agreement between the user and the company. So a company can have any policy they want as long as they are clear about it and they don`t betray the policy later when times get tough.

However, taking a more general approach to it, I think that the government does have a role, at least, in setting some guidelines as to what is fair, because people aren`t -- at the risk of being paternalistic - the public isn`t going to go in and read those policies carefully and understand them. I think that one thing that is happening, though, is Internet sites are being held to a higher standard than offline companies have been for years.

Glassman: How so?

Byrne: Your credit card information and even aspects of your medical history are sold all the time. But consumer advocates are suddenly acting like "I`m so shocked to hear that this is happening." And the Internet companies, it doesn`t seem to me, are doing anything different than what offline companies have been doing for years. But, maybe that means that offline companies should have been policed a long time ago.

Glassman: Let me ask you a question that has been a big concern of e-commerce companies -- the sales tax issue. How beneficial is it for e-tailers to essentially escape the kinds of sales taxes that local retailers have to pay? And if that situation changes, as it may, how much damage would that do?

Byrne: I think that the government took a wise approach to at least have a sales tax moratorium. This whole thing about a nexus, meaning, that you pay a tax in Kentucky if you have some physical presence or nexus in Kentucky, could be a monstrous headache to really figure it out and act honestly. Honest businessman trying to follow the law will get states coming after them. So, if there is going to be any tax on it, I`d rather see a national 3 percent or 4 percent tax that gets whacked up among the states rather than piecemeal taxes.

Glassman: Wouldn`t that still have an impact on sales?

Byrne: Well, it is worth a few percent. But I don`t think customers, when they shop, are really factoring all the economics. For example, we offer free shipping, but we wonder, every day, are we better off offering free shipping or offering our products cheaper and adding something for shipping? Because when customers compare the price on a product, do they really understand that our product is cheaper at $180 for something that somebody else sells for $170 plus shipping? I`m not sure customers totally factor that in, and I`m not sure that they factor in tax either. So, it is probably not going to make as big a difference as people think. If, overall there were, say, a flat 3 percent or 4 percent tax put across all Internet sales, it probably wouldn`t make that huge of a difference. Internet companies would raise their prices 3 percent or 4 percent, and at the margin that would show up in reduced sales. But, you know, it wouldn`t wipe out the industry.

Glassman: What about another issue that we look at, which is the dissemination of broadband technology. How much of a help to your business would it be to you to have the majority of Americans be able to access your site very, very quickly with broadband?

Byrne: Well, it would help. When I think of broadband I think of speeds like T1 speeds or more. It becomes a worldwide wait for people to go on a 56K modem, especially a site like ours, where we have a lot of pictures and they are slow downloads. I don`t know if we have to get everybody on broadband, but if everybody was on, you know, 128(K) or DSL (digital subscriber line), or something, that would be an advantage.

Glassman: You mentioned you are a libertarian. Do you think other government activities, such as antitrust enforcement and regulators holding up mergers, may have hampered the spread of the Internet?

Byrne: I think the Microsoft case is pretty absurd. I mean, on balance the inflation rate in the last eight years has been about 3 percent or 4 percent lower than it would have been, basically due to Bill Gates. I`m not a big fan of Bill Gates, I don`t know him, I have no personal reasons to say this. And, in fact, I think he has acted pretty ruthlessly in many ways, but the facts of this case are on his side, I think.

It reminds me of the Ayn Rand vision of the world. And I`m not a big fan of Ayn Rand, either. But the Ayn Rand vision is that there are a small number of real creators in the world, and they are surrounded by all these Chihuahuas that nip at their heels. And, you know, when you look at what Bill Gates has contributed to Western civilization and then he`s got these know-nothings in the Clinton administration attacking him, it does drive me crazy. There`s a saying that kind of covers it, that people should lead, follow or get out of the way.

Glassman: That`s a good one. It`s been great talking to you. We`ve gone way over our allotted time. But, thanks, so much, and I`d like to do this again.

Byrne: Feel free to call. I`d love to do this any time.

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